Monday, January 4, 2010

Is the Government Trying to Smash the Money Market Fund Industry?

How confused is the government when making regulations? Sometimes they appear very confused. On the other hand, they may not be confused at all but simply have evil intent. A new proposal by the SEC to change money market rules and regulations is a case in point, where either confusion or evil exists in boat loads.

Tyler Durden at Zero Hedge as an extensive discussion on the new proposed money market regulations. Durden writes: regulations proposed by the administration, and specifically by the ever-incompetent Securities and Exchange Commission, seek to pull one of these three core pillars from the foundation of the entire money market industry, by changing the primary assumptions of the key Money Market Rule 2a-7. A key proposal in the overhaul of money market regulation suggests that money market fund managers will have the option to "suspend redemptions to allow for the orderly liquidation of fund assets."
What is really going on here is the extending out of moral hazard. The SEC is doing nothing here but diluting money market mutual funds from being concerned about the true liquidity of the assets they buy.

One would think that the government would want more vigilant money market funds. This does the opposite. Further, the possibility that money market firms will be able to suspend resumptions may make them less attractive option for the cautious.

Thus, we have confusion by extending moral hazard or evil by attempting to create a less attractive money market industry that can freeze your assets at will.

Durden continues:

Ironically, the proposed change to Rule 2a-7 seeks to make dramatic changes to the composition of MMs: from 90 days, the WAM would get shortened to 60 days. And this is occurring at a time when the government is desperately seeking to find ways of extending maturities and durations of short-term debt instruments: by reverse rolling the $3.2 trillion industry, the impetus will be precisely the reverse of what should be happening, as more ultra-short maturity instruments are horded up, leaving a dead zone in the 60-90 day maturity window.
Here we see the confusion at the SEC. In one sense, they are making it easier for money market funds to ignore liquidity concerns, while at the same time they institute iron fist regulations that require more liquid assets (60 days versus 90 days), which is even at cross-purposes with the Treasury's own goals of extending maturities.

Or is this more evil? Yields at 90 days have been significantly more attractive than yields 60 days out. Is this an attempt to keep yields down at money market funds to make them less attractive?

Here's Durden again:

Some other proposed changes to 2a-7 include "prohibiting the funds from investing in Second Tier securities, as defined in Rule 2a-7. Eligible securities would be redefined as securities receiving only the highest, rather than the highest two, short-term debt ratings from a requisite nationally recognized securities rating organization.
This is simply driving the industry to buy the securities of the US government and those of oligarch controlled firms--and again forcing them into these lower yield securities.

Thus, the overall conclusion from these proposals is either :

1. The SEC is very confused. Which is quite possible.

2. There is evil intent in these regulations to shrink the money market industry and drive those funds into the hands of the big banks.

Durden takes the position that it is proposition 2: money markets account for a huge portion of the $11 trillion of mutual fund assets as of November (per ICI, whose opinion, incidentally, was instrumental in shaping future money market policy), $3.3 trillion to be precise, and second only to stock funds at $4.8 trillion, one can see why an administration, hell bent on recreating a stock-price bubble, would do all it can to make money markets extremely unattractive. In fact, the current administration has been on a roll on this regard: i) keeping money market rates at record lows, ii) removing money market fund guarantees and iii) and even allowing reverse repos to use money markets as sources of liquidity (because we all know that the collateral behind the banks shadow banking arrangement with the Fed are literally crap...

In essence, the money market optionality is precisely the equivalent of moving physical money from TBTFs to community banks in the "shadow economy." Because where there is $3.3 trillion out of $11 [trillion], there could easily be $11 trillion out of $11 [trillion], which would destroy the whole concept of Fed-spearheaded asset-price inflation, and would destroy overnight the TBTFs, as equities would once again find their fair value. It is no surprise then, that the current financial system, and its political cronies loathe the concept of Money Markets, and have done all they could to make them as unattractive as possible...

Obviously, attempts to push capital out of MMs have succeeded: after peaking at $3.9 trillion, currently money markets hold a two year low of $3.27 trillion. Furthermore, the number of actual money market fund operations has been substantially hit: from 2,078 in the days after the Lehman implosion, this is now down to 1,828, a 12% reduction. At this rate soon there won't be all that many money market funds to chose from...

Could this action, whereby investors will no longer have access to money that historically has been sacrosanct and reachable and disposable on a moment's notice, be the last nail in the coffin of money markets? We believe so, however, we are not sure if it will attain the desired effect. With an aging baby boomer population, which would rather burn their money than invest in the stock market again and relive the roller-coaster days of late 2008 and early 2009, the plan may well backfire, and result in even more money leaving the shadow system and entering such tangible objects as deposit accounts (at community banks, of course), mattresses and socks.
I have written often that regulations put into certain legislation may only be understood by a few, but may have profound consequences.

That appears to be the case with this legislation. We are either dealing with extreme confusion, or more likely, a planned desire to make money market funds less attractive? Are you going to keep your funds in a money market fund now that you know they may be given the right to freeze your redemptions?

I digress from Durden's view on two points:

1. His belief that the decline in money market assets to-date has been the result of a designed plan to reduce those assets. I do not believe that is the case. After Reserve Fund broke the buck in September of 2008 there was sheer panic by some. Many of those that withdrew funds at that time will never come back into money markets--not because of some specific play by the government then aimed at money markets.

2. His belief that this is an attempt to drive money into the stock market. That won't happen. Money market players are conservative investors. If they aren't in money market funds, they are going to put it in the banks, where the Federal Reserve has much more control over it. That the play, if this is a designed play: To drive the money into the hands of the TBTF banks.

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