By Steve Johnson and Ruth Sullivan
Published: September 5 2010 08:31
Investors in loss-making money market funds are less likely to be bailed out by fund sponsors in the future, increasing the risks of a run on the $5,000bn (£3,247bn, €3,896bn) sector, according to Moody’s, the ratings agency.
In the absence of government intervention, this could have a “destabilising” effect on financial markets, Moody’s argued.
Moody’s calculated that, during the 2007-09 financial crisis, 62 money market funds – 36 in the US and 26 in Europe – were bailed out by their sponsor or parent company at a cost of at least $12.1bn (£7.8bn, €9.4bn), with one investment house handing over $2.9bn.
These bail-outs prevented funds from making losses, or “breaking the buck” in industry jargon, allowing investors to walk away unscathed.
However, even before the crisis, financial rescues were far from uncommon, according to Moody’s. It found that 146 funds would have broken the buck without the intervention of their parent company between 1980 and mid-2007, suggesting supposedly ultra-conservative money market funds are vulnerable to losses even in relatively normal market conditions.
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Yet Moody’s argued that “the continuing ability of fund sponsors to financially support their money market funds might be challenged in the intermediate to long term”.
It said larger fund sizes, meaning greater exposure to individual issuers; greater correlation in asset prices; a dearth of broker-dealers to provide liquidity; and lower management fees and profit margins due to historically low interest rates and low recovery rates on securities that defaulted during the financial crisis “increase substantially the cost to management companies of providing financial support to their funds”.
“If another financial crisis on the scale of the recent one were to happen some sponsors might not support their funds,” said Henry Shilling, senior vice-president at Moody’s Global Managed Investments group.
He argued that in a future crisis, fund sponsors might “respond in unison” by withdrawing support, lessening the reputational damage to any one investment house but increasing the likelihood of a run on a sector vital for the smooth functioning of capital markets.
The comments chime with a growing undercurrent in the industry that the era of unwritten, but implicit parental support for money market funds could be edging towards a close.
Justin Meadows, chief executive of the MyTreasury trading platform, told FTfm last month: “To be perfectly frank, neither the funds or their parents are prepared to wear the risk [of implicit guarantees] any more.”
One senior industry figure concurred, saying: “The bills are becoming bigger and bigger. $2.9bn is a big cheque and you wonder how long people are going to go on like this.
“But the role that money market funds play in financing the economy is substantial. We are the ones that swallow all the short-term paper.”
Mr Shilling said recent tightening of money market fund regulations in Europe and the US should lessen the need for sponsors to bail out funds, but argued there was little regulators could do to ensure sufficient liquidity in the event of a run on the sector.
Copyright The Financial Times Limited 2010.
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