I had several calls this week from clients regarding money market funds and government insurance. Essentially, the conversation would go something like this:
“Tom, I heard recently that the government will no longer be insuring money market funds. Should we do something about this? Should we be concerned?”
And I would reply “you DO know, that money market funds were never insured before last fall…right?”
“Really?”
It’s true. Most money market funds were not insured before the fourth quarter 2008. Oh sure, there were “insured” money market options/choices around before 2008. But their yields were so low, you needed a microscope to see them. And in case you did not know, the actual technical name for money market funds…ALL money market funds…is “money market MUTUAL funds.” Which is why you get a prospectus when you open a money market account.
The objective of a money market mutual fund is to maintain its’ $1.00 per share price, and return you a few bucks in interest/dividends. Make sure all those assets they were invested in added up to $1.00 every night. That’s it. Their marching orders: Keep that $1.00 price per share. Or die.
And last fall, a few money market mutual funds had some trouble maintaining their $1.00 per share price. Their assets get priced every business day. More on this part in a moment.
Anyway…when the “financial crisis” spilled over into 2009, the Government continued to extend their “insurance” on money market funds. That coverage will cease in October 2009 (very soon).
Part of the reason why interest rates on money market funds fell to zero was because:
- The Fed aggressively cut interest rates — and promises to keep them low, at least for the present time
- There is no incentive to pay a higher rate to attract deposits — all money market funds essentially became the same everywhere
- What’s the price (yield) for safety?
Knowing that the “government backstop” of money market funds may not be renewed in October, I instructed TD Ameritrade (during the month of August) to move all money market assets from their traditional money market fund (which carried the government backstop) to an FDIC insured money market fund. There is no cost or transaction charge involved in this move. It was done strictly for peace of mind.
Why did the government have to insure money market funds in the first place?
The answer: Lehman Brothers
Don’t misunderstand: Lehman Brothers themselves did not kill the safety of money market funds. It was “allowing Lehman Brothers to go under” that dragged money market funds with them. Like it or not, Bear Stearns and Lehman Brothers were two major players in the commercial paper market.
And commercial paper is what “drove the bus” called money market funds.
You didn’t really think money market funds were just T-bills, did you?
So…how was it that a money market fund at a bank or brokerage firm would be paying (for example) 1% and an outfit like ING could pay 3%?
Hmmm. Exactly what WAS in that money market over there? It certainly wasn’t all treasury bills.
But I digress. Lehman Brothers was not only a market maker/facilitator for the commercial paper market. They also borrowed heavily to fund their day-to-day operations with commercial paper.
OK, so remember a moment or so back when I wrote “a few money market mutual funds had some trouble maintaining their $1.00 per share price. Their assets get priced every business day”? Here is where things fell apart:
Lehman was a big player in the commercial paper market (as were all the big banks, along with GE Credit, Ford, GM and AIG, and others). When you manage a money market fund, and your balance sheet is choking on stuff like short term financing notes (commercial paper) from companies that may not open for business the following Monday…well…what do you think you can sell those investments for?
A lot less than you paid for them.
Which is why suddenly, money markets assets stopped “adding up” to $1.00 per share. It’s like walking home with a lousy report card in your hand.
Bad.
Taking Bear Stearns and Lehman Brothers out of the commercial paper market is like taking the umpires off the field in a Little League game. All that’s left are little kids who don’t know the rules. Actually, it’s not fair to compare those two companies with umpires. But a Little League game without umpires looks like disorganized chaos. And that’s when Uncle Sammy pulled up to the field, and change the rules.
{ 0 comments }
Mark to Market Accounting: a basic analogy
by Thomas Mullooly on March 12, 2009
How mark to the market accounting helped kill Wall Street
Mark-to-market accounting is what’s used in your brokerage account — your margin account at a Wall Street firm. To understand mark to market accounting, let’s look at what happens in a retail brokerage account that trades on margin:
Suppose you invest $80,000 in cash in a brokerage account. You sign up for margin capability. Before you place a trade in your account, you have the ability to buy up to $160,000 worth of securities with only $80,000. You will pay margin interest on any outstanding balances, and your “margin maintenance” is recalculated every night – based on the gain or loss in value of the securities in the account. This is how a margin account works.
Using the above illustration, you have 50% equity in the account, and have an outstanding margin (or debit) balance of $80,000.
Suppose the value of the assets in the account drop from $160,000 to $145,000. You now have 45% equity in your account. You still have buying power and seem to be in no imminent danger of a margin call. Remember, you still owe $80,000. If you were to close the account now, you would sell the assets for $145,000. The margin debit balance of $80,000 would be paid (margin interest would also be included). The securities dropped almost 10% in value (from $160,000 down to $145,000) but you lost nearly twice that percentage, because you leveraged the trade. You would be left with the remainder… approximately $65,000.
But suppose the value of the assets in the account dropped from $160,000 to $100,000. You now have 20% equity in your account. Remember, you still owe $80,000. At this stage, you have no more “buying power.” This means you cannot take money from the account, nor can you buy any additional investments. In fact, at 20% equity you have a “margin call” and your broker would be contacting you requiring you to deposit more money (or other securities) to boost the equity in the account.
Margin works wonderfully when the assets in your account are rising in value. But margin will wipe you out when the assets in your account are falling in value.
The assets in the account are repriced every single night in a margin account. And the equity is calculated every day and the amount needed for “margin maintenance” is also calculated every day. And when your account gets upside down, you have a margin call, and it needs to be rectified right away.
Margin accounts are calculated using mark to the market accounting.
Banks (and brokerage firms) that own mortgage backed securities have been required — since November 2007 — to use mark to market accounting on these securities. Coincidentally, this was just around the time these mortgage securities started dropping precipitously in value. 2007 saw many mortgage firms get wiped out, and brokerage firms and banks holding these assets started realizing the volatility of these assets.
Remember banks and brokerage firms were required to employ mark to market accounting beginning in November 2007 for mortgage backed securities. As real estate values collapsed, and foreclosures began to rise, banks and brokerage firms no longer wanted to hold the securities as investments on their books. It is no wonder then, that six months later (March 2008) that one of the biggest holders of mortgage backed securities — Bear Stearns — was caught in a massive credit squeeze. The assets that they regularly borrowed against were no longer “borrow-able.”
Bear Stearns — which had traded at well over $100 per share months before, agreed to sell themselves to J.P. Morgan Chase for two dollars per share. This figure was ultimately increased to $10 per share.
By mid– 2008, Merrill Lynch had decided to unload a $31 billion pool of mortgage backed securities that they owned, and essentially announced they would take the best offer. These mortgage backed securities had been held on the books (it’s estimated) at $.80 on the dollar. This pool was sold for $.22 on the dollar in July, only after Merrill Lynch agreed to subsidize part of the losses that might be incurred by the buyer.
These are anecdotes and examples using vast over-simplification and are being used to illustrate how mark-to-market accounting works.
While not directly connected, mark to market accounting required that other banks and brokers investing in similar type investments market their own similar assets down to similar levels. Thus, the entire mortgage backed market froze. Trades were no longer taking place, because every time a trade would take place, it would require the values of similar securities to be repriced everywhere. These securities could no longer find a value and could not be borrowed against, hampering most lending capabilities at these firms.
{ 0 comments }