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US Treasury listen to the Banks re Money Funds Wednesday, October 01, 2008

Image via WikipediaWhen the scheme to underwrite money market funds was mooted by the US Treasury a few weeks ago with the aim of dissuading investors from making panic withdrawals, I commented here how the banks were understandably annoyed since it put them at a considerable competitive disadvantage.

The details of the scheme which finally aired on Monday had addressed these concerns in a number of ways

temporary scheme only lasting 3 months, albeit that will undoutedly be extended if current circumstances prevail
only covers investments made up to 19 September i.e. investors who fled/flee to "safety" after this date are not protected
Sliding scale fee charged to a fund based on how far below the "buck" the fund is valued at, with lowest rate being 1 basis point [0.01%]

The scheme does provide unlimited protection, unlike for bank deposits which is capped at $100k. It also covers all investors including foreign and institutional ones.

The Treasury payouts will be triggered if a participating fund sees its net asset value fall below $0.995 a share but the fund must be liquidated within 30 days. Investors will receive their capital in full.

It is almost certain that every fund will seek to join the scheme - not because they have to or have problems, but because they need to preserve investor confidence and will not want to cause investors concern by not joining.

Labels: Money fund, money funds, Money market

posted by John Wilson @ 8:31 AM Permanent Link ,

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US Cavalry rides to the rescue of Money Market funds Saturday, September 20, 2008

Image via WikipediaTiming is everything - no sooner had I written about the fallacy surrounding money market funds breaking the buck and the need for regulators to either require fund manager to set aside capital to cover their implicit guarantees or else increase the prominence given to risk warnings, than the US Treasury Secretary, Hank Paulson steps in to underwrite such funds with Government money.

According to Reuters

The Treasury said it would back money market funds whose asset values fall below $1 a share. Separately, the Fed said it would lend money to banks to finance purchases of certain assets from money market funds.
Set to last for at least a year, it is understood that the guarantee is unlimited, transforming US money market funds into a far safer haven than bank deposits, which is sure to delight the banks [NOT!]. Significantly, might this have the unintended consequence of starting a switch of funds out of bank deposits to this new safe haven for anyone with funds exceeding the existing FDIC limits of $100,000 per depositor per bank, especially since money funds typically pay higher rates than bank deposits? Act in haste, repent in leisure?

The Treasury clearly acted to stem a panic and sudden exodus from such funds, current estimated at $3.5trillion, which would have created further havoc in markets. According to reports citing the Investment Company Institute, money-market fund investors withdrew a record $169 billion during the seven-day period that ended Wednesday. This was causing funds to hoard cash and buy Treasury Bills, which drove their yields down to virtually zero. In shunning the commercial paper they typically buy, yields on these assets shot up to 8% and according to the Wall Street Journal, even firms like IBM were paying 6% for money.

Interestingly it is suggested that a fee is going to be levied for this guarantee, without clarifying from whom this is to be collected - fund managers or investors? Likewise, it is unclear whether any investment constraints will accompany the insurance but this would seem reasonable to assume since otherwise reckless funds might invest in excessively risky assets to increase returns, knowing such "bets" were underwritten.

Prior to the announcement, the LA Times reported that
Legg Mason Inc. said it would make $630 million available to its funds to guard against losses, taking a hit against quarterly earnings. The Baltimore-based asset manager had already injected $2.2 billion into seven funds since November to cover potential losses on debt issued by so-called structured investment vehicles.

source Wall Street Journal

Labels: Money fund, money funds, Money market

posted by John Wilson @ 8:39 AM Permanent Link ,

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Money Funds - the mythical damn weakens Friday, September 19, 2008

I've written a number of times over the last year about money market funds [here, here, and here] and the myth surrounding "breaking the buck" i.e. the notion that they always return the capital invested and hence are safe. On a number of occasions during the last 12 months, Managers of money funds have been required to financially support them in order to preserve this fallacy i.e. directly top-up funds to maintain investors capital.

Money market funds invest in short-term money market instruments such as Govt Treasury Bills, Certificates of Deposit, and Repos. Such short-term horizons should minimise the likelihood of capital losses arising but cannot eliminate it and any losses directly impact the value of the fund.

As an industry, Money Market Fund Managers are very aware that if confidence in these funds were to be damaged and the illusion of safety to be impaired, the impact would manifest itself in huge withdrawals from a sector with trillions under management.

In 2008, the top ten Managers by funds under management were:

Fidelity $425.6bn
JP Morgan $267.9bn
Blackrock $259.8bn
Federated $231.1bn
Dreyfus $199bn
Schwab $194.4bn
Vanguard $191.4bn
Goldman Sachs $183.5bn
Columbia $146.8bn
Morgan Stanley $112.6bn

source FT.com

However, the fallacy was exposed this week when Reserve Primary's Money Market Fund was forced to announce that it had "broken the buck" - the fund was priced at 97cent following losses on Lehman short term debt. This is the first fund to actually price a fund at below $1 in 14 years, all other losses having been funded by the managers.

As I stated in past posts, most fund managers aren't capitalised sufficiently to provide such guarantees other than for small losses. It was for this reason that BNY Mellon and State Street both saw sharp falls in their share price, amidst concerns about potential money fund losses, with the former having admitted capital losses on one of its institutional money funds but confirming it would be supporting their net asset values.

At the same time, Putnam Investment decided to close it's money fund and return $12bn of funds to the investors. It did so not because of losses experienced, but because of the potential for losses especially after a period of heavy redemptions, when some assets may not have realised their value due to the need to sell them quickly to fund the said redemptions.

Given clear examples of implicit support by Managers, you would expect the regulator to either require these off-balance vehicles to be brought on balances or ensure risk warnings are given plenty of airing. Fund managers want neither of these, but unless something is done soon we may face a "mis-selling" scandal when a large fund encounters losses too great to be compensated by its' manager. Despite this, I doubt regulators will want to introduce any measures that could affect confidence in fund managers or the funds at present.