This page has been archived and commenting is disabled.
The Euro as Neutron Initiator?
By Marla Singer and Geoffrey Batt
In September of 2008 the Reserve Primary Fund, loaded with exposure to Lehman Brothers debt, faced massive withdrawals and promptly "broke the buck." (Slipped below $1.00/share NAV). The result was a cascade of credit crunches for major corporations dependent on commercial paper for not just their near term financing, but their day to day operations. Firms like Honeywell, General Electric, 3M, Boeing and WalMart were gripped in what might even be called a destructive co-dependent relationship with the short term cash available in the commercial paper market. Particularly in an environment of low interest rates, money market funds desperate for yield are ravenous lenders to these large cap firms that divert their cash elsewhere and use the commercial paper market to make up the difference. The constant "roll risk" means that any seizing up of the commercial paper market could deliver sudden and unexpected defaults by the country's largest and most respected firms.
In May [2008], about $530 million of the Lehman debt in the Reserve Primary fund was commercial paper. Another $250 million was in medium-term notes. The fund also had $150 million in medium-term notes tied to AIG and $100 million in AIG-related floating-rate notes.
[...]
The Lehman debt, whose face value was $785 million, had to be written down to zero for the flagship fund of New York's Reserve Management Corp. That pushed the fund's per-share price down to $0.97, a bracing signal to investors and a jolt to money-market investors world-wide.
The resulting, panicked cash exodus from money market funds meant many firms couldn't roll their debt over.1
That, however, is only half the story. Most large money market funds also make extensive use of repurchase agreements, effectively short term loans made by the money market fund, generally to financial institutions and collateralized by securities of one kind or another. Since repos are generally subject to daily mark-to-market margin requirements, the deterioration of collateral can quickly become an expensive proposition for the borrower. Should the borrower default, or fail to meet a margin call the money market may end up selling the collateral into an already distressed market, compounding the problem. Bond yields spike. Equity tanks. Cash constrained large caps start to lose the ability to raise capital through the sale of common stock as it quickly becomes prohibitively dilutive to do so. Those that do further erode the value of collateral.
Lather. Rinse. Repeat.
The combination of both of these drains, a cash exodus from money market funds and the deterioration of collateral, can prove ruinous and the resulting credit crunch can quickly balloon to the broader market, as it did in 2008.
Given this background, it is less than comforting to examine the holdings of the larger money market funds in the context of a crashing Euro.
Fidelity's Institutional Money Market Fund's March 31, 2010 holdings disclosure shows that 16.3% of the funds assets were tied up in repurchase agreements, many with European banks and collateralized with corporate obligations.
Similarly, JP Morgan's Prime Money Market Fund's April 30th, 2010 disclosure bristles with exposure to European financial institutions and firms.
It is impossible to know exactly what sort of exposure to a weakening Euro either fund actually has, or if large caps continue to be addicted to the commercial paper gambit, but it will certainly be entertaining (provided you aren't in them) to find out if money market funds prove, once again, to be the neutron initiator to a plutonium laced market.
- 1. "Breaking Buck," The Wall Street Journal, September 18, 2008.
»
- 5734 reads
- Printer-friendly version
- Send to friend
- advertisements -
Just like polonium 210 and beryllium...initiator for a nuclear weapon.The fusion stage is the derivative overhang.
2010:
http://williambanzai7.blogspot.com/2010/05/2010.html
May the Weak-Force be with you..
Not to worry, I have a plan
www.youtube.com/watch?v=iesXUFOlWC0
Speaking of NAV's. I know of a US state that is still holding its Lehman paper @ par in its sub funds... It has a state fund for local .govs... Think of it as the account your local water district parks its spare cash in until it needs to draw down big blocks of it. The safe cash fund levered up bank bonds at the bottom and still held its lehman paper at par the last I checked. The rot is everywhere... Over here, Over there, Everywhere.
Please don't tell me it's California... What else can this state do wrong?
"It's not a twomah"
You're right Arnie, but it's just as bad.
Duplicate
Triplicate -wow! 3 for 1
Marla is back! Another interesting post. Maybe I'm a cause or a symptom of this problem.
I moved most everything out of MM's when I heard Ben was working on repo's with them. I use Vanguard, who is usually pretty cautious, but I just don't trust the MM's (especially muni MM's) to ride this out.
However, where did I go: CD's. Which I imagine will be repaid with IOU's when the big liquidity crunch hits. However, I did at least check to make sure they weren't on the (unofficial) troubled bank list (maintained by Calculated Risk).
Think gold makes sense but GLD is (may be) a scam and what do I do with beaucoup oz. of gold. Can't carry it, probably can't defend it.
Conclusion: Middle class is screwed. When you destroy the middle class you destroy civilization. Rich don't care, they can get away with anything. Poor don't care, they've got nothing to loose. The middle class holds it together, does the work, pays the taxes. When we are defunct, it's time for the new (and improved) Dark Ages. This one comes not from the barbarians without, but from the bastards within. Hope we at least get to string them up as part of the "transition."
Perhaps a more vicious version of what the British do to their leaders...
Start around 4:40 in if you're pressed for time.
It's remarkable that this idea gets so little play at ZH. Obviously this is true. And once you accept that it is true, a steamer trunk of nastiness opens up in your face. Rise of monarchy. Destruction of the Constitution. Evaporation of the rule of law and the Bill of Rights. Rise of intolerance. Crushing ignorance, failure of all eduction models, defeat of reason. Return of religious oligarchy. Return of Feudalism.
Everyone wants their old style market back, so they can go back to the gambling tables. What the fuck is that about, anyway? I want my civilization back, thanks. It takes like 500 years to make a civilization -- even a little one -- and you miss them once they are gone.
Spot on, spot on. You will miss them once they are gone. People will finally see what happens when civilization is destroyed. They will see intolerance rise (people banning by who they are). You will see the rise of Monarchy religous or otherwise and despotism because the US will be broken up into 5 or more states and a different ruler in each one. You will see the rise of ignorance over intelligence (except for the rich), so they can control the people. Men and women should read what it was like back in the dark ages or even a few centuries ago in other countries. Where women where objects and men where animals, and depending on what their birthright was or how much money they had they where "gentlemen". It was a world of the one with power ruled and the others had to obey. Whoever ruled made the rule and then the local potentate or big man made his rules on top of the other rules in essence squeezeing the serfs (watch for that to come back again).
We in the US have taken for granted our freedom. We thought it was okay to hate and be intolerant and be ignorant of what we do and say because HEY it was freedom. As we have the freedom to do all that and more, we also have the freedom to fail. We will be thrown in a society that will be just like we acted and when we are there we will hate it. We will hate it because it's one thing to actually say it, it's another to live day in and day out in a world or civilization that requires you to be that way Old addage from the Emperor of the known worlds in the Dune books "every man has a place, every man in his place". And americans aren't truly ready for that.
From a retail perspective money markets outlived their usefulness a long time ago. In the high inflation 80's it was a place to park cash/checking funds and receive a yield that kept pace with inflation erosion a lot better than regulated, plain old bank savings accounts did. It wasn't quite as safe as putting your money "in the bank" but with double digit inflation and interest rates there were other things to worry about.
Now money market funds, both inside and outside banks have taken over everything and you have to bend over backwards not to be invested in them. Retail Joe & Jane have higher money market risk than ever, as outlined in this post, and for what? .75% APR? Yikes. Sure there are regs about the safety level of the debt instruments these things invest in and I think they can buy more risky paper with a small percentage of the assets but this is no tome to be blindly trusting a Moody's AAA rating or playing around in the long tails of distributions.
But it's such easy money for financial firms they've set things up so that all lose change constantly gets swept into one of these things. Try moving into "cash" in your Fidelity account. You can't do it. And now the SEC was whipped up a rule whereby they can decide suddenly to disallow money market redemptions...maybe while you're trying to make payroll or pay a bill...all for .75% a year. Talk about a risk/return imbalance.
What are the chances the new financial consumer protection whatever-the-hell-it-is agency will address this before the bottom falls out?
At the very least MM funds should have floating NAVs to drive the point homf for investors that they aren't risk free.
The banks will NOT ALLOW any major business sector to be self funding. Walmart, Intel, etc etc will get showered in 0 interest cash until it drags everything in the market to the rolling commercial paper trap.