Prime Rate Capital Management Comment on MMFs One Year after Lehman

Dennis Gepp, chief investment officer at Prime Rate Capital Management, has issued the following statement commenting on money markets a year on from the collapse of Lehman Brothers:

“In the space of a year the financial markets have gone from being generally liquid and relatively free of government interference to being a market which is still illiquid and where governments are seen as key to the continued existence of their financial institutions. Banks are now dependent on the whims of their political paymasters. The consequences of the wholesale, nationalisation of the banking system, are only now beginning to be felt as the politicians begin to take control. What this will mean for both banks and the economies involved is still unclear, It certainly seems that there will not be any quick return to the norms of the 1990s.

“With the collapse first of Bear Stearns and Northern Rock, then of Lehman it rapidly became clear that this was a systemic crisis and that governments had to stand behind their financial institutions in order to avert a complete breakdown of the global financial system. They soon realised, however, that the initial actions taken were not enough and more support rapidly followed, as well as dramatic cuts in interest rates, bringing the Fed funds rate to target a range of 0-0.25% and taking the UK base rate to an all time low of 0.5%.

“Spreads in the US between three month Libor and three month treasury bills (T-bills) have narrowed to a mere 16 basis points from a high point in September 2008 of over 450 basis points. The collapse in spreads has happened as rates have plummeted. T-bill rates fell from 45 basis points in March to 10 basis points in August while one month Libor dropped similarly.

“Although the current low rates are necessary to allow economic growth to return, they are proving particularly painful for institutions and individuals who, because of their particular requirements, have relatively large percentages of their holdings in cash. For these investors, the current low rates will inevitably have a painful knock on effect on spending plans.”

“In August, the MPC maintained rates at 0.50% but revealed a split within its ranks as regards to the quantitative easing programme. With the possibility of £25bn being tapped, the surprise of an extra £50bn (to help keep the CPI 2% target) to £175bn, was surpassed by the fact that King, Besley and Miles had been out voted for an extra £75bn. The new programme would be expected to take three months to complete, with the ceiling to be kept under review. The rate paid of 0.50% is to be kept for the commercial banks’ reserves although the market is questioning if this rate will in fact be reduced going forward. The quarterly inflation report revealed that although the recession may well soon be over, recovery could still be a long way off, with the prospects of higher unemployment and with the banks still looking after their balance sheets, hence the reluctance of further increased lending.

“GBP Libor rates continued to ease throughout August, with the three month rate falling by twenty basis points to a new low of 0.69%, while day-to-day cash continued to yield between 0.30 and 0.45%.”


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