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Strategies & Market Trends : US Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: gpowell who wrote (75)	9/19/2008 2:22:39 AM
From: gpowell	Read Replies (2) \| Respond to of 97

To be clear. As we all know, a bank deposit in a fractional reserve system is never backed up wholly by a tangible asset. But a bank is legally obligated to redeem $1 of deposits with $1 of high powered money (cash). And there is never enough cash to redeem all deposits. You should appreciate the money multiplier reducing effect inherent in exchanging deposits for cash and the secondary ripple effects this will have on the economy. Now contrast that with a MMMF. A share in a MMMF is simply a claim on a share of the underlying asset. If that asset value drops to zero, the MMMF is not obligated to make the shareholder whole again. It's certainly not a good thing for assets to drop to zero value, but there is no multiplier effect as in a bank failure. Even if we assume that MMMF shareholders demand redemption such that the remaining underlying assets must be sold at fire sale prices - those assets still exist and still provide the same services. Assuming no impairment in those assets, all that has occurred is a transfer of ownership. Appreciate also, that as the price of fixed income securities falls the yield rises - so at some point smart money will reverse the redemption trend. There's the rub - a run on a MMMF is an incredibly stupid thing to do if the underlying assets are sound (a run on a bank, pre-FDIC, is smart thing to do if you think others will run). If the assets of an MMMF aren't sound - well the loss is already there - redeeming before anyone else figures it out just makes you a little smarter than everyone else. Redeeming when you don;t have to make you a little dumber. Now, none of this isn't to say that a massive wave of redemptions in MMMF won't have some ripple effects, but that will come mainly from the transaction costs of the transfer and the loss of the primary and secondary services that MMMFs provide.