Run-Free Funds Expand

Louise Bowman at Euromoney reports

Fidelity Investments has announced plans to convert up to $125 billion-worth of prime US money market funds (MMFs) into government-only funds –

Meaning, funds that invest only in government securities.

...a move that is a direct consequence of the new SEC regulations covering this business that were announced in July.

...From October next year, MMFs must hold at least 99.5% of total portfolio assets in cash or government securities and repos collateralized by such instruments to be exempt from new regulations imposing fees and gates on such funds in times of stress. The rules are designed to slow deposit runs and reduce systemic risk

In case you missed it, in the financial crisis the Reserve Fund, which held a lot of Lehman debt, suffered a run, and too big to fail quickly expanded to money market funds.

What are they invested in now?

Of the $125 billion in the three Fidelity funds, only 22% is currently invested in government fund-eligible assets, according to BAML. That means $97 billion (78%) now invested in CDs, CP, non-government repo and other instruments will need to be rolled into government holdings. Of this, $9 billion is bank CP, $2 billion non-financial CP and $15 billion non-government repo....less than 10% of the $97 billion in short-term unsecured bank paper held by the three Fidelity funds marked for conversion was issued by US institutions.

This is, in my view, great news. Money market funds were promising complete safety -- you can take your money out at any time -- and lending it, unsecured and uninsured, to banks. Not just too big to fail American banks, but (say) Greek banks.

I thought this would be more of a challenge. You can always promise greater yields during good times and hope for a bailout in bad. Or, each investor hopes to get out ahead of the others. Apparently not,

"Many investors have told us that they want access to money market mutual funds with a stable NAV that will not be subject to liquidity fees or redemption gates," stated Fidelity when news of the conversion became public. 

Though to some extent that's because the temptation is low right now.

With credit spreads on non-government funds as low as they are, the returns are simply not attractive enough versus government funds ... 

Louise worries that this spread will rise.  

The expectation is that...unsecured funding costs for the banks will rise. This has particularly serious implications for non-US banks, as they are far greater users of this market than their US counterparts, which have ready access to cheap deposits.

It will. It should. But paragraph 1 should inform paragraph 2. A higher rate will induce people to take the risk and hold commercial paper directly, or suffer the indignities of the fees and gates in return for higher yields. Supply does equal demand!

Like the other Squam Lakers, I think that floating values are a better solution for non-government funds. But I like emergence of run-free, treasury-backed money market funds!

(This is "narrow banking" but I try not to use that word. The point is not to "narrow" banking. Using that word reinforced the fallacy that the size of credit creation must contract. The point is that risky investments should have floating-value or run-free liabilities, and fixed-value liabilities should be backed by government securities. For more, "Toward a run-free financial system")