Tuesday, April 29, 2008

Commercial paper vs. repurchase agreements in money market funds

I have noticed that the commercial paper (CP) outstanding has been creeping down in recent weeks even as money market fund deposits soar (although nonfinancial CP is creeping up)... could this mean that repurchase agreements (actually, they are reverse repurchase agreements, known as "repos") are becoming more attractive to money market fund managers? Do they tend to pay higher rates than CP? I do suppose that reverse repurchase agreements do allow banks to gain liquidity without dumping more of their "hard to value" assets. A typical repurchase agreement would cover a mortgage-backed security or CDO or corporate loan with an agreement by the bank to repurchase the asset within a short period of time. Money market funds have traditionally bulked up on large amounts of commercial paper, but after the SIV scandals they pulled back a bit. And with treasury bill yields as low as they are, fund managers have to do something to get decent returns. Repos actually seem like an ideal fit for both the banks with capital tied up in illiquid assets and money market funds searching for yield.

I haven't seen any press coverage of this angle on money market fund investment yet, in particular an evaluation of risk and what range of assets banks are repo'ing to money market funds. I am curious whether a repo is considered more or less risky than CP. After all, isn't a repo virtually the same as the CP used for SIVs, with the only different that the backing asset is now on the bank balance sheet and that the bank is now assuming that the asset will not be offloaded in the near future?

Personally I do not feel that there is any significant risk with repos, but these days, who knows.

Of course, it is possible that the pullback in CP was simply less buying by money market funds in anticipation of withdrawals for payment of taxes for April 15. But, I would expect that to be reflected in the normal seasonal adjustment.

-- Jack Krupansky

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