Friday, 26 June 2009

The types of instability

Money market funds were one of the more minor vectors of the crunch. Since they did not want to break the buck, and as they had rather limited loss absorption capability (thanks to the lack of anything akin to equity), they were sellers of the debt of any institution rumoured to be in trouble. In other words, they exacerbated funding liquidity risk but helping to turn a rumour into reality.

Belated the SEC has proposed revisions to the regulatory framework for funds: see here for a prospectus.

What these proposals will do is turn a nasty dynamic destabiliser into a static one. Since funds will be unable to invest in low quality instruments, they will not be able to fund lower quality firms at all. In effect the barrier to entry for the big boys club will get higher.



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