Commentaries

from Rolfe Winkler:

Morning Links 1-27

Note: Apologies for no links yesterday. Busy day writing columns!

SEC to vote on new money fund rules (Johnson, WSJ) Unfortunately, the SEC won't do away with $1 NAVs, price fluctuations will be published on a 60 day lag. So investors will continue to treat money funds as cash equivalents, even though they aren't, and the systemic risk they pose won't really go away.

Fed weighs interest on reserves as new benchmark (Lanman, Bloomberg) This will be a key interest rate to watch whether or not the Fed makes it the benchmark. The expansion of the Fed's balance sheet over the past year+ has stuffed banks full of excess reserves, reserves that banks will lend out if the economy -- and loan demand -- picks up. The Fed needs to keep those excess reserves sequestered in order to prevent inflation. To do so, it may have to pay higher rates. For a fuller explanation see this previous column.

Failed Senate vote on budget commission shows difficulty in cutting deficits (Faler, Bloomberg) So much for a fiscal commission based on the base-closing commission...

After three months, only 35 subscriptions to Newsday's website (Koblin, NY Observer) Print subscribers get free online access. But this is still not a good showing for selling online only subscriptions. The NYT needn't worry that it's pick up will be this small when they put up their pay wall. I, for one, will pay for their content, as I pay for WSJ. I 'd subscribe to FT too if their website wasn't so slow...

Top English central banker supports splitting banks (Thomas, NYT) This should come as no surprise. A speech by Mr. King in October laid out his support for steps similar to those Obama just released.

Roubini: Greece is bankrupt (Khan, CNBC) Thank you, Captain Obvious. ;)

from Rolfe Winkler:

Geithner: Some rescue programs will end, others won’t

Tim Geithner testified before the Congressional Oversight Panel for TARP this afternoon. A few interesting comments with respect to Treasury's bailout initiatives:

On PPIP (Public Private Investor Program):

The Treasury will continue ... its plans to buy small-business loans and to remove toxic assets from bank balance sheets through the Public-Private Investment Program, a Treasury official told reporters earlier today on condition of anonymity. The first PPIP funds are expected to begin operating later this month or in October, the official said.

This is bad news. PPIP was a terrible idea to begin with. It provides cheap, non-recourse government financing to encourage investors to buy toxic assets from the banks. This takes banks off the hook and puts taxpayers on it.

Other, unused programs will be allowed to expire, including a program guaranteeing money-market mutual funds and the Capital Assistance Program, which was established earlier this year to provide extra money to banks that needed it and couldn’t access private markets.

"Unused" doesn't seem a fair modifier to me. No, there weren't any money market funds that broke the buck and required a taxpayer bailout, but the industry as a whole has benefited tremendously from the Treasury guarantee they've been able to market to investors.

On TARP:

Money market funds and California RANs

There’s one group of investors that aren’t likely to jump at the chance to buy California’s short-term RAN notes when they go on sale later this week: money market funds.

The notes are expected to carry a second tier rating of MIG 2, a notch below the top rating of MIG 1. That’s problematic for money market fund managers who are staring at the SEC’s proposal to limit money fund investments to short-term debt rated only the very best.

Higher Credit Quality: The proposal would limit money market funds to investing only in the highest quality securities — that is, not “Second Tier” securities. Currently, most funds are permitted to invest up to 5% of their assets in “Second Tier” securities.

5% may not seem like a lot, but when money market funds hold roughly $3.8 trillion in assets, it’s not chump change.

To be money market eligible, California would have to secure some kind of bank back stop. But given the still uncertain outlook for the state, it could be difficult to get a bank to guarantee up to $10.5 billion.  JP Morgan loaned the state $1.5 billion so it could end the IOU program early, which the state will pay back with RAN proceeds. But I’m not sure if JP Morgan or any other bank is going to want to be on the hook for $10.5 billion into next year when California’s future revenues are still so uncertain.

from Rolfe Winkler:

Deutsche breaks the buck

A week ago, I wrote about Paul Volcker's call for money market funds to stop using the $1 NAV. In conditioning investors to believe their principal isn't at risk, money funds can be very dangerous, systemically-speaking. When the buck gets broken ...

1. Investors panic: Their money was supposed to be safe.
2. Since the fund has promised to redeem them at $1 per share, instead of at the day's market value, investors have an incentive to get out as quickly as possible. The quicker they redeem, the more likely they are to get all their money back. It's a bank run.

According to a report in today's WSJ, Deutsche Bank is now launching a money fund with a floating share price:

Unlike conventional money-market funds, the proposed DWS Variable NAV Money Fund will allow its net asset value, or NAV, to fluctuate rather than trying to maintain a stable $1 share price. The fund will require a $1 million minimum investment, a regulatory filing said.

The idea of floating money-market NAVs has been hotly debated. In the wake of the Reserve Management Co.'s Reserve Primary Fund falling below $1 last fall, regulators have searched for ways to make the $3.6 trillion money-fund industry more stable ....

Many in the fund industry are opposed to the idea of floating money-market NAVs, saying the move would essentially destroy the money-fund business.

They think it could destroy the business because if the NAV floats, then it's not possible to market the funds as "cash equivalents." Suddenly they're just another bond fund, albeit an ultra-short/relatively safe one.

If you want the nitty gritty on why the $1 NAV is so crucial to the marketing of money funds, take a look at the March report of the Investment Company Institute's working group on money funds, in particular section 8, pages 107-111. In a nutshell, allowing money funds to use amortized cost accounting, i.e. NOT marking their assets to market, provides for many tax, operational, legal and liquidity conveniences that an ultra-short bond fund doesn't.*

More money market funds should follow this example. Hopefully the Obama administration pushes them in that direction when it releases its report on money market fund reforms September 15th.

Reforming money markets – it’s about time

The New York Times has a nice piece on SEC musings on money market reform given the run on this $3.7 trillion market after Lehman Brothers’ spectacular failure. It’s about time considering how vulnerable these funds became to market excesses during the boom. But it doesn’t look like the proposed reforms go far enough considering that most people park their money there so they can get it out quickly if needed.

You’ll remember that that Reserve Primary fund, was slammed with withdrawals in September, causing it to “break the buck” when the value of a share fell below $1 – a huge no-no in the money market world.

The SEC’s answer is to force funds to keep a ready amount of cash or investments like U.S. Treasuries that can be readily converted into cash within 24 hours so they don’t freeze up if and when investors rush to pull out their money.

From the NYT:

Among the specific proposals, retail funds would be required to keep at least 5 percent of their assets in cash, Treasury securities or assets that could be converted into cash within one day, while at least 15 percent of assets would have to be readily convertible to cash within one week. Institutional money market funds would be held to a stricter standard.

Of course there are downsides.

While these moves would make the funds safer and improve their ability to handle withdrawals, it would inevitably result in lower yields for investors.