Tuesday, May 06, 2008


The Depression Chronicles – 3: Money market funds

I am always astonished at the optimism of economists and, if we can judge from the stock market, investors. At the slightest improvement of one economic indicator or another—or even a deterioration of an indicator that is "less than expected"—hallelujahs can be heard up and down Wall Street that are quickly echoed in the financial news.

This week's cause for jubilation was a slightly positive gross domestic product (GDP), which means—so we are told—that the economy is not in recession after all. The other bright spot was "better than expected" employment figures. Never mind that these statistics—and especially before they are "corrected"—are worth even less than the U.S. dollar. You'd be better off spending that dollar by buying a tip sheet at the race track.

I admire Paul Krugman, not as an economist but as one of the few writers in "big media" with any sense at all. So I was disappointed when he began yesterday's column with—

Cross your fingers, knock on wood: it’s possible, though by no means certain, that the worst of the financial crisis is over. That’s the good news.

Krugman's bad news is that—

as markets stabilize, chances for fundamental financial reform may be slipping away. As a result, the next crisis will probably be worse than this one.

Don't worry, Paul. We have a long way to go before the "markets are stabilized."

Today's chronicle relates to money market funds. Deborah Brewster leads off with—

Legg Mason, one of the world’s biggest fund managers, has reported its first loss in at least 25 years and become the first fund group to raise public capital to shore up losses arising from the credit crisis.

Legg, which manages money market funds, equities and fixed income, said investors pulled out a net $19 billion during the quarter, and its market losses amounted to $28 billion.

Part of the problem was those darned ol' subprime mortgages, so elegantly packaged into structured investment vehicles (SIVs) by the nation's top financial-mathematical wizards "to reduce risk." Christopher Condon reports that—

SIVs accounting for at least $31 billion in debt have defaulted in the past 10 months as the collapse of the subprime market caused investors to shun securities linked to the mortgages....

... Chief Financial Officer Charles Daley said the company bought $150 million of SIV-issued debt from its money funds, placing the assets on Legg Mason's balance sheet. The company is still liable for any future losses from $890 million of SIV-related debt it swapped with Barclays Plc in December.

In other words, the company had to bail out its money funds.

Legg Mason still controls almost a trillion in assets—

Assets under management fell 4.8 percent in the quarter to $950.1 billion as investors withdrew $19.2 billion and market losses reduced assets by $28.5 billion. Equity outflows were $17 billion while bond funds lost $7 billion.

Money market funds are touted as "almost like a savings account," but the money isn't government-insured—at least officially. A lot of little people have money in these funds, and the failure of a major fund would go a long way toward setting off a real financial panic among the general public.

Of course there's no expectation that Legg Mason or the funds under its control will actually fail (there never is, is there?). Moody's, the same rating service that gave all those packaged subprime mortgages a top-of-the-line AAA rating, is giving Legg Mason—

... [a] senior debt rating at A2, with a negative outlook. The money manager should stabilize in the next three to six months, and probably won't be forced to "provide material additional support to its money market funds beyond the current levels," Moody's said.

So with assurances like that, how could you go wrong?

Legg Mason plans to raise a billion dollars to tide it over. This is the company's second trip to the well—

In November, the company received $1.25 billion from private-equity firm Kohlberg Kravis Roberts & Co.

According to Wikipedia,

Money market funds seek a stable $1.00 Net Asset value (NAV). Since the 2a-7 rule was adopted [that restricts the kinds of investments that can be made] only one fund "broke the buck" in 1994, paying investors $0.96 per share. That fund was the Community Bankers US Government Fund and had invested a large percentage of its assets into adjustable rate securities. As interest rates increased, these floating rate securities lost value.

Quite likely, short of total economic implosion, Legg Mason and its ilk will survive—thanks to more stringent regulations than were imposed upon the investment banks. On the other hand, it's hard to see why the small-time saver would want to put money in any of them. They appear to be a relatively high-risk venture with the promise of very little gain.

Related posts
Many in finance found to be SIV-positive (10/30/07)
Must-View of the Day (11/17/07)
The Depression Chronicles – 2: A view from the vault (4/28/08)


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