New reports from Fitch Ratings and the Financial Times say U.S. money market funds are cutting their exposure to European banks, presumably to protect themselves in the event of a full-blown EU debt crisis.
But neither report answers a critical question posed by a RepoWatch reader: How are they cutting back — buying less commercial paper, pulling back on repo lines, or something else?
Here’s why that matters, according to the RepoWatch reader, who works on Wall Street:
If the money market funds are reducing their repo lending to European banks – where they have historically been crucial providers of short term financing, according to the Financial Times – then this would be a direct funding squeeze reminiscent of the run on the U.S. repo market in 2008.
It could be an early warning sign of danger, like a “canary in the coalmine, I think,” said the reader.
On the other hand, if money market funds are reducing their exposure by selling European bank notes or commercial paper, this would likely increase the banks’ financing costs and might force them to rely more on repos, where they will need more collateral, but it wouldn’t necessarily lead to a market-wide credit crisis.
E-mailed the reader:
The uncertainty expressed by the money market funds with respect to bank exposure to sovereign credits will manifest in the same way that uncertainty about bank exposure to the housing market did in 2008. If unsure, the lenders pull back. If bad news continues, the pull-back could accelerate into another “run”.
Many Americans know that some money market funds were threatened with ruin in 2008 when customers withdrew their savings in a panic akin to a run on a bank. But few seem to know that money market funds themselves helped trigger the 2008 panic by earlier launching runs of their own, withdrawing from the repurchase and asset-backed commercial paper markets, where they had been major funders. That withdrawal was a key cause of the financial crisis of 2007-2008, and it’s one reason money market funds are being watched so carefully today.