Nate Geraci
April 4, 2009
At the end of February, assets in money market mutual funds stood at $3.9 trillion, a staggering 53% increase from a precrisis level of $2.5 trillion in June 2007.
The stampede to cash triggered by the carnage of the financial crisis has clearly left money market mutual funds playing a greater role in investor portfolios. But such a flight to cash hasn’t always translated into a flight to quality. If you’re struggling to make ends meet after the financial crisis, check out Intelligent Car Leasing.
Taking Stock Of Crumbling Markets
As the credit crisis progressed and money market fund assets swelled, average credit quality of non-Treasury debt instruments declined.
Shortly after the initial credit shocks in July 2007, losses began showing up in money market mutual funds. Investor appetite for asset-backed commercial paper, particularly mortgage-backed paper and related structured investment vehicles, evaporated. Holders of some outstanding paper, including money market funds, suffered principal losses.
During the ensuing 12 months leading up to the dramatic breaking of the buck by the Reserve Primary Fund, there were nearly two dozen issuer bailouts of money market funds totaling billions of dollars.
The collapse of the $65 billion Reserve Primary Fund (carrying $785 million in Lehman commercial paper) last September unleashed heavy selling of money market funds in general-and outright panic selling of funds associated with certain issuer pedigrees.
Most negatively affected were funds whose issuers were regarded as having limited capacity for covering potential losses in money market funds (i.e., generally nonbank issuers).
Also pushed to the side were funds, whether associated with a large holding company or not, believed to be holding meaningful amounts of at-risk commercial paper. These developments posed significant risks both to commercial paper and CD markets as more than one-third and one-quarter of so-called “prime” money market funds were invested in commercial paper and CDs, respectively. That included domestic and non-U.S. issues, according to the BIS Quarterly Review.
It is difficult to overstate the importance of the Reserve Primary Fund debacle as well as steps taken shortly thereafter by the U.S. government. On September 19, the federal government (aka taxpayer) stepped in to assume the risk of guaranteeing funds’ net asset value. The guarantees helped, marketwide, to put investors at ease and to increase fund manager confidence in taking on commercial paper.
The collapse of Reserve Primary Fund-and the real and significant danger it posed to global financial markets, to shareholders and, subsequently, to taxpayers-makes painfully clear the need for clean, sweeping disclosure-related reform.
Lack Of Disclosure
Like other mutual funds, money market mutual funds are required to report holdings only quarterly and, at that, 60 days in arrears.
Consequently, any money market fund holding information in the hands of a shareholder, analyst or regulator is between three and five months stale. This is especially critical for money market funds since, by regulation, they must maintain a dollar-weighted average maturity of 90 days or less.
Due to the size of this reporting lag, it is highly likely that a money market fund’s holdings, at times, will bear little or no resemblance to holdings currently reported in the public record.
Furthermore, given that money market funds compete for market share primarily on the basis of yield, there is serious risk of manager gaming of the reporting schedule; that is, of “dumpster diving” for yield in between holding reporting dates.
What’s to keep a manager from loading up on high-yielding two-month Lehman commercial paper in August, for example, if it rolls off or matures before the next quarterly holdings beauty pageant? Who will ever know-provided there’s not a default event?
Certainly not the shareholder or anyone else evaluating the activities of the fund based on the finely aged quarterly holdings reports.
Surprisingly for the manager, such activity may well comply with the fund’s broadly framed prospectus guidelines. And it works so long as the rating agencies continue to coast six to 12 months behind the ratings reality curve, maintaining clean reports of health for Lehman-like issuers. But “success” also depends on avoiding blowups in the yield-enhancing roulette game.
Taking A Page From ETFs
One of the truly great attributes of ETFs is their transparency. Their laundry, so to speak, is hung out on the line for all to see in real time.
Holdings transparency is always, always critically important.
Would the Reserve Primary Fund have been holding Lehman commercial paper had it been required to publicly display its holdings on a daily or weekly basis?
Alas, the winds of change are blowing investors’ way.
The Investment Company Institute’s money market working group should be applauded for recommending that money market funds fully disclose holdings monthly and only two days in arrears. (You can read the ICI’s paper here).
Meaningful and relevant reporting cycles for money market mutual funds is, perhaps, the single most important and impactful step that could be taken to improve confidence in the world’s most important pool of money funds.
The transfer of risk from the taxpayer back to the shareholder will remain highly problematic until either long after systemic risk abates or, preferably, the shareholder is better equipped to evaluate risk through improved disclosure.
The ICI working group’s recommendations ought to be taken a step further-they ought to be mandated by regulation. And, given the short maturities held in money market funds, the reporting cycles ought to be further shortened-perhaps to a two-week cycle. Let’s keep the laundry out where all can see.
