Oh boy, this is badly timed. The run on money market funds appears to have abated, thanks to the insurance plan implemented by Treasury, but the commercial paper market, important for day-to-day business funding is still under big-time stress because the amount of money committed to short-term, non-government holdings has contracted.
The new bit of bad news comes in the New York Times. A Wachovia $9 billion short-term investment fund (note this is NOT a money market fund and thus not subject to the $1 net asset value commitment) has restricted access by its investors, who are almost entirely higher education institutions.
Wachovia maintains that the fund is sound (where have we heard that one before?) but the issue is liquidity. Even AAA bonds have taken a hit, falling 6.5% in September (I have yet to see comparable info on shorter-dated paper), and in a stressed market like this, selling more than fairly small amounts could well have a disproportionate price impact. Presumably, the hope is that once the bailout bill has passed and the next TAF auction, three times as large as the last one (October 6) has concluded, the stress will alleviate. But the fund understandably cannot make any promises.
The initial reports appear to be that the colleges in question are for the most part,troubled rather than disrupted by this action, although a few said they would face some difficulties (there is so far no sign this development will lead to extreme moves like delay of payrolls or immediate expenditures). The limit seems to be large relative to the holdings (initially 10%, now 26%) but the idea that you can’t get your hands on the bulk of your money is nervous-making, to say the least.
The New York Times does not give any figures on the aggregate amount committed to this sort of fund, but it is a no-brainer that this sort of news will lead some investors to withdraw funds from similar entities (if nothing else in an anticipatory fashion), which in turn will lead to selling of fund assets (placing further stress on short-term funding markets), with the potential for other funds to similarly restrict withdrawals, which will only pour gas on this new credit market fire.
From the New York Times (hat tip reader Dwight):
In a move suggesting how the credit crisis could disrupt American higher education, Wachovia Bank has limited the access of nearly 1,000 colleges to $9.3 billion the bank has held for them in a short-term investment fund, raising worries on some campuses about meeting payrolls and other obligations.
Wachovia, the North Carolina bank that agreed this week to sell its banking operations to Citigroup, has held the money in its role as trustee for a fund used by colleges and universities and managed by a Connecticut nonprofit, Commonfund.
On Monday, Wachovia announced that it would resign its role as trustee of the fund, and would limit access to the fund to 10 percent of each college’s account value. On Tuesday, Commonfund said that by selling some government bonds and other assets held in the fund, it had succeeded in raising its liquidity to 26 percent.
Still, Wachovia’s announcement sent shock waves through higher education, sending hundreds of college presidents rushing to check their financial vulnerability on every front.
Some smaller colleges that had not previously arranged lines of credit were feverishly seeking to negotiate those on Wednesday. And some large institutions said they were facing, at the least, a major financial inconvenience as a result of Wachovia’s action.
The University of Vermont, for instance, said that about half of its liquid operating assets — $79 million — were invested in the fund.
“It appears that the asset is secure,” said Richard H. Cate, vice president for finance and administration at the University of Vermont, because, he said, much of the $9.3 billion is held in securities that will become available when they mature. “But we’re not real thrilled with the fact that we can’t access all of our money when we want it.”
Wachovia’s action was perhaps the most tangible signal yet that the credit crisis could have a powerful impact on higher education. Another sign came on Tuesday as Boston University, saying it needed to respond to the financial crisis with cautionary steps, announced an immediate hiring freeze and a moratorium on new construction projects. That decision was unrelated to the action by Wachovia, where Boston University was not an investor.
On Tuesday, officers of Commonfund held a lengthy conference call to provide details of Wachovia’s action to representatives of more than 900 colleges and universities, many of whom were upset, said W. Judson Koss, a spokesman for Commonfund.
“The whole issue is liquidity,” Mr. Koss said. “This is a fund that has been in operation for over 35 years, and is invested in nothing but Triple-A government and corporate paper, all top-notch equities.
“We’ve been going along just fine, but Wachovia had a liquidity concern. They asked, ‘What if there’s a run on the bank and we can’t redeem these securities?’ So they were the ones who pulled the pin on the grenade.”
Colleges have used the fund, formally called the Commonfund Short Term Fund, almost like a checking account, depositing revenues including tuition payments and withdrawing funds daily to finance payrolls, maintenance expenses, small construction projects and other short-term needs, college officials said.
Nearly 60 percent of the securities in the fund are scheduled to mature by Dec. 31, and thereafter would be available to investors, Commonfund said in a statement. When the remaining funds would become available was unclear. The fund said it was seeking a trustee to succeed Wachovia.
To date, none of the securities have defaulted, and all were continuing to pay timely principal and interest, the statement said.
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I wonder what David Swensen is doing.
The schools are rightfully scared. Illiquid assets should scare anybody right now.
On the other hand, since there seems to be a premium for liquidity, if you can afford to hold on to such short term investments, you should be able to turn quite a profit.
Have you seen the Fed’s balance sheet lately?
Matt Dubuque
This is an example of how the “far away” credit crunch is starting to hit next door, hot and heavy.
A county in the SF Bay Area near where I live just lost 5% of their entire portfolio due to exposure to Lehman bonds. This means big cutbacks in a previously prosperous county.
I have a continuing concern about the municipal bond market as well. As funding dries up, general revenue bonds become hard both to place and to carry on the books.
And that has a direct local effect.
Matt Dubuque
mdubuque@yahoo.com
What are the normal functions of universities anyway? Nowadays most of them seem to be more interested in investing money than fostering inquiry.
Ask not for whom the bell tolls…
SlimCarlos,
I suggest you read the IMF paper on 124 banking crisis The most successful approaches by far did not involve trying to validate bubbly valuations. They entailed letting prices fall but making clear and acting on a plan to recapitalize the main actors. Only by letting asset prices fall can you ascertain the amount necessary to pump into the system, and do triage.
And in the Great Depression, contrary to popular retellings, the Fed in fact did try to reflate early on, It expanded the monetary base considerably in 1930, but money supply fell nevertheless because individuals and businesses were pulling money out of banks. You cannot reflate if the institutional plumbing has the equivalent of a water main break. We were unable to reflate until 1934, AFTER deposit insurance was instituted in 1933.
Japan, which had a vastly higher savings rate than we do, tried shoring up asset values and failed miserably. They then went to recapitalize the banking system, in 1999, but then it was too late, they were and remain stuck in a deflationary hole.
Yves, very nice comments. If Mr Bernanke is such a great student of GD and Japan, why does he insist on adding money as the remedy? For all the buildup about what a student of all this he is, I am not impressed. Maybe he feels Japan’s route was better than GD route in terms of misery. If i could one other question, on quite a few sites there are serious battles going on between any kind of bailout vs the do nothing / Austrain route, do you have a stand?
Flipped by CNBC to see if the American VP debate was on, … it was reported that the department of education stepped into credit markets effectively trying to prop up loan prices and keep lenders in the market by providing liquidity. Was in the millions of dollars, sounded like a stampede of lenders trying to get out since September
Tuition, textbooks, and other higher education costs have soared since the early 1990s in North America. Higher education is due for a correction, and should provide an interesting story line as the global settling of accounts continues.
The GAO has investigated a number of the rising costs in higher education, but no direct collusion charges have been pursued. Perhaps the best description is of a bubble in the higher education sector baring many parallels to the housing bubble. Both are financed by securitized long term, low risk debt that is the single most dramatic leverage available to the borrowers. While there are fewer college students than homeowners, the bubble has gone on longer, the debt is legally harder to walk away from, and the loan to income ratio is higher.
On the one hand more accessible education is good for the economy longer term, on the other hand foreign demand could stem the deflation and displace American students. Along with media, higher education is one of America’s strongest (service) export sectors. It will be exporters that lead America out of the housing+consumer led recession. So I mark it as a positive in either case for the medium to long term.
Beyond that there is the question if in aggregate the higher education system could better allocate resources by imposing financial constraints — the cost of educating an english major, as one example, being redirected to another sector of the economy.
It would be nice to know which schools are hit the most!
In other related news, Calculatedrisk has a fairly good link to this general liquidity story!
From Charlie Rose: A discussion about the economy with Mort Zuckerman & Andrew Ross Sorkin
Here they are talking about what good folks they are:
http://files.commonfund.org/video/EndowmentInstitute.html
Lumber plunged to a 17-year low on speculation that the credit crunch in the U.S. will limit demand for building materials.
Home prices dropped in 24 of 25 U.S. metropolitan areas in July from a year earlier as foreclosures eroded property values, according to Radar Logic Inc. New-home sales fell to a 17-year low in August, the Commerce Department said Sept. 25. Lumber futures fell 15 percent in September, capping a 21 percent drop in the third quarter that was the biggest since 2002.
“The credit crunch is definitely affecting demand,” said Jamie Greenough, a lumber broker and analyst at Global Futures Corp. in Vancouver. “Jobs aren’t getting done because people can’t get financing.”
Lumber futures for November delivery dropped $2.80, or 1.4 percent, to $196.40 per 1,000 board feet on the Chicago Mercantile Exchange. Earlier, the price fell the exchange’s $10 daily limit to $189.20, the lowest for a most-active contract since October 1991. Futures are down 18 percent in the past year.
Off Topic:
Can some enlighten me about the market for 3 month T-bills? Specifically if one holds a 3mth Tbill to maturity at today’s prices they would earn 0.1673 %
I understand why banks would find that attractive as its purpose is primarily collateral for other work.
Why would any mutual, MM, pension funds buy them at this point? Have they stopped and simply been replaced by broker-dealers?
Is it contractual clauses limiting cash positions, a bet that yields will further decrease, term limitations where high quality short term debt is avoiding the market and the only liquidity left is t-bills? Are T-bills just a parking spot marginally preferential to cash?
@ Yves:
>> I suggest you read the IMF paper on 124 banking crisis The most successful approaches by far did not involve trying to validate bubbly valuations.
Would love to. Reference? I am sure you've posted it here but I just scanned through I couldn't immediately see what you are referring to.
I think the big difference between our respective POV's is that you see this as a banking crisis whiolst I see this as an comprehensive economic crisis. You see the banks as being broke. I see the country as being broke.
In Japan (and this is the deflationist's eternal retort), the banks were broke, but the country wasn't. Household savings were high, and a productive manufacturing sector provided for vibrant export earnings. By stark contrast, the US sees not only the banks broke, but households broke as well. (When I say "broke" I mean hopped up on credit they won't be able to pay back.) And critically, the US no longer has the means to self-finance their consumption.
Thus, Japan did not have to, as their economy slowed due to a contracting banking sector, finance externally at increasingly dear rates. As their imposion occurred, they got dividend cheques each month from overseas.
The US is in a quite different spot. It has no means now of self-financing and will have to go cap in hand just to stay afloat.
Credit expansion was the lifeblood of the Japanese banks. Credit expansion is the lifeblood of the entire American economy. That's a big difference. You simply cannot unwind a bubble economy without driving the economy itself into insolvency, including its productive sectors, without which an economy will never come back.
I look forward to reading the IMF piece. Then perhaps I can speak to the other 123 cases cited.
>> And in the Great Depression, contrary to popular retellings, the Fed in fact did try to reflate early on, It expanded the monetary base considerably in 1930, but money supply fell nevertheless because individuals and businesses were pulling money out of banks. You cannot reflate if the institutional plumbing has the equivalent of a water main break. We were unable to reflate until 1934, AFTER deposit insurance was instituted in 1933.
Fair enough. I am not stuck on a single measure. But we agree that reflation was a key part of the recovery? If so, why aren't we hearing more about it these days?
If I may answer my own question (!), I believe it's because the powers-that-be cannot afford to unnerve foriegn creditors. It's the policy action that dare not speak its name.
But surely hear, amongst friends, we can call a spade a spade?
Regards and thanks for this space.
This is about the most encouraging news yet. Once the effects of this crisis begins to really hit the “intellectual elite” the seriousness of the country will intensify dramatically. On second thought, maybe this is the worst possible news yet. If Alan Paton hadn’t already taken the title, one could write a book.
“You simply cannot unwind a bubble economy without driving the economy itself into insolvency, including its productive sectors, without which an economy will never come back.”
This massive asset deflation is not going to be contained to the US (take a look at a 6mo bric chart), so a cut for ROW int rates is inevitable. I can’t imagine the US isn’t on the receiving end of the ensuing disintermediation. Good luck modeling that into your “never” scenario.
@ Yves:
The sentiment expressed here hits the nail on the head. But this is practically the only time I’ve heard it said out loud? How come? I mean, it’s blindingly obvious what the endgame is, yet, even as the Emperor is prancing down the street stark naked, everyone seems to commenting on his hair. It’s all quite amazing.
http://www.ft.com/cms/s/0/dd9aa390-84d6-11dd-b148-0000779fd18c.html
America will need a $1,000bn bail-out
By Kenneth Rogoff
Published: September 17 2008 19:06 | Last updated: September 17 2008 19:06
One of the most extraordinary features of the past month is the extent to which the dollar has remained immune to a once-in-a-lifetime financial crisis. If the US were an emerging market country, its exchange rate would be plummeting and interest rates on government debt would be soaring. Instead, the dollar has actually strengthened modestly, while interest rates on three- month US Treasury Bills have now reached 54-year lows. It is almost as if the more the US messes up, the more the world loves it.
But can this extraordinary vote of confidence in the dollar last? Perhaps, but as investors step back and look at the deep wounds of America’s flagship financial sector, the public and private sector’s massive borrowing needs, and the looming uncertainty of the November presidential elections, it is hard to believe that the dollar will continue to stand its ground as the crisis continues to deepen and unfold.
SlimCarlos,
Rogoff (with Carmen Reinhart) has done very serious work on financial crises. They have constructed a major database with economic indicators included. I think their definition of a crisis focuses them on events bigger than what the IMF looked at (ie, the Reinhart/Rogoff has somewhat fewer incidents, but much longer timeframe, they’ve gone back 800 years) and done more intensive data gathering on them. Both of them are very straight shooters
Here is a post with a link to the IMF paper.
Here is a post with a link to a short but good Reinhart/Rogoff paper.
The University of Washington is also having trouble withdrawing their money from Northern Trust.
http://seattlepi.nwsource.com/local/381280_uwsuit01.html
Northern Trust has said they will make up for any losses.
This whole story is an ancient one. Boring and obvious. The solution is truly as simple as the problem, greed and a lack of integrity. Capitalism is based on trust. Trust is completely broken. Completely. The financial institutions whose very survival requires the ongoing trade of money, are unwilling to trade. John Q. Public has no trust, so he doesn’t spend. The entire system comes unravled in a self reinforcing negative feedback loop fed by a lack of trust. The quickest and best way to fix it s to rebuild the trust, by bringing those who are responsible to account for the probelm. I believe that only when every man believes that the scamers and gamers of the system will fear, and regret their deeds. I have a friend who ran a large state employees pension fund for several years. He recently described a meeting he had with the funds Ibankers about strategy and mechanism. Following a lengthy description of the opportunities in hyrbid products, derivatives etc., he asked the bankers, “what happens to the last guy holding this paper when the market corrects?” Long pause…….followed by arrogant laughter:):):):) “why the hell do you care, you’ve already cashed out at that point.” Until the rot s truly purged from the system, via real accountability and fear, we will languish in a lengthy and painfull lull. I am in the