Last Updated Jul 27, 2011 8:52 PM EDT
Don't believe me? Let's take a look around.
First, assets have been pouring out of money market funds. Since the start of 2009, they've seen $1.1 trillion in negative cash flow, dropping total assets from $3.8 trillion to $2.7 trillion. Those lower asset levels, combined with the fee waivers made necessary by the extraordinarily low interest rates we've seen for the past few years, have slashed -- if not entirely eliminated -- the revenue managers have earned from these funds.
Next, we have the European debt crisis, in which each week brings a new dose of dire news about the financial outlook for one Euro nation or another. The largest money funds, it was recently reported, have roughly 50 percent of their assets in debt issued by European banks -- banks which are exposed to the debt issued by those financially-strapped European nations. If (or, more cynically, when) some combination of Greece, Italy, Spain et. al. end defaulting on their debt, the chain reaction could end up spelling trouble for a large portion of the holdings of many of our nation's largest money funds.
In "normal" times, those fund managers could always flee to the comparative safety of domestic debt. But, as you might have read, we're having our own troubles here in the United States. While the smart money is still betting against a default by our federal government, the fact of the matter is that, with each passing day, what once could be written off as the talk of the unhinged can no longer be so easily dismissed.
While most experts believe that in a worst-case scenario a Treasury default would knock only a few percentage points off of the value of short-term Treasury bills, that would be enough to pose a severe risk to the ability of money market funds to maintain their $1 share price.
There's also the question of how a Treasury default would impact the short-term corporate debt owned by prime money market funds. It's impossible to predict, of course, but it's hard to envision a scenario in which the effect would be positive.
And even absent a default, a lower credit rating on U.S. debt (which the credit ratings agencies are strongly hinting about) would also have a negative impact on money market holdings.
So many fund managers are operating their enormously depleted money market funds at or very near a loss, in an environment in which there are almost literally zero safe havens to invest those assets.
Could it get any worse?
From the manager's perspective, it just might. For a Reuters report this week quoted Boston Federal Reserve President Eric Rosengren saying that a combination of reforms are needed to lower the risks posed by the money market industry.
As I've written earlier, money market reforms have been the subject of a spirited debate between federal regulators and industry insiders. In short, regulators want to reform the money market industry so that the federal government won't have to bail the industry out during the next financial crisis, as they did in 2008.
The industry, of course, wants to maintain the status quo as much as possible, thereby protecting the revenue that they earn from these funds in more normal times.
The big sticking point in this debate is money market share prices. Regulators -- and most disinterested experts -- believe that if money market share prices were forced to float (rather than maintaining a stable $1-per-share price), investors wouldn't feel compelled to pull their money from these funds at the first sign of trouble, which causes a host of liquidity-related ripple effects.
The industry argues that floating share prices would scare most investors from money funds. In addition to the negative impact that would have on fund managers' bottom lines, it would also deprive our corporations of an important buyer of a large portion of the short-term debt they use to fund their daily operations.
According to the Reuters article, the opinion of the Boston Federal Reserve "carries strong influence" in this debate, which is why it is so noteworthy that the President weighed in. The fact that he endorsed a floating share price as one of the possible solutions, while ignoring completely the industry-proposed liquidity bank solution, is considered a strong indicator of the shape of future reforms.
The industry's deteriorating economics have resulted in more than 100 money funds being shuttered in the past two years. And it's entirely possible that we'll see more if future reforms reduce fund managers' profits.
That's not, to be clear, an argument against undertaking a serious effort to reduce the systematic risk posed by money market funds. And it would be folly to try to predict the shape of that reform. But the looming makeover of the industry, along with the host of unprecedented factors that money funds are currently facing, combine to make this the most challenging time in the money market industry's history. Which is why if you happen to see a money market manager in the next few days, I strongly encourage you to give him or her a big hug. They need it.
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