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ARS Update: Calling All Money Market Investors

Posted by Larry Doyle on March 1, 2012 7:41 AM |

Sallie Krawcheck Sallie Krawcheck was formerly president of global wealth and investment management at Bank of America and has also held senior positions at Citigroup and Sanford C. Bernstein & Company. She clearly understands the game.

Krawcheck wrote an excellent piece in The Wall Street Journal yesterday on the risks embedded in money market funds. Her work was largely exemplary, BUT fell short of fully informing readers and investors of risks within these funds.

As is often the case on Wall Street, we need to listen not only to what is said about a specific fund, market, or transaction BUT then often what is NOT said in order to fully understand the risks involved.

Let’s navigate and help complete Ms. Krawcheck’s work. She wrote, Money-Market Funds Aren’t What You Think:

The Securities and Exchange Commission is reportedly finishing a proposal to increase regulation on money-market funds, the $2.7 trillion industry that provides corporations with an important short-term funding source and individuals and institutions with an alternative to traditional bank deposits.

The SEC’s aim is to reduce the risk of a meltdown in the event of another 2008-style panic. Its proposal is said to include mandating capital backing for money funds and ending their convention of reporting assets at a fixed $1 net asset value—instead having it “float” to represent the funds’ underlying value, as with other mutual funds.

The industry opposes additional regulation, arguing that earlier SEC actions are sufficient. But meaningful risk—and significant misunderstanding of this risk—remains in this business, and additional reforms can help.

All good to this point. Krawcheck is highlighting risks and ongoing developments behind the scenes.  The industry is fighting to maintain the status quo. No surprise. Let’s continue . . .

From hundreds of conversations I have had with money-fund investors, here is what they generally don’t know (despite—or perhaps because of—being bombarded with pages upon pages of legal disclosures):

They don’t know that, notwithstanding SEC actions since 2008, their funds may not be fully safe. They don’t know that as recently as last summer, the largest money funds averaged 45% of their investments in European bank paper, with one major player at just under 70%. They don’t know that, were the investments to falter, half of the top 10 money-fund providers are not large and presumably well-capitalized banks but instead asset managers that don’t have anything like banks’ capital resources.

Nor do money-fund investors know that the largest money-fund managers have been gaining share in the industry over time, therefore concentrating and potentially heightening the risk of a failure. And they don’t know that, while these firms will likely go to extreme lengths to avoid “breaking the buck,” the $1 net asset value represents an implicit, rather than explicit, guarantee. Even then, there is no certainty that firms will be successful in raising capital in a downturn since, by definition, they will be trying to do so during a market dislocation.

Krawcheck continues to provide excellent and very valued insights. However, when she writes:

And here’s what the industry should recognize as it considers whether to support regulation: In the court of public opinion—not to mention among arbitrators—implicit guarantees like not breaking the buck can become viewed as explicit regardless of what written legal disclosures may say.

For a cautionary example, one need only look to Auction Rate Securities, a debt instrument once marketed as a cash alternative by the broker-dealers. Certainly there are differences, but like money funds, ARS looked like cash, acted like cash, and were talked about by the industry as cash—and when they lost value in 2008, clients, arbitrators and some regulators demanded that the broker-dealers reimburse clients. And so Wall Street firms did, to the tune of what looked to be billions of dollars in settlements.

Krawcheck does expose Wall Street’s dirty practice in the marketing of ARS, but also comes up short. A regular reader yesterday highlighted this paragraph to me and opined that Ms. Krawcheck seems to indicate that the ARS debacle is completely in the rear view mirror.

The ARS debacle remains front and center in terms of the most heinous scams ever perpetrated on Wall Street. In speaking yesterday with the single most informed source on the street, I was informed that ~$85 billion ARS remain outstanding broken down as follows:

Student Loans: ~ $40 Billion
Municipals: ~$25 Billion
Closed-End Preferred:  ~ $10 Billion
Other:  ~ $8 Billion-10 Billion

If you own a money market fund I would call your broker TODAY and inquire whether your particular fund is holding any ARS (auction-rate securities). These ARS are valued at a significant discount to par.

If your fund does hold ARS, then I would recommend you tell your broker to sell that fund, and if you want to maintain it in a money market fund to purchase one without ARS exposure. To that end, I would want to know what exactly the fund does own before purchasing. I would have little interest in owning a fund with European sovereign debt exposure as well.

In this day and age, do not blindly buy any investment product, money market fund, or otherwise.

We will give Ms. Krawcheck an overall grade of a B+.

Navigate accordingly.

Larry Doyle

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I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.

  • Peter S.

    “We will give Ms. Krawcheck an overall grade of a B+.”

    Let me suggest that being given a B+ for full disclosures involving matters of financial securities falls remarkable short of what should be an acceptable grade.

    Ms. Krawcheck suggesting the ARS debacle has been resolved for those whose life savings have now been frozen for years is merely purposeful subterfuge.

    An A+ is her fiduciary responsibility – its “principle to the penny” – and not a nickel short.

    Another excellent commentary on the ARS nightmare the major financial media has for the most part ignored.

    • LD


      You are correct. I graded her relative to that which we would typically see come from the industry which would be somewhere in the vicinity of a C.

      Your response does make me think what the chances are that Ms. Krawcheck would have written at all IF she were still the head of the wealth management practice at BofA.

      Where are all the current heads of those business units at the major financial firms laying out what Ms. Krawcheck wrote…AND highlighting the ARS exposure as well??

      Navigate accordingly…..!!

  • Friend of a friend

    The spouse of one of your Holy Cross classmates forwarded me the link to this post. Interesting and much to agree with but I believe you missed on one point:

    “If you own a money market fund I would call your broker TODAY and inquire whether your particular fund is holding any ARS (auction-rate securities).”

    SEC registered money market mutual funds (2a-7 funds) were NEVER allowed to invest in any type of auction security of any structure. Not before 2008 and not since. This was because the lack of certain liquidity on the auction date forced a look at the final, legal maturity of these issues which were well outside the 393 day limit on MMF holdings. of course, variable rate demand notes (VRDNs, ,VRDOs, etc) have always been MMF-eligble and continue to be used widely by taxable and tax-exempt MMFs.

    And while the rate reset feature and put might make VRDs look like ARS, they are different because of the VRD’s obligation of the backup liquidity provider to provide liquidity if the remarketing agent can not.

    Point? SEC registered MMFs may have their issues but they are in no danger from auction-rate issues.

    • LD


      Very interesting comment and thanks for sharing it. The question I would pose is the following: merely because SEC registered money market funds were NEVER allowed to invest in ARS does that categorically mean that they NEVER did invest in ARS?

      I ask for the simple reason that I have been informed by others that in calling their brokers to inquire on this very point that funds did seem to hold ARS. Perhaps those holdings were the VRDNs to which you allude.

      All this said, Ms. Krawcheck and you do raise very good points for investors, that is, what exactly does reside within your money market funds?

      Thank you.

  • Friend of a Friend

    Sorry, I meant 397 days, not 393. If you are curious, 397 is 13 30-day months plus one week.

    LD – I am in the business and have reviewed many MMF holdings reports over the past two decades and have never seen an ARS position held in a duly registered 2a-7 MMF. To invest in such an issue would have been as big a violation of Rule 2a-7 as buying a 30-year Treasury – it just was not done.

    More importantly, the average financial advisor, at least in 2008, did not know the difference between an ARS and a VRD – trust me, I spent hours back the trying to teach advisors the different. Asom nearly every MMF management company issued a statement in Feb or March 2008 confirming no ARS.

    The bigger recent and current risk in prime MMF has been their holdings of Debt issued by European banks (CDs, commercial paper, repo, etc.). While those exposures have been dramatically reduced, particulalry to the troubled countries, it is still there. If one is worried about a current risk in the holdings, I would place more focus on the issuers than on ARS which have never been a real risk for MMFs.

    • LD

      Great info and deeply appreciated. TYVM…!!

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