Sun, June 26, 2011
Money Market Exposure to European Debt Jangles Nerves
As the Greek debt tragedy plays itself out, it’s become apparent that problems in Europe have the potential to nick some U.S. money market funds.
In the fall of 2008, The Reserve Fund, a venerable money-market fund, startled its account holders when it was forced to write off a large amount of short-term debt from Lehman Brothers after the Lehman bankruptcy. The write-off caused its shares to drop from the accepted one dollar to 97 cents, prompting the money market fund’s investors to pull $27 billion out in two days.
Earlier this month, financial journalist James Grant noted that the five largest money funds (Fidelity Cash Reserves , Vanguard Prime Money Market Fund Institutional Shares, Fidelity Institutional Money Market Market Portfolio , Fidelity Institutional Prime Money Market Portfolio, and BlackRock Liquidity Funds TempFund) are holding, on average, about 40% of their assets in the short-term debt of several European banks. Last week ratings agency Fitch stated that about half of the assets of the top 10 money funds are invested in European bank debt. The existence of these holdings has gotten a fair amount of attention, as Fed Chairman Ben Bernanke even commented on them in his press conference on Wednesday. Some money market fund investors responded to the news by pulling $3.6 billion out of non-Treasury money market funds on Thursday.
Since these holdings are neither Greek sovereign (government) debt nor debts of specifically Greek banks, one might wonder why the news is raising concerns. The problem is that European banks hold a significant amount of Greek sovereign debt; in the event of a Greek default, the banks would have to immediately write down the value of those bonds. Moreover, a crisis unfolding in Greece could spread to other European countries, causing the value of their sovereign bonds to drop. A cascade of defaults could impair the ability of some banks to pay their short-term debts on time, in which case a money market fund might be forced to write off the debt and reduce its share value below $1. Although the Fed provided a temporary money market fund insurance program after the 2008 credit crisis, presently such funds are not insured.
So now that the Fed chairman has described the exposure of the $2.7 trillion money market fund industry to European banks as “very substantial,” investors in money markets are starting to get spooked.
What I find puzzling is why anyone would invest in one of these funds when they typically pay a return of 0.01%. As Randall Forsyth has observed in this week’s Barron’s, these money market funds are offering their investors “return-free risk.”
Until the European debt crisis blows over, investors with large amounts of cash who use money-market funds would be well-advised to use funds that invest exclusively or primarily in US Treasury securities. If you’re intent on getting a zero yield (or a negative yield, if you include inflation) you should at least use an investment that’s fairly safe.