As we await the latest performance by the dynamic duo of Ben Bernanke and Hank Paulson, I would hope they are spending some time investigating something of their own: Namely, why the money markets have frozen in the United States.
I would recommend they start with what is happening in the fallout from the Primary Reserve fund breaking of the buck for its money market fund.
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This was due to the fund holding Lehman securities -- which triggered a mass exodus of shareholders from the fund. According to Reuters, the fund said it had about $23 billion in assets last Tuesday, down from about $65 billion as of Aug. 31. It's now down to $1.637 billion. The fund halted redemption of shares last week. This has triggered redemptions from the entire fund complex, not just the money market.
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This is where the story gets interesting. On Monday, the SEC issued an order that provides for "an orderly plan of liquidation of fund assets to meet outstanding redemption requests and for making appropriate payment to the fund's shareholders."
Dow Jones reported that the regulator also granted the postponement of payment for shares which have been submitted for redemption, also requested by the Reserve, saying it is necessary for the protection of shareholders: "The Reserve had asked the regulator to postpone the date of payment of redemption proceeds for a period longer than seven days after the tender of shares for redemption."
Seems reasonable, doesn't it?
Unfortunately, it has massive implications for the rest of the money market and mutual fund business.
Shareholders are concerned about this occurring elsewhere, even with the new $50 billion money market plan. This means money market managers don't want to invest in anything that isn't the safest, most liquid asset, which they know they can retrieve in the shortest period of time. It's return OF capital, not ON capital. This is why 3 month Treasury bills yield 0.7 percent and why the 3-month OIS (Overnight Index Swap)-U.S. Libor spread has exploded to the upside. All bills below 3 months are yielding 0.3 percent to 0 percent, with security fails being a constant threat.
The implications are not for an immediate buyout of $700 billion in distressed mortgages, but for the SEC to make a statement that they are not going to freeze future redemptions from mutual funds or money markets.
Then, it would be a good idea for Mr. Paulson and Mr. Bernanke to provide a larger, detailed program for assisting the money market funds. Outside of finance, people don't understand that the money markets are the engine of liquidity for our financial industry and our economy. We need action on this immediately.