PrefBlog

The previously scheduled end of the world has been postponed.

Accrued Interest foresees a period of intense confusion:

Bonds are highly illiquid right now. Even Treasuries are showing unusual bid/ask spreads. There are many many many players who are going to be caught on the wrong side of this thing.
…
Some hedge funds are going to get crushed. I mean, anyone who was leveraged short financials may wind up getting busted out. That will result in some weird trading in seemingly unrelated instruments.

The Reserve Primary Fund buck-breaking has caused a huge onslaught of MMF redemptions:

Confidence in money-market funds was shaken this week when Reserve Primary Fund became the first in 14 years that failed to repay investors in full because of losses on debt issued by Lehman Brothers Holdings Inc. Investors responded by pulling a record $89.2 billion from funds on Sept. 17, according to data compiled by the Money Fund Report, a newsletter based in Westborough, Massachusetts. That equaled 2.6 percent of industry assets.

… and so Treasury is writing CDSs on Money Market Instruments:

The U.S. Treasury Department today announced the establishment of a temporary guaranty program for the U.S. money market mutual fund industry. For the next year, the U.S. Treasury will insure the holdings of any publicly offered eligible money market mutual fund – both retail and institutional – that pays a fee to participate in the program.

This is wild. I’m going to have to think about it a little more … but will this lead to a new financial industry? In which CP that’s issued will not only have bank-lines guaranteeing liquidity, but CDSs guaranteeing credit? Maybe this will be a good replacement business for the currently unfashionable municipal bond insurance game!

The American Bankers’ Association is upset because the Treasury move undercuts their FDIC advantage:

“Today’s action will undermine the role of banks during this current crisis and has the potential to have an extremely negative impact,” [ABA CEO Edward] Yingling said in the statement. “Our bankers are, understandably, very upset.”

Banks compete with money funds by offering accounts that are already covered by the Federal Deposit Insurance Corp. The extra margin of safety gives banks a competitive advantage with some consumers who want to avoid any chance of losses. Money- market funds hold about $3.35 trillion in assets.

Maybe that’s what will happen … MMFs will have to sign up with the FDIC / CDIC and all the other deposit guarantors, fill out all those forms and pay the insurance fees, and hire ex-regulators at fat salaries (only the smartest and most knowledgable ones, of course). Maybe they’ll even have to keep some capital with the fund to absorb losses and maintain capital and leverage ratios – and show the MER as a P&L item. Investor advocates will doubtless consider this a step forward. Because then everybody will get free money, right? Extra return without the slightest scrap of risk or necessity of thought is a fundamental human right, isn’t it?

Mind you, I’m not disagreeing with the Treasury move. Clearly, redemptions on the scale reported will have a long term negative effect and a short-term horrific effect … all the usual sales conduits busted, liquidity guarantees exercised, bank balance sheets bloating, the discount window getting a workout to finance the bloat … the move seems to me to be the lesser of the two evils.

And – as I have often said – the ultimate cause of the credit crunch is that there is a lot more demand for short-term investments than there is supply; which has led the industry to create pretend-short-term paper. Heightened uncertainty about the long-term ability to finance short-term will have effects that I’m going to have to think through carefully, but are guaranteed to be … interesting.

Sorry this report is late. I was up all night typing up the list of big winners! … No, I cannot tell a lie. I went home early and was asleep by 9pm and am now bright-eyed, bushy-tailed and eager to find out who goes bust next week.

There were sixteen other index-included $25-pv-equivalent issues trading over 10,000 shares today.

This entry was posted on Saturday, September 20th, 2008 at 2:35 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.