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Wednesday, 24 September 2008

Photo-call or phone call?

What's it worth to Obama, McCain or others fighting for political air like our PM to get a photo-call with Hank Paulson or Ben Bernanke right now? It's probably the political value equivalent of Goldman Sachs getting through on the phone to Warren Buffett at siesta time on Tuesday?
What are shadow banking's alternative investors, the hedge funds, doing? They may be responsible for options & futures exchanges experiencing record volumes right now, but at the other end of the risk scale, while politicians scrap over $700bn bailout, hedge funds (who bravely make money in extreme volatility, on the downticks as easily as on the upticks) have timorously shifted $100bn into prosaic money market funds and hold $500bn in cash, probably very short term deposits! This is 20% of hedge funds' funds (or one third of what they had a year ago, and equivalent of about 4-5% ratio to worldwide bank deposits!) Why don't hedge funds make 30-90 day depos and thereby help bring down the 90 day rate?
For those who need to be advised about Money market funds (principal stability funds); they invest in minimum credit, market, and liquidity risks, and in USA are regulated not by the Fed, but by the SEC (Investment Company Act, 1940, Rule 2a-7) which restricts MM funds by quality, maturity & diversity i.e. only the highest rated (lowest yield) debt with maturity of 13m or less, plus Weighted Average Maturity of 90 days or less, and not over 5% in any one issue, issuer, except Treasuries or repos, but CP, short-term bonds, CDs, Depos, if highly liquid and a stable value not volatile - defintiion of volatile being liquid assets that can turn to vapour on contact with air.
In Europe the recipe is less precise and enhanced (high return) money funds (which by definition are entirely exposed to short term valuations) have been embarrassed (20 failed) due to investing in loss-making ABCP. It was capital flight ($200bn in less than a week) out of money market funds a year ago that forced many banks, after losing their other key funding sources, who crowded into interbank money markets for cash that widened the spreads so much that liquidity dried. The dash for cash was aggravated by banks hoarding against credit-product losses, driving up wholesale funding cost to levels not seen in ten or more years. The interbank lending stress persists (low cost for overnight, v.high cost for 3 months money) as banks desperately needed funds not just to shore up balance sheets after writing down hundreds of $bn, but also even at times just to remain solvent across their counters and to pay staff wages and utility bills.
Confusion over risk valuations and market liquidity support for different structured products was the main reason behind MM funds' sell-off. While most ABCPs have the 100% liquidity support where bank originators/ sponsors/ underwriters/ guarantors/ insurers step in and provide liquidity if programmes cannot meet maturity or cross pre-agreed delinquency/ cash-flow/ interest loss against minimum expected threshold/ trigger conditions, the conduits (Structured Investment Vehicles) have partial back-up such as 10% ABCPs issued by SIVs, covered by standby CPs from originators etc. Isn't banking just like Top Gun, rattatatatat, kerpow with the acronyms. Banking is acronym heaven.
Because of investor confusion in failing to distinguish SIVs from ABCPs and not appreciating the 100 % liquidity back-up it became hard for MM funds to offload this paper before maturity i.e. corporate and syndicated loan desks and structured finance parts of banks suddenly did not want short term paper either! Ratings agencies were blamed probably unfairly. The highest rating a MM fund can have is "triple-A V1+" i.e. a Through-the -cycle credit rating plus a Point-in-time volatility risk rating, reflecting interest rates, credit spreads, FX risk, liquidity & leverage on a fund's price &d total return. Compared to US MM funds, Europe's Enhanced cash funds, with riskier ABCP or ABS.L, can have triple-A for credit quality but not low volatility risk ratings.
Top-rated MM funds benefited from the credit crunch as yields on these instruments shot up and investors crowded into in safe haven cash. Yield spread on MM instruments rose to 50-70 bp over expected rates from only 5-10 bps before. But, generally, returns on MM funds are on or below LIBOR, which again begs the question of why don't hedge funds just go make 90 day deposits at their banks?

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