Counterparties: Bailouts and money market funds

By Ben Walsh
June 21, 2012

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Shadow banking has at least one component that non-financial types have actually heard of: money market funds. These are supposed to be low-risk investments, with accordingly low yields. MMFs are all about keeping your principal intact – a net asset value (NAV) below $1 is generally a mortal failure.

In the fall of 2008, the Reserve Primary Fund famously broke the buck after it was stuck with massive amounts of Lehman Brothers debt, unleashing any manner of craziness into a market that had been treated by many as a savings account.

In congressional testimony today, SEC Chairman Mary Schapiro said the nearly $2.5 trillion Americans have invested in money market funds are no safer than they were in 2008:

[Money market funds] still remain susceptible today to investor runs with potential systemic impacts on the financial system, as occurred during the financial crisis just four years ago. Unless money market fund regulation is reformed, taxpayers and markets will continue to be at risk that a money market fund can “break the buck” and transform a moderate financial shock into a destabilizing run. In such a scenario, policymakers would again be left with two unacceptable choices: a bailout or a crisis.

More than 300 times since 1970, Schaprio says, fund mangers have injected their own cash to keep NAVs above $1. Recently, they’ve supported their funds through “fee rebates“. That’s a particularly invidious way for funds to describe what is in effect life support and why Shapiro has called funds’ stable NAVs “fiction“. The alternative, floating asset values similar to short-term bond funds, is opposed by the industry. Vanguard said they would do “irreparable damage“. Corporate and municipal borrowers also may face higher costs, according to a recent study.

On the New York Fed’s blog, a group of Fed economists and officials make the case that much more is at stake than simply investor returns and borrowing rates: “MMFs’ vulnerability to runs not only puts their investors at risk, but also poses considerable systemic risk to the U.S. financial system”.

It may be tentative good news, then, that money market outflows hit $28.2 billion this week, the highest level in six months. And longer term, the trend is strongly in favor of insured savings accounts over money market funds. – Ben Walsh

On to today’s links:

Banks
Moody’s downgrades 15 financial institutions – Credit Writedowns

Charts
2,000 years of economic history, charted – Economist
Younger American families lost more than half their net worth between 2007 and 2010 – Economic Policy Institute

Alpha
“We are extremely lonely” – Meet the hedge fund manager who wants to invest in Greece – Bloomberg

Billionaire Whimsy
Larry Ellison just bought a Hawaiian Island – Businessweek

The Singularity
Why software is better at investing than 99% of active investors – Techcrunch

Facebook
Congress declares it’s looking into “substantial problems” in the IPO process – WSJ

New Normal
The US’s for-profit prison industry by the numbers – ProPublica

Must Watch
Syrian satirist: “They broke my hands to stop me drawing Assad” – Guardian

Oxpeckers
BBC’s Mark Thompson is in talks to be the next NYT CEO – Guardian

Long Reads
Why women still can’t have it all – The Atlantic

Crisis Retro
Banks have complex structured products that they’d love to sell to wealthy Asian clients – WSJ

It’s Academic
Famous economic theory may be backed up by, you know, what actually happens in the real world – MIT

Boondoggles
Why did the environmental movement send 40,000 people to a failed summit in Rio? – Foreign Policy

EU Mess
Greece is now being forced to sell a famous state-owned resort – Bloomberg

The Fed
The Fed has an inflation ceiling – The Atlantic

China
China’s factories are in their eighth month of contraction – Reuters

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