U.S. Money Funds Risk Losses If Europe Crisis Sparks ‘Wildfire’
The European debt crisis would pose a threat to U.S. money-market mutual funds if a rash of sovereign defaults caused big banks to fail to meet obligations within the next three months.
“It would take a very rapid decline and not just in the smaller European countries” for the debt crisis to threaten U.S. money funds, George “Gus” Sauter, chief investment officer at Vanguard Group Inc. in Valley Forge, Pennsylvania, said in an interview. “You’d probably have to see Spain and Italy get into difficult shape.”
Greek lawmakers are scheduled to vote this week on a five- year austerity plan for the cash-strapped nation to secure more international aid and avoid the euro-area’s first sovereign default. Money funds could be hurt by a default because they have lent to European banks that, in turn, have lent to Greece and other heavily indebted European countries.
U.S. money funds eligible to buy corporate debt had about $800 billion, or half their assets as of May 31, in securities issued by European banks, Fitch Ratings estimated. European lenders held more than $2 trillion at year-end in loans to Greece, Portugal, Ireland, Spain and Italy, the most indebted European countries, the Bank of International Settlements estimated.
“It’s not about whether Greece defaults, it’s what happens after that, and there’s uncertainty behind that,” Alex Roever, head of short-term fixed-income strategy at JPMorgan Chase & Co. (JPM) in New York, said in a telephone interview.
European Union leaders vowed June 24 to prevent a Greek default as long as Prime Minister George Papandreou pushes a $78 billion euro ($111 billion) package of budget cuts and asset sales through Parliament this week. Greece needs to cover 6.6 billion euros ($9.4 billion) of maturing bonds in August.
“Money-market mutual funds still remain vulnerable to an unexpected credit shock that could cause investors to doubt the ability to redeem at a stable net asset value,” Eric Rosengren, president of the Federal Reserve Bank of Boston, said in a June 3 speech. Some funds have “sizable exposures” to European banks through short-term debt, he said.
The $2.68 trillion money-fund industry is the biggest collective buyer in the commercial paper market.
The bankruptcy of Lehman Brothers Holdings Inc. led to the Sept. 16, 2008, closure of the $62.5 billion Reserve Primary Fund when it suffered a loss on debt issued by the bank. Reserve Primary triggered a wave of redemption requests when it became the first money-market fund in 14 years to expose investors to losses.
Customers were denied access to most of their cash for months as the fund liquidated. Investors, fearing that other funds might fail, withdrew $230 billion from the industry by Sept. 19 in a run that threatened to cripple issuers of short- term debt.
Money market funds are limited to securities that can be converted into cash within 13 months.
JPMorgan’s Roever and Peter Rizzo, senior director of fund services at credit rater Standard & Poor’s in New York, said U.S. managers have been reducing their European bank holdings and shortening the average maturities of those remaining. That would allow them to withdraw more quickly without having to sell securities into a potentially illiquid market.
S&P estimated that 80 percent of European bank holdings is limited to three months or less, and 95 percent to six months or less among the 500 U.S. and European money funds it rates.
“The risk is if something takes the crisis from Greece to Portugal, Ireland and beyond and it spreads like wildfire,” Deborah Cunningham, head of taxable money-market funds at Pittsburgh’s Federated Investors Inc. (FII), said in a telephone interview. Federated is the third-biggest money-fund provider after Fidelity Investments and JPMorgan.
Multiple sovereign defaults could be managed if the banks don’t have to write down the bonds’ full value, said Anthony Carfang, a partner at Chicago-based Treasury Strategies Inc., which advises corporate treasurers.
“A whole lot of very bad things would have to happen very quickly for this to even approach a problem for money funds,” Carfang said in an interview.
Rules adopted by the U.S. Securities and Exchange Commission after the Reserve Primary debacle would also protect funds if investors spooked by the European crisis suddenly began withdrawing money, Carfang said. Funds now must keep 30 percent of holdings in securities that can be converted to cash within seven days.
The risk from securities issued by European banks has been “mischaracterized,” said Mercer Bullard, founder of Fund Democracy, a consumer group that advocates on behalf of U.S. mutual-fund investors.
“There is no empirical basis for the assertion that these holdings pose a threat to money-market mutual funds’ net asset values,” Bullard, a law professor at the University of Mississippi, said in testimony June 24 before a subcommittee of the House Financial Services Committee in Washington.
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