Shadow Banking Is Back: Money Market Funds Are Flush With Cash

 |  Includes: DIA, SPY
by: John M. Mason

On Sunday I reported that funds have been flowing back into money market funds since late October and early November … a three-month move. Now, the Investment Company Institute (ICI) confirms this flow of funds.

Citing the ICI, Katy Burne writes in the Wall Street Journal, "Investors plowed $149 billion into U.S.-based money market funds between the start of November and January 30, bringing total assets under management to $2.695 trillion, close to the most since mid-2011." One reason for this move is that the rules about deposit insurance have changed.

Burne writes, "The funds received billions of dollars that until recently were stashed in zero-interest checking accounts held by businesses, municipalities and charitable organizations. Those accounts had been guaranteed by the federal government, but the guarantees expired in December 2012 for balances over $250,000."

She continues, "Barclays estimates that $250 billion will move to money funds, considered by many to be the next-safest investment option." Thus, monies are flowing back into the "shadow banking" area of the financial markets.

As I quoted in my post, mentioned above, this may be the start of a reversal of the outflow of money from money market funds that occurred post-August 2007. Quoting this post, "In fact, it was in these institutions that a large part of the bank "run" took place in August 2007 and following. (See Gary Gorton, "Slapped by the Invisible Hand: The Panic of 2007", Oxford University Press, 2010.)

I wrote that, "The financial crisis occurred when institutions started moving money out of subprime mortgage securities, money market funds, asset-based securities, and other pooled securitized instruments." Furthermore, I argued, "One could argue that if money is starting to flow back into the money market funds, that the actions of the Federal Reserve might finally be doing what Mr. Bernanke and other Federal Reserve officials are trying to accomplish."

Maybe the FDIC insurance was allowed to expire on these large accounts in order to get money moving in the financial sector once again. The problem the money market funds face is where to invest all this cash.

The backbone of these money market funds is their effort to keep the value of a share stable at $1 a share. This generally means that the funds will invest in the least volatile debt. To provide yield to investors and to prevent the possibility of investors losing money, the funds have apparently waived their management fees.

But, in this low interest rate environment, the temptation to move out on the risk curve is rather strong. The ICI reports that since November 41 percent of the inflows went into Treasury securities and other money market instruments like repurchase agreements.

However, some funds are reported to be acquiring some debt issued by European banks. Tom Nelson, chief investment officer of Reich & Tang states that funds are a "little bit more aggressive on names that they would have hesitated on "before late 2012.

The important thing, it seems to me, is that things are stirring in the financial markets that have been dormant since late 2007 or early 2008 when the financial crisis hit. I have also reported new life in others areas of the financial markets that seemed to have died away over the past five years. The thing is, movement is starting to take place.

Up to now, things have been very quiet on the commercial banking front, except for the very largest institutions. There are lots of reasons why small- and medium-sized commercial banks are not lending now. They have their own solvency issues and they are also facing a huge cost of new regulatory burdens. My expectation is that we will not see a major picky-up in the lending of these smaller financial organizations for some time.

But, we are now seeing a stirring in other areas of the financial world. I am betting on the fact that we will see a pretty strength revival of the "shadow banking" system. History shows us very clearly that once something has been started, even though it may face some severe setbacks, it will revive … and become a part of the "new normal."

In other words, shadow banks are here to stay and will play a part in any revival and recovery that takes place in economic growth. So, funds are flowing back into the money market funds. Good! It is an important start!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.