Federal Reserve Governor Jeremy Stein spoke yesterday in Frankfurty on "Dollar Funding and Global Banks," saying, "I will focus my remarks on one important aspect of this issue--namely, the growing use of wholesale dollar funding by global financial institutions. I'll begin by briefly discussing research I've been doing, along with my coauthors Victoria Ivashina and David Scharfstein, which examines some of the consequences of this funding model during times of market stress." We also discuss the most recent liquidation in the money fund space; on Friday, the Sterling Capital Money Market Funds (formerly BB&T funds) liquidated.

The Fed's Stein writes, "To test the model's implications, my coauthors and I focused on events in the second half of 2011, when the credit quality of a number of large euro-area banks became a concern and U.S. prime money market funds sharply reduced their lending to those banks. In a span of four months, the exposure of money funds to euro-area banks fell by half, from about $400 billion in May to about $200 billion in September. Coincident with this contraction in dollar funding, the CIP basis widened in the direction predicted by our model, increasing the cost of obtaining synthetic dollars via the FX swap market."

He tells us, "We used data from the international syndicated loan market to test the model's predictions about the reaction of lending to this type of funding stress. We found that dollar-denominated lending by euro-area banks fell relative to their euro-denominated lending, while this result did not hold for U.S. banks.... Finally, euro-area banks that relied most on funding from U.S. money market funds also cut back most sharply on their dollar-denominated lending."

Stein explains, "This last result is similar to one in recent work by my Fed colleagues Ricardo Correa, Horacio Sapriza, and Andrei Zlate. They documented that the U.S. branches of foreign banks that experienced the most shrinkage in their dollar-denominated large time deposits--funding that had been mostly provided by money market funds prior to mid-2011--cut their U.S.-based commercial and industrial lending by more than banks that fared better on this score. Taken together, these findings have two types of policy implications: one for central bank responses to dollar funding pressures and another for measures to regulate foreign banking firms that rely heavily on short-term wholesale funding."

He adds, "Finally, the central role played by money market funds in the 2011 episode is a reminder of the fragility of these funds themselves--and of the risk created by their combination of risky asset holdings, stable-value demandable liabilities, and zero-capital buffers. The events following the Lehman Brothers bankruptcy in 2008 provide even starker evidence of the risks that money market funds pose for the broader financial system. In light of these vulnerabilities, I welcome the recent proposed recommendations by the Financial Stability Oversight Council for further money market fund reforms."

The prospectus filing announcing the liquidiation of the Sterling Capital Money Market Funds says, "The Board of Trustees of Sterling Capital Funds has approved the liquidation and termination of the Sterling Capital National Tax-Free Money Market Fund, Sterling Capital Prime Money Market Fund and Sterling Capital U.S. Treasury Money Market Fund. Accordingly, the assets of each Fund will be liquidated on or about December 14, 2012. After paying in full all known or reasonably ascertainable liabilities of a Fund, including without limitation all charges, taxes and expenses of such Fund, whether due, accrued or anticipated, that have been incurred or are expected to be incurred by the Fund, the Fund will distribute to its shareholders their pro rata share of the proceeds. Proceeds of each Liquidation are expected to equal $1.00 per share, and will be distributed to shareholders of the applicable Fund in a complete redemption of their shares on or about December 14, 2012 in the manner set forth below."

Note that the advisor recent launched Sterling Capital Deposit Account and Sterling Capital Ultra-Short Bond Fund. Sterling Capital becomes the 8th fund manager tracked by Crane Data to liquidate or merge its money market funds away in 2012 (73 managers remain, several other tiny complexes that we didn't cover have liquidated too). These include: MTB (merged into Wilmington), Fifth Third (merged into Federated), Victory (liquidated), Old Mutual (liquidated), Bishop Street (liquidated), Highland/Pyxis (liquidated), and TCW (liquidated). See our Nov. 13 News, "Consolidation Continues: Pyxis, Some Dreyfus Muni MFs Liquidating".

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