U.S. money market fund guarantee, R.I.P.

After today, money market mutual fund accounts no longer will have the backing of the U.S. Treasury. Uncle Sam is betting that fund investors won’t care -- or won’t notice.

The Treasury is allowing its year-old guarantee of money fund assets to expire, in one of the first big reversals of the government’s involvement to stem the financial crisis.

The unprecedented backstop was put in place a year ago after one of the nation’s biggest money funds, the Reserve Fund, suffered a run on assets because of losses tied to Lehman Bros. IOUs that it owned.

The government’s blanket guarantee of fund accounts had the desired effect: After a record outflow of $120 billion in the week ended Sept. 23, fund assets quickly stabilized. Confident investors soon began adding more cash to the funds -- even though the Treasury’s guarantee only covered industry assets as of Sept. 18.

After hitting a record high of $3.85 trillion in January money fund assets have been gradually declining, reaching $3.45 trillion this week. But the slide more likely is the result of investors pulling cash to invest in riskier assets (i.e., stocks and bonds) than because they’re worried about the U.S. guarantee expiring.

With the Federal Reserve committed to holding short-term interest rates near zero indefinitely, the funds are earning little on the short-term corporate and government debt they buy. Their investors, in turn, are earning next to nothing, even though most funds are waiving all or most of their management fees: The average taxable money fund pays an annualized yield of just 0.06%, according to IMoneyNet Inc.

Pete Crane, editor of the Money Fund Intelligence newsletter, notes that even though the guarantee program is disappearing many of the debt securities that money funds own retain some kind of government or Federal Reserve backstop, thanks to the alphabet soup of lending programs put in place amid the credit crisis last fall.

Under one program, for example, the Fed would finance bank purchases of certain money fund assets if the funds needed to sell quickly to meet redemptions.

The bigger issue on the horizon: proposals to revamp the basic structure of money funds, to make another emergency situation less likely. The Securities and Exchange Commission is sorting through a raft of ideas aimed at boosting money fund safety. The President’s Working Group on Financial Markets will issue its own proposals by Dec. 1.

The most hotly debated question: Should the funds be forced to float their share prices rather than maintain the $1-a-share constant value that has been the industry hallmark for nearly 40 years?

A year ago it was Reserve Fund’s warning that it would "break the buck" because of heavy redemptions that triggered the run on other funds. In theory, if money fund investors knew their principal value could fluctuate slightly from day to day they couldn’t be stunned by another Reserve Fund-like episode.

Not surprisingly, however, the money fund industry is loathe to give up the accounting mechanics that allow funds to commit to a constant $1 share value, even though they can’t explicitly guarantee that they'll honor that price if you want your money back.

Stable pricing provides "enormous benefits to money market fund investors," said Paul Schott Stevens, head of the Investment Company Institute, the trade group for mutual funds. That's true. But for millions of people and companies, stable pricing also is critical for keeping money funds competitive with guaranteed bank deposits. Take away the constant share value and I'd bet many money fund investors would head straight for the bank.

-- Tom Petruno

Photo: The Treasury building in Washington. Credit: Chip Somodevilla / Getty Images

Corporate 'clunkers' turn to gold for yield-hungry investors

Wall Street has had its own wildly successful version of "cash for clunkers" going since spring. It’s known as the junk bond market.

When I last wrote about the junk market, on July 27, the average annualized yield on an index of 100 junk issues had just tumbled through the 10% threshold as investors continued to pile into the bonds.

Now, not quite two weeks later, the yield on that index is on the verge of dropping below 9%. It stood at 9.02% on Thursday, the lowest since May 2008.

In this cash-for-clunkers exercise, you don’t get cash -- you give it, to buy bonds of firms that may variously qualify as clunkers: companies that often are heavily in debt and, in some cases, face serious risk of being unable to pay their creditors what they owe them.

Through July, 187 such companies worldwide had defaulted on their bonds, up from 50 in the same period of 2008, according to Standard & Poor’s.

Amid the credit crisis last fall most investors wouldn’t touch junk bonds. As the securities' prices plunged, average yields on the bonds rocketed toward 20%.

But since spring, with rising hopes for an economic recovery, the junk market has rallied dramatically as investors have poured back in to grab rich yields. And prices of the lowest-quality bonds have rallied the most, pushing their yields down sharply, as Bloomberg News details in this story.

The average junk bond mutual fund now is up 31.6% year-to-date, counting interest earnings and principal gain, compared with a 16% return for the average domestic stock fund, according to Reuters/Lipper data.

Kingman Penniman, head of junk-bond research firm KDP Investment Advisors in Montpelier, Vt., notes that the market is notorious for attracting momentum-chasing traders. That can make for steep rallies -- and deep sell-offs.

Still, he thinks that a lot of yield-hungry conservative investors have stayed away from the junk market but would dearly like to get in at some point, if the economy continues to show signs of bottoming. "I think there is a floor there" for bond prices, he said -- which means a ceiling for yields.

Veteran junk investor Martin Fridson of Fridson Investment Advisors in New York says that, despite the fear of rising defaults, the numbers have been going down in recent months as credit markets have improved, allowing some companies to refinance debt. There were 26 bond defaults worldwide in March, but just 14 in July, according to S&P.

Of course, that trend could reverse if the economy is headed for a double-dip recession, meaning a recovery in the next few months followed by another slump in 2010. But for now, "A lot of companies have dodged the bullet" of default, Fridson said.

Like Penniman, Fridson sees many investors waiting on the sidelines. "One group says, ‘It’s too early to buy.’ The other says, ‘I guess we missed it,’ " Fridson said.

In theory, at least, that’s money that should be itching to move into the junk market on any sell-off, if investors can hang onto the hope that the worst of the recession is past.

-- Tom Petruno

Junk bond yields slide as rising defaults don't scare buyers

Wall Street's rally of the last two weeks also has stoked more buying in the "junk" corporate bond market -- enough so to send a benchmark of average junk yields into single-digits for the first time in more than a year.

The average annualized yield on KDP Investment Advisors’ index of 100 junk issues fell to 9.77% at the end of last week, the lowest since June 2008.

The index’s yield had rocketed as high as 17.7% in December amid the credit markets’ meltdown and fears of global depression. But it has mostly been declining ever since as buyers have returned to the junk market.

Investors haven’t been fazed by the surge in bond defaults this year as the deep recession has left a rising number of junk issuers unable to make their debt payments. Through Friday, 184 companies worldwide had defaulted on their bonds this year, up from 48 at this time last year, according to Standard & Poor’s.

S&P estimates that the 12-month default rate of junk issues will reach a record 14.3% of the market by March. That would surpass the previous peak of 12.5% in the early 1990s.

Yet yield-hungry investors -- and traders looking to play hot markets that have momentum -- have been willing to take their chances in junk securities this year. The basic investment premise for junk bonds is that, even though a large chunk of them will default over time, the high interest rates on those that keep paying will more than make up for the losses in a diversified portfolio.

Compared with blue-chip stocks, junk returns already this year have been spectacular, as falling yields have lifted the market value of many issues. The Vanguard High-Yield Corporate bond mutual fund was up 23.4% for the year through Friday, compared with the 10.1% return on the Vanguard 500 Index stock fund. The average junk fund is up 27.2% this year, according to Morningstar Inc.

At this point, is it better to wait to buy junk? If economic data worsen and the stock market slides again, junk bond prices would almost certainly go south as well, driving yields higher. How much higher is the question.

After falling to 10.24% on June 15, the KDP index yield quickly rose back to 10.82% by June 23 as the stock market began to sell off. But then the yield mostly treaded water until the sharp break lower that began the week of July 13.

Investors and traders already know that junk defaults are likely to reach unprecedented levels next year, and that still hasn’t scared them off. What would it take?

-- Tom Petruno

SEC proposes rule changes to boost money fund safety

Money market mutual funds, already paying near-zero yields, could see those payouts fall further under proposed new rules to boost the safety of the portfolios.

The Securities and Exchange Commission today proposed tightening restrictions on money funds’ investments, hoping to avoid a repeat of the sudden demise of the $60-billion Reserve Primary fund last September.

Money funds, which hold a total of $3.6-trillion in investors’ savings, would have to hold more of their assets in only the most liquid securities, so that they have ready cash to pay off investors who want out.

The most liquid assets also typically pay the least, so owning more such securities probably would put more downward pressure on fund yields. The average taxable money fund’s annualized yield now is a mere 0.13%, according to iMoneyNet Inc.

Money funds already are designed to allow investors to get in or out at will, at a constant $1-a-share asset value. But when investors deluged the Reserve Primary fund with redemption notices in September it was unable to meet all of those requests.

That triggered a run on other money funds, forcing the U.S. Treasury to step in and guarantee fund assets to stem investor panic.

SEC commissioners today proposed that funds serving individual investors would have to hold at least 5% of their assets in cash, Treasury securities or other investments that could be sold in one day. At least 15% of assets would have to be in securities that could be sold within a week.

Those percentages would be doubled for funds that serve institutional investors.

The SEC also proposed that the maximum average maturity of fund holdings be cut to 60 days from the current 90 days, which also would likely depress portfolio yields further. . . .

Money funds' stable $1-a-share pricing facing U.S. review

Money market mutual funds could eventually be forced to float their share prices rather than maintain the constant $1-a-share value that has made the industry a popular haven for investors’ cash.

That idea is mentioned in the Obama administration’s wide-ranging plan to revamp financial-industry oversight.

Regulators, the administration says, should consider whether it would be better for the financial system overall if investors were weaned from believing that money funds can’t lose principal value.

When a major money fund suffered investment losses that caused it to slightly drop its share price last September, the news triggered a run across the $3.6-trillion industry. That forced the Treasury to step in and issue a blanket guarantee of money fund assets, to calm investors.

"The vulnerability of money market funds to ‘breaking the buck’ and the susceptibility of the entire . . . industry to a run in such circumstances remains a significant source of systemic risk," the administration says in its blueprint for regulatory reform.

Because money funds own mostly short-term, high-quality corporate and government IOUs, they haven’t been required to reflect daily fluctuations in the value of those IOUs in their share prices, unless the securities permanently lose value (say, in the case of a bankruptcy).

That has allowed the 38-year-old industry to maintain $1-a-share pricing, which to investors has made the funds appear as safe as federally insured bank accounts.

The industry fears that allowing money fund share prices to float, even if the daily changes were tiny, would destroy investors’ faith in the funds.

Given the record low yields on money funds -- an average of just 0.13% currently, according to iMoneyNet Inc. -- even a slight share decline could wipe out interest earnings.

The administration said it was open to other ideas to reduce the risk the industry poses to the financial system, including requiring the funds to buy emergency insurance from private sources to damp the risk of runs.

The Securities and Exchange Commission will take up the question of money fund reforms at a meeting Wednesday, and may ask for public comment on the $1-a-share pricing issue and other possible changes in money fund regulation, Bloomberg News reported.

-- Tom Petruno

BlackRock to buy Barclays unit, forming $2.7-trillion titan

Money management giant BlackRock Inc. late Thursday agreed to buy Barclays Global Investors -- including the iShares exchange-traded funds -- creating the world’s biggest asset manager.

The deal would boost BlackRock’s assets to more than $2.7 trillion from $1.3 trillion, vaulting it well above its nearest rival, State Street Corp., which manages about $1.4 trillion.

The takeover is a potential coup for 56-year-old BlackRock Chairman Larry Fink, a UCLA grad who founded the company in 1988. The New York firm is best known for its fixed-income funds, a business that puts it head-to-head with Newport Beach-based Pimco.

With the purchase of San Francisco-based Barclays Global, which pioneered index-fund investing nearly 40 years ago, BlackRock would gain a much larger presence in the stock fund business, including via Barclays’ exchange-traded funds. Barclays' iShares unit is the industry leader in developing and managing popular stock and bond ETFs.

Reuters has some interesting factoids on Barclays Global and its historical connections to Wells Fargo & Co. and UC Berkeley. Go here.

Barclays Global is being shed by British banking titan Barclays as the latter seeks to raise capital to offset soaring loan losses.

BlackRock agreed to pay $6.6 billion in cash and 38.7 million of its shares for Barclays Global. The deal would give Barclays a 19.9% stake in BlackRock, which plans to rename itself BlackRock Global Investors.

BlackRock’s shares closed at $182.60 on Thursday, up $4.08, before the deal was announced, although it had been expected. The stock is up 36% this year.

Pimco, which is owned by Germany’s Allianz, manages about $800 billion. Pimco just this month launched its first bond ETF and plans at least six more, competing directly against iShares’ offerings.

-- Tom Petruno

Photo: BlackRock CEO Larry Fink. Credit: Carolyn Cole / Los Angeles Times

Sidelined cash is huge, but is it antsy to go somewhere?

Besides the apparently moderating recession, what gets Wall Street bulls excited these days is talking about the mountain of cash sitting on the sidelines -- particularly in money market mutual funds.

Money fund assets have risen dramatically in the last three years, to the current $3.7 trillion from $2 trillion in mid-2006.

Sooner or later, bulls surmise, investors will grow weary of tiny yields on money funds -- now averaging a record low 0.15% on taxable funds -- and will funnel a chunk of that cash into the stock market, providing more fuel for an extended bull run.

In a research report on Monday, Jack Ablin, chief investment officer at Harris Private Bank in Chicago, said that whenever money market assets have exceeded 25% of the capitalization of the Standard & Poor’s 500 index, stocks have rallied over the following two years. That number currently is 43% after having peaked at 58% in mid-December.

There’s no doubt that some fickle money-fund cash will flow into stocks; indeed, after peaking in early January, money fund assets have edged lower as the stock market has surged.

But money funds might not provide as much juice as the bulls expect.

For one thing, much of the cash flow into money funds over the past two years had little to do with the collapsing stock market, said Peter Crane, chief executive of research firm Crane Data.

Corporations, which account for two-thirds of money-fund assets, have built up funds for purposes ranging from emergency reserves to bankrolling mergers, and are unlikely to put that cash into stocks, Crane said.

That’s a big reason why overall money-fund assets are down only 4% from their mid-January peak despite the torrid market rally since early March.

"Money is trickling back in off the sidelines, but the thought that this wall of cash will come pouring back into the market overnight is ridiculous," Crane said. "If it were going to do that, it already would have."

So-called retail money funds -- those used by individual investors as opposed to institutional investors -- have been losing assets at a faster clip this year. Retail fund assets are down 8.2% from their January peak.

But the build-up of cash in those funds in 2008 was due in part to dissatisfaction with fixed-income investments that went awry, such as exploding auction-rate securities and some surprisingly risky short-term bond funds, Crane said. So some of that money now may be heading back into other income-oriented investments -- including corporate-bond funds, which have seen hefty inflows this year, and bank accounts -- rather than into stocks.

Still, bulls believe that a significant amount of the cash on the sidelines will eventually find its way into equities once bear-market scars fade a bit more (and assuming there isn’t another market bomb on the horizon).

"It’s like donuts," Ablin said of the stock market. "You swear them off. You’re never going to have them again. Then you try them and slowly you get back into them again."

-- Walter Hamilton

Plunge in junk bond yields shrinks cushion for defaults

Sticking with stocks was a good idea this year. Sticking with junk corporate bonds was an even better idea.

The junk, or high-yield, market has rallied powerfully since the stock market bottomed on March 9. Bond prices have surged, driving yields down sharply.

The average annualized yield on an index of 100 junk issues tracked by KDP Investment Advisors has plunged to 10.59%, down from an 18-year high of 17.7% in December.

The average junk bond mutual fund’s year-to-date total return -- price gain plus interest earnings -- was 21% through Thursday, according to Lipper/Reuters data. By contrast, the total return of the average domestic stock fund was 9.3%.

The same improved investor sentiment that has boosted the stock market also has lifted junk bonds, which are debt issues of companies rated below investment-grade: If the economy begins to recover in the second half, so should the finances of many now high-risk companies.

But as with the rallies in the stock and commodity markets, the question is whether the junk rally has gone too far.

"It’s feeding on itself," said Kingman Penniman, head of KDP in Montpelier, Vt. In other words, the better the market does, the better it does, as money chases after it.

That’s great for "momentum" traders, but "for fundamental investors, it’s murder," Penniman said.

What gives him pause, he said, is that the riskiest junk bonds have rallied much more since early March than those of better quality.

Yet even if you believe that the economy will get better in the second half, many financially challenged companies are too far gone to be saved, Penniman said. The credit outlook for those companies "is getting worse, not better," he said.

Indeed, defaults by junk companies are continuing to surge. A total of 25 U.S. companies defaulted on their bonds in May, bringing the year-to-date total to 101, according to Standard & Poor’s.

That left the trailing 12-month default rate at 8.25% of the junk bond universe. And S&P predicts much more to come: It is forecasting the 12-month default rate to reach 14.3% by April 2010.

"It could reach as high as 18.5% if economic conditions are worse than expected," S&P warned in a report this week.

Obviously, investors know that defaults are going higher. So a bet on a diversified portfolio of junk bonds is a bet that interest income from the companies that keep paying their debts will more than offset losses from defaults.

The question is whether average junk yields now under 11% will be enough to compensate for the bombs that have yet to go off -- or whether it’s smarter to wait for an inevitable market "correction" before putting more money into the junk bin.

-- Tom Petruno

American Funds parent Capital Group to cut 9% of staff

L.A.-based Capital Group Cos., parent of the American Funds mutual fund group, plans to cut about 9% of its global workforce this month in its second round of layoffs this year.

The privately held company, one of the world’s biggest asset managers, told employees this week that 820 jobs would be lost out of a total of about 9,000, spokesman Chuck Freadhoff said.

Like many money managers Capital Group has been shrinking staff as assets have dived with the stock market’s plunge over the last 18 months. The company, known for its conservative, "value"-oriented investing style, manages about $850 billion in stocks and bonds, down from a peak of $1.2 trillion.

Fund companies charge management fees as a percentage of assets. So as the market value of their investments has plunged, and as some investors have pulled money out, fee income also has slumped.

Although jobs are disappearing across the financial industry, Capital Group’s unprecedented staff cuts are a heavy blow to the firm’s self-starter culture. The company slashed about 500 jobs in January, and in March gave advance warning about the layoffs announced this week.

The new cuts will be across nearly all departments, including marketing, accounting and office services, Freadhoff said. But as with the January layoffs, the firm said none of its portfolio managers or analysts would lose their jobs. The long tenure of the 80-year-old company’s investment management staff has always been one of Capital Group’s selling points with investors and financial advisors.

Capital Group employs more than 2,500 people in Southern California, including its downtown L.A. headquarters staff and its account-servicing staff in Orange County. Freadhoff said the firm wouldn’t say how many of the new layoffs would be in the Southland until all of the affected workers had been notified.

-- Tom Petruno

Money manager TCW Group loses CEO Beyer

L.A.-based money manager TCW Group, which hopes to launch itself as a publicly traded firm in the next few years, won’t be doing so under current Chief Executive Robert D. Beyer.

In a surprise, the 49-year-old Beyer will step down at the end of this month after less than four years in the job, TCW announced today.

In a letter to some of his colleagues, Beyer said he was leaving because he believed the company would need a different style of management as it makes the transition to being an independent firm. He said the decision to depart was his alone.

It ought to be an interesting job opening for the growing universe of restless Wall Streeters, as the financial industry continues to shrink: TCW, parent of Trust Co. of the West, manages about $100 billion in stocks and bonds, mainly for institutional clients such as public pension funds, companies and universities.

The company has been majority-owned by banking giant Societe Generale of France since 2001, when TCW founder Robert A. Day sold Societe a controlling stake.

But like many banks, Societe Generale has been rethinking its long-term business plan amid the upheaval in the global financial system. In January, Societe agreed to merge its European and Asian money management operations with those of rival Credit Agricole.

Although TCW will remain part of Societe for now, the plan announced in January calls for TCW to be spun off as its own company within five years.

The 65-year-old Day, who has remained chairman of the company, said Vice Chairman Marc I. Stern would take over as interim CEO on July 1. Stern, also 65, had been president of the firm from 1990 to 2005.

Beyer follows William Sonneborn out the door. Sonneborn, 39, stepped down as president of TCW last year to become CEO of KKR Financial Holdings.

-- Tom Petruno

Photo: Robert D. Beyer. Credit: TCW