In Greek crisis, investors face new risk

For years, US funds have taken investors’ money and lent it out where they can get the best returns.

European banks have been a target lately, so much so that about 50 per cent of the funds’ $1.6 trillion in prime money market assets is in the debt of European banks. Now that Europe is struggling to contain its debt crisis, these safe investments could be a tad less safe.

Though Greece’s Parliament has voted in favour of an deeply unpopular austerity measures, there is no guarantee that the country will come out of its financial crisis.

While any losses on money market funds could be minimal, especially compared with the turmoil that could ensue in stock and bond markets, the possible effect on this corner of the financial markets shows how the ripple effects could reach far and wide if Europe cannot resolve its debt crisis.

“A lot of them are exposed to a risk of a blowup somewhere in Europe,” Ohio State University banking and monetary professor Rene M Stulz said about money market funds.

“It does present systemic risk.”

Some experts and the funds themselves play down the risks, expressing confidence in the underlying safety of the European banks’ debt that they own.  A primary fear is that if a European bank indebted to the funds is weakened in the crisis, then it might have a hard time repaying its loans. But even the perception of trouble could, in a worse case, cause financial markets to seize up and send investors rushing to withdraw money.

That is what happened after the collapse of Lehman Brothers in 2008 hit one fund that owned Lehman debt, the Reserve Primary Fund, causing a huge run on all funds. Some investors have already withdrawn money from these funds.

Their worry is that the chance of a Greek default increases if the government fails to turnoround its economy even after a set of tax increases, wage cuts and asset sales. In case of a subsequent default  the European governments will have to step in again. But the fear of a default could potentially set off turmoil across the world’s financial markets.

If that happens, analysts say, Greek bond yields would jump. The euro and stock markets would fall. The cost of lending among European banks might potentially spike as banks doubt one another’s creditworthiness.  The funds hold large amounts of debt of banks in nations at the core of Europe, like France and Germany. They now lend about $240 billion to French banks, or 14.8 per cent of the funds’ assets, according to Fitch Ratings. French banks are among the biggest holders of the government debt of Greece and other weak countries, which would leave them exposed if Greece or other nations run into more trouble.

As the crisis has simmered over the last two years, fund managers have decreased their direct lending to banks in the weakest countries of the euro currency zone – Greece, Portugal and Ireland – and even in Spain and Italy. Their holdings in Greek debt are zero. Their percentage of assets in Spanish debt has declined to 0.2 per cent from 3.3 per cent in 2008.

“With very few exceptions, the money market mutual funds don’t have much direct exposure to the three peripheral countries which are currently dealing with debt problems,” Federal Reserve chairman Ben S Bernanke said recently. “They do have substantial exposure to European banks in the so-called core countries: Germany, France, etc. So to the extent that there is indirect impact on the core European banks, that does pose some concern to money market mutual funds.”

Underscoring those worries, the president of the Federal Reserve Bank of St. Louis, James Bullard, told Dow Jones Newswires recently that the bank planned to keep open its dollar-lending program with the European Central Bank and other Central Banks beyond the August 1 expiration date. That move should help ease some of the pressure on European banks providing an alternative to money market funds to help them fund their daily operations in dollars.

Bernanke said the industry was still working on reforms to make money market funds safer. After the financial crisis of 2008, the Securities and Exchange Commission put in tougher regulations, cutting to 60 days from 90 days the average maturity of debt that the funds can hold so that they can get out of bad loans more quickly.

In addition, at least 30 per cent of their assets must be in cash or other holdings that can be exchanged for cash within a week, and 10 per cent in assets that can be changed for cash in a day. Regulators also have new powers to suspend redemptions if there is a run on a fund. But the moves are incomplete. The industry and regulators are still discussing possible changes, like plans for buffer funds to bail out investments that get into trouble.

In the last two weeks, investors have withdrawn $45.6 billion from prime money market funds, according to data from the Investment Company Institute. That is the biggest two-week withdrawal since another jittery two weeks in March last year.

After the Lehman panic in 2008, investors lost out when the Reserve Primary Fund “broke the buck,” reporting a share price of 97 cents to savers who had long expected an unwavering share price of a dollar. They faced another cost when, amid the panic, redemptions were frozen and they could not get to their money. There were also bigger systemic costs since US corporations that borrowed from money funds were shut out of the market for a time.

Danbury, Connecticut-based Matson Financial Advisors’ Michael Matson said that in the past year he has had 20 to 30 clients ask to move out of money market funds and into short-term bank accounts because of rising global concerns.  

Money market accounts have typically offered a higher return than bank accounts. But their returns have dwindled as interest rates have fallen in recent years – and bank accounts offer the additional security of a guarantee from the Federal Deposit Insurance Corp.

“There is a heightening anxiety about protecting principal, linked to the craziness of 2008, Madoff and what is happening around the world,” said Matson, who advises people living in the Westchester County and Connecticut area and are making investments from $500,000 to $3 million. “People are now realising we are interconnected and what happens in Greece may impact on Main Street, Connecticut.”