I Give You The Stupidity Trap... Errr... Liquidity Trap

“No one has ever paid above and beyond their interest income to be in a fund. But if we see another cut, we’ll likely see negative yields.” –Peter Crane

I give you the Stupidity Trap… errr… the Liquidity Trap…

Treasury Bills Trade at Negative Rates as Haven Demand Surges: “Treasuries rose, pushing rates on the three-month bill negative for the first time, as investors gravitate toward the safety of U.S. government debt amid the worst financial crisis since the Great Depression.

The Treasury sold $27 billion of three-month bills yesterday at a discount rate of 0.005 percent, the lowest since it starting auctioning the securities in 1929. The U.S. also sold $30 billion of four-week bills today at zero percent for the first time since it began selling the debt in 2001.

“It’s the year-end factor,” said Chris Ahrens, an interest-rate strategist in Greenwich, Connecticut, at UBS Securities LLC, one of the 17 primary dealers that trade directly with the Federal Reserve. “Everyone wants to be in bills going into year-end. Buy now while the opportunity is still there.”

The benchmark 10-year note’s yield tumbled 11 basis points, or 0.11 percentage point, to 2.63 percent at 4:48 p.m. in New York, according to BGCantor Market Data. The 3.75 percent security due in November 2018 gained 31/32, or $9.69 per $1,000 face amount, to 109 23/32. The yield touched 2.505 percent on Dec. 5, the lowest level since at least 1962, when the Fed’s daily records began.

The two-year note’s yield fell 10 basis points to 0.84 percent. It dropped to a record low of 0.77 percent on Dec. 5.

If you invested $1 million in three-month bills at today’s negative discount rate of 0.01 percent, for a price of 100.002556, at maturity you would receive the par value for a loss of $25.56.”

Awesome. Just awesome. What could possibly go wrong in a zero rate world? Oh wait, all those under funded pension plans can’t earn the yields they need to fund the outrageous promises that were made to indignant, arrogant Baby Boomers during this Age of Entitlement.

*** Astute market watchers may recall that it was the low rate world created by Alan ‘The Maestro’ Greenspan that inspired pension plans to ‘reach for yield’ and migrate into securitized debt such as Mortgage Backed Securities (MBSs) and Collateralized Debt Obligations (CDOs) in the first place. All aboard the failroad? Good. Giddy up! ***

Money-Market Fund Yields May Fall to Less Than Zero, Crane Says: “Investors in money-market mutual funds that focus on U.S. Treasuries may lose money for the first time if the Federal Reserve cuts interest rates next week and yields become too small to cover expenses.

Record-low yields on government debt have already led money-market funds to waive fees to keep returns positive. If the Federal Open Markets Committee, as expected, cuts its target rate, some Treasury funds may allow returns to turn negative, said Peter Crane, president of Crane Data LLC, a money-fund research firm in Westborough, Massachusetts.

“No one has ever paid above and beyond their interest income to be in a fund,” Crane said. “But if we see another cut, we’ll likely see negative yields.”

The U.S. Treasury sold $27 billion of three-month bills on Dec. 8 at a discount rate of 0.005 percent, the lowest since it started auctioning the securities in 1929. The U.S. also sold $30 billion of four-week bills yesterday at zero percent for the first time since it began selling that debt in 2001. Money- market managers could impose a system of incremental debits or charge monthly account fees, Crane said.

Institutional money-market funds that invest only in Treasuries and related repurchase agreements had an average seven-day yield of 0.12 percent, after fees, as of Dec. 8, according to iMoneyNet, a research firm also based in Westborough. The average institutional Treasury money fund charges a management fee of 0.29 percent, Crane said.

Money-market funds are considered the safest and most liquid investment after bank deposits and Treasuries.

Their shares sell and are redeemed at $1 each, and the income generated by their investments is credited daily to a shareholder’s account. At the end of every month, the credits are paid either in cash or by giving the investor more shares.

Daily Charges

According to Crane, if a fund’s expenses exceed its income, accounts could accrue daily charges instead of credits. The fund would then settle the charges at the end of the month by taking shares away.

Such charges aren’t the same as breaking the buck, which happens when investment losses cause a money fund’s net asset value to fall below $1 a share. In September, the Reserve Primary Fund fell to 97 cents a share because of losses on debt issued by the bankrupt Lehman Brothers Holdings Inc. triggering a run on U.S. money-market funds. It was the second money fund ever to break the buck.

Instead of charges, money funds could introduce a monthly account fee that is taken out in shares, Crane said. Either way, investors would lose money, he said.

No New Cash

Of the 500 largest U.S. money-market funds, 41 have daily annualized yields at or less than 0.05 percent, including four funds with zero yield. The 41 funds are probably waiving all or part of their regular fees to keep from taking money out of principle, Crane said.

Falling yields on Treasuries led some Treasury-only funds, including those run by JPMorgan Chase & Co. in New York and Boston’s Evergreen Investments, to turn away new investors. Barring new customers protects returns for investors already in the funds because managers don’t have to buy as many new Treasuries with yields lower than current holdings.

The Federal Open Markets Committee is scheduled to meet Dec. 16 in Washington. The panel is expected to halve its target rate to 0.5 percent, according to the average estimate of 72 economists surveyed by Bloomberg.”

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