Thursday, June 30, 2011

US Money Market Funds & Euro Bank Debt

Perhaps, like you, I was horrified to read the Wall Street Journal's lead staff editorial on Monday and, that same day, to see clips of Ben Bernanke's testimony played on business cable channels confirming that their is concern at the Fed regarding substantial US money market fund holdings of European paper. No doubt bought and held for the higher yield on said paper, reflecting its greater risk. Duh.

To connect the dots, European banks hold lots of Greek debt. Greek debt has fallen in value due to that country's ongoing fiscal crisis. It's generally believed that European banks have not chosen, nor been forced by European financial regulators, to write down their Greek debt to market price levels.

Thus, it's highly likely that many European banks have overstated asset values. Their short-term paper, held by US money market funds, are thus vulnerable to default, in the event that something sets off a chain-reaction of Greek debt default and subsequent further devaluation of Greek debt held by the European banks.

How in the hell can this have happened in the wake of the US financial crisis of 2008? Between the multi-billion dollar bailouts, radical new regulatory law, and Federal guarantees of money market fund assets, you'd think our financial regulators would be on top of this one.

What's the difference between allowing banks with FDIC-insured deposits to engage in risky trading and underwriting, and allowing federally-insured money market funds to buy the short-term, unsecured debt of European banks holding Greek debt?

Only the matter of the specific risky activities, not the probably outcomes, nor the inherent risks.

As the Journal editorial expressed, our "regulators miss the systemic risk right in front of them."

This is neither trivial, nor a joke. Our vaunted Congress and federal regulatory agencies have already failed to head off yet another risky activity by private financial sector players.

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