WSJ: Money market funds accepting riskier repo collateral

Some money market mutual funds, which since the financial crisis have made repo loans mainly collateralized by government securities, have begun accepting corporate debt and stocks as security, reports the Wall Street Journal September 16.

This move to riskier collateral is driven by a shortage of risk-free collateral, a desire to earn a higher return on the repo loan, and the unintended consequences of recent financial reforms, writes reporter Eleanor Laise.

From the report:

Some funds are also taking a riskier approach to the common money-fund strategy of investing in repurchase agreements. Known as “repos,” these are short-term loans, often backed by government securities. A number of money funds have lately broadened the types of collateral they will accept to include not just government securities but also corporate debt and stocks.

At least one money fund that bills itself as a government fund has also taken this step. The American Beacon U.S. Government Money Market Select fund this year started investing in nongovernment repos “to get a better yield,” said Mike Fields, chief fixed-income officer at American Beacon Advisors Inc. The fund tries to reduce risk by demanding more collateral, Mr. Fields said.

Money market funds are key repo lenders, and in the financial crisis of 2007-2008 they led the run on the repo market as, spooked by falling values for mortgage-backed securities, they demanded more collateral or refused to roll over the short-term loans.

A major event of the crisis was the Reserve Primary money market fund’s share price falling below $1, after the value of its Lehman unsecured commercial paper tanked because Lehman couldn’t roll over its repos.

The Securities and Exchange Commission, which regulates money market funds, has since ruled that the funds must keep at least 10 percent of their assets in securities they can sell in one day and 30 percent in securities they can sell in one week, so they can raise money quickly in a crisis.

But there’s a shortage of short-term securities, in part because few trusts have been selling asset-backed commercial paper since the collapse of securitization during the crisis. ABCPaper is a short-term, often overnight, IOU that banks and their off-the-books trusts sold to investors like money market funds to raise cash for their securitization operations.

Another reason for the shortage is that banks are holding onto the securities to build up their reserves.

The Wall Street Journal reports that the dwindling pool of securities has left money funds with heavy exposure to financial institutions, especially big European banks, and demand for the securities has driven down yields.

“To boost their returns, some funds are increasingly using complex, and sometimes risky, investments,” Laise reports.


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