Money markets are the new interbank markets

By Felix Salmon
June 27, 2012

Last week, I bemoaned the end of the interbank market — a market which looks like it might never come back, and which certainly hasn’t been done any favors by today’s news that Barclays is paying $453 million to settle allegations that it manipulated the key interbank interest rate.

Now Steven Davidoff has an interesting take on a broader phenomenon — that of money-market funds. There are many big differences between commercial paper, on the one hand, and interbank lending, on the other — but those differences are narrowing, and the commercial paper market has to a first approximation become an entirely financial market, a place for banks and shadow banks to do their short-term borrowing while the interbank market remains closed.

According to David S. Scharfstein of Harvard Business School, who also testified last week, of the 50 largest issuers of debt to money market funds today, only two are nonfinancial firms; the rest are banks and other financial companies, many of them foreign.

Once upon a time, before the financial crisis, money-market funds were a mechanism whereby individual investors could make safe, short-term loans to big corporates, disintermediating the banks. But all that has changed now. For one thing, says Davidoff, “about two-thirds of money market users are sophisticated finance investors”. For another, the corporates have evaporated away, to be replaced by financials. In the corporate world, it seems, the price mechanism isn’t working any more: either you’re a big and safe corporate and don’t want to run the refinancing risk of money-market funds suddenly drying up, or else you’re small enough and risky enough that the money market funds don’t want to lend to you at any price. At this point, money-market funds control just $2.6 trillion, down a whopping $1.7 trillion from the $4.3 trillion they had before the crisis.

This is very similar to what is quite familiar in the interbank market: instead of a market where supply and demand are matched at a certain price, we have a market which simply isn’t clearing — where no deals get done at all. The corporates are out entirely, as are a huge swathe of the retail investors; what’s left is financial investors lending to financial borrowers, taking advantage of the fact that the shadow banking system doesn’t have the same kind of capital adequacy rules that the real banking system has.

All the more reason, then, to regulate these animals with a heavy hand. The industry is screaming blue murder, but the louder they shout, the less compelling they sound. As Davidoff says, the money-market industry’s argument basically comes down to saying that it’s important to make retail investors believe their money is secure, even when it isn’t. And that’s not the kind of argument that any regulator should have any time for.


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Once upon a time, before the financial crisis, money-market funds were a mechanism whereby individual investors could make safe, short-term loans to big corporates, disintermediating the banks. But all that has changed now. … the corporates have evaporated away, to be replaced by financials.

The implication seems to be that before the crisis there was a larger share of nonfinancial commercial paper issuers. This is not true.

Financial businesses have *always* issued the majority of commercial paper. And since the crisis, the financial share has fallen, not risen. In fact, the current share of commercial paper outstanding issued by financials — 53 percent — is the lowest it has been since the data begins in 1945.

Posted by JW_Mason | Report as abusive

(first paragraph is a quote from Felix.)

Posted by JW_Mason | Report as abusive

JW-Mason – are you referring to the financial share of the CP market as a whole, or the financial share of the holdings of money-market funds, which Felix is alluding to?

Posted by Suncoke | Report as abusive

The market as a whole. Is there reason to think money market fund holdings are systematically different?

Posted by JW_Mason | Report as abusive

(also, 53 percent is wrong — sorry! — that’s the share of domestic financial issuers. The overall shift from financial to nonfinancial borrowers is not as dramatic but still qualitatively the opposite of what the OP suggests.)

Posted by JW_Mason | Report as abusive

I’ve written a response to this post. It’s at ml.

Posted by JW_Mason | Report as abusive

The shrinking of money market funds is a great thing. They were always deceptive for borrower and lender. Circa 2007 GE was a top 10 global company by market cap. Moreover, they were a diversified conglomerate with diverse businesses.

What better company to finance a third of its longterm assets with overnight money.

GE was probably the biggest and best example but their was, is, and will continue to be a 10 to 1 global imbalance between assets people want 100% safe and on call at a moments notice and approperate counterparties on the other side of the trade.

The size and scope of JPM’s cheif investment office is proof positve that even the largest and best run banks in the world can’t deploy mountians of hot money deposits safely.

Posted by y2kurtus | Report as abusive

@ y2kurtus: The shrinking of money market funds is a great thing.”

David Merkel’s second opinion, with some excellent points: me-money-market-funds/

Posted by crocodilechuck | Report as abusive

I’ll be the first to admit that being on the wrong side of David Merkel is generally a bad place to be.

I’ll also admit that as an FDIC regulated banker I’m biased towards banks being the keepers of safe liquid assets.

The FDIC has never needed a dime of taxpayer money to meet their obligations. It is an entirely industry funded safety mechanism. It absolutly benifits from the full faith and credit of the treasury backing it up… but it has never called upon that line.

Money market funds froze in the crisis… it was only an implicit emergency guarentee that kept them from failing in mass. Yes the same was and is true of banks… but again, banks paid for it through good times and in bad via their FDIC premiums.

Focus for a minute on Merkel’s accurate observation that money funds have a much smaller asset/libility mismatch. He argues that’s a good thing… I’ll respond that the most imporntant assets society requires (from the tractors that plant our crops to the trucks that transport them to the plants that transform corn into cornflakes)… those assets can’t be funded with short term paper.

As we watch the money market industy shrink remember that it is shrinking from both ends. Consumers have little use for an asset which currently delivers risk without return. Companies have learned that cheap funding is little comfort if it can be withdrawn in a moments notice… espically when they can borrow for 10 years at 2%.

Posted by y2kurtus | Report as abusive

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