News Archives: December, 2009

Crane Data and Money Fund Intelligence wishes all of its subscribers and visitors a Happy New Year! We wish you all the best of luck, and higher yields, in 2010.... Below, we continue with our 10 most important stories of 2009 from Crane Data's News archives. We excerpt from the second half of our major stories of the year by date. See yesterday's Crane Data News for the first half of our "Top 10."

Sept. 14, 2009. Road to Consensus Clear After Comments on SEC MMF Reform Proposals. At least 135 letters have now been posted commenting on the SEC's Money Market Reform Proposals. Given the volume of feedback (we'll be reading these for the next several weeks), we would expect any Final Rules on Money Market Fund Reform to appear around year-end, at the earliest. Many of the letters argue for extended implementation periods, as well, so don't expect any action anytime soon. We believe the road to consensus and compromise is now relatively clear, though there are a number of minor issues that the SEC could have a tough time with. Every single letter has lambasted the idea of a floating rate NAV, save for perhaps one or two from fringe (or anonymous) individuals. So we'd be shocked if this strange 'concept' wasn't excluded from the final rules and from any serious future discussions.

Sept. 17, 2009. Treasury Guarantee Ending Friday, But Plenty of Support Remains. Up until the last week or two, it seemed like the expiration of the U.S. Treasury's Temporary Guarantee Program for Money Market Mutual Funds would expire without anyone noticing. Though investors appear to be sanguine, a number of reporters have shown interest in the topic of late.... Crane Data points out that, though the $1.00 NAVs of funds will no longer be guaranteed after Friday, almost every major segment of the money market will continue to enjoy some type of government support into 2010. Taxable money funds hold over half of their assets (54.3%) in Treasuries (14.0%), Government Agency Securities (22.1%), and Repurchase Agreements (18.3%) (almost all of which are now backed by Treasuries or Agencies). Commercial Paper (16.3%) and Asset-backed CP (included in CP) continue to have access to the Federal Reserve's AMLF and continue to be indirectly supported by the CPFF, which both have been extended through Feb. 1, 2010. Also, Certificates of Deposits and Eurodollar CDs (20.1% of money fund assets) continue to have access to a myriad of U.S. and European government guarantee and support programs for substantial portions of their debt.

Nov. 13, 2009. Money Fund Asset Declines Continue, YTD Drop Almost $500 Billion. Money market mutual fund assets declined for the fifth week in a row and the ninth week out of the past 11 according to the latest statistics from the Investment Company Institute. The declines moderated in the week ended Wednesday, November 11, with assets dropping by $3.68 billion to $3.335 trillion, their lowest level since the end of January 2008. Money fund assets have declined by $495 billion, or 12.9%, year-to-date, and have declined by $585.2 billion, or 14.9%, since setting a record high of $3.920 trillion on Jan. 14, 2009.

Nov. 27, 2009. Reserve Primary Fund Debacle Nears Resolution as Court OKs SEC Plan. Investors in the ill-fated Reserve Primary Fund, which 'broke the buck' in September 2008, should soon see their total recovery increase to 99 cents on the dollar after a court okayed the distribution of most of the fund's remaining assets. The SEC released a "Statement of Securities and Exchange Commission Chairman Mary L. Schapiro on the Court's Order Adopting the SEC's Proposed Distribution Plan in the Reserve Primary Fund Case" late Wednesday, which says, "We are pleased with the court's order adopting the SEC's distribution plan in the Reserve Primary Fund case."

Nov. 30, 2009. Money Funds Await PWG Report, Rule 2a-7 Changes Pushed Into 2010. Money market mutual funds are bracing for the possible arrival this week of a report from the President's Working Group on Financial Markets, but it appears that the SEC's finalized Money Market Fund Reform Proposals won't be appearing any time soon. The PWG report, which had been originally expected Sept. 15, is expected to comment on the SEC's proposed changes to Rule 2a-7 and on the possibility of a floating NAV and a private liquidity facility. While we've received no word on whether the PWG report is still on schedule [we still expect something soon], we have heard that the SEC is rolling back its timetable on final 2a-7 amendments to the first quarter of 2010. (Comments from the SEC indicate that there may also be a second round of proposals later in 2010.)

Below, we excerpt from what we consider the 10 most important stories from Crane Data's News archives for 2009. While ultra-low yields and fee waivers, mergers and consolidation, and of course massive asset outflows were major issues for money funds this past year, the list is dominated by regulatory proposals and discussion. We list the first five major stories of the year below by date. We'll continue with the remaining five in tomorrow's Crane Data News.

Jan. 19, 2009. Group of Thirty Recommendation Poses Threat to Money Market Funds. The Group of Thirty, a "private, nonprofit, international body composed of very senior representatives of the private and public sectors and academia" recently issued a publication entitled, "Financial Reform, a Framework for Financial Stability," which contains suggestions that, if implemented, would change money market funds dramatically and could threaten the very existence of the money fund business.

March 18, 2009. ICI MM Working Group Ships Report: WAM, Liquidity Changes in Store. The Investment Company Institute said today that its "Board of Governors has received a report from the Money Market Working Group and has unanimously endorsed the Group's recommendations concerning new regulatory and oversight standards for money market funds." No major changes were proposed, and, unsurprisingly, the report opposes floating NAVs, insurance and capital reserves for money funds. Suggestions of note include adding a 5% 1-day and 20% 7-day liquidity mandate, reducing the WAM maximum from 90 to 75 days, adding monthly client concentration and portfolio holding disclosures, eliminating investment in 'Second Tier' securities, and implementing stess-testing of portfolios.

April 1, 2009. Treasury Extends Money Fund Guarantee Program Until Sept. 18, 2009. Yesterday, the U.S. Treasury Department "announced an extension of its temporary Money Market Funds Guarantee Program through September 18, 2009, in order to support ongoing stability in financial markets." The Program, originally launched on Sept. 19, 2008, had been scheduled to end on April 30, 2009. Most funds will continue to pay 1.5 basis points for coverage and will have until April 13 to reapply. We expect a number of Treasury and government funds to drop coverage, but we expect prime and tax-exempt funds to virtually all reenlist.

June 18, 2009. Treasury's 'Financial Regulatory Reform: A New Foundation' on MMFs. Yesterday, the Obama Administration and Department of the Treasury unveiled a white paper entitled, "Financial Regulatory Reform: A New Foundation," which spends less than two of its 89 pages discussing money market funds. It says under the section, "Reduce the Susceptibility of Money Market Mutual Funds (MMFs) to Runs," "The SEC should move forward with its plans to strengthen the regulatory framework around MMFs to reduce the credit and liquidity risk profile of individual MMFs and to make the MMF industry as a whole less susceptible to runs."

July 1, 2009. SEC Releases 197-Page Text of Proposed Money Market Fund Reform. The SEC has released the full text of its proposed "Money Market Fund Reforms". The 197-page document's summary says, "The Securities and Exchange Commission is proposing amendments to certain rules that govern money market funds under the Investment Company Act. The amendments would: (i) tighten the risk-limiting conditions of rule 2a-7 by, among other things, requiring funds to maintain a portion of their portfolios in instruments that can be readily converted to cash, reducing the weighted average maturity of portfolio holdings, and limiting funds to investing in the highest quality portfolio securities.... In addition, the Commission is seeking comment on other potential changes in our regulation of money market funds, including whether money market funds should, like other types of mutual funds, effect shareholder transactions at the market-based net asset value, i.e., whether they should have 'floating' rather than stabilized net asset values."

Yesterday, the Federal Reserve Board proposed "amendments to Regulation D that would enable the establishment of a term deposit facility," according to a statement. It says, "Under the proposal, the Federal Reserve Banks would offer interest-bearing term deposits to eligible institutions through an auction mechanism. Term deposits would be one of several tools that the Federal Reserve could employ to drain reserves to support the effective implementation of monetary policy. This proposal is one component of a process of prudent planning on the part of the Federal Reserve and has no implications for monetary policy decisions in the near term."

The Fed's full proposal says, "The Board is requesting public comment on proposed amendments to Regulation D, Reserve Requirements of Depository Institutions, to authorize the establishment of term deposits. Term deposits are intended to facilitate the conduct of monetary policy by providing a tool for managing the aggregate quantity of reserve balances. Institutions eligible to receive earnings on their balances in accounts at Federal Reserve Banks could hold term deposits and receive earnings at a rate that would not exceed the general level of short-term interest rates. Term deposits would be separate and distinct from those maintained in an institution's master account at a Reserve Bank as well as from those maintained in an excess balance account. Term deposits would not satisfy required reserve balances or contractual clearing balances and would not be available to clear payments or to cover daylight or overnight overdrafts. The proposal also would make minor amendments to the posting rules for intraday debits and credits to master accounts as set forth in the Board's Policy on Payment System Risk to address transactions associated with term deposits."

It explains, "The Federal Reserve has addressed the financial market turmoil of the past two years in part by greatly expanding its balance sheet and by supplying an unprecedented volume of reserves to the banking system. Term deposits could be part of the Federal Reserve's tool kit to drain reserves, if necessary, and thus support the implementation of monetary policy. Term deposits would be distinct from balances held by eligible institutions in their master accounts. Term deposits could not be withdrawn prior to maturity, would not satisfy required reserve balances or contractual clearing balances, and would not be available to clear payments or cover daylight or overnight overdrafts. Term deposits would, however, be eligible to collateralize discount window advances."

The Fed says, "Term deposits could be structured in many different ways. For example, term deposits could be offered at one maturity or several maturities. Moreover, the interest rate or rates paid on term deposits could be set through an auction mechanism or, alternatively, could be set administratively or by a formula.... The maximum-allowable rate for each auction of term deposits would be no higher than the general level of short-term interest rates. For these purposes, 'short-term interest rates' would be defined as the primary credit rate and rates on obligations with maturities of up to one year in which eligible institutions may invest, such as rates on term federal funds, term repurchase agreements, commercial paper, term Eurodollar deposits, and other similar rates."

Finally, they say, "Any 'eligible institution' could hold term deposits.... Branches and agencies of foreign banks are included within the definition of 'eligible institution' and could therefore hold term deposits. Unlike branches of domestic banks, branches and agencies of the same foreign bank that are located in different Reserve Bank Districts may have separate master accounts at the corresponding Reserve Banks. The proposal anticipates that each affiliated branch of a foreign bank would be eligible to bid separately at term deposit auctions and maintain separate term deposits at that branch's Reserve Bank unless the Board determines otherwise."

BNY Mellon's Liquidity DIRECT online money market fund "portal" (formerly known as Money Funds Direct), recently posted a new issue of its "Liquidity Directions" newsletter. The latest edition features comments on global liquidity and money funds by Jonathan Spirgel, Managing Director of Liquidity Services at BNY Mellon and a review of proposed money fund reforms by Peter G. Crane of Crane Data LLC.

The first piece, "Half-Empty or Half-Full?, is subtitled, "A Puzzling Predicament for Global Liquidity." The newsletter asks Spirgel, "Even the most liquid of assets, such as money market funds, have come under increased scrutiny. What are portfolio managers and regulators doing to ensure fund safety?" He says, "Early in the credit crises, a high-profile fund 'broke the buck' and this sent shockwaves throughout the industry. Much like banking, the industry is tightening its standards while working closely with government regulators to ensure safety, stability and liquidity. New regulatory proposals include shorter maturity limits, more stringent ratings, and periodic stress tests to examine a fund's ability to maintain a stable net asset value in the event of market shocks."

Liquidity Directions also asks, "What makes BNY Mellon's Liquidity DIRECT one of the industry's top investment portals for cash management?" Spirgel answers, "Through Liquidity DIRECT, we offer a wide range of money markets funds, as well as individual securities available through BNY Mellon Capital Markets, LLC, a registered broker-dealer, all on a single investment platform. Also, since we are part of the world's largest custodian bank, we also offer a wide range of first-class custody services. BNY Mellon has over $22 trillion in assets under custody and is consistently ranked as the industry's top custodian. This adds considerable comfort as clients seek safekeeping in capital markets around the world."

Crane writes in "A Review of Proposed, and Likely, Money Market Fund Reforms, "Pending SEC proposals would require funds to maintain a portion of their portfolios in instruments that can be readily converted to cash, shorten the weighted average maturity of holdings from 90 days to 60, and limit investments to only the highest quality securities. The new proposals would also require money market funds to report their holdings monthly to the SEC; and permit a money market fund that has 'broken the buck' to suspend redemptions to allow for the orderly liquidation of fund assets."

Crane says in the newsletter, "Other significant proposed changes include eliminating 'illiquid' and 'second tier' securities from money funds, requiring liquidity buckets of 5% or 10%, and 15% or 30% for daily and weekly holdings for retail or institutional funds, and requiring the disclosure of monthly portfolio holdings (from quarterly). We expect the WAM to change, but to 75 days instead of 60. We expect the liquidity buckets to be toned down, and the retail vs. institutional distinction to be removed. We'd also guess that the 'illiquid' bucket, currently 10%, is reduced to 5%, but that the ban on 'tier 2' securities sticks."

Finally, Crane adds, "While the majority of the potential changes to money funds involve minor technical issues and tweaks, the SEC also asked market participants to comment on the theoretical possibility of a floating net asset value for money funds. Practically every single comment letter submitted opposed this radical idea. It's important, too, to note that this concept was put out for discussion only, and not proposed as a change in current regulations. Given the lack of support for the concept and the uncertainty surrounding such a drastic change, we think it's highly unlikely that regulators will alter the core concepts of money market funds' structure, the $1.00 a share stable value and amortized cost method of valuation."

Minority-and-woman-owned fixed-income asset manager Utendahl Capital Management has just filed with the SEC to launch Utendahl Floating NAV Fund, a quasi-money market offering that will invest in two underlying portfolios, Utendahl Credit Floating NAV Fund, run by PIMCO, and Utendahl Government Floating NAV, run by Utendahl. The hybrid, though it doesn't use the term "money market" in its name, certainly sounds like it will operate like one, but without the $1.00 NAV. It appears to follow in the footsteps of Deutsche's DWS Variable NAV Money Fund. (See Crane Data's Sept. 3 News "Deutsche Proposes Floating NAV MMFs to Join Stable in SEC Comment".)

The Utendahl Floating NAV Fund's filing says, "The Fund seeks to provide high levels of current income while providing daily liquidity and principal preservation. The Fund is a 'fund of funds' that seeks to achieve its investment objective by investing in a combination of underlying funds managed by the Adviser. The Fund's assets are allocated among the Underlying Funds. The allocation between the Credit Fund and the Government Fund will remain in a range of at least 20% and no more than 80% allocated to each of the Underlying Funds."

It says, "The Underlying Funds maintain an average portfolio maturity of 90 days or less (weighted by the relative values of its holdings), and generally do not invest in any securities with a remaining maturity of more than 465 days (approximately 15 months). In general, the majority of securities will have a remaining maturity of 397 days or less. Each of the Fund and Underlying Funds is a floating NAV fund and seeks to maintain a net asset value close to $10.00 per share. Unlike money market funds, the Underlying Funds do not seek to maintain a stable share price of $1.00 and will not use the amortized cost method of valuation."

The filing continues, "Instead, the Underlying Funds generally value their portfolio securities using current market prices furnished by an independent pricing service. As a result, each Underlying Fund's share price, which is its net asset value per share (or NAV), will vary and reflect the effects of unrealized appreciation and depreciation and realized losses and gains. This feature is designed to maintain liquidity and reduce the likelihood of shareholder redemptions prompted to avoid unrealized depreciation or realized losses."

The fund's expenses have been capped at 0.20% and its minimum is $5 million. It will be managed by Thomas Mandel of Utendahl Capital Management. The fund will be distributed by Foreside Distributors and administed by Atlantic Fund Administration, both located in Portland, Maine.

This mark's Utendahl's first return to the "cash" space since halting redemptions on its UCM Institutional Money Market Fund (UCMXX) the week of the money market meltdown in September 2008. UCMXX was liquidated in April 2009 with no losses to shareholders. Crane Data doubts that floating rate "money market funds" will be permitted by regulators, and thinks investor interest will be slim even if they're allowed. But we'll of course be watching developments with great interest.

P.S. Merry Christmas from Crane Data LLC! We wish all of you a safe and happy Holiday!

We learned from a J.P. Morgan Securities "Short-Term Fixed Income Research Note" released last night that the Task Force on Tri-Party Repo Infrastructure Payments Risk Committee just issued a Progress Report. The report says, "The Task Force on Tri-Party Repo Infrastructure was formed in September 2009 under the auspices of the Payments Risk Committee, a private sector body sponsored by the Federal Reserve Bank of New York.... The Task Force's objective is to develop a set of recommendations for improving and mitigating risks related to triparty repo transactions, given the important role such transactions play in supporting the liquidity and efficiency of U.S. securities markets and in the implementation of monetary policy. The primary areas of focus for this effort are clearance and settlement arrangements, credit and liquidity risk management practices and tools, and arrangements for facilitating the orderly disposition of collateral in stress scenarios."

The Progress Report says, "Through its recommendations, the Task Force seeks solutions intended to assure the Federal Reserve and other key stakeholders that tri-party repo arrangements will not amplify systemic credit and liquidity risks during potential future market disruptions.... The Task Force is confident that a ... strengthening of tri-party repo arrangements will be achieved and that these arrangements will continue to contribute importantly to the liquidity of U.S. government and other securities markets. The Task Force membership includes representatives from the two tri-party clearing banks, collateral providers including banks and securities dealers, cash investors that are counterparties to collateral providers (including custodians/asset managers, hedge funds, and money market mutual funds), DTCC, and industry associations (SIFMA, ICI, MFA)."

J.P. Morgan Securities' Research Note, entitled, "Is the tri-party over? Changes coming to the repo market," says, "Over the past 25 years, tri-party repo has evolved into a large and systemically important market, one that figured prominently in the 2008 market turmoil. Repurchase agreements are a form of secured lending and are typically understood as a bi-lateral transaction where one party agrees to sell an asset and repurchase the same asset at a higher price at a later date. In practice, most of the repo market relies on tri-party arrangements where a custodian bank stands between borrowers (seller) and lenders (buyer). The custodian bank manages the settlement risk, clears trades, provides valuation, and position reporting."

The Report continues, "With hindsight, several important lessons emerge with regard to secured funding generally: Dealer liquidity contingency plans in many cases did not adequately consider the potential for a broad pull-back in repo financing or an abrupt change in the terms of that financing; Cash investors might have had difficulty managing the risks associated with a dealer default in which they needed to liquidate large portfolios of repo collateral simultaneously; Margin levels received by repo cash investors in certain asset classes became inadequate; and, Market participants did not sufficiently anticipate the potential for some types of repo collateral to lose price transparency and liquidity for extended periods of time."

It adds, "On a number of aspects, a broad consensus is emerging. These include the following: Implement multiple operational improvements to substantially reduce the size of the daily unwind and therefore the size of the intraday secured exposures taken on by the clearing banks; Strengthen collateral margining practices; Enhance liquidity risk management practices; Identify sound practices for contingency planning by tri-party repo cash investors for a possible dealer default; and, Improve the transparency of the tri-party repo market."

Finally, the report concludes, "The Task Force, in conjunction with the Federal Reserve, will sponsor an outreach workshop with a broad set of market participants beyond those directly involved with the Task Force in early 2010. Given the urgency of its mission, the Task Force intends to conclude its work and issue its report and recommendations by the end of Q1 2010. The Federal Reserve is expected to incorporate the results in a white paper that will be issued for public comment."

In his latest "Arrowhead Weekly" publication, Arrowhead Credit Research Corp. Director of Research Barry Weiss writes, "We discuss States specifically and their credit issues below in this week's spotlight.... I thought we could take a ... look at what has over the past year become a very popular investment trend in the cash sector, and how large Muni debt has become in the taxable, short-end world. The instrument I am thinking of is Variable Rate Demand Notes (VRDNs), which have become a very popular investment for cash managers over the past two years."

Arrowhead's Weekly continues, "Before this newfound popularity began, VRDNs were primarily the play things of tax-exempt managers. But when the markets began to crater, spreads on VRDN's widened to levels considered relatively cheap to what they had been historically to LIBOR, and managers found that only discomfort awaited them in the unsecured commercial paper market. As such, managers embraced VRDNs as a nontraditional addition to their taxable funds. How do you recognize a VRDN in a portfolio? Some managers identify them as such, but others do not, instead referring to them as municipal debt or even as finance/banking in cases where taxable versions of VRDNs are purchased."

Weiss says, "To be clear, as an investment, VRDNs are not necessarily improper and can be a nice diversification play. But like any investment, too much of something can mean a lack of proper diversification and worse, VRDNs are not the boring, mundane Muni debt investments many think they are. Not all VRDNs are the same, and that is partly what makes VRDNs a bit more dangerous than most realize. There is a high degree of complexity in the structure of any VRDN, the underlying credit is not generally the most creditworthy of municipal issuers (they tend to be entities rated below A- and many times are unrated), and the structure not only contains administrative and operational risks but there can be a high degree of potential basis risk."

He explains, "VRDNs are generally structured so that a lower rated Muni debt issuer will pay for a conditional or unconditional support facility provided by a highly rated institution, with a demand or put feature. Once an investor utilizes the put, a remarketing agent is notified, and that agent has a set time to resell the bonds. If a resell failure occurs, it is up to the tender agent to purchase the securities, drawing on the support facilities if need be. A final piece of complexity, VRDNs tend to use the Bond Market Association (BMA) index for reset levels, not the LIBOR many financial participants focus on.... VRDNs are not simple and there are many places where things can get uncomfortably complicated."

Arrowhead writes, "Working from the bottom up, the underlying credit is most likely not a highly rated or maybe not even a rated entity. Given it is highly unlikely that managers analyze the underlying credits, support facilities are of utmost importance. Here too, however, there is plenty of risk, complexity and in the end, not as much diversification as it would seem. Support generally comes in two forms: a Letter of Credit (LOC), an irrevocable and unconditional guarantee; or a Stand By Bond Purchase Agreement (SBPA), a conditional facility."

Finally, Weiss says, "As stated, many consider this type of instrument a safe, mundane play. But while I don't necessarily consider them aggressive instruments, they are not as plain vanilla as it would seem. If the support is structured in the proper manner, and the provider is a strong credit, the trade idea, assuming some yield pick-up can be worth the sizable transactional, basis and operational risks. But risks are aplenty, and diversification is not as beneficial as one expects at first blush."

On Sunday, Investment News mentioned FDIC-insured brokerage sweeps in "Schwab outlines products, enhancements for 2010". They say, "Included in the mix are expanded trust capabilities, online foreign-stock trading and Federal Deposit Insurance Corp.-insured sweep accounts for parking clients' cash at multiple banks." And on Friday, we hear news that Bill Gross isn't practicing what he preaches. (See Crane Data's Nov. 20 News, "PIMCO's Bill Gross Says 'Anything But 0.01 Percent' in Latest Outlook".) Bloomberg wrote Friday, "Pimco's Gross Boosts Cash to Most Since Lehman Failed", which says, "Bill Gross, who runs the world's biggest bond fund at Pacific Investment Management Co., cut holdings of government debt and boosted cash to the most since Lehman Brothers Holdings Inc. collapsed in September 2008."

The Investment News piece explains, "For RIA clients, he [chief executive Walter W. Bettinger II] singled out a plan for 'a multibank sweep initiative which enables advisers to deliver to their end-clients likely a higher yield than they can get today in a traditional sweep money market fund.' Schwab officials wouldn't comment on when the offering will be ready, but said the firm has to make systems and other operational adjustments."

IN adds, "TD Ameritrade this month plans to double the FDIC-insured capacity it offers on sweep accounts by adding a second bank affiliated with TD Bank Financial Group, its largest stakeholder, a spokeswoman said. It began offering its first sweep vehicle in May as an alternative to rock-bottom money market rates with a government guarantee."

The Bloomberg PIMCO article says, "Gross increased cash in the $199.4 billion Total Return Fund's to 7 percent in November from negative 7 percent in October, according to Pimco's Web site.... Cash and equivalent securities can include commercial paper, short-term government and mortgage-backed securities, short-maturity company bonds and money market derivatives, according to the site."

We assume that most bond funds, which have grown to $2.13 trillion YTD and which have seen asset increases of a stunning $560.7 billion through Oct. 31, have been increasing cash levels due to the flood of inflows. Note that the ICI doesn't publish cash holdings for bond funds, but that stock funds' holdings of "Liquid Assets of Stock Mutual Funds" remains near record low levels at 3.9% in October. (See ICI's monthly "Trends in Mutual Fund Investing".)

After a 5-week pause in outflows, money market mutual fund assets again took a turn downward in the latest week, though the large size of the drop was likely due to a Dec. 15 tax-payment date. The mutual fund industry's trade group, the Investment Company Institute, said last night, "Total money market mutual fund assets decreased by $51.13 billion to $3.269 trillion for the week ended Wednesday, December 16." Year-to-date, money fund assets have declined by $561 billion, or 14.6%.

ICI's weekly release continues, "Taxable government funds decreased by $17.36 billion, taxable non-government funds decreased by $29.15 billion, and tax-exempt funds decreased by $4.63 billion.... Assets of retail money market funds decreased by $3.76 billion to $1.073 trillion. Taxable government money market fund assets in the retail category decreased by $520 million to $165.85 billion, taxable non-government money market fund assets decreased by $2.59 billion to $671.51 billion, and tax-exempt fund assets decreased by $650 million to $235.72 billion."

It adds, "Assets of institutional money market funds decreased by $47.37 billion to $2.196 trillion. Among institutional funds, taxable government money market fund assets decreased by $16.84 billion to $855.88 billion, taxable non-government money market fund assets decreased by $26.56 billion to $1.176 trillion, and tax-exempt fund assets decreased by $3.97 billion to $164.65 billion."

This latest weekly decline caused institutional assets to surpass retail assets for the biggest year-to-date declines in dollar terms (down $290 billion vs. $282 billion), but retail assets continue to show much larger percentage declines (down 20.8% vs. 11.6% for inst). Money fund assets have now declined to levels not seen since mid-January 2008, though they still remain $1 trillion higher than their level of November 2006.

Year-to-date through Wednesday, Crane Data's Money Fund Intelligence Daily, which tracks a smaller universe than ICI and which has been adding funds (and thus inflating assets slightly) throughout the year, shows an overall asset decline of $454 billion (12.8%). Treasury Institutional funds show the sharpest dollar declines (down $188 billion, or 36.9%), followed by Prime Retail funds (down $108 billion, or 14.1%), Tax Exempt funds (down $85 billion, or 18.0%), Government Institutional money funds (down $85 billion, or 14.4%), Government Retail funds (down $62 billion), and Treasury Retail (down $61 billion, or 41.3%). Prime Institutional funds are the only category to show an increase, $133 billion, or 14.7%, YTD.

While most market observers continue to believe that the Federal Reserve remains on hold as far as the eye can see, our admittedly rose-colored outlook detects several baby steps towards a rate hike by mid-2010. Yesterday's FOMC Statement says, "Information received since the Federal Open Market Committee met in November suggests that economic activity has continued to pick up and that the deterioration in the labor market is abating. The housing sector has shown some signs of improvement over recent months.... Financial market conditions have become more supportive of economic growth. Although economic activity is likely to remain weak for a time, the Committee anticipates that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a strengthening of economic growth and a gradual return to higher levels of resource utilization in a context of price stability."

The Fed continues, "With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time. The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period."

Finally, they say, "In light of ongoing improvements in the functioning of financial markets, the Committee and the Board of Governors anticipate that most of the Federal Reserve's special liquidity facilities will expire on February 1, 2010, consistent with the Federal Reserve's announcement of June 25, 2009. These facilities include the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Primary Dealer Credit Facility, and the Term Securities Lending Facility.... The Federal Reserve is prepared to modify these plans if necessary to support financial stability and economic growth."

In other news, the Investment Company Institute recently issued the statement, "ICI Statement on House Passage of Regulatory Reform Bill," which says, "ICI President and CEO Paul Schott Stevens made the following comment on the House of Representatives' approval of H.R. 4173, a bill designed to reform the nation's financial regulatory system: ICI supports modernization of the U.S. financial services regulatory framework.... However, a number of provisions included in the House-passed bill must be addressed as the legislative process continues. Among other things, the bill, in its current form, could subject mutual funds to wholly inappropriate forms of bank-like regulation were regulators, however improbably, to deem mutual funds to be a source of 'systemic risk.' In addition, the bill could unfairly require mutual funds and their shareholders to contribute to a dissolution fund for failing financial institutions. Mutual funds do not and cannot 'fail' in a manner that would require payments to funds or their shareholders out of any such dissolution fund. We look forward to continuing to work with Congress to resolve these issues."

But The Wall Street Journal says in "Fund Industry Bristles at Bill," "Not everyone is persuaded by ICI's arguments. The fund group's refusal to acknowledge that money-market funds could fairly fall under the new rules undermines its broader arguments, said Mercer Bullard, associate professor at the University of Mississippi School of Law and president of Fund Democracy, an advocacy group for mutual-fund shareholders."

The Federal Deposit Insurance Corporation, in a notice entitled, "FDIC Board Approves Advance Notice of Proposed Rulemaking Regarding Safe Harbor Protection for Securitizations," said yesterday, "The Board of Directors of the Federal Deposit Insurance Corporation (FDIC) today approved an Advance Notice of Proposed Rulemaking (ANPR) Regarding Safe Harbor Protection for Treatment by the FDIC as Conservator or Receiver of Financial Assets Transferred by an Insured Depository Institution in Connection With a Securitization or Participation.... [T]he FDIC has provided important safe harbor protections to securitizations by confirming that in the event of a bank failure, the FDIC would not try to reclaim loans transferred into a securitization so long as an accounting sale had occurred. However, with the Financial Accounting Standards Board June 2009 changes in FAS 166 and 167, most securitizations will no longer meet the off-balance sheet standards for sale treatment when they take effect on January 1, 2010."

The release continued, "On November 12, the FDIC Board approved a transitional safe harbor that permanently grandfathered securitization or participations in process through March 31st, 2010. The ANPR will seek public comment on what standards should be applied to safe harbor treatment for transactions created after March 31st. FDIC Chairman Bair commented, "Today's ANPR will move the discussion forward to achieving a broad agreement on securitization reforms that can be implemented by all the regulatory agencies. As deposit insurer and receiver for failed insured banks and thrifts, the FDIC has a unique responsibility to control the risks to the Deposit Insurance Fund. The misalignment of incentives in securitizations has contributed to massive losses to insured institutions, to the DIF, and to our financial system."

Tom Deutsch of the American Securitization Forum (ASF), commented on "Regulatory Capital Rules re FAS 166/167, "The ASF supports change to the risk-based capital rules that appropriately reflect the risks that different types of securitizations present to insured depositary institutions. However, we are concerned that the bank regulatory agencies have chosen to treat all securitizations with a one-size-fits-all approach, regardless of the actual risks involved. The risk-based capital regime should reflect differences in credit risk among these transactions, thereby promoting effective risk management and preserving the ability to fund consumer and business credit demand via securitization. We look forward to continuing to work with bank regulators to refine the capital rules going forward to achieve those goals."

Also, today the FDIC released "FDIC Board Finalizes Regulatory Capital Rule for Statements of Financial Accounting Standards", which says, "The Board of Directors of the Federal Deposit Insurance Corporation (FDIC) today finalized the regulatory capital rule related to the Financial Accounting Standards Board's adoption of Statements of Financial Accounting Standards Nos. 166 and 167. Beginning in 2010, these new accounting standards will make substantive changes to how banks account for securitized assets that are currently excluded from their balance sheets.... The rule provides temporary relief from risk-based measures. Banks will be required to rebuild capital and repair balance sheets to accommodate the new accounting standards by the middle of 2011."

While asset totals have stabilized in recent weeks (see the Federal Reserve's weekly "Commercial Paper Outstanding" series), both commercial paper, and asset-backed commercial paper totals have dropped sharply over the past two years. ABCP now totals $492.9 billion, representing 40.75% of the $1.2095 trillion in commericial paper outstanding. Money market funds own approximately $522 billion of CP, or 43.6% of all CP, and about $212.7 billion in ABCP according to recent ICI statistics and Crane Data estimates. CP, including ABCP, has fallen from the largest segment of money fund portfolios prior to the onset of the subprime liquidity crisis in August 2007, to the 4th largest sector currently.

See also, an update on ABCP issues in Canada in The Globe and Mail's "On the road to ABCP reform", which says, "More than two years after the asset-backed commercial paper train crashed, Canada's market cops are poised to take banks to the woodshed for their role in the country's worst-ever investment wreck."

The Federal Reserve's latest quarterly Z.1 "Flow of Funds" Survey was released late last week. The 125-page report contains a number of tables relating to money market mutual fund assets and holdings. The Third Quarter 2009 edition shows that the largest investors in money market mutual funds remain by far the household sector, followed by funding corporations (which includes securities lenders), and nonfinancial corporate businesses.

Money fund assets declined by $221 billion in Q3, following a decline of $155 billion during Q2'09. Households, which account for $1.359 trillion, or 40.4%, of the $3.363 trillion tracked in the Fed's series, accounted for the bulk of the decline, down $125 billion. Funding corporations showed the second largest decline, losing $101 billion to $705 billion in the quarter, representing 21.0% of assets. Funding corporations are defined as "Funding subsidiaries, nonbank financial holding companies, and custodial accounts for reinvested collateral of securities lending operations. (Figures are from table L.206 on page 79 entitled, "Money Market Mutual Fund Shares.")

The third largest segment, nonfinancial corporate businesses, now holds $700 billion, or 20.8%, and actually showed a $12 billion increase in money fund shares during the quarter. Life insurance companies rank fourth with $257 billion (7.6%) in money funds. Private pension funds also increased their holdings in money funds slightly, adding $4 billion to $96 billion (2.9%). Nonfarm, noncorporate businesses hold $86 billion (2.5%), state and local governments hold $81 billion (2.3%), the category "rest of the world" holds $61 billion (1.7%), and state and local government retirement funds hold $19 billion (0.5%).

The Fed's Flow of Funds Table L.121, which covers money fund holdings, shows Agency and GSE-backed securities accounting for the biggest declines in Q3. Governments dropped $98 billion, but at $635 billion they still represent the largest percentage holding (18.9%). Time and saving deposits are the second largest sector with $545 billion (16.2%), followed by "Open market paper" at $514 billion (15.3%). Security RPs rank 4th with $495 billion (14.7%), Treasury securities rank 5th with $426 billion (12.7%), Municipal securities rank 6th with $421 billion (12.5%), Corporate and foreign bonds rank 7th with $168 billion (5%), and Foreign deposits and miscellaneous holdings total $160 billion (4.7%).

In a press release issued this morning, The Institutional Money Market Funds Association, or IMMFA, "announced changes to its Code of Practice, to come into force in January 2010." It says, "In light of the events over the last two years, the IMMFA Code has been revised to provide additional protection to investors in money market funds, through improved standards for maturity, credit quality, liquidity and disclosure."

The IMMFA Code of Practice is "a set of best practice standards for the management and operation of triple-A money market funds and compliance with the Code is mandatory for IMMFA members." The revised Code "will help compliment the requirements currently imposed by individual EU regulatory authorities" and includes new provisions which limit liquidity, interest rate, and credit risk, and impose additional disclosure obligations on funds."

The new Code includes: "A weighted average final maturity (WAFM) of not more than 120 days. Funds must respect the AAA-rating credit criteria established by the credit rating agencies.... [A] weighted average maturity (WAM) of not more than 60 days.... [A] minimum of 5% in overnight securities and 20% in securities maturing within one week. Funds must follow a Board-approved liquidity policy. Fund providers must manage shareholder concentration. Funds must disclose their WAM, WAFM, liquidity ladder and performance data monthly. Funds must make available the percentage held by the top ten shareholders upon request."

Chief Executive Gail Le Coz says, "The IMMFA Code of Practice is increasingly used as a benchmark by which money market funds are measured. The revisions are a proactive step by the industry to enhance the existing money market fund framework and will help ensure the resilience of money market funds, allowing them to continue to deliver against their objectives of capital security and liquidity."

She adds, "The revisions reflect the conclusions of a working group of industry experts, which has conducted detailed analysis of the appropriate risk limitations within a money market fund. This honest assessment highlighted a number of improvements which should be made, and we are satisfied that the revised Code of Practice will lead to more robust funds which provide additional benefits to investors, markets and fund management companies."

The release adds, "Money market funds are a vital cash management tool for institutional investors across Europe. Investors appreciate the diversification, same-liquidity and segregation of assets offered by these funds. By virtue of their investment in high quality, short-term money market securities, these funds also help provide businesses with access to lower cost financing and contribute liquidity to the European money markets.... IMMFA is the trade association for providers of triple-A rated money market funds, and covers nearly all of the major providers of this type of fund outside the US. Funds under management exceed E425 billion as at November 2009."

Saturday's Wall Street Journal article "In Year of Investing Dangerously, Buffett Looked 'Into the Abyss'" gives a revealing look at the day-by-day thoughts of Warren Buffett during the height of the financial crisis. The piece contains some interesting comments on money market mutual funds, and serves as a timely reminder of how dire the situation was during that fateful week.

The WSJ describes Sept. 15, 2008, "By this point, Mr. Buffett was beginning to worry about the entire financial system.... The commercial-paper market, which helps finance the day-to-day operations of businesses around the country, was seizing up. On Sept. 16, the Reserve Primary Fund, a big money-market fund, revealed huge losses, due in part to holdings of Lehman's commercial paper."

It continued, "If the commercial-paper market had frozen completely, more major financial institutions and possibly even household names such as GE would have failed, Mr. Buffett says, 'because their checks would have failed to clear.' That would have triggered panic in the nation's money-market funds, which held about $3.5 trillion in assets, because some of them held commercial paper. The resulting chaos, Mr. Buffett concluded, could have crashed global financial markets, threatening Berkshire."

The Journal quotes Buffett, "I felt that this is something like I've never seen before, and the American public and Congress don't fully understand the gravity [of the problems]... I thought, we are really looking into the abyss." At a birthday party for a wealthy friend in Omaha, several guests asked Mr. Buffett if their money-market funds were safe. He found the questions worrisome: They suggested widespread fears about the safety of funds long perceived to be invulnerable to losses. He said, "When people who drive Rolls-Royces are worrying about their piggy banks, you know you've got a problem."

The WSJ piece continues, "Mr. Buffett says he still felt the government had the tools to head off calamity. He stayed in close touch with government officials, fielding phone calls from then-Treasury Secretary Henry Paulson, who was cobbling together a bank-bailout package and was interested in Mr. Buffett's thoughts about structuring it. Senators seeking guidance about the package also phoned him. As the government swung into action, Mr. Buffett recalls, he gained confidence that the crisis would be resolved. A government guarantee of assets in money-market funds, which came days after the Reserve fund's troubles emerged, was a big step forward, he says."

Money fund assets were flat in the latest week, declining by a mere $360 million to $3.320 trillion as of Wednesday, December 9, according to the Investment Company Institute's statistics. Over the past five weeks, money fund assets have decreased by a mere $18 billion, or 0.5%, averaging declines of a mere $4 billion a week. This follows a 34-week slide when funds dropped by $568 billion, or 14.5%, and averaged weekly declines of $16.7 billion.

ICI's latest weekly report says, "Taxable government funds decreased by $1.46 billion, taxable non-government funds increased by $3.15 billion, and tax-exempt funds decreased by $2.05 billion. Assets of retail money market funds decreased by $5.91 billion to $1.073 trillion.... Assets of institutional money market funds increased by $5.55 billion to $2.247 trillion."

Year-to-date, money fund assets have declined by $510 billion, or 13.3%. Retail assets have declined by $282 billion, or 20.8%, while Institutional assets have declined by $238 billion, or 9.6% YTD. Over the past 52 weeks, total money fund assets have fallen by $457 billion, or 12.8%, retail assets have fallen by $278 billion, or 21.4%, and institutional assets have fallen by $187 billion, or 8.2%.

It of course remains unclear whether this recent pause signals that the large outflows from money funds are finished. Since asset levels remains over $1 trillion higher than they were just over 3 years ago (they were at $2.311 trillion on Nov. 22, 2006), there still may be plenty of "hot money" to exit. But we believe institutional money will only leave in volume when sharp rate hikes begin, and even then one could argue that these investors have few other super-safe and liquid options. We also believe that the majority of rate-sensitive, brokerage-related or market-timing retail money is already gone, so that these outflows should slow substantially going forward. (See the December MFI for more discussion on our asset projections for 2010.)

This month, Crane Data's Money Fund Intelligence newsletter interviewed Robert Deutsch, Managing Director and Head of Global Liquidity for J.P. Morgan Asset Management. J.P. Morgan is the world's largest manager of money market funds, running almost $360 billion in U.S. domestic and approximately $200 billion in "offshore" US Dollar, Euro, Sterling, Yen, and RMB liquidity funds. Deutsch discussed client concerns, regulatory issues, ultra-low yields, and more in our Q&A. We excerpt some of the highlights below.

Deutsch tells MFI, "This financial crisis has challenged every investor and manager of money funds. It was the most challenging environment we had ever seen, and there are still the unresolved regulatory issues to be addressed. In addition, the challenges for our clients continue. They are trying to evaluate counterparty risks in a more in-depth way than ever before and that is a fairly challenging thing to do. They are updating their investment guidelines, many of which haven't been updated substantially in quite a while."

On regulatory changes, he says, "We are very supportive of what the SEC is doing. We think they are on the right track. We did submit our own letter, as well as supported the ICI position. We pointed out in our letter a couple of things that we think should be different than what the SEC proposed. We are supportive of having liquidity standards, but they suggested potentially having two liquidity standards, one for retail funds and one for institutional funds. We think that is a very bad idea.... I think having two standards can create confusion and more complexity than is needed in the regulation."

On the regulatory reform timetable, Deutsch says, "Our expectation is that the President's Working Group will release their paper this month, and the SEC will release its rules and specifics in the first quarter of 2010.... Call it [the SEC's changes] kind of a 'Phase One' release and tightening of guidelines. But we also understand beyond that there will be further discussion around broader issues; one of the things that will be discussed and debated will be the stable $1 dollar NAV vs. the floating NAV. We are very interested in that debate and engagement. We think it's very important to maintain the stable dollar net asset value for money market funds."

Look for more excerpts from our extensive interview in coming weeks. For a full copy of the article or the most recent issue of MFI, e-mail

Today's Financial Times writes "Wall of US cash still looking to find a home", which discusses the recently oft-discussed concept of "trillions" of liquidity poised and ready to support stocks and other asset prices. We've argued against the "wall of cash" theory in the past, mainly due to its poor performance historically and to the dominance of transactional assets in money funds. But we have noticed the heavy correlation since March between outflows from money funds and increases in stock prices. However, most market commentators fail to appreciate the money market's, the broader economy and seasonal factor's influences on money fund balances.

The FT says, "The financial market panic of 2008 was characterised by a huge stampede into cash.... Using US money market mutual funds as a proxy for demand for cash, this trend continued until March this year, when money fund balances peaked at $3,760bn. This peak, of course, coincided with the start of the rally in risky assets, which has lifted everything from equities to corporate bonds. Since then, $560bn has flowed out of these money market funds, according to analysis by JPMorgan. The balances are still quite high. Indeed, despite the outflows, there is still $1,000bn more in money market funds than in early 2007."

But the article quotes a JPMorgan report, "Before the crisis began in 2007, many liquidity focused investors were heavily engaged in enhanced cash or ultra-short total return strategies that were supposed to provide better returns without compromising liquidity. The poor performance of these strategies in the crisis lingers with many of these investors, suggesting they're unlikely to try it again." FT says, "Some money is likely to switch out, however. The JPMorgan report says that institutional money fund balances -- which represent the bulk of such funds -- could drop by 10 per cent and retail balances could fall 20 per cent over the next year. This would add up to $400bn moving out of cash."

Crane Data's most recent Money Fund Intelligence notes that money fund asset outflows have slowed of late. Our December issue, which was released Monday, said, "[M]oney market mutual funds have declined by an eye-popping $510 billion in 2009. Assets peaked at a record $3.922 trillion in January, and they have been sliding steadily since mid-March.... Money fund assets are currently at $3.319 trillion according the Investment Company Institute's weekly totals. They have declined by 13.3% year-to-date, likely making 2009 funds' second worst year in history after 1983's 18.4% decline. But the most recent weekly and monthly statistics show that the outflows have slowed."

Assuming this week will show asset inflows for money funds (Crane Data's Money Fund Intelligence Daily shows a $7.3 billion increase through Tuesday), money funds will have risen in two out of the past four weeks. Assets declined by $49 billion in November, according to our Money Fund Intelligence XLS, the smallest decline since May. October saw assets decrease by $65 billion and September by $115 billion. Frankly, it looks like much of the "hot" money is already gone. If zero interest rates haven't driven off the $3.3 trillion yet, it must have an awfully good reason to be in "cash".

MFI also said, "Judging from the 2003-2004 rate cycle and overall historical asset trends, we estimate that money fund assets will decline by about 5% in 2010, bottoming out around the $3.1 trillion level. We also expect assets to resume their climb in 2011 and follow rising rates higher."

Assets in the FBR Fund for Government Investors were merged into the Legg Mason-sponsored Western Asset Government Money Market Fund. In a prospectus supplement dated December 7, 2009, the FBR funds says, "Effective as of the close of business on December 4, 2009, shares of the FBR Fund for Government Investors are no longer offered. Effective on that date, the assets of the Fund were transferred to another money market fund as part of a reorganization transaction and the Fund has been terminated as a separate investment series of The FBR Funds."

Western spokeswoman Mary Athridge tells Crane Data, "This transaction was undertaken to give shareholders in FGI the opportunity to be part of a larger fund with a similar investment objective and investment strategies and offers the potential for greater economies of scale. The Western Asset Fund is much larger ($6.7 billion in AUM as of September 30, 2009) as opposed to FGI, which had $70 million in AUM as of December 1, 2009."

She adds, "There was a tax-free reorganization on December 4, 2009 in which FGI investors received Class A shares of Western Asset Government Money Market Fund with the same aggregate net asset value as the FGI shares they owned immediately prior to the reorganization. While a relatively small transaction, this is one step in continuing to build up Legg Mason and Western Asset's liquidity business. We are continuing to explore options such as this type of transaction in order to build our liquidity business."

For more on liquidations, mergers, outsourcing and consolidation, see the December issue of Money Fund Intelligence, which features the article, "BlackRock, BGI Merger Shrinks Money Fund Manager Universe". The piece says, "Though formerly major players Reserve and Credit Suisse have exited the money fund stage, almost all of the other retreats have been either partial or have been very minor.... Liquidated funds from Monetta, Monarch, Calamos, and Pax World, combined would barely eke out a 0.1% in market share."

The December issue of Crane Data's flagship Money Fund Intelligence newsletter predicts that 2009's sharp money fund asset outflows will moderate and come to an end in 2010, and MFI also discusses recent regulatory issues with JPMorgan Asset Management's Robert Deutsch. The 30-page monthly PDF features the articles, "MF Assets Down $500B, But Are Declines Ending?," "Defending the $1 NAV: JPMorgan's Bob Deutsch," and "BlackRock, BGI Merger Shrinks MF Mgr Universe." It also features news, fund performance, and more, and shows the Crane Money Fund Indexes continuing to hit record low yield levels.

MFI writes, "Money fund assets are currently at $3.319 trillion according the Investment Company Institute's weekly totals. They have declined by 13.3% year-to-date, likely making 2009 funds' second worst year in history after 1983's 18.4% decline. But the latest weekly and monthly statistics appear to show the outflows slowing."

Deutsch discusses client concerns, regulatory issues, ultra-low yields, and more in our monthly Q&A. He tells Crane, "This financial crisis has challenged every investor and manager of money funds. It was the most challenging environment we had ever seen, and there are still the unresolved regulatory issues to be addressed. In addition, the challenges for our clients continue."

In November, our Crane Indexes continued drifting lower or remained flat. The Crane 100 saw its 7-day and 30-day yields (as of Nov. 30) fall to 0.07% and 0.08%, respectively, while the broader Crane Money Fund Average fell to 0.04% on both its 7-day and 30-day yields. The Crane Institutional MF Index dipped to 0.06% (7-day annualized) and 0.07% (30-day), while the Crane Retail MF Index remained at a rock-bottom 0.02%. The Crane Tax Exempt MF Index remained at 0.05% for its 7-day and 30-day yield average.

Assets tracked by Crane declined by $49 billion in November, a slower rate of decrease than October's $65 billion or September's sharp $115 billion. To request the full issue of Money Fund Intelligence or our Crane Index benchmarking excerpt, e-mail Pete Crane. Or look for more excerpts from our articles in coming weeks.

The Vanguard Group features money funds its latest "In the Vanguard" newsletter, with the article, "Stability for yield: A fair trade?" The feature, in Vanguard's well-timed contrarian tradition, discusses why money funds are appropriate even with almost no yields. It says, "Last year was tough for investors. This year, it's savers who are having trouble."

Vanguard asks, "What's behind the falling payments? To revive the economy, the U.S. Federal Reserve has slashed short-term interest rates, which in turn affects yields for money market funds and bank savings products. Until the Fed changes this policy, you can expect yields to remain extremely low."

The piece quotes David Glocke, who oversees Vanguard's taxable money market funds, "`Throughout the industry, yields on money market funds are near zero. Despite Vanguard's low costs, we're not immune from the overall trend." Vanguard warns, "Undeniably, low yields are disappointing, but they don't necessarily mean you should trade in your vehicle. Your needs and goals, not the current interest rate environment, are what should drive your decision."

"The important thing is to put into perspective what you need this money for," says Vanguard's `John Juliano. "Sometimes, the yield is not the primary concern; the safety of your money is the primary concern.... [T]he upside is, you might get more yield, but the downside is that you'll see more price fluctuation."

It continues, "Traditional investment guidelines call for using cash investments such as money market funds only for short-term goals.... You could get a higher yield for your savings by swapping into a bond fund with a long duration, but you'd also assume greater risk. Say you bought a bond fund with a duration of ten years. With every percentage-point increase in interest rates, the price of that fund could be expected to drop by about 10%, easily wiping out the benefit from the higher yield."

Finally, they conclude, "Ultimately, you may decide that higher yields aren't worth the trade-off with higher risks and that trading in that stable, low-yielding money market fund isn't such a good idea after all."

Brian Sack, Executive Vice President of the Federal Reserve Bank of New York spoke last night at the Money Marketeers of New York University on "The Fed's Expanded Balance Sheet." He said, "As financial markets seized up last year and the economy sank to deeply negative growth rates, the Federal Reserve aggressively deployed a wide range of policy tools. It not only cut the federal funds rate all the way to its effective lower bound, but it turned to so-called unconventional monetary policy measures to stabilize the financial system and stimulate the economy. These measures had dramatic implications for the Fed's balance sheet."

Sack explained, "The initial expansion of our balance sheet was driven primarily by efforts taken to provide short-term funding to the markets. These facilities -- including the Primary Dealer Credit Facility, the Term Auction Facility, the foreign-exchange swaps with other central banks, the Commercial Paper Funding Facility, and the various money market support facilities -- were focused on extending credit at maturities of up to three months to various types of firms. These liquidity facilities were a key part of the government's efforts to restore stability to the financial sector.... [G]iving financial institutions greater confidence about their access to funding, and that of their counterparties, was a crucial step toward achieving stability. At this juncture, it is well appreciated that short-term funding markets are functioning much better and that liquidity pressures for most financial institutions have subsided."

He continued, "I would argue that creating these liquidity facilities and implementing them was a lot harder than exiting from them. In fact, the exit from these facilities to date has been fairly straightforward. Almost every facility was designed to provide a useful source of funding during stressed financial market conditions but to be an unattractive source of funding once markets returned toward more normal functioning. That structure has worked extremely well. Summing across these facilities, the total amount of credit extended has fallen from a peak level of $1.5 trillion late last year to around $160 billion today. We expect these balances to continue to decline over time, with many of the facilities set to expire on February 1."

Sack also said, "With that in mind, monetary policymakers have asked the Federal Reserve staff to develop the ability to offer term deposits to depository institutions and to conduct reverse repos with other firms. These tools are similar in nature, as they both absorb excess reserves by replacing them with a term investment at the Fed.... The development of both of these tools has made considerable progress. As indicated in the recent statement from the New York Fed, the Open Market Desk will soon begin conducting a series of small-scale, real-value term reverse repo transactions as part of our efforts to ensure the readiness of this tool. With the successful completion of those transactions, we will have achieved the operational ability to do term reverse repos with primary dealers against Treasury and agency debt collateral, using the triparty system for settlement."

BlackRock completed its merger with Barclays Global Investors yesterday to become the third largest manager of money market mutual funds worldwide with over $300 billion in assets (as of Nov. 30, according to Crane Data). While the funds remain distinct entities for now, rebranding has already begun with the Barclays name being replaced by BlackRock (and BGI with BCF). BlackRock remains the fifth largest money fund manager in the U.S. with over $215 billion, but Barclays large "offshore" money fund presence adds to the new entities' heft outside the U.S.

A new "Q&A for shareholders of the BlackRock Liquidity Funds" says, "Please describe BlackRock's Cash Management business. With $355 billion in liquidity assets under management (as of Sept. 30, 2009), the new BlackRock will be one of the only cash businesses with a leading position in every major market in the liquidity space: U.S. retail, U.S. institutional and international cash."

It asks, "Will there be changes to BlackRock's approach to managing cash? No. BlackRock's conservative approach to cash management has been consistent throughout our long history of managing money market funds and other short-term cash assets. This unwavering commitment is one of the primary reasons cash investors have made BlackRock among the largest managers of liquidity assets in the world. Our extensive experience through multiple interest rate cycles and market events, our rigorous credit standards and our unremitting focus on risk management have enabled us to consistently and successfully target the fundamental objectives of cash investors -- safety, liquidity and yield."

"Will there be changes to the portfolio management team? The cash portfolio management team will continue to be led from Wilmington, DE, by BlackRock veterans Rich Hoerner, CFA and Chris Stavrakos, CFA with investment centers located in London, New York City, Princeton, NJ and San Francisco. The integration will combine the talents of both the legacy BGI and BlackRock teams into a single unit, following BlackRock's team approach to portfolio management."

"Will there be a change to my account manager? The Global Client Group for cash management has been reorganized to more effectively serve our combined client base. As a result, you may experience a change in account manager; affected clients will be introduced to their new contact in the coming weeks." For more information, visit BlackRock's Cash website.

Supply-side investment research firm Laffer Associates recently published a paper on "The Fed's Exit Strategy: Possibilities and Limitations," which "takes a deep dive into the Fed's monetary policy toolbox to find out how the Fed most likely would attempt to prevent its ballooning balance sheet from igniting inflation, and illustrates possible policy limitations." The summary says, "The U.S. banking system sits on about $1 trillion in excess reserves.... There is no single, simple solution for the Fed to successfully drain $1 trillion from the U.S. banking system or convince the banking system that it's optimal to hold huge excess reserves, and inflation risk remains elevated."

Economist Kenneth Petersen writes, "Milton Friedman got it right and Keynesian Phillips-curve economists got it wrong: Sustainable inflation is always and everywhere caused by too much money chasing too few goods. Fast forward to today's monetary environment, and everyone should be concerned about inflation, big time.... The Fed knows this and is cramming to come up with an exit strategy that removes excess reserves from the banking system (asset management) and locks-up reserves (liability management) prior to when the 'too much money chasing too few goods' scenario is upon them. Several tools are available to the Fed, but no silver bullet exists as political and technical concerns prevail. Initially the Fed would attempt to smoothly remove excess reserves from the banking system and attempt to convince banks to keep reserves tied up at the Fed, but should those attempts fail, the Fed would pull out all the stops and force banks to keep large reserves parked at the Fed."

He continues, "In tri-party term reverse repos, the Fed sells an asset and promises to purchase the same asset back at a later date and at a higher price. A custodian bank -- like Bank of New York Mellon and J.P. Morgan Chase -- acts as an intermediary between the parties involved in the repo transaction, which collects collateral and marks-to-market. By engaging in tri-party term reverse repos, the Fed theoretically would be able to drain several hundred billions from its balance sheet for up to two years, which is the typical length of term repos. The Fed also could attempt to engage in tri-party open reverse repos, but these could be much harder to find counterparties for."

Petersen says, "To drain, say, $500 billion from its balance sheet, the Fed could split the collateral between Treasury securities and AAA-rated agency MBS, and most likely be able to successfully clear both of these trades. Although, the Fed likely would have to engage in these tri-party term reverse repos with more counterparties than just its usual primary dealer counterparties -- as the primary dealers may not have the interest or the liquidity to engage in large trades. These other counterparties would be money market mutual funds, but also could be government sponsored enterprises.

He explains, "The $3.3 trillion money market mutual fund industry would kill for just a little more yield currently, and as long as that hunger for yield at almost any cost persists, the Fed would have an eager counterparty to engage with in the money market mutual fund industry. Besides, the money market mutual fund industry may feel obliged to help out the Fed since the Fed provided a safety net under the industry during the credit crisis by establishing the money market investor funding facility and the asset-backed commercial paper money market mutual fund liquidity facility."

Finally, Petersen writes, "While these operations would drain the Fed's balance sheet of potentially hundreds of billions, they also would be associated with upward pressure on the effective Fed funds rate. So while the target Fed funds rate set by the FOMC would remain unchanged, the effective Fed funds rate would drift upward. This could convince banks to increase their prime interest rate, which again would make home equity lines of credit, credit card loans, car loans, and student loans more expensive. The risk of pushing the effective Fed funds rate well beyond the target funds rate, could restrain the Fed's ability to engage in large tri-party term reverse repos. Nonetheless, the Fed would likely start engaging in such trades in the first half of 2010."

To request a copy of the Laffer paper, e-mail Ken Petersen or Pete Crane.

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