The U.S. Treasury Department's Office of Financial Research released a paper late last week entitled, "A Map of Funding Durability and Risk, written by Andrea Aguiar and Thomas Wipf from Morgan Stanley and Rick Bookstaber from the OFR. The 28-page report explores how "the dynamics of the financial system and the undercurrents of its vulnerabilities rest on the flow of funding." In particular, the paper analyzes high profile failures from the recent economic crisis -- the seizing up of short-term funding at Bear Stearns; the counterparty exposures and near-bankruptcy of American International Group; and the Lehman Brothers bankruptcy -- to illustrate the need to understand funding flows and related collateral flows. It examines how, "Stresses to one part of the system can spread to others, in an extreme case resulting in a threat to financial stability." We also briefly discuss Euro money funds and the possibility of negative rates below.
The paper tells us, "The funding map shows the path of funding from the key funding sources -- like money market funds, pension funds and corporate treasurers -- through the Bank/Dealer to the users of that funding. Flows are not shuffled from one institution to another, the report states; they are transformed in various ways.... Funding provides the fuel for these transformations. For that reason, the possible loss of funding under stress is a dominant risk to the Bank/Dealer's ability to create or intermediate these transformations."
It explains, "This paper uses the funding map to introduce the concept and importance of "funding durability," defined as the effective term of funding in the face of signaling and reputational considerations during periods of stress." In other words, the authors say, durability determines how long a Bank/Dealer can remain independently solvent without reducing assets that in turn would create broader market stress. "When the loans and commitments that the Bank/Dealer makes are more durable than the funding sources used to finance them, there is the risk of a funding shortfall," the paper says. This can lead to a forced sale of assets or fire sale.
The paper states, "Money market funds are not a source of durable funding because for liquid funding they are limited in the term of their secured funding under the Securities and Exchange Commission's regulation 2a-7. Also, during a stress event, money market fund investors may redeem their shares, requiring the money market fund to liquidate its investments."
"If less durable funding is used to fund an asset that is difficult to fund in normal environments, there is a risk that funding might be pulled away in a stressed environment while the exposure that is being funded remains," the authors assert. "On that basis, funding with low durability should be limited to securities such as U.S. Treasuries and other top-quality sovereign debt, while only highly durable funding should be used for illiquid securities such as sub-investment grade asset-backed securities and longer-term, illiquid obligations."
In conclusion, the authors state that the funding map can be used as a schematic for identifying the data that are needed to track funding and related collateral flows through different entities linked to a Bank/Dealer. "Once populated with the required data, this model will emphasize funding-related vulnerabilities and trace possible paths of contagion, as well as highlight alternative paths for critical funding and securities," it tells us.
In other news, The New York Times features "Europe Likely to Get Negative Interest Rates", which says, "First there was ZIRP. Now get ready for NIRP. The first is "zero interest-rate policy," the strategy for trying to stimulate economic growth that the United States has undertaken for the last 5 1/2 years (and the Bank of Japan much longer than that). The second is "negative interest rate policy." And that's what the European Central Bank is likely to put in place on Thursday for the 18 nations that use the euro currency. That, anyway, is the move that leaders of the European bank have telegraphed to markets."
According to Crane Data's Money Fund Intelligence International, there are currently 98 funds denominated in Euro with just E79.0 billion in assets. (These are domiciled in Dublin and Luxembourg and marketed to multinational corporations. These don't include French money funds, which we consider more akin to ultra-short bond funds.) Our Crane EUR MMF Index is currently yielding 0.12% on average, so these funds do have some room to see yields fall. We expect the gradual exodus out of this sector to continue though, and we may see funds close to new investments in order to delay the impact of negative yields. The 10 largest managers of Euro money funds include: BlackRock (E17.8B), Goldman (E13.0B), JPMorgan (10.9B), Deutsche (E9.4B), BNP Paribas Insticash (E7.7B), SSgA (4.3B), Amundi (E3.9B), HSBC (E3.9B), Morgan Stanley (E2.7B), and Fidelity (E1.2B).
