Institutions Pull Out of Prime Money Funds

Oh, oh..."breaking the buck" is very bad for money market funds (see post-Lehman collapse).  The contagion of a Greek default will spread throughout the Euro zone.  Guess what US money market funds invest in for "safety"?  Answer: Euro bonds.

http://www.bloomberg.com/news/2011-06-29/institutions-pull-out-of-prime-money-funds.html

In a Greek Default, Higher Risk for Money Market Funds

This is why the powers-that-be fear a Greek default so much.  Remember the post-Lehman liquidity crisis that brought on the 2008 financial meltdown? 

http://mobile.nytimes.com/article?a=810271&f=23

Money market funds have long been a popular haven for conservative investors, but they could become one way that the tremors of the financial crisis in Greece touch the pocketbooks of Americans - about 50 million of them.

For years, the funds in the United States 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 percent 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, especially if Greece's Parliament votes down a set of deeply unpopular austerity measures Wednesday morning.

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," René M. Stulz, professor of banking and monetary economics at Ohio State University, 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.

While the author is correct that sovereign debt defaults will have a crippling effect on our global financial system, the most dangerous and biggest systemic risks are unquantifiable, due to the proliferation of over-the-counter, non-transparent trading of credit default swaps.  Due to the high-leverage nature of said cds', when and if peripheral Euro countries default, the collapse of the credit markets will be catastrophic.

Translation?  Economies will tumble, commerce would freeze up, and a trip to the local ATM or bank teller would prove futile.  In other words, good luck.

FDIC warns on moral hazard for money market funds

The operative word is "outgoing" FDIC Chairwoman.  The truth always comes out when they are about to leave office.

http://www.reuters.com/article/2011/05/10/funds-moneymarket-idUSWAT01510720110510

Redemption suspension

The words "suspend redemptions" evoked panic and fear in hedge fund investors in 2008 after Lehman Brothers collapsed. Insolvent hedge funds had to delay investor demands for redemptions because they lacked access to liquidity during the financial crisis. A credit freeze ensued, and no one trusted their counterparties who were equally insolvent.

Fine, hedge fund investors are allegedly savvy and required to understand the outsized risks and rewards of investment in hedge funds. An accredited investor needs to have a minimum income of $200,000 and a minimum net worth of $1 million, but most have income and net worth levels much higher than the minimum thresholds. They understand "high risk/high reward"--at least they're supposed to.

But the latest financial reform being pushed by the Obama financial team "to protect consumers" includes the following language: "suspend redemptions to allow for the orderly liquidation of fund assets." This clause is in direct conflict with Securities Exchange Commission (SEC) Rule 2a-7, which provides minimal risk, no volatility, and redeemability for money market funds. In other words, when the average Joe parks his money in a money market account, he expects miniscule interest earned, in return for the safety and liquidity of funds being instantaneously accessible via a computer keystroke or a visit to the bank teller.

What this "financial reform" clause does is allow financial institutions to NOT guarantee your request for cash withdrawal if financial markets are collapsing. In other words, how "safe" is your cash if you can't even access it in times of financial distress--or when there's a run on banks?

This is the same SEC which is chartered to protect investors from unscrupulous swindlers and regulate free, orderly markets. Given their dismal track record of protecting investors from the likes of Ponzi schemers Bernie Madoff and Allen Stanford, it should come as no surprise that savers and investors will become incredibly vulnerable should the next financial iceberg hit again.