Money Market Funds are in the Fight of Their Lives
Money market funds aren't exactly the safe-haven investments they're cracked up to be.
In September 2008, when Lehman Brothers failed, money market investors fled funds in droves, exposing investors and capital markets across the globe to huge systemic risks.
Now, to better safeguard investors and prevent the commercial paper market from shutting down in future crises, SEC chairwoman Mary Schapiro is proposing to re-make the money market mutual fund industry in the image of banks.
The SEC staff is recommending money market funds set aside capital reserves, as banks are required to do, and fund sponsors issue stock or debt to bolster their positions as a "source of strength," as bank holding companies are expected to do.
Also, the staff recommended restricting redemptions under certain circumstances and potentially requiring funds to collect upfront fees to further cushion themselves in times of trouble.
Industry leaders immediately attacked the plan as an assault on their business. They're threatening to sue the SEC.
The battle ahead isn't just about changing an industry.
It is about reshaping modern finance, the future power of regulators, and the real world implications of moral hazard.
Money Market Funds Explained
Money market funds are mutual funds. Investors who buy shares are pro-rata owners of the underlying investments that funds hold.
Money market mutual funds are restricted by SEC rules under the Investment Company Act of 1940 to purchasing only the highest-rated debt of issuing companies. They also invest in government securities and repurchase agreements.
The duration of the debt instruments they hold cannot exceed 13 months and the average weighted maturity of their portfolios has to be 60 days or less. Additionally, funds can't hold more than 5% of one issuer, except for governments or repurchase agreements.
The first U.S. money market mutual fund, The Reserve Fund, was established in 1971 to directly compete with banks for investor deposits. At that time "Regulation Q" prohibited commercial banks from paying interest on checking accounts.
Money market funds quickly drew in investors looking to earn interest on cash positions.
By September 2008, the size of the oldest money fund in the U.S., the Reserve Primary Fund, was $64.8 billion. Total industry assets were $3.8 trillion.
Anatomy of a Money Market Fund Panic
On Sept. 15, 2008 Lehman Brothers filed for bankruptcy and everything changed.
Bankers Committed Fraud to Get Bigger Bonuses
In case you didn't catch the article titled "Guilty Pleas Hit the 'Mark'" in the Wall Street Journal, I'm here to make sure you don't miss it.
This is too good.
Three former employees of Credit Suisse Group AG (NYSE: CS) were charged with conspiracy to falsify books and records and wire fraud. They were accused of mismarking prices on bonds in their trading books by soliciting trumped-up prices for their withering securities from friends in the business.
By posting higher "marks" for their bonds in late 2007, they earned big year-end bonuses.
What a shock!
What's not a shock is that, after a bang-up 2007, Credit Suisse had to take a $2.85 billion write-down in the first quarter of 2008. No one knows how much of that loss was attributable to the three co-conspirators who were fired over their "wrongdoing."
Two of the three accused pled guilty. Also not shocking is the reason David Higgs – one who pled guilty – gave for his actions. He said he did it "to remain in good favor" with bosses, who determined his bonus and who profited handsomely themselves from his profitable trading and inventory marks.
As for Salmaan Siddiqui, the other trader who pleaded guilty? His attorney Ira Sorkin, the former Securities and Exchange Commission (SEC) enforcement chief, said of his client: "What he did was the result of his boss and his boss' boss directing him to do it."
You know what else is shocking?
Robo-Signing is the Tip of the Iceberg for the Banks
What may be good news for delinquent credit card holders may also be really bad news for banks.
It turns out the "robo-signing" of foreclosure affidavits is just the tip of the iceberg.
In what one judge called "robo-testimony," falsely attested-to statements by bank document custodians have been submitted in courts around the country by banks trying to win judgments against delinquent credit card debtors.
Apparently, tens of millions of credit cards issued by banks have not been accompanied by good recordkeeping, either.
Chasing down delinquent borrowers in court requires original credit agreements and accurate payment histories to verify outstanding balances and claims.
As it turns out, banks aren't providing them – either to the courts or to third-party debt collection companies that buy uncollected debts for pennies on the dollar.
As a result of these shoddy practices, judgments already granted to banks could be overturned and they could be sued by state attorney generals or pursued by the Consumer Financial Protection Bureau.
The same banks could even be potentially charged by the Justice Department under the Racketeer Influenced and Corrupt Organizations (RICO) Statutes for selling dubiously documented accounts to debt collection companies.
While some debtors will take comfort in what they read here, investors in banks may want to question how legal issues and regulatory investigations will impact their stocks.
Don’t Be A Wall Street Patsy
You want to know the truth? The truth is that Wall Street has stacked the deck against you.
That's why you need to understand how the game is played. Otherwise you'll end up a Wall Street patsy.
So, here's the truth along with some lessons that will help you play the game like a pro.
First, though, we'll need to debunk a few myths…
Let's start with the myth that the Street lowered brokerage charges for the benefit of retail investors. At one time, these fees used to be obscenely high and fixed.
But, on May 1, 1975, fixed commissions were abolished after brash upstarts like Charles Schwab and disgruntled investors decided to attack The Street's price-fixing schemes.
The negotiated commissions regime that followed lowered the cost of access to the stock market, essentially ushering in the era of the "individual investor."
The influx of these individual investors, many of whom didn't have enough money to create diversified portfolios, soon became a boon for mutual funds – which have since grown like weeds in an untended sod farm.
Wall Street Changed the Game
Since the commission business was no longer profitable, Wall Street moved its retail business to an "assets under management" model.
So instead of making money on commissions the game changed to gathering as many assets as you could into a retail investor's account and charging a fee to "manage" them; in other words, just watch them.
That's one of the reasons why Wall Street advocates a "buy and hold" strategy for retail investors. They don't want you to take those assets away from them.
It's the same thing with mutual funds.
And conveniently, if your broker puts you into mutual funds that are losers, it's not your broker's fault.
Now, it's the mutual fund manager's fault. That way the broker can't be blamed if your account loses money.
Instead, your broker can tell you, "Don't fire me, let's fire the mutual fund manager and let's find you a better fund to invest in. But, no matter what happens, we need to buy and hold and not try and time the market."
That's what retail investors are told to do over and over and over again.
But guess what? That's definitely not what Wall Street firms do.
In fact, while you're being told to buy and hold, exchange specialists, market-makers, hedge funds and every trading desk at every Wall Street bank and firm are busy trading.
Some individual investors began to see how Wall Street was really making its money and started trading themselves.
Of course, that only increased the competition for easy trades as more retail investors traded in and out of stocks.
To continue their advantage over the public, Wall Street fought to do away with the uptick rule. The rule was wiped out so traders could short sell any stock at any time.
But it's the big Wall Street players who benefit from the rule change because they can use their huge capital positions and work with each other to drive down stocks they have shorted.
Who gets hurt? The buy-and-hold retail investors who are told to buy more at lower prices are the ones who get fleeced.
And, who is selling to them?…
Liquidity Liquor and the Battle Ahead
Equity markets have been charging ahead for a few weeks. Not just here in the U.S., either.
They've been rising in Europe too. Even China's Shanghai Composite, after falling 22% last year, has been percolating higher.
Thanks to the ECB filling Europe's punchbowl, last year's sovereign debt hangover has been mellowed by some 100-proof "hair-of-the-dog" liquidity liquor…
And it feels good.
This party atmosphere is infectious!
After the European Central Bank (ECB) poured some $600 billion (and counting) into the party bowl and let teetering European banks ladle themselves out as much as they could stomach, the Federal Reserve signaled that it wanted to throw in some free "shots," in the form of more quantitative easing or some other easy money contribution, to make sure Europe isn't the only party house on the block.
And now the International Monetary Fund (IMF) – the usually stodgy party-poopers of fiscal discipline fame – are trying to get themselves invited!
They know they're not usually welcome while any economic bacchanal is raging, so they're asking for donations of $500 billion to $600 billion (on top of the $400 billion in commitments they're already packing), so they can man the kegs and stills and pump in whatever juice is necessary to make the budding soiree a true world party.
It's amazing how giddy easy money makes everyone feel.
How else could we go from fearing the next "Lehman moment" to feeling like there's enough money and time for over-indebted countries and increasingly strung-out banks to heal themselves?
Don't get me wrong: I love a good party. I'll stay until the music stops, or until the punchbowl is empty. I just hope I hear the music stop before everyone realizes the punchbowl's been cracked.
There's no reason not to be participating in this rally. And there's no reason not to be aware of what's driving it.
It's 2007.2, and Our Next "Lehman Moment' Is Coming Fast
It seems that my Thursday edition of Wall Street Insights & Indictments was warmly received by the bullish crowd, many of whom reached out to me to thank me for my optimism.
I'm sorry to burst your bubbles, but I am not a raging bull (but thank you for asking).
In fact, I'm still bearish.
There's a big difference between being bullish and playing all stocks (and other asset classes) from the long (that means "buy") side, and judiciously buying select momentum stocks with fat dividend yields, which is what I was recommending on Thursday.
I was talking about taking the path of least resistance, which I identified as "upward," based on equity activity through year-end and so far in 2012. You've heard the old adage "the trend is your friend." Well, that's what I was talking about. The trend has been up.
I'm bearish because I'm afraid of a European meltdown and a "hard landing" in China.
But there's a huge danger in missing what could be the beginning of a real bull market.
So, it makes sense to start putting on solid positions and even speculating here and there. But I am not all in – not yet. However, the time is coming. But, that is also the problem.
I'm fearful that a crash is coming, and maybe soon. If we get one, and everything flushes out and we get a capitulation bottom amidst a global panic sell-off, then I'll be all in, all the way, for the long-term. I'm talking about loading the boat up with stocks and commodities and enjoying a generational ride that will last for maybe 10 years, or more.
These Four Investing Lessons Mean Everything Today
Talk about information overload…
There's so much news and data, so many opinions about events and data points, so many financial publications, so many shows, so many stocks, mutual funds, exchange-traded funds (ETFs), futures, options, derivatives, so many opposing points of views about everything, it's enough to make your head explode and your investing comfort level implode.
Most people tend towards like-minded analysts and economic analysis that confirms what they're seeing and thinking. There's a kind of comfort zone there, where "We're in this together and if we're wrong, well, I wasn't alone; but if we're right, boy am I smart."
Then there are the "skittish" investors who think they know what they're doing – that is, until they hear a different opinion from someone, anyone, they think has a leg up on them. And what do they do then? They usually ask, "Really?" Meaning, "Do you know something I don't know?" Chances are, at that point, they are going to panic.
And, of course, there are those investors who know they are right, and stick by their convictions and positions all the way to, well, you know where.
Maybe you've been there.
I was there myself when I started trading professionally on the floor of the Chicago Board of Options Exchange (CBOE) in 1982.
But I quickly distanced myself from all the noise that distracted me from being a successful trader.
There is no magic bullet to being a successful investor; that's the bad news. The good news is that it's a lot simpler that everyone makes it out to be.
Here are the four most important trading lessons I have learned:
Paul Krugman is Dead Wrong: Debt Matters
Paul Krugman, the Princeton University economics professor, Nobel Prize winner, and regular New York Times op-ed contributor says, "Debt matters, but not that much."
Not only is he off the reservation on this one, but he's completely fallen off his high horse.
In the real world, debt actually matters a lot.
In a Houston Chronicle opinion piece last week, Krugman, riding his horse – whose name might as well be Liberal Conscience – trampled conservatives under the guise of an economics lesson that derided "deficit-worriers" for wrongly seeing "America as being like a family that took out too large a mortgage, and will have a hard time making the monthly payments."
According to Krugman, that's a bad analogy and "the way our politicians think about debt is all wrong, and exaggerates the problem's size."
Decide for yourself. Either debt matters a lot, or not that much…
The World According to Paul Krugman
Professor Krugman calls all the conversation in Washington about debt and deficits a "misplaced focus" and says all of the economic experts "on whom much of Congress relies have been repeatedly wrong about the short-run effects of budget deficits."
He derides the fears that deficits will cause interest rates to soar by pointing out that they haven't moved.
What he doesn't say is that they haven't moved because they're not free to move.
The fact is that the U.S. Federal Reserve has corralled the free market in interest rates by knocking short-term rates to almost zero through successive open market operations and extraordinary quantitative easing measures.
Mr. Krugman mocks those waiting for rates to rise and notes that while they wait "rates have dropped to historical lows."
Maybe what he doesn't realize is that the Fed's actions themselves have been nothing short of historical.
The crux of Mr. Krugman's supposition that debt doesn't matter much is based on his bashing of the popular analogy comparing America's debt problems to those of a mortgaged homeowner.
All of which Krugman claims is "a really bad analogy in at least two ways."
He says, "First, families have to pay back their debt. Governments don't – all they need to do is ensure that debt grows more slowly than their tax base."
"Second," he says, "an over-borrowed family owes the money to someone else; U.S. debt is, to a large extent, money we owe ourselves."
He goes on to say that the debt from World War II was never repaid and didn't make postwar America poorer.
In fact, the Professor points out, "the debt didn't prevent the postwar generation from experiencing the biggest rise in incomes and living standards in our nation's history."
Krugman is Flat Out Wrong
First off, the homeowner analogy is excellent–not irrelevant.
Mr. Krugman is wrong when he says that homeowners have to pay back their debt. The truth is they don't have to.
Let's Play Insights &
Today I want to play a special game I call Insights & Indictments Jeopardy!
It's based on the classic T.V. game show where contestants vie to pose the correct "question" to the answers that are revealed in an array of categories.
For example, let's say the category is "Federal Agencies."
The first "answer" happens to be: "This new organization holds primary responsibility for regulating consumer protection in the United States."
If you ring your buzzer first and shout out the question, "What is the Consumer Financial Protection Bureau?" you would be right.
Okay, let's play Jeopardy!
Today our category is actually going to be the Consumer Financial Protection Bureau (CFPB); see how many you can get right…
- The CFPB was founded as a result of this July 2010 Wall Street reform and consumer protection act, which was meant to save America from being used and abused by Wall Street crooks and bankers in the future.
- In a sign that the GOP mostly opposes new powers being granted to the CFPB, this is the number of Republican Senators who actually voted to enact the reform and consumer protection act.
- When the president nominates an appointee as director of the CFPB, the same act requires this kind of confirmation.
- This man's appointment yesterday as CFPB director is controversial because he is being seated without the above confirmation
- This CEO of the American Bankers Association said Obama's move to install the director without the required confirmation complicates efforts of banks, and puts the bureau's actions "in constitutional jeopardy."
- This Harvard law professor was the principal architect of the CFPB when she was an aide to President Obama and the Treasury Department.
- Interestingly, the director of the CFPB also gets a seat on the board of this powerful government-backed corporation.
- In the alarming situation I've just described, S.O.S. stands for this.
Got your answers? Let's see how you did…
Give yourself half credit if you got any part of the long explanation correct and 100% credit if you got most of it right. If you get most of these, but stumble on the last one, don't feel bad. (And you won't, when you find out what it is.) But if you did get the last one right, and even if you didn't get any of the other questions right, congratulations… you are the new champion.
Here are the correct "questions" (along with some explanations).