Flight to quality may break more money funds

By Floyd Norris
The New York Times
Thursday, September 17, 2008

http://norris.blogs.nytimes.com/2008/09/17/flight-to-quality/

A money manager advises that the ultimate flight to quality is under way, and he cannot find Treasury bills to buy.

He told me that he had to go out to December to find a T-bill that he could purchase with any yield at all, and that was well under one-tenth of a percentage point. The others, if they could be purchased at all, were available only for the amount they will be worth when they mature.

What is going on here?

I suspect there is a run on money market funds, or at least the ones that do not own only super-safe assets. With the money going into Treasury funds, they must find very-short-term Treasuries to buy.

But that run may have more serious consequences. Many money funds own asset-backed commercial paper that they seem to have rolled over time and again. The assets backing the paper may be very hard to sell even close to par if the conduit that issued the paper cannot get alternative financing. If that paper is sold, the new market value could force other money market funds to break the buck, and away we go in another downward spiral.

One way to halt that spiral could be for banks to take the funny paper as collateral for loans, and then pledge it at the Fed to secure loans. (The Fed has liberalized its lending rules.)

And in the end, the government may end up owning a lot of very dubious paper.

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