Financial Markets Are Uncertain

The Great Storm of the Financial Markets

The European debt crisis combined with Hurricane Irene are lead to a scramble for cash, significantly impacting the performance of the money market. Money market mutual funds have turned from putting money into investment grade corporate securities to investing in European banking debt. Specifically, money market mutual funds have invested in debt issued by European banks that, in turn, hold debt issued by troubled governments like Greece, Ireland and Portugal. According to Fitch Ratings, which released a report on money market mutual funds in June, 50 percent of all prime money market fund assets are invested in European banking debt. (1)

If that was not bad enough, the approaching Hurricane Irene is causing turmoil in New York financial markets as traders scramble for cash. Market participants sought to lock up short-term loans through Tuesday in the repurchase market, which is a key source of liquidity for Wall Street traders. These loans are backed by Treasury bonds. Concern about being able to access cash to fund operations at trading desks resulted in repurchase rates rising by as much as 10 basis points or 0.1 percent. (2) Hurricane Irene is putting pressure on money markets at the very moment when it faces renewed threats from Europe.

To make matters worse, investors have been withdrawing funds from the money market. Money market funds saw their assets decrease by over $2 billion to just over $2.6 trillion for the week ending August 24. (3) Granted, this is quite a lot of money. With over 50 percent invested in potentially insolvent European banking debt, the actual amount of recoverable money in those funds may be half that number or $1.3 trillion. This represents a staggering loss for money fund investors, and by implication the larger money market, since money funds are big participants.

Other problems are plaguing the money market as well. The Federal Reserve recently committed itself to low interest rates for another two years, dealing a blow to savers and money market investors. With the inflation rate holding steady at 3.6 percent, according to the Consumer Price Index, this implies negative real interest rates. (4) Inflation is slowly eating away at the value of money market accounts, and with interest rates at record lows, there are few good news items to look forward to. Another liquidity crisis like 2008 may be on the horizon for the money market.