Recently, Richard Berner, head of the Treasury's Office of Financial Research (OFR), spoke on "Lessons from the Financial Crisis - Eight Years Later, and mentioned repo and money funds a couple of times. He commented, "The financial crisis of 2007-09 now seems distant, and the chance of a future financial disruption seems remote. So it's not surprising that some question why we need continued vigilance over financial stability." We review his comments below, and we also excerpt from recent briefs from Fidelity Investments and Wells Fargo Securities.
OFR's Berner tells us, "If nothing else, we learned in the crisis that vigilance is vital. The years of calm before the crisis bred complacency about risk. Hidden weak spots in the financial system surfaced in the crisis, with significant adverse consequences for the economy. Major gaps in our ability to measure financial activity also surfaced and limited our ability to recognize weak spots, even when they were in front of us. The Office of Financial Research (OFR) was established to provide data and analysis that policymakers and industry need to assess and monitor coming storms. The OFR has played key roles in filling those gaps."
He explains, "Collecting data describing bilateral repurchase (repo) agreements is an important example of the OFR's essential work to improve data scope. Repo markets, a linchpin for financial system functioning, provide more than $3 trillion in daily funding for securities transactions. But those funding sources misfired in the financial crisis. Investors under stress ran from them, and funding and liquidity dried up."
Berner continues, "Bilateral repo transactions, settled between the transacting parties, account for half the U.S. repo market. But data about bilateral repo are limited. The OFR, in collaboration with the Federal Reserve System, is filling that gap with a permanent collection of repo data. Those data will help industry to manage risk and officials to improve market resilience."
He says, "Creating an alternative to LIBOR is another example of essential OFR work. LIBOR, formerly the London Interbank Offered Rate, is an interest-rate benchmark used to price borrowing rates on major consumer purchases, such as homes and cars, and for $150 trillion in derivatives. LIBOR's central role and broad use as a reference rate mean it must be reliable. Attempts at manipulation and the decreasing relevance of the markets used to establish the rate sparked calls for alternatives. The Federal Reserve Bank of New York and the OFR are working to devise a more reliable, widely accepted alternative. Even if financial activity moves out of the range of the Federal Reserve's collection authority, the OFR would still be able to collect the needed data."
Finally, Berner adds, "While some OFR monitors use data unavailable elsewhere, the U.S. Money Market Fund Monitor makes existing Securities and Exchange Commission data accessible to industry and policymakers in new ways to reveal risk. This monitor puts at users' fingertips more than 4 million records of monthly data on the holdings of about 500 funds spanning the last five years -- previously available only as separate individual filings and industry-level monthly reports. The monitor is gaining wide acceptance in the industry, and other agencies are calling on the OFR for access to the money fund monitor and other monitors, and for help in developing similar ones."
In other news, an update from Fidelity Investments entitled, "Money Market Investors Ponder Rate Outlook and Looming Debt Ceiling states, "With supply constrained nearing year-end, the Fed RRP facility was the next viable source of supply for MMFs.... At the end of 2016's third quarter, many MMFs had one-third or more of their portfolios invested in the facility. At year-end, investors had utilized $468.4 billion of the facility -- close to the 2015 year-end total of $474.6 billion. The government's borrowing limit -- the debt ceiling -- is anticipated to be reinstated in mid-March. Post-election politics could influence the process. In a scenario where Congress doesn't raise the limit, experience from recent years would indicate that the Treasury's cash balance -- regulated by law -- would have to decrease dramatically, curtailing T-bill issuance."
The piece continues, "The Treasury has already started taking steps to address this possibility. It has drawn down its cash balance while scaling back recent T-bill auctions. With little incentive for the Treasury to change this strategy in the first quarter, investors could see reduced auction sizes, which could put downward pressure on rates. Reduced auction sizes could also put downward pressure on other money market rates, such as agency securities and the repurchase (repo) markets.... If Congress doesn't act by the deadline, the Treasury can use "extraordinary measures," but that would only give it breathing space until late summer or early fall. In such a scenario, interest rates on bills set to mature around the time of a potential payment default may rise."
Fidelity also comments, "As of December 31, 2016, government MMFs stood at $2,181 billion -- 81% of total money market assets. To the extent that debt ceiling constraints result in fewer T-bills, government MMFs may be more dependent on the Fed's RRP facility for supply, which could mean lower yields on those funds. With this imbalance, yield spreads between prime and government MMFs could widen further and potentially offer additional incentives for short-term institutional investors to segment their cash, to try and take advantage of the higher prime rates."
Finally, Wells Fargo Securities' latest "Short-Term Market Strategy" says that, "2016 was the year of Money Market Fund Reform; a much talked about and debated regulatory change whose final chapter closed on October 14, 2016, resulting in a complete flip flop of the money market landscape.... Despite the exodus from Prime funds, total Money Market fund assets remained relatively stable in 2016, averaging $2.72 trillion. Total fund assets touched a low point around the October reform implementation date, but have since recovered, ending 2016 above $2.7 trillion. The influence of MMF reform will be apparent in many of the 2016 Year in Review charts as we consider it to be the most significant structural short-term market event of the year."
Wells writes, "Although Prime and Government funds make up the lion's share of MMF assets, tax-exempt funds are another important asset category that experienced dramatic outflows in 2016. Tax-exempt fund assets dropped by 50 percent, which contributed to a sharp spike in the weekly SIFMA index, attracting a number of a-typical investors to the VRDN market, which eventually caused the index to partially retrace."
They conclude, "With the amount of cash that moved to Government funds in late 2016, eligible investment supply quickly became a concern for many asset managers. This was alleviated by a sharp increase in short-dated government assets. Treasury bills outstanding rose, trough-to-peak, by almost $400 billion. Short-term agency issuance also supported the growth of government funds, particularly floating rate securities issued by the Federal Home Loan Bank."
