New York Times on Auction-Rate Securities … Again

The New York Times recently complained about a recent lawsuit involving auction-rate securities failing in a blog, “When Law Obscures the Facts” (http://dealbook.blogs.nytimes.com/2009/10/09/when-law-obscures-the-facts/#comment-323241). The article says, “The collapse of the auction-rate securities market is a largely forgotten part of the financial crisis, a disaster that was soon overwhelmed by bigger ones — except for the investors who were caught up in it, The New York Times’s Floyd Norris writes in his latest High & Low Finance column.” (To read the original, see: http://www.nytimes.com/2009/10/09/business/09norris.html?dbk.)

It continues, “The investors thought they were buying safe short-term securities — sort of like a money market fund but with an expectation of a slightly higher return. The securities were supposed to be easy to sell for face value. Now, Mr. Norris says, many of the investors are stuck with securities that pay ridiculously low yields. In some cases, the securities will never mature, so the investors will never get their money back unless they sell them for a fraction of what they paid. Those who thought they were being safe and cautious in fact were taking huge risks.”

As we wrote in a comment, calling the auction-rate securities market “forgotten” is a laugher. The New York Times has written about this tiny sector of the investment marketplace more times than I can count. Investors, all clearly qualified, sophisticated institutions, enjoyed outsized returns for years. Meanwhile, The Times never uttered a peep. Why didn’t they question why the sector was able to pay higher rates than money market mutual funds? Investors accpeted the returns, so were clearly were aware of the risks. Any additional attempts to extort more money from financial institutions only rewards a handful of lawyers and punishes the vast majority of investors who had enough sense to avoid higher-yielding “free lunches” like auction-rate securities in the first place.

Crane Data Surveys Subscribers on Money Fund Reg Changes

The following is taken from the August issue of Crane Data’s (http://www.cranedata.com) Money Fund Intelligence newsletter, and gives our subscribers opinions on the SEC’s proposals for Money Market Mutual Fund Reform.

Crane Data recently surveyed MFI subscribers and readers of our website at www.cranedata.com about the SEC’s recent Money Market Fund Reform Proposals and issues facing money funds. The responses indicate that ultra-low interest rates have surpassed regulatory changes as the most important issue facing money funds, and that the proposals overall are rated relatively favorably.

MFI e-mailed the brief survey questions to its 800+ readers and received 26 responses. Respondents included primarily money fund managers and sales professionals, but also a number of money fund investors and money market securities issuers. We first asked readers to rate the SEC’s proposals on a scale of 1 to 10, with 10 being the highest. The average score was 6.3. The SEC proposals overall got ‘8’ scores (the highest) from 7 respondents and ‘1’ scores from two. (See page 2 for a summary of the full survey results.)

 Like Liquidity Mandates, Hate 30%

 We then asked, “Which of the SEC’s proposed MMF Reform amendments do you think would do the most good?” The most popular option, “Adding liquidity mandates,” was chosen by 48.3% of respondents. This was followed by “Other” (20.7%), where the majority of write-in options cited the 120-day maximum “spread WAM” as likely the most effective mandate.

 The next question asked, “Which of the SEC’s Proposed MMF Reform Amendments do you think would do the most harm?” Responses were widely distributed with “Moving WAM from 90 to 60 days” garnering the most votes (27.6%), followed again by “Other.” This time the write-ins included: “introduction of Floating NAV,” “differentiating between retail/institutional funds, as it relates to liquidity requirements (30% 7 day punitive!),” and “showing the shadow price to investors.”

 MFI then asked, “What are the most important issues facing money market mutual funds in the coming months?” Respondents were asked to rank the choices (see below left) in order of importance.

 “Ultra-low interest rates” ranked the most important issue (1.7), followed by “Regulatory changes” (2.2), “Competition from banks or new products” (3.6), and “Rising rates” (3.8). “Consolida- tion” trailed in importance (3.9) followed by “Other” (4.3), where a couple of write-in responses included the,  “threat of floating NAV.”

We then asked readers to “Rate the attractiveness of a floating NAV.” Though the overall average of 3.5 indicates this concept’s unpopularity among the money fund community, there were some surprising pockets of support for the idea.

Ten of our 26 respondents rated the concept a ‘1’ (plus one who went off the scale with a zero), while 4 respondents gave the concept a ‘10’. One respondent commented, “potential changes to accounting treatment make it less desirable.”

We then asked, “If you could add or remove a change, what would it be?” Survey takers’ comments included: “Change liquidity mandates,” “I would nix removal of illiquid securities,” “Remove floating NAV from comment consideration,” “In addition to the punitive 30% 7 day liquidity bucket for institutional funds (should be lower) the ‘maturity limit for other portfolio security’ should not be reduced from 397 days,” “Removing second tier securities,” “2nd tier reinstated,” “Removing illiquid securities,” “Liquidity mandates,” “Limit FRNS longer then 12 months and limit the % of FRNs in the fund,” and “don’t change illiquid bucket.”

Finally, we asked, “Are there any other important issues you think Crane Data should address in a comment letter or in an article?” Readers said: “US government support in the form of liquidity backstop would help the industry. Not an FDIC insurance but a perpetual program to buy securities, or lend against them in the event of market  disruptions,” “The notion of having to distinguish between retail and institutional funds for determination of liquidity requirement,” “Definitely have concerns with publicly publishing actual security prices. Eliminating illiquid securities could potentially stifle innovation — why not have a low max of say 5%?”

Investors in particular responded unfavorably to a theoretical floating rate NAV. One wrote, “If the NAV were re-priced and allowed to float, [our bank] would likely be forced to remove 100% of the $50M we have invested in MMFs. We do not want to be forced out of the MMF market!”

MFI SUBSCRIBER SURVEY           

1. Overall, on a scale of 1 to 10 with 10 being the highest, how do you rate the SEC’s MMF Reform proposals?            Average           6.3

2. Which of the SEC’s Proposed MMF Reform Amendments do you think would do the most good?   

a. Moving WAM from 90 to 60 days.   10.3%

b. Removing Second Tier Securities      6.9%

c. Adding Liquidity Mandates   48.3%

d. Removing Illiquid Securities   6.9%

e. Disclosing monthly portfolio holdings 6.9%

f. Other ________       20.7%

3. Which of the SEC’s Proposed MMF Reform Amendments do you think would do the most harm?   

a. Moving WAM from 90 to 60 days.   27.6%

b. Removing Second Tier Securities      10.3%

c. Adding Liquidity Mandates   10.3%

d. Removing Illiquid Securities   20.7%

e. Disclosing monthly portfolio holdings 6.9%

f. Other            24.1%

4. What are the most important issues facing money market mutual funds in the coming months?            

 (rank highest to lowest with 1 being the highest, 2 being next, etc.)        

a. Regulatory Changes  2.2

b. Consolidation           3.9

c. Ultra-Low Interest Rates       1.7

d. Rising Rates  3.8

e. Competition from Banks or New Products    3.6

f. Other            4.3

5. On a scale of 1 to 10 with 10 being the highest, rate the attractiveness of a floating NAV.      

Average           3.5

Source: Crane Data.

Fund Associations in Europe Pushing for Money Fund Definition(​s)

This was originally published on http://www.cranedata.com…. The Brussels-​based European Fund and Asset Management Association and the London-​based Institutional Money Market Funds Association recently published a report entitled, “EFAMA and IMMFA Recommendation for a European Classification and Definition of Money Market Funds” (​link pending). The report says, “There is currently no common definition of money market funds across Europe.” This effort “defines clear-​cut rules to clarify what the ‘​money market fund’ label should include,” according to a press release issued jointly by the two organizations.

The full report says, “​At the end of 2008, European money market funds had EUR 1,​350 billion under management, compared to EUR 1,​186 billion at end 2007…. The main domiciles of money market funds at end 2008 were France (​EUR 488 billion), Luxembourg (​EUR 335 billion) and Ireland (​EUR 319 billion). These three domiciles represented 85% of the European money market funds market.” See http://www.cranedata.com’s News for the full article and links.

The While we appreciate any effort by Europe and others to restrict the use of the term “​money market fund” to only those vehicles adhering to strict regulatory oversight and abiding by strict quality, maturity, diversity, and soon liquidity, standards like those in the U.​S., we believe the splitting of categories will continue to only confuse the marketplace. We would urge Europe to restrict the term “​money market” to only the “​short-​term,” highest quality, and most liquid securities. However, we look forward to the discussion and appreciate the efforts of IMMFA and EFAMA. (​Note that IMMFA Chairman Travis Barker is scheduled to speak at Crane’​s Money Fund Symposium in Providence August 25.)

The Die Is Cast: Government Support of Money Funds

We’ve been discussing the fact that the Treasury Guarantee Program for money market mutual funds and the Federal Reserve’s extensive support of the money markets, including the AMLF, CPFF, MMIFF, etc., clearly indicates that money market mutual funds are too big to fail. But only recently have some others begun thinking about the implications of these explicit, and implicit, guarantees. We’ve said for weeks, whether these guarantees are extended or not, the die has been cast. The government will have no choice but to step in to support the money markets should the “1,000 year flood” we just experience return at some point.

In our Crane Data News from May 28 (“CCMR Report Supports ICI Recommendations, Government Guarantees” at http://www.cranedata.com/news/#item-2310), we quote, “The Committee on Capital Markets Regulation, an “independent and nonpartisan 501(​c)(​3) research organization dedicated to improving the regulation of U.​S. capital markets” that counts a number of mutual fund industry heavyweights among its members, recently released a report entitled, “The Global Financial Crisis: A Plan for Regulatory Reform. This report incudes a brief section that weighs in on the issue of changes in money market mutual fund regulations. The CCMR Report supports the ICI’​s recent recommendations, but also appears to come out in favor of continuing a system of government guarantees for money funds.”

The CCMR Report is the first mention (outside Crane Data conversations) to discuss the implied nature of the government’s support of money markets and money market mutual funds. While we believe that the Treasury’s Guarantee Program will terminate in September, we’re pretty confident that the Treasury cannot afford to allow another money fund to “break the buck” at any point in the near future.

We’d love to hear more on this topic and would be happy to discuss in more detail off-line.

Crane Seeks Money Fund Investor Feedback

I’m seeking individual investors and institutional investors to interview them on their thoughts regarding the future of money market funds. The Investment Company Institute, the trade group representing mutual funds, and various regulators and other parties have proposed a series of improvements and suggestions, but the investor has yet to be heard.

Is the $1.00 share price important? Would you sacrifice yield for safety? Are you familiar with the current set of money fund regulations, or could fund companies do a better job of educating their investors? Are you interested in monitoring portfolio holdings?

If you’re interested, contact me (Pete Crane, pete@cranedata.us). I would love to schedule an interview and hear your thoughts. Or please feel free to post on this blog!

Attempting to Standardize “Money Market Fund” Worldwide

There has been talk recently about changing the regulations governing U.S. money market mutual funds in the United States, the mother of all money market mutual fund marketplaces with 63% of the worldwide $5.4 trillion in money fund assets. What some fail to appreciate, however, is how much better U.S. money market funds fared than every single one of their “cash” counterparts, particularly when compared to Europe’s cash offerings.

Bank savings, reserve accounts, enhanced cash, ultra-short, auction rate … everything got savaged. Though U.S. money funds had a number of bailouts and one “breaking of the buck”, the total amount of damage was significantly less severe than practically every other locale and sector. The money fund regulations truly proved their mettle.

What became painfully clear during the Subprime Liquidity Crisis, however, is the threat of contagion. When Reserve Fund broke the buck, it brought into question every similar institutional money fund. Many forget that money market funds originally came under duress due to problems in “enhanced” funds in Europe, specifically BNP and AXA Libor Plus.

Additional concerns over “enhanced cash” funds, such as Columbia Strategic Cash, GE Enhanced Cash, Florida’s Local Government Investment Pool, etc., made it painfully clear that even in the U.S. the regulatory line dividing “money market funds” from other vehicles needed to be strengthened, not removed.

Europe in particular needs a Rule 2a-7, and it’s looking increasingly likely, primarily due to the fact that many who objected to the strict definition of “money market fund” are no longer around to protest.

Doom and Gloomers Seize on False $550 Billion Number

A video click circulating on a number of blogs discusses Representative Paul Kanjorsky’s (D-Pa.) assertion that $550 billion was taken out of “money market accounts” in an “hour or two” on Thursday, Sept. 18, 2008. While the situation was dangerous, we believe that the major facts in this account are false and confused.

See Rush Limbaugh’s blog ( http://www.rushlimbaugh.com/home/daily/site_021009/content/01125106.guest.html), The Market Oracle (http://www.marketoracle.co.uk/Article8805.html), and The Zero Hour (http://www.forexhound.com/article.cfm?articleID=125182). They source the Zero Hedge in a post entitled “How The World Almost Came To An End At 2PM On September 18.”

They quote Kanjorski, “On Thursday at about 11 o’clock in the morning the Federal Reserve noticed a tremendous drawdown of money market accounts in the United States, to the tune of $550 billion was being drawn out in a matter of an hour or two. On Thursday at about 11 o’clock in the morning the Federal Reserve noticed a tremendous drawdown of money market accounts in the United States, to the tune of $550 billion was being drawn out in a matter of an hour or two.”

There are a host of errors in the segment referenced above. First, $550 billion in a matter of hours is ridiculous. While money market mutual funds (not “money market accounts”) were seeing tremendous redemption pressure, the amount totalled at most half that over the entire week (not hours). Money market accounts, which are presumably bank money market deposit accounts (Kanjorski later cites a $250K FDIC limit increase), likely only saw modest outflows. (Retail money market mutual funds saw only modest declines during the week, so money market deposit accounts likely only saw modest redemptions.)

Saying the drawdown would have grown to $5 trillion is ridiculous. Bank savings and money market deposit accounts only amount to $4.0 trillion in total, and money market mutual funds totaled $3.6 trillion at the time. While the situation was certainly dire and unprecedented, somebody is confusing an awful lot of facts and numbers.

To read the account of events while it happened, visit our News archives at  http://www.cranedata.com.

Feedback on the Future

I’d like to encourage any interested parties to submit comments and preferences on whether any changes should be made to money market funds. Regulators, managers and investors are now debating the future shape of money funds, so we’d like to hear some other people’s opinions before fully weighing in with our recommendations.

Though we believe that money funds have performed well during the past year-and-a-half’s mayhem, we recognize that some may demand that something be done. Our goal is to minimize the harm that any changes may bring, and to attempt to further protect both investors and fund managers with any new regulations.

Feel free to post here, or to e-mail me at pete@cranedata.us. I’d be happy to discuss, and to pass your opinions along.

Sincerely,

Pete Crane

President

http://www.cranedata.com

Fed Should Invest in Money Funds, Not CP

This thought is from my partner Shaun, “The Federal Reserve’s plan to invest directly in commercial paper has a salutary effect in the short run, providing liquidity to this important market. Longer term, however, the government may be undercutting the money market funds. The risk is that the government will dominate the market for the best paper, in the same way that Fannie and Freddie came to dominate the prime mortgage market. Prime money market funds will be pushed into buying riskier credits. A better way to support both money market funds and the commerical paper market would be to put money directly into prime money market funds. Why set up a parelell system, when we already have a very effective system to provide liquidity to commercial paper issuers?”

We welcome any thoughts as to what might be done to help the money markets!

Brokerages Wimp Out Again Caving to Auction-Rate Extortion

Once again, a state attorney general with nothing to do whatsoever with the issue has stepped in to demand millions in “penalties” for supposed crimes by large financial institutions. Of course, everyone now believes the “little guy” was deceived and cooerced into buying higher-yielding but sold-as-money-market auction rate securities. It’s embassassing….

The thought that any of these investors didn’t know they were taking more risk than they would be in a money market mutual fund is ridiculous. Money market mutual funds, though no retail investor has ever lost money, go to extraordinary lengths to make sure that anyone coming within a mile of them knows they can lose money. If money fund investors all know they could theoretically lose money, wouldn’t auction-rate securities buyers too?

Once again, we’re left with millions upon millions of legal costs and regulatory paranoia costs piled upon financial institutions, and the small investors that did the right thing — ignored the higher yields and stayed safe — will be left paying the tab. Meanwhile the greedy investors that stretched for yield are left laughing.

So we get another modern regulatory lesson. Don’t work hard and play by the rules. Go greedy, because your state attorney general will make sure you, they, and the trial lawyers, get another fat payday compliments of the Everyman.