Money Market Madness

The subprime story de jour came from Sentinel Management group who halted redemptions from their Money Market portfolio due to liquidity concerns.  I contend that this by far has been the most frightening thing to come out of this credit mess thus far.  I do not say this because I expect a enormous failure in the money markets.  My belief is that Sentinel was a money manager who was not prudent and got caught reaching for yield in the middle of a credit crunch - hopefully.  I do however believe that this is a major event, because it has opened people's eyes to the amount of risk they are taking. 

People invest in money market funds as a safe place to put their cash that they are not using in hopes to earn a little bit of yield.  Taxable money market funds usually fall in three categories: 

Cash Reserves/Prime Money Market - Investing in various money market securities but mostly Commercial Paper, Yankee Bonds, medium tern notes, CD's and Repos.

Goverment Money Market - These funds sometimes invests in T-bills, but usually in Repos and Agency securities. 

Treasury Money Market - These funds invest in T-bills exclusively. 

Below are the 7 day effective yields for these equivalent funds in Fidelity (a company who manages many people's 401(k)'s):

Fidelity Cash Reserves - 5.20%

Fidelity Government Money Market - 5.26%

Fidelity Treasury Money Market - 4.61%

One thing I find interesting is that the Government Money Market Fund (essentially funded by Repos and Agencies) has a greater yield than the Cash Reserves (which has Commercial Paper).   

These spreads can be illustrated by the AA nonfinancial CP spread illustrated in the diagram below:

Source: www.federalreserve.gov

Notice the major spike that occurred last week.

What is troubling is that the amount of issues outstanding has increased dramatically lately.  See the chart below to see what I mean.

Source: www.federalreserve.gov

Asset backed commercial paper, which Kevin DePew at Minyanville looked at today, has grown by leaps and bounds.  This paper is securitized by receivables, which can include mortgage payments.  This stuff, although not the same thing as CDO's backed with some prime loans, reeks of the same characterics.  Moody's writes,

"Asset-backed commercial paper (ABCP) is a form of senior secured, short-term borrowing, in contrast to
corporate commercial paper, which is senior unsecured short-term corporate debt. Asset-backed commercial paper programs offer low-cost financing to companies that could not otherwise directly borrow in the commercial paper markets ."

Sound familiar?

Taking one look at FRB's volume statistics show these trends in much greater detail.  The market has been flooded with this stuff as of lately, unlike the other types of commercial paper.  This means that essentially, the same people who can't pay there mortgage and have stopped shopping at Wal-Mart, may now holding some of their retirement assets in the receivables of company's that they are unable to pay. 

The average money market investor invests in money markets because he/she is usually very conservative, or needs a safe place to put money that is readily available.  In both instances "safety" is the reason why people invest and the general theme. The other main concern is of course liquidity.

Liquidity is reason why I am concerned with these securities because they so closely resemble the CDO's which started this mess.  When people begin to realize this, they may begin to panic and create an even uglier mess as companies that are part of some cash management program will find that they are no longer able to manage their cash how they wanted to. 

When the spread on sub-prime backed CDO's goes up, the conservative investor in money market funds says, "Thank god I'm in cash".  What however, does this investor say or do when a similar thing happens to funds that resemble his safe haven are halted in a fund and publicized. What does he do when he learns that his fund is invested in a bunch of stuff that he doesn't understand and have comparisons to CDO's and other things that he watch blow up from his Money Market perch just 3 weeks prior? 

He goes into a treasury market fund - back 100% by T-bills, the last safe haven. 

If this happens, just imagine what the spread would look like as redemptions soared in 401(k)'s and investment accounts across the country.  Even if there isn't a run for the banks, since these asset backed notes a major purchaser, such as a Fidelity or State Street, can also influence the market greatly if they choose not to purchase them

I hope that people do not panic in unison, but if a few do and continue and all of a sudden there is another dislocation to of supply and demand, the Fed will have to inject much more money into the system to prevent large scale redemption halts.  I fear that this little "slip-up" by tiny fund will lead to bigger panic, which inflicts further damage in a credit crunch.  In writing this I do not mean to induce any panic whatsoever, but rather awareness so that the few who do may look to see what they own and evaluate the situation for themselves.  The fact remains that many people just simply do not know what they own, and if their broker tried to call them up tomorrow and asked them to put their conservative funds into a Commerical Loan backed by receivables for 60 bps over T-Bills, many would not hesitate to say , "No".  This, I unfortunately believe, will be the next "shoe to drop".