NEW MONEY MARKET REGULATION IN EFFECT 10/17/2016

MONEY MARKET REGULATIONS GO INTO PLAY 10/17/2016
I WANT TO ADDRESS WHAT MEMPHIS IS TALKING ABOUT IN HIS COMMENTS FOR THOSE OF YOU THAT ASKED FOR CLARIFICATION. HERE IS THE COMMENT THAT MEMPHIS POSTED IN RESPONSE TO THIS POST I MADE
http://www.myladies.co/emerging-markets-hard-currency119-2/

MEMPHIS SAYS:
Thanks again ML for pointing us towards some well written discussions!

There is certainly a lot of capital moving across the globe and I particularly liked your observation that these are not EVER linear discussions such that we can point to A and conclude that it led to B.
With new regulations everywhere and central planning at a level never before seen? The search to find value is certainly one that will require us to “sharpen our ax” in the days ahead!

In reading this I could see much support for the position that much of this capital is simply “passing thru” with no intent for the long term.
By way of example, we can so mply look at last week’s new regulations on the money market industry and the resultant flow of over $1T that came IN ANTICIPATION of the change. All these $ had to park somewhere!

Good stuff, keep it coming!
Blessings, Memphis

BEFORE WE GET INTO THE MONEY MARKET REG THAT WENT INTO EFFECT ON OCTOBER 17TH I WANT YOU TO UNDERSTAND A FEW TERMS OK.

NAV = NET ASSET VALUE

T-BILLS = TREASURY BILLS

MONEY MARKET FUND = AN INVESTMENT WHOSE OBJECTIVE IS TO EARN INTEREST FOR SHARE HOLDERS ALL THE WHILE MAINTAINING A $1 NAV. MONEY MARKET FUNDS ARE SHORT TERM SECURITIES LESS THAN 1 YEAR COMPRISED OF HIGH QUALITY LIQUID DEBT USUALLY TREASURY BILLS AND CORPORATE PAPER.
YOU CAN WATCH A QUICK VIDEO HERE.
http://www.investopedia.com/terms/m/money-marketfund.asp

ALRIGHT LET’S LOOK AT THIS NEW RULE AND THE EFFECTS IT WILL HAVE ON MONEY ACROSS THE GLOBE.
http://macro-ops.com/what-the-new-sec-money-market-fund-regulations-mean-for-the-financial-system/
On Oct. 17th a new SEC rule finally comes into play that will affect money market funds and liquidity across the financial sphere. There’s potential for some really big moves here.

Most investors don’t know this is coming, making it a giant surprise when it finally happens. And that’s because SEC rules tend to get complicated, and their knock on effects get even muddier. We’ll do our best to simplify exactly what’s happening and what it means for the markets.

The story starts with money market funds — the open-ended mutual funds that invest in short-term debt such as US Treasury bills and commercial paper. These funds have always been a popular alternative to bank deposits because they were considered just as safe, while also providing a higher yield.

But the key to their “safety” was the funds’ promise to keep their net asset value (NAV) fixed to $1-a-share. This guaranteed that you would at least get back as much as you put into the fund. And it was widely believed that this $1 level would always hold. Whenever the value of the fund went above $1-a-share, you would be paid out in dividends.

This all changed in the 08’ financial crisis.

The entire financial system, from fiat currencies to debt, is based on confidence. And when this confidence falters, you start having serious problems.

REMEMBER THIS PLEASE WE WILL BE TALKING A LOT ABOUT CONFIDENCE BECAUSE CONFIDENCE AND LACK OF CONFIDENCE IS WHAT MOVES MARKETS.

Before 08’, the markets had confidence in Lehman Brothers and considered them a “safe” asset. That obviously didn’t last…

Lehman collapsed. And in the process, it set off a chain reaction.

Lehman, like other trusted institutions, used the money markets for short-term funding. And it could do that because it was a trusted institution that people believed could always pay its debts. And this trust is what keeps the financial system going — including the money markets.

You can imagine what happened to money market funds’ $1 NAV promise once Lehman failed.

The Reserve Primary Fund, the oldest US money market fund, “broke the buck”. Its NAV fell to 97 cents and all hell broke loose.

Now Lehman was only a small portion of the Reserve Fund’s assets, but it didn’t matter. Confidence was lost when the $1 NAV level didn’t hold up. Investors stampeded out of the Reserve Fund, causing it to collapse. This in turn triggered a run on other money funds, threatening the liquidity of the whole financial system.

As we explained before, money market funds invest in many short-term debt securities like commercial paper. Banks and big corporations rely on those loans from the funds to pay their day-to-day bills. Without that funding, operations seize up and you have a chain reaction that creates a liquidity crisis. This is exactly what was happening, which is why the government had to step in with bailouts to make sure the whole system didn’t collapse.

Now the key here is liquidity. Liquidity is the lifeblood of the financial sphere, and without it, the system chokes up.

Here’s where our October SEC rule comes into play. They decided, “Damn, we don’t want this happening again”, and set some new standards that are finally coming online on October 17th.

These new rules basically say that prime and municipal money market funds (the funds invested in riskier assets than T-bills) will have to float their NAV’s. They would also be required to impose liquidity fees and redemption gates when times get rough like in 08’.

Now the point of these rules is to make the entire market safer. If the NAV isn’t pegged to $1 and is allowed to float below that level, it should give investors a better idea of the risk they’re involved with. And the extra redemption rules should prevent runs on money market funds that kill liquidity.

These rules may sound all well and good, but they usually cause unintended consequences. Whenever you put new regulations into play, market participants are forced to adjust in one way or another. These adjustments and their effects become difficult to predict.

And this is what we’re now seeing. Investors are making a massive shift in the money markets. They’re moving from riskier prime funds that will be forced to abide by these new rules, to safer government funds which are exempt.

The reason they’re moving is because of their risk aversion. Investors are used to their money market funds being 100% safe and returning their money. But if you introduce a floating NAV, then there is a realistic chance of actually losing on these short-term investments. That’s why you’re seeing the shift to T-bill funds that can still hold that $1 NAV promise.

So far $500 billion has moved from prime to government funds. Total assets in prime funds have now dropped below $1 trillion for the first time in 17 years. Many prime funds are also closing because of these new rules and investors’ responses. According to Sagar Patel of Morningstar, the number of prime funds has dropped from around 500 before the law, to 460 today. He believes more will continue to shut-down as we get closer to the actually implementation time. He even expects another $500 billion to move out of prime funds in the next few months.

DO YOU UNDERSTAND WHAT WE JUST READ? FOR THE FIRST TIME IN 17 YEARS THERE ARE LESS THAN 1 TRILLION IN PRIME FUNDS. SO WITH THIS CAPITAL OUT OF MONEY MARKET FUNDS WHERE WILL IT GO??

This is clearly a massive shift that is completely changing the money market landscape. Now there are a couple of things that may happen as a result.

First, we may get more easing on the interest rate side of things. As we know, US Treasuries are considered some of the safest assets in the world. And because of the global deleveraging we’re going through, we’ve seen a relentless bid causing a massive run up in their prices. Interest rates are also being pushed lower and lower as a result.

THIS IS WHAT WE HAVE BEEN TALKING ABOUT ALL WEEK LOWER AND LOWER INTEREST RATES.

The hundreds of billions of dollars flooding into the T-bill market will only exacerbate this trend. Especially when the $1.51 trillion t-bill market is already short on supply. As of now, the Treasury’s plan is to add about $188 billion in additional bill supply during the next two quarters to help cope with the increased demand. But there’s no guarantee that will be enough. The quick influx of funds could be enough to disrupt the T-bill markets’ structure. That would result in some wonky action in short term interest rates. But no one is really sure what will happen.

The other problem that’s brewing is in the lending markets. And problems in the lending markets are extra dangerous because they directly affect liquidity, which as we said, is the lifeblood of the financial system.

The prime markets are where a lot of large corporations and banks get their day-to-day financing from commercial paper. This is considered unsecured funding (meaning there’s no underlying asset backing it up) and is based on the credibility of the borrowing firm. This is a preferred route to access short-term capital for many institutions because it’s quick and avoids SEC involvement, which usually becomes expensive.

But now with the new rule change and all this money flowing out of the prime money market funds, this source of funding is drying up. More corporations will be forced to find other ways to support their daily expenses like payroll. But unfortunately, these other options are more expensive, and will likely lead to a slowdown in business activity and possibly unmet obligations. This could only be a negative for equity markets as corporate costs go up to account for the change.

And even worse off are foreign banks that depend on prime unsecured financing to meet their dollar obligations. A lot of these banks don’t have US customers depositing cash with them. This means they don’t have a ready supply of dollars available like US banks. In order to get the dollars they need, they access commercial paper through prime funds.

US dollars are the key to the liquidity of banks around the world because USD is a global reserve currency. It’s used in all types of transactions, even when neither party is based in the US. This makes access to dollars extremely important. But now with these new prime fund requirements, these banks are facing dollar liquidity problems.

WE WILL TALK MORE ABOUT LIQUIDITY PROBLEMS DURING THE WEEK AND ABOUT CARRY TRADE PROBLEMS THAT COULD BE ON THE HORIZON. DO YOU ALL REMEMBER WHAT A CARRY TRADE IS?

A CARRY TRADE IS A STRATEGY WHERE AN INVESTOR BORROWS MONEY AT A LOW INTEREST RATE TO PURCHASE A BETTER ASSET WITH A HIGHER RETURN. THIS STRATEGY IS SEEN ALL THE TIME IN THE FOREX MARKET.

HERE AE A FEW EXAMPLE OF WHAT FUNDS ARE SAYING TO THEIR CLIENTS REGARDING THIS NEW SEC RULES.
Fidelity Money Market Mutual Fund Changes
https://www.fidelity.com/mutual-funds/fidelity-funds/money-market-funds-statement

Bank of America Pulls Out Of Money Market With New SEC Regulations
http://www.forbes.com/sites/brianmenickella/2016/08/28/bank-of-america-pulls-out-of-money-market-with-new-sec-regulations/#7b8357bee061

5 Things Investors Should Know About New Rules on Money-Market Funds
http://www.wsj.com/articles/5-things-investors-should-know-about-new-rules-on-money-market-funds-1470775793

I WILL BE BACK WITH MORE IN THE MORNING AND PLEASE CONTINUE TO ASK QUESTIONS AND LEAVE ME COMMENTS

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5 thoughts on “NEW MONEY MARKET REGULATION IN EFFECT 10/17/2016

  • R

    Wow! I am gobsmacked with this continuation of our/my education and it includes tidbits from Memphis!!
    I am so excited to chew on a ‘doublemint’ piece of knowledge. (reference to the OLD gum commercial dates me).
    Yes indeed, the swirl of the liquidity waters are vortexing around the drain as we hear a distant “s-l-u-r-p” sucking down the last of the money market investors going down that drain. LOL !!! ehem- not funny.
    I have images of elderly grandparents bemoaning their life savings forever lost as in those caught up in the MF Global debacle (2011) tapped into the customers funds to cover their margins. tsk tsk.
    I sit on the edge of my seat to see how this plays out.
    It certainly heralds change.

    • MY LADIES

      YES RENI, AND SO IT SHALL BE WRITTEN AND SO IT SHALL BE DONE….CHANGE IS NO LONGER COMING IT IS HERE…

  • Memphis

    Thanks again ML for taking the time to highlight the important shifts that are taking place within the financial world! Some of the authors comments resonated strongly with me such as his reference to unintended consequences with ANY major regulatory change (gov’t “fixing” the problem). Often an important key to us if we can find it or to borrow an insight here from George Soros:

    “Misconceptions play a prominent role in my view of the world!”

    This topic is a great opportunity then for us to consider. Why? Cause we get to watch it play out in real time! If we regard this from the lens of it’s effects on capital flows in their attempt to stabilize, to secure, against a future liquidity crisis we already see it is having the effect of driving capital from the private sector money funds into gov’t securities. The ripple effects from this will likely be observable to us IF we know to be watching!

    A superficial look at the matter received only from the talking heads of mainstream television will never do if we wish to properly understand a matter so if I may let me offer some further material that was written on this topic in late August by Martin Armstrong as he also observed the shift in capital that was taking place IN ANTICIPATION OF this event. As to the true “crisis” of ’08 he observed:

    “The critical factor is always liquidity. Liquidity is the lifeblood of the financial system. When confidence is lost, people hoard money …”

    In the interest of full disclosure here, this subject meant very little to me (I lacked understanding of it) until I viewed it from the perspective of 1) looking at the whole and, 2) doing so thru the lens of history. It then quickly gained context and became alive to me!
    Here are two brief quotes with links to the full blogs (from about 6 weeks ago) where Armstrong expounded on this important SEC change. I offer these in hopes that the serious student might also benefit and if some of the language seems ominous try to remember that we are simply, thus far anyway, repeating history. Nothing more…
    Blessings to all, Memphis

    “The October SEC rule will change the valuation of money market funds by eliminating this presumption that what you put in is always there. The funds will be marked-to-market and the SEC thinks this will prevent another run during a crisis. The rule, of course, exempts funds who invest ONLY in government paper. So everything else is perceived to be “risky” so it must be marked-to-market for transparency, but if it is a pure government fund, hey, the rules do not apply.”

    “Already, the weak minded are moving to government-only funds that will be just like the Japanese funds were who hid any losses. The accounting will assume you have lost nothing as long as it is government paper. Investors are already being told that their money market funds restricted to government paper are 100% safe and will always return their money. The floating NAV values for all other funds are risky.”

    “What is happening is very clear, almost $500 billion has moved from money market funds into government funds. Total assets in money market funds have now dropped below $1 trillion for the first time in 17 years. This is very bad for it will enhance the economic decline when banks are already not supporting the economy and hoarding cash deposited at the Fed in its Excess Reserves facility.”

    “Despite the hoopla that [has been circulating stating that] the end is near signaled by the sales of US Treasuries, to the contrary, the landscape is changing already [in the reverse] and the new rule has not yet [even] gone into effect. As always, you have to pick up the rug to see the real trend. Analyzing just the surface never reveals the truth. You have to pay closer attention.”

    https://www.armstrongeconomics.com/world-news/sovereign-debt-crisis/new-sec-money-market-rules-sending-cash-into-treasuries/

    “Funds only investing in government paper are now PRESUMED 100% safe so there is no marked-to-market. Consequently, there are two primary types of funds. One is marked-to-market, so there will be no guarantee you get back 100%. The other will be fully invested in government bonds they claim is risk-less but historically [this does not hold true for it is that] no AA+ corporation fails (non-bank) where [as in a sovereign] government default and you get nothing. There, you will be told you lost nothing, but in reality, you may not be able to sell. When the crisis comes, the only buyer will be the central banks and if they stop buying, look out below. Only the “stupid” money will be going into government paper money market funds and they deserve what they will get. Their losses will help to create the coming Phase Transition where everyone starts to panic out of government paper globally as in 1931.”

    https://www.armstrongeconomics.com/world-news/banking-crisis/heads-they-win-tails-you-lose/

  • Lonestartxcowboy

    Another WOW moment, ML!

    Such great information to snack on with my morning coffee! Thank you for such educational pieces. This allows me to better understand other articles I read.

    Here is a good one from this morning!

    http://www.bloomberg.com/news/articles/2016-10-21/hedge-fund-managers-struggle-to-master-their-miserable-new-world

    The wring of the hands have not just begun, they have been that way for some time now.

    • MY LADIES

      LONESTAR THANK YOU VERY MUCH WE WILL TALK MORE ABOUT THIS TOMORROW. THANKS FOR BRINGING IT IN

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