Monday, September 28, 2009

Latest Monetary Policy Proposal From the Fed Puts Your Money Market Fund At Risk

"Nothing good can come from the Federal Reserve… It's immoral, unconstitutional, impractical, promotes bad economics, and undermines liberty," from the book "End the Fed," by Congressman Ron Paul.

The Federal Reserve is discussing the possibility of using "reverse repo" transactions with money market funds that would be aimed at draining liquidity from the financial system.  The transaction would involve swapping the toxic assets on the Fed's balance sheet for part of the $3 trillion sitting in investor money market funds.  Typically a repo transaction is a policy tool used by the Fed and executed with the Fed's primary dealers in order the "fine tune" systemic liquidity and regulate the Fed Funds rate.   They are short term in nature and involve swapping short term Treasuries in exchange for cash, with the Treasuries being the collateral in order to "guarantee" that the short term trade can be unwound with little or no risk.

Here's the link to the article that revealed this proposal:  Fed Wants To Drain Money Market Funds

The current Fed proposal is based on the fact that the primary dealer system only has enough cash to drain $100 billion from the system.  Here's what is really going on with this proposal (without getting into the technical details of how repos work):  

The Fed has purchased trillions of dollars of toxic assets from banks.  We don't know what price the Fed paid and we don't know how corrupted the underlying collateral is (the Fed refuses to disclose both pieces of valuable information).  Most of the securities involve severely distressed underlying collateral like credit card receivables, subprime mortgages, auto loans and now commercial real estate mortgages.  Most of these assets will eventually be worth less than 10 cents on the dollar.  If the Fed were to hold onto these assets, the Fed, and the banks that ultimately are the shareholders of the Fed, stand to lose trillions. 

What the Fed proposal would do would move these toxic nuclear waste assets from the Fed's balance sheet and into money market funds, in exchange for cash sitting in the money market funds.  The biggest problem is the Fed has no basis for valuing these assets other than the price it paid the banks for them, so at what price will the Fed value these securities in order to establish the market value basis for the repo transaction?   In other words, the Fed can stick a random price on these assets and swap them for the cash in the money market funds and say "trust us, we're Fed - we'll make you whole."  

Without going in-depth into the problems that could occur which might make the Fed's promise wothless, this proposal, if made effective, would expose money market funds to a significant, if not catastrophic level of risk.  To be sure, each fund individually has charter limits which would put a cap on the amount of cash the Fed could "repo" out of the individual fund and replace it with garbage assets.  However, these assets were fraudulently rated AAA in the first place and have no business being put into money market funds.  Money market funds are supposed to be basically risk-free funds in which investors "park" cash and earn a small amount of interest.

At best, this is a move by the Fed to justify draining a large amount liquidity from the system by using one of its monetary tools to drain cash from money market funds.  This has never been done before and is well outside of the traditional boundaries of repo/reverse repo tool used by the Fed with primary dealers. At worst, I believe this is a veiled attempt by Bernanke to move toxic assets from the Fed's balance sheet and onto the public, under the false pretenses of using money market funds  to drain liquidity from the system, rather than putting these near-worthless assets back on to the balance sheets of the Fed's primary dealers.

Hopefully this idea goes away. If it does become reality, I would not, under any circumstances trust this situation and would withdraw all funds from any money market funds you own and either move the cash into gold or into a short term Treasury bond fund.


  1. Excellent analysis Dave!
    You've nailed the Fed and their intentions again!

  2. Presumably money market funds would do this voluntarily, I mean they can't be forced to take the garbage, right?

  3. Thanks. This whole show going on in DC and NYC is getting more and more Orwellian. I don't see how anyone can trust anything that comes from Bernanke or the Obama Administration.

  4. Dennis, I don't know. We don't the specifics of the proposal. I guess my point is, is it really worth the risk of trusting the people running the Fed OR your money market fund?

    How about investors who placed their trust with the Reserve Fund? The hippie running the first and oldest money market fund blew that thing to smithereens.

    Why take risks like that and why trust the Fed?

  5. Dave,
    To me this is a very dangerous move. Hopefully it will command some more attention.

  6. gyc, what's more dangerous, Pats letting McDaniels get away or this move? LOL...

    Agree, and I've had some conversations with people who "get" what's going on, and yet still are willing to give the Fed the benefit of the doubt on this.

    Hopefully this just goes away - this is why I don't keep money in banks, money market funds and why I rolled out of my IRA and paid the 10% penalty. IRA's will be the one asset left that they sweep off the table before the system collapses.

  7. I pulled our money out of Allianz paid the penalty after reading a shocking fact about the amount of liabilities. However I have a Money Market Account but you are just referring to the Money Market Funds correct? I know the Funds are no longer insured since 9/19/09 but the money market accounts are FDIC insured at least the one I have then again I am almost thinking mattress (lol) after having read Denningers piece tonight and knowing what I did about FDIC already YIKES!

  8. Lori, money market funds/accounts are the same thing. What I am recommending to clients is that they put as much as they feel comfortable with into physical bullion (gold and silver soverereing-issued coins like eagles, maple leafs etc) are the best. I don't like the private-minted stuff, but that's my preference. I think the official coins will appreciate a lot more vs. spot.

    The thing about the coins, you ALWAYS find a coin dealer or individual who will buy them from if you need cash.

    I would only keep cash in your securities accounts in short term Treasury-ONLY funds. Make sure the prospectus prohibits anything except Treasuries. Money market funds typically have some portion of the fund that can be invested in non-Treasury paper - that's why they "break the buck," aka blow up.

    With the FDIC situation, eventually we could get to a point where a "bank holiday" is declared, and if that happens, your cash may still be money good, but you can't get to it until they re-open the banks and print the money needed to meet withdrawal demand.

    GOLD AND SILVER bullion coins are good anytime, anywhere in the world. Period.

  9. Dave, you wrote:

    The Fed has purchased trillions of dollars of toxic assets from banks.

    The fed's balance sheet states assets of 2 trillion $ plus change. Are these assets held off the balance sheet?