David Galland, of Casey Research, is long on conspiracy in his Pragmatic Capitalist article on money market funds.
Let’s be clear. The US Treasury has not suddenly decided to withdraw its guarantee on money market funds (MMFs) — the guarantee was due to expire on September 18, 2009 ever since its original implementation on September 19, 2008 was extended beyond an initial three-month period. This is not some Tim Geithner-imposed conspiracy to, in Galland’s words, “kill” the funds, which have been experiencing troubles since Lehman collapsed last year.
However, Galland does make a good point when it comes to how the decline of MMFs is impacting other asset classes.
Here’s his commentary:
As of September 2009, there was $3.58 trillion in money market mutual funds, of which just shy of $2 trillion is sitting in taxable non-government funds. But that money is starting to move: over the last month, money market mutual fund redemptions have been on the rise - with assets falling by a significant 15.3%. With the government pulling its guarantee, and given the risk associated with the money market funds, I have to wonder how many more investors might also decide to pick up stakes in the days and weeks just ahead?
And where might all that money head? Most likely, given the cautious nature of money market fund holders, into FDIC-insured accounts and CDs, and into Treasury funds and instruments. That, of course, helps the banks, and it helps the government meet its aggressive funding needs, while simultaneously taking pressure off interest rates.
We’ve written before that at low interest rates, the business model of money market funds — investing in things like commercial paper, repos and short-term bonds — simply breaks down. The funds cannot pay their fees and still pay investors an attractive return at zero per cent interest rates.
With annualised yields on MMFs at something like 0.1 per cent — before taxes — it’s little surprise that investors are leaving the funds in droves. And, as the Wall Street Journal pointed out on Saturday — they do indeed appear to be leaving for things like Treasuries, as well as junk bonds:
Last month, investors put twice as much money into intermediate-term and junk-bond funds as into short-term bond portfolios. As a result, they have exposed themselves to much greater risk from rising rates or falling credit quality. When interest rates go up, as in 1994, investors in longer-term bonds can get slaughtered.
“People feel they have to choose between the frying pan of zero yields and the fire of risk,” said Crane Data’s president, Peter G. Crane. “And they’re sick of the frying pan, so they’re jumping into the fire.”
…
The riskiest bonds of all right now are Treasurys. If the economy improves and rates rise, they will get hammered. The longer the bond, the harder the hammering.
Related links:
Back to bondage - FT Alphaville
Buck-ling money market funds - FT Alphaville
Sympathy for the money market funds - FT Alphaville
