Monday, December 22, 2008

Forcing investors into risks - kill the money funds


The government money fund may be a thing of the past. Net of expenses, the returns on government money funds is currently close to zero and may actually turn negative as current securities roll-off. Some funds have started to lower fees. Others have closed the funds are have begun to get out of the business. The net result will be that investors will start to either move out to riskier assets or move to bank CDs. While not explicit, the Bernanke policy of taking rates to zero will kill the money funds as we normally know them.

In scenario one , moving out to riskier assets, the change in portfolio composition will be good for the economy. The flight to quality will be reversed. A simple case would be for the money fund holder to move from a government fund to a general money fund that is holding commercial paper, assets other than Treasuries. A riskier move would be for investors to move out the yield curve to Treasury or corporate bond funds. The final move may be to equities if the perception is that they are less risky by being cheap.

The second scenario which can happen at the same time would be a move from government money funds to bank deposits which are federally insured. Money funds have a federal insurance guarantee for a temporary period. This will move money from the shadow banking system to the regulated banking system. My guess is that he government doe not care if money funds are closed and would welcome money moving back to the banking system.

But, investors start buying risk assets, who will buy the Treasury bills?

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