The EU Commission lets money market funds continue the unholy game of banks

Michel Barnier, Member of the EC in charge of Internal Market and Services, gave a press conference on the adoption of the communication on shadow banking and proposes draft regulation on money market funds. (EC Audiovisual Services, 4/9/2013).

The European Commission adopted yesterday a proposal for measures on shadow banking introducing new but quite loose and thus ineffective rules and controls for money market funds (MMFs). This is a parallel financial system created by the major banks in order to avoid even the few controls and restrictions that the official banking system has to live with. Money market funds have not been ‘discovered’ recently. As a matter of fact the credit crunch in the US and the sovereign credit crisis in Eurozone had an adverse effect on MMFs because all economic agents businesses and individuals alike became more prudent and avoided risky placements.

However after the West overcame the core of the credit crisis and one after the other the major countries and the Eurozone started introducing more restriction on banks, money funds became again a handy instrument for lenders to avoid the new controls imposed on them. Let’s take one thing at a time.

The universe of MMFs

According to the Financial Stability Board (FSB) – the international body that brings together national authorities responsible for financial stability in significant international financial centres – shadow banking as it termed the credit intermediation which involves entities and activities outside the regular banking system, “had a size of around €51 trillion in 2011. This represents 25-30% of the total financial system and half the size of bank assets. Shadow banking is therefore of systemic importance for Europe’s financial system”.

The main players in the shadow banking universe are the money market funds (MMFs), controlled directly by the mainstream banks. Those financial instruments are an important source of short-term financing. According to the FSB “In Europe, around 22% of short-term debt securities issued by governments or by the corporate sector are held by MMFs. They also hold 38% of short-term debt issued by the banking sector. Because of this systemic interconnectedness of MMFs with the banking sector and with corporate and government finance, their operation has been at the core of international work on shadow banking”. There are two categories of MMFs. The short-term, which can hold assets (debt paper) with residual maturities which do not exceed 397 days (short-term MMF) or two years for the standard MMFs.

In terms of geographical distribution, the biggest share of money funds is concentrated in the United States (around €17.5 trillion) and in Europe (Eurozone with €16.8 trillion and the United Kingdom with around €6.8 trillion). For comparative purposes it must be noted that the entire banking system of Eurozone (comprising a round number of 6,000 banks) has total assets of an order of €27 trillion. Obviously shadow banking accounts for more than half of euro area’s banking system. The Commission estimates that “The great majority of MMFs are bank sponsored. Nine out of the 10 biggest EU MMF managers are sponsored by commercial banks. This illustrates the high degree of interconnectedness between the banking and the MMF sectors”.

Banks turned MMFs

In any case this is a very elusive market and given its size and the fact that it is deeply interrelated with the official banking system, the risks lurking in it may bring down again the entire western financial construction. But the banks don’t care about that as long as they can usurp other people’s money. As mentioned above the shadow banking construction is a mutation of the major western banks. Not to forget the huge change of philosophy the official banking system has undergone during the past twenty years. The major banks in the US and the Eurozone are not anymore the credit complement and the financial support of the real economy.

Western banks have emancipated themselves and play now the financial game for their own account, not for the real economy. Everyday banking services for businesses and individuals have become a very small part of the banking industry’s activities and their core business is nowadays ‘investment banking’. A large part, probably the largest in this investment banking is closely related to money market funds.

What rules?

According to analysts the rules proposed now by the European Commission for MMFs do not go all the way the European financial watchdogs wanted it to be. The Commission’s announcement almost apologetically recognises that by admitting “To the extent possible, we seek alignment with the international work on shadow banking, mainly with the recommendations formulated by the Financial Stability Board (FSB) and the European Systemic Risk Board (ESRB)”.

The Commission recommendations contain a provision of a framework for money market funds which are sold and incorporated in Europe. They simply demand that MMFs “would be required to have at least 10% of their portfolio in assets that mature within a day and another 20% that mature within a week”. The new draft rules also demand that the MMF cannot have an exposure of more than 5% to a single borrower. For standard MMFs, a single issuer could account for 10% of the portfolio. In short a standard MMF can lend all the money it has borrowed to ten people or business, without informing its depositors about that. If one or two of the borrowers prove unable to repay their debt the MFF may go bankrupt, because at the same time some of its depositors/investors may ask for their money back.  In this way a new major crisis may be triggered.

In the MMF world there are no deposit guarantee schemes. Given also that nine out of ten MMFs are ‘sponsored’ by the major banks, this interconnectedness may transfer almost automatically the risks and the problems from money funds to banks, then to the real economy again. As there are no fund resolution mechanisms and no guarantees of any kind, the MMF industry should have been placed under more stricter rules and controls than the banks. But the Commission didn’t dare going that far. Leaving the MMFs almost completely uncontrolled is like letting their owners, the banks, to continue doing their dirty tricks under another name.

The way the Commission decided to go by introducing quite loose and ineffective controls and restriction in the MMFs industry it’s like letting the banks to continue their unholy game, playing freely with other people’s money. On top of that central banks in the US and the Eurozone continue supplying the banks with zero or close to zero cost liquidity, a large part of which finds for sure its way to money funds.

From that point onwards everything is possible. The MMFs will ‘invest’ other people’s money along with the free liquidity from central banks to all possible and impossible placements. If the MMFs’ bets produce gains their parent banks keep the profits for themselves. If MMFs bets fail the banks will do what they did three years ago. Go to central banks and governments and ask for more capital and more liquidity. Bankers, whose direct bonuses have been capped, find through the MMFs, a new way for a fat remuneration, probably tax-free.

In short the MMFs are there to continue the dirty games of the banks and bankers. Gaining money in this unholy manner is like exploiting the entire real economy, workers and employers alike.

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