Wednesday, September 24, 2008

Money market instruments is where all the action is at


The Wall Street problem is not a equity crisis but a debt crisis. It is not even a bond crisis though that will come later. The real issue is financing in the money market area. Cash is flowing into money markets. Hedge funds are raising cash levels; there may be over $100 billion in funds that are being held back. Mutual funds are raising cash levels. Banks are hording cash and not lending to each other. In fact, it may actually be a portfolio rebalancing crisis.

Cash is moving from money market funds which include LIBOR and commercial paper to Treasury funds. This has pushed down the Treasury rates while keeping risky paper at higher levels. Look at the the commercial paper offerings.The ABS numbers tell a story of massive deleveraging. The financial paper is flat and the non-financial paper is growing but it is all at short maturities. Money is moving out of stocks into cash but the cash is not being put to work in risky assets

Funds are only taking on short term risk because of the expectation that there will be a run on the funds. If there is a shadow banking system through the mutual funds market, then the firm is a run on shadow bank. This is a problem with providing instant liquidity without breaking the buck.

The issue of portfolio rebalancing to safe assets is an international problem because the Bank of England will cut liquidity offerings because the money being lent is being put back into low interest rate accounts at the central bank. The banks are not lending the funds they are borrowing but reserving them as a cash hoard.

The uncertainty is the current environment is not measurable so it becames a true unknown. Hence, hold the risk free asset. The unknown has to be converted to something that is measurable.

No comments: