The FCIC, an agency created to "examine the causes, domestic and global, of the current financial and economic crisis in the United States," released its comprehensive 633-page report entitled, "Financial Crisis Inquiry Report" yesterday. The press release, entitled, "Financial Crisis Inquiry Commission Releases Report on the Causes of the Financial Crisis," says in its subtitle, "This Crisis was Avoidable – a Result of Human Actions, Inactions and Misjudgments; Warning Signs Were Ignored." It adds, "Today the Financial Crisis Inquiry Commission delivered the results of its investigation into the causes of the financial and economic crisis." The work contains a number of references to money market funds, commercial paper and events in the money markets during 2007 and 2008.
The release comments, "The Commission concluded that the crisis was avoidable and was caused by: Widespread failures in financial regulation, including the Federal Reserve's failure to stem the tide of toxic mortgages; Dramatic breakdowns in corporate governance including too many financial firms acting recklessly and taking on too much risk; An explosive mix of excessive borrowing and risk by households and Wall Street that put the financial system on a collision course with crisis; Key policy makers ill prepared for the crisis, lacking a full understanding of the financial system they oversaw; And systemic breaches in accountability and ethics at all levels."
Chapter 2 on "Shadow Banking," gives some money fund history, saying, "In the '70's, Merrill Lynch, Fidelity, Vanguard, and others persuaded consumers and businesses to abandon banks and thrifts for higher returns. These firms -- eager to find new businesses, particularly after the Securities and Exchange Commission (SEC) abolished fixed commissions on stock trades in 1975 -- created money market mutual funds that invested these depositors' money in short-term, safe securities such as Treasury bonds and highly rated corporate debt, and the funds paid higher interest rates than banks and thrifts were allowed to pay. The funds functioned like bank accounts, although with a different mechanism: customers bought shares redeemable daily at a stable value. In 1977, Merrill Lynch introduced something even more like a bank account: 'cash management accounts' allowed customers to write checks. Other money market mutual funds quickly followed. These funds differed from bank and thrift deposits in one important respect: they were not protected by FDIC deposit insurance. Nevertheless, consumers liked the higher interest rates, and the stature of the funds' sponsors reassured them."
Chapter 13, "Summer 2007: Disruptions in Funding," says on page 252, "In August, the turmoil in asset-backed commercial paper markets hit the market for structured investment vehicles, or SIVs, even though most of these programs had little subprime mortgage exposure. SIVs had a stable history since their introduction in 1988. These investments had weathered a number of credit crises -- even through early summer of 2007.... SIVs held significant amounts of highly liquid assets and marked those assets to market prices daily or weekly, which allowed them to operate without explicit liquidity support from their sponsors. The SIV sector tripled in assets between 2004 and 2007. On the eve of the crisis, there were 36 SIVs with almost $400 billion in assets."
Page 253 continues, "The next dominoes were the money market funds and other funds. Most were sponsored by investment banks, bank holding companies, or 'mutual fund complexes' such as Fidelity, Vanguard, and Federated. Under SEC regulations, money market funds that serve retail investors must keep two sets of accounting books, one reflecting the price they paid for securities and the other the fund's mark-to-market value (the 'shadow price,' in market parlance). However, funds do not have to disclose the shadow price unless the fund's net asset value (NAV) has fallen by 0.05 below $1 (to $0.995) per share. Such a decline in market value is known as 'breaking the buck' and generally leads to a fund's collapse. It can happen, for example, if just 5% of a fund's portfolio is in an investment that loses just 10% of its value. So a fund manager cannot afford big risks."
It adds, "But SIVs were considered very safe investments -- they always had been -- and were widely held by money market funds. In fall 2007, dozens of money market funds faced losses on SIVs and other asset-backed commercial paper. To prevent their funds from breaking the buck, at least 44 sponsors, including large banks such as Bank of America, US Bancorp, and SunTrust, purchased SIV assets from their money market funds. Similar dramas played out in the less-regulated realm of the money market sector known as enhanced cash funds.... As the market turned, some of these funds did break the buck, while the sponsors of others stepped in to support their value. The $5 billion GE Asset Management Trust Enhanced Cash Trust, a GE-sponsored fund that managed GE's own pension and employee benefit assets, ran aground in the summer.... Bank of America supported its Strategic Cash Portfolio -- the nation's largest enhanced cash fund."
Finally, on page 254, the report describes, "An interesting case study is provided by the meteoric rise and decline of the Credit Suisse Institutional Money Market Prime Fund. The fund sought to attract investors through Internet-based trading platforms called 'portals,' which supplied an estimated $300 billion to money market funds and other funds. Investors used these portals to quickly move their cash to the highest-yielding fund. Posting a higher return could attract significant funds: one money market fund manager later compared the use of portal money to 'drinking from a fire hose.' But the money could vanish just as quickly. The Credit Suisse fund posted the highest returns in the industry during the 12 months before the liquidity crisis, and increased its assets from about $5 billion in the summer of 2006 to more than $25 billion in the summer of 2007. To deliver those high returns and attract investors, though, it focused on structured finance products, including CDOs and SIVs such as Cheyne. When investors became concerned about such assets, they yanked about $10 billion out of the fund in August 2007 alone. Credit Suisse, the Swiss bank that sponsored the fund, was forced to bail it out, purchasing $5.7 billion of assets in August. The episode highlights the risks of money market funds' relying on 'hot money' -- that is, institutional investors who move quickly in and out of funds in search of the highest returns." Look for more excerpts, including the Bankruptcy of Lehman, next week.
