The Moral Hazard of Money Market Fund Madness

Here we go again:

Forget for a moment the IMF, and instead direct your gaze upon the MMF: Money Market Funds. These are a type of mutual fund that is, according to the SEC, required by law to invest in low-risk securities. They pay dividends that are supposed to reflect short-term interest rates. They are not (repeat NOT) federally insured.

Except they were.

Recall that during the credit crisis, these supposedly uninsured, supposedly low risk vehicles for squeezing a few pennies more out of cash fell below their One Dollar ($1) benchmark. When that happened, the Fed and Congress rescued them with a bailout as well.

Why on earth taxpayers were on the hook for an investment 3rd parties made is beyond my comprehension. Investors in equities were not made whole for their losses, that is the chance they took. Investors in bonds were not made whole, unless they were clever enough to lend to banks. Despite the foolishness and bad investment judgment of creditors to Bank of America, Citigroup, Bear Stearns, etc. were made whole.

The idea of systemic risk sure comes in handy from time to time.

And guess what? It appears that we are once again, looking at systemic risk of the banks and money market funds, who once again, made some very ill-advised lending. Only this time, instead of giving money to home buyers who could not possibly ever pay it back, they lent money to Countries, who could not ever pay it back.

Here is Randall Forsyth in this morning’s Barron’s

RETURN-FREE RISK.” That’s just one of the turns of phrase that Jim Grant has tossed off over the years as editor of the invaluable Grant’s Interest Observer and as Barron’s most illustrious alum.

The term could well apply to major money-market funds, which provide yields barely visible to the naked eye but could suffer collateral damage from any potential fallout from a possible default by Greece. Grant was way out ahead of the crowd by pointing out in his latest issue, dated June 17, that the five largest money funds, Fidelity Cash Reserves (FDRXX), Vanguard Reserve Prime (VMRXX), Fidelity Institutional Money Market Market Portfolio (FNSXX), Fidelity Institutional Prime Money Market Portfolio (FIPXX) and BlackRock Liquidity TempFund (TMPXX) held an average of 41% of their assets in European banks’ short-term debt. Fitch Ratings added in a report last week that the top 10 money funds, with assets of $755 billion, had about half their assets in European bank liabilities.

It’s doubtful that any money-fund holder has forgotten the aftermath of the Lehman Brothers bankruptcy in 2008, which caused The Reserve Fund, a pioneer in the field, to “break the buck” — have its net-asset value fall below $1 a share — owing to its holding of Lehman commercial paper. Since the crisis, the Securities and Exchange Commission has mandated money funds hold at least 10% of their assets in paper that can be converted into cash in one day and 30% in paper due in 60 days or less (or redeemable within seven days).

European Central Bank President Jean-Claude Trichet last week declared the financial risk situation was “code red.” That was his characterization of an assessment by Europe’s new risk monitor, the European Systemic Risk Board, that the highly interconnected financial system inside and outside the European Union means debt woes of several countries could spread rapidly if conditions worsen, the Associated Press reported.

Given that, money funds with European exposure and yielding about 0.01% would seem the very embodiment of return-free risk. But it seems the generals have prepared well for the last war, so 2008-style runs aren’t likely.

It appears that once again, bankers have shown themselves to be incapable of assessing risk properly. And why should they? Every time they screw up, most of them get rescued, while a tiny percentage are allowed to ignominiously whither and die.

The lesson these banks have learn is not to be more prudent with their risk taking, but rather, to make sure they are not amongst the smallish group of financiers who are unconnected in DC. The credit crisis taught them that Risk Management is for Suckers, and the real money s in pol;itical lobbying and owning a Congressman or two.

Moral Hazard anyone?


Show Ralph the Money
Barron’s, JUNE 25, 2011¬†

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