‘None. Zilch. Zip.’

Author: David Kotok, Post Date: December 7, 2008
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Steve Shorkey, Director for Debt Capital Markets at Wachovia Securities needed few words to describe the use of one of the Fed’s new tools.  

Don’t be confused.  In this case zero use is an indicator of total effectiveness.   The Fed has cured a sector of the credit markets without having to apply a single dollar.   The announcement and design of the program was sufficient to return this important credit market sector to functionality.

Shorkey wrote:

“The Money Market Investor Funding Facility (MMIFF) has been in operation for two full weeks, spanning two Federal Reserve reporting periods (November 26th and December 3rd). During that period of time, there has been no activity under the program. None. Zilch. Zip. That’s a pretty solid indication that the MMMFs (money market mutual funds) feel secure with their liquidity positions and see no need to sell any of the CDs, bank notes, or CP of the 50 obligors that they may hold and that are eligible to be sold to the Fed.”

Remember: it was not long ago that a MMMF faced losses and had to “break the buck.”  The fund had held a position of Lehman paper and the failure of Lehman triggered the loss and an immediate run on the MMMF.  The fear of loss in MMMFs spread like a wild fire and all MMMFs experienced withdrawals.  That, in turn, meant forced liquidation of assets.  The sale of those assets triggered interest rate spikes (high rates from lower prices).  Within days the entire commercial paper (CP) market froze.  That meant the firms which depend on CP had lost their financing mechanism.  This is exactly how a contagion works.  It starts in one place and spreads rapidly and intensifies.

The government’s response to this contagion commenced with a guarantee of the MMMF balances as of September 19.  It was followed by a series of initiatives designed to stop the hemorrhaging and restore the MMMF sector to functioning.  These initiatives worked. 

Shorkey’s research paper helps us summarize the position of a MMMF manager today.  Please note how this has benefitted those investors who followed events closely and were worried about safety.  They acted quickly and profitably.  Other investors frozen by panic lost out.

If you are managing a MMMF nowadays, let’s review your position according to Shorkey:

(1) Government’s insurance on investor’s deposits? Check (via the just extended government insurance program).

(2) Ability to sell any Asset Backed CP in your portfolio at par? Check (via the AMLF program).  Readers please note that the AMLF is the Fed’s Asset-Backed Commercial Paper MMMF Liquidity Facility run by the Boston Fed.  It will buy unlimited amounts of Asset Backed CP at par from MMMFs.

(3) Ability to sell most of the other assets held in your portfolio at par? Check (via the MMIFF).

(4) Basically, MMMF portfolio managers have no excuse for breaking the buck, at least through April 30, 2009.

The Fed’s programs aimed at CP are a total success so far. And the money market funds are returning to full functionality.  The spreads are narrowing.  Here is an excerpt from Shorkey’s December 5 report:

“Total MMMF assets rose for the 10th consecutive week, increasing by $29.1B to a record total of $3.743 trillion. Retail assets increased by $6.7B to $1.283B while institutional assets rose by $22.34B to $2.46B in the week ended Dec. 3rd.  The trend in flows between fund types in the MMMF are complex and are by no means in a straight line, but in general, Prime funds seem to be picking up balances as interest wanes among investors holding Treasury and Government MMMFs as the yields on those ultra-safe funds are near historic lows. A significant portion of the inflows are coming from stock and bond mutual funds.”

Readers should note how the CP markets are also returning to function at credit grades lower than the A-1/P-1 rating level.  “Total CP outstanding now stands at $1,652MM, having edged up $50B over the past month. ABCP comprises approximately $732B of that total, while financial issuers stand at $709B.  A-2/P-2 outstanding is now $81B, substantially above the first-half 2008 average of roughly $60B.

At Cumberland we have been arguing that massive and creative Federal Reserve policy used without limits will break loose the logjam in the credit markets.   The Fed has been at work on this intensely for only a matter of weeks and the Fed started to intensify this effort only after the failure of Lehman.  Doubters who have hoarded their money in government money market funds at near zero interest were motivated by pure fear.  They are not paying attention to the changes taking place.  Like scared rabbits, they will miss the opportunities staring them in the face.

Cumberland won’t.  We see terrific opportunities in the credit markets in many sectors.  They range from tax-free municipal bonds to money market type instruments.  We intend to seize them for our clients.

Many thanks to Steve Shorkey for his superb work on this sector and for granting us permission to share it with our readers.

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