US MM Funds – The Dumbest Money of All

The ‘crap out’ in stocks may scare us to death but it will be a freeze up in short term liquidity that will kill us. We’re getting closer by the day.

The liquidity issues that are emanating out of Europe are extending around the world very quickly. One area that I continue to think is vulnerable is the US money market funds. There is a good reason to worry about these funds. After all, this is the dumbest place on earth to put a dime. Consider the numbers.

The average cash MMF is yielding an 1/8th percent per year. There’s tax on that too. The net comes to about 10 basis points. For every $100 you have in a cash fund you have income of ten-cents. For this lousy dime you are taking risks. There is this assumption that a money fund can never be worth less than 100. There is no truth to that. It happened three years ago.

What if a money fund “broke the buck” and all of a sudden it was worth only 99%? The loss would only be $1. But that $1 is also equal to ten years worth of interest. From a gamblers perspective you are betting 100 dollars to win only 7.

How much risk should one be willing to take when the return is only 10 basis points? Easy answer. Zero.

You might think that there is no chance for a money fund to trade at 99. If so, consider the words of Boston Federal Reserve President, Eric Rosengren, in a July, 25 2011 interview with Reuters:

A “combination” of solutions will be needed to reduce the risks faced by the short-term funds and their investors — including one resisted by many fund marketers that would no longer fix the net asset value (NAV) of a fund share at $1.

“We still need to make further progress in reducing the risk that money-market funds could be a source of instability resulting from an unanticipated credit shock.”

In a speech at Stanford University on June 3, Rosengren said money funds could be affected by European debt woes.

The 4+% drop in stocks today was a sideshow for what is happening in the funding markets. The important news came from BNY Mellon. (Zero Hedge link for details). BONY is now charging to take deposits! We also have Tbills with negative yields. The only conclusion? Money has a negative value. If that is the case then money funds will break the buck. I think we’re pretty close to the edge with this.

If you accept the premise that Zero Return must also equal Zero Risk then what is the solution to the current crisis in the funding markets? Simple. Charge more for money. If the return is raised, the appetite for risk will rise from zero. Problem solved.

The one thing that is absolutely not going to happen is an increase in basic interest rates. For there to be a balance that attracts short term funding and stabilizes things in the capital markets I believe the Fed Funds rate would have to be about 1.5%.

Not only is that not going to happen we might even get the reverse. The Fed could easily attempt to buy some market peace by issuing a statement that the policy of zero interest rates would be extended for a minimum period of one year. I consider this to be a “high probability” to happen in the next 30 days.

My conclusion is that the Fed is going to do exactly the opposite of what is needed. Their action will precipitate a new round of instability. Funding sources that are now under stress are only short date financing. One week to one month is where the problems lie today. But the Fed’s action could very well push out the instability to impact longer maturities like 3 and 6 months. Should that happen, the lights will go off pretty quickly.

Bernanke’s no dope. He must see what is happening in front of his eyes. He must understand that ZIRP is at the heart of the problem. But he is pregnant with ZIRP and his “baby” is going to term.

About Bruce Krasting 208 Articles

Bruce worked on Wall Street for twenty five years, he has been writing for the professional press for the last five years and has been on the Fox Business channel several times as a guest describing his written work.

From 1990-1995 he ran a private hedge fund in Greenwich Ct. called Falconer Limited. Investments were driven by macro developments. He closed the fund and retired in 1995. Bruce also been employed by Drexel Burnham Lambert, Citicorp, Credit Suisse and Irving Trust Corp.

Bruce holds a bachelor's degree in economics from Ithaca College and currently lives in Westchester, NY.

Visit: Bruce Krasting's Blog

Be the first to comment

Leave a Reply

Your email address will not be published.