How to Create a Time BombFebruary 03, 2010 Posted by: Joe Morgan, CFA
Duuh duuh duuh,
Duuh duuh duuh,
Let the boys be boys!
Last week the SEC adopted new rules designed to strengthen the money market fund world (or "2a-7 world" if you want to get technical), which are targeted at increasing liquidity, credit quality and transparency (See the details here). Without going into too much detail, the new rules will effectively limit investment options for these funds, including the development of a concentration of funds to be invested in the very short term.
About 48 hours later it was announced the Reserve Primary Fund — the only one of these types of investment vehicles to "break the buck" during the crisis — completed its final distribution to shareholders some 16 months after locking up. Investors not only lost principal during this period (almost two cents on the dollar) but also lost any potential interest or, more importantly, ability to use the funds. This experience even forced some investors into bankruptcy — all for a vehicle that was supposed to be "good as gold."
Quite interesting timing if you ask me.
At its core, I am happy the SEC is making some changes, especially directed toward increased liquidity of these funds, but I'm also fearful of the unintended consequences of such changes.
Anytime government bureaucrats dive deep into the world of finance, there are surely mistakes and misunderstandings to be had. The question is whether the added "protection" provided by regulatory changes outweighs losses incurred due to investor efforts to circumvent or exploit the new rules.
In this case, I am concerned that a dramatic and sustained increase in demand for debt maturing less than 30 days will recreate a bubble-and-burst scenario quite similar to the mortgage bubble just experienced. This outsized demand will create a "step" in funding costs from 30 days to 31 days (and longer). When the economy gets rolling again, anyone issuing, say, 90- to 360-day debt will need to seriously consider issuing 30-day debt and taking on refunding risk each month.
On the margin that doesn't sound so bad, but imagine a broad scale...Read More