Money Market Funds Might Need Bailout Again

The Wall Street Journal raised the specter of another money market fund crisis that could require bailout of money market funds that have unwisely invested too heavily in the short-term debt of European banks caught up in the contagion of sovereign debt problems in Greece and elsewhere.

The WSJ lead editorial excoriated the mutual fund industry for reaching for yield on money market funds by loading up on European bank securities equal to 50% of their $2.7 trillion assets. Forbes also raised this issue by quoting Jim Grant’s Interest Rate Observer on Saturday as to huge position by Fidelity and BlackRock’s money market funds in European securities that may be worth less than the funds’ purchase price.

US money market funds apparently hold far too risky a position in the short-term debt of the European banks because they are the repository of sizable investor money being held on the sidelines until the economic future becomes clearer. However, some 40% of this paper has a maturity of 7 days or less, so that it would require an inability to refund these very short-term obligation for there to be a crisis.

These French, German, Dutch, British banks face potentially troublesome write-downs from the possible debt default of Greece and its ramifications for Ireland, Portugal, Spain and Italy. European banks have loans outstanding to these nations of over $1.5 trillion.

In the wake of Lehman’s bankruptcy in September, 2008, a large money market fund holding an unwise batch of Lehman bonds, and suffered from its net asset valuation falling below the sacrosanct $1.00 a share. This event triggered a panic among holders of money market funds– which are supposed to be almost as safe as short term Treasuries.

The Federal Reserve was forced to guarantee the hundreds of billions ordinary citizens held in these funds, which were basic savings that were thought to be entirely secure. When the crisis quieted down, the guarantee was removed. Let’s hope there is no repeat of the 2008 crisis in the money market fund industry.