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2013 Review and 2014 Forecast - Part I: The Last Bubble - Eric Janszen
Federal Reserve officials have discussed whether regulators should impose exit fees on bond funds to avert a potential run by investors, underlining concern about the vulnerability of the $10tn corporate bond market.
What is the difference between that and capital controls?
What is the difference between that and capital controls?
I used the term improperly to get a laugh.
Most properly, "capital controls" means controlling the flow of funds across the national border.
The rules for bond funds are aimed at transactions within the US , so they are not really capital controls
this makes no sense, would this just apply to bond funds, or bond etf's? In an ETF, the underlying assets are not sold, just the ownership is transfered.
Would this effect institutions with individual bond holdings? So the big boys have an escape hatch but J6P who needs a fund for diversification and
cost savings gets skewered. It might make sense in a money market world, where the 1.00 a share share price is only available to the first people who
liquidate and is not shared equally among all holders. I would favor a floating value for money markets, if capital gains were not subject to income tax.
Also in a mutal fund you sell for the settling price of the portfolio at close. So you never really know what your sale price is going to be. If the fund
has a bad day, you will not get what the NAV was yesterday. So the analogy of a bank is broken. You cannot redeem your shares for more than they are
worth. And the shadow bank thing is fishy too. A bank creates money by making a loan. Buying or selling a mutual fund only transfers existing bonds and dollars between two parties.
Does the "almighty" fed see an interest rate spike in the near future??
This makes perfect sense if one's goals are to oversee as much of the financial system as possible while minimizing the risk of having to provide support to other areas of the financial system (which happened to the Fed repeatedly in 2007-2010).
For example, for the last few years, the Fed and SEC have been attempting to put redemption limits on money market funds to prevent a repeat of 2008 when the Fed had to create an emergency credit facility to stop an ongoing run on those funds. After that experience, they seem to view money market funds as dangerous in providing the illusion of liquidity while investing in assets that, in the crisis, turned out to be quite illiquid. Viewed from that perspective, long-term bond funds pose similar risks that could warrant similar solutions.
The preferred outcome could be to force investors either to (i) invest in bonds directly, or through a broker, where the investors would bear all of the liquidity and pricing risk, and where the Fed would have no obligation to provide support, or (ii) put their money into a bank, which the Fed will regulate and to which it can provide a liquidity backstop, if necessary.
Diversification and cost to investors are not considerations.
As an added bonus, this might ultimately force credit creation out of the capital markets and back into the Fed-regulated banking system.
This makes perfect sense if one's goals are to oversee as much of the financial system as possible while minimizing the risk of having to provide support to other areas of the financial system (which happened to the Fed repeatedly in 2007-2010).
For example, for the last few years, the Fed and SEC have been attempting to put redemption limits on money market funds to prevent a repeat of 2008 when the Fed had to create an emergency credit facility to stop an ongoing run on those funds. After that experience, they seem to view money market funds as dangerous in providing the illusion of liquidity while investing in assets that, in the crisis, turned out to be quite illiquid. Viewed from that perspective, long-term bond funds pose similar risks that could warrant similar solutions.
The preferred outcome could be to force investors either to (i) invest in bonds directly, or through a broker, where the investors would bear all of the liquidity and pricing risk, and where the Fed would have no obligation to provide support, or (ii) put their money into a bank, which the Fed will regulate and to which it can provide a liquidity backstop, if necessary.
Diversification and cost to investors are not considerations.
As an added bonus, this might ultimately force credit creation out of the capital markets and back into the Fed-regulated banking system.
On close inspection it appears that these are in fact measures not to prevent bond holders from selling bonds but to prevent bond funds from suffering redemption runs that force the Fed into a liquidity provider role. Now if such rules were to apply to accounts with the Treasury Department directly then we'd have to conclude that the Fed is concerned about the liquidity of the Treasury bond market itself. Current interest rates indicate otherwise.
The Financial Times reported last week that the Federal Reserve was examining redemption fees for bond mutual funds as a possible tool for preventing runs. Fed Chair Janet Yellen today contradicted the report, saying oversight of the funds industry lies with the SEC.
“I am not aware of any discussion of that topic inside the Federal Reserve,” she said in a press conference following a meeting of the Federal Open Market Committee.
BlackRock Inc. (BLK), the world’s biggest money manager, is encouraging regulators to scrutinize the risk of an investor flight from mutual funds and consider potential restrictions that would help prevent asset sales.
“There is no historical evidence that this type of run has ever occurred, however, it’s worth doing deeper analysis to understand the questions better,” Barbara Novick, BlackRock’s vice chairman, said in a telephone interview yesterday.
We build a model of a financial intermediary, in the traditionof Diamond and Dybvig (1983), and show that allowing the in-termediary to impose redemption fees or gates in a crisis—a formof suspension of convertibility—can lead to preemptive runs. Inour model, a fraction of investors (depositors) can become in-formed about a shock to the return of the intermediary’s assets.Later, the informed investors learn the realization of the shockand can choose their redemption behavior based on this informa-tion. We prove two results: First, there are situations in whichinformed investors would wait until the uncertainty is resolvedbefore redeeming if redemption fees or gates cannot be imposed,but those same investors would redeem preemptively, if fees orgates are possible. Second, we show that for the intermediary,which maximizes expected utility of only its own investors, im-posing gates or fees can be ex post optimal. These results haveimportant policy implications for intermediaries that are vulnera-ble to runs, such as money market funds, because the preemptiveruns that can be caused by the possibility
of gates or fees mayhave damaging negative externalities.
From a straight read of the abstract, intro and conclusion is sounds more like an argument "against" gates on withdrawls. However reading between the lines, one has to wonder.
Was a proposal to add gates circulating? Was this paper handed to someone with a wink and a nod?
We build a model of a financial intermediary, in the traditionof Diamond and Dybvig (1983), and show that allowing the in-termediary to impose redemption fees or gates in a crisis—a formof suspension of convertibility—can lead to preemptive runs. Inour model, a fraction of investors (depositors) can become in-formed about a shock to the return of the intermediary’s assets.Later, the informed investors learn the realization of the shockand can choose their redemption behavior based on this informa-tion. We prove two results: First, there are situations in whichinformed investors would wait until the uncertainty is resolvedbefore redeeming if redemption fees or gates cannot be imposed,but those same investors would redeem preemptively, if fees orgates are possible. Second, we show that for the intermediary,which maximizes expected utility of only its own investors, im-posing gates or fees can be ex post optimal. These results haveimportant policy implications for intermediaries that are vulnera-ble to runs, such as money market funds, because the preemptiveruns that can be caused by the possibility
of gates or fees mayhave damaging negative externalities.
From a straight read of the abstract, intro and conclusion is sounds more like an argument "against" gates on withdrawls. However reading between the lines, one has to wonder.
Was a proposal to add gates circulating? Was this paper handed to someone with a wink and a nod?
i agree these proposed regulations are aimed at runs on funds which would in term require liquidity backstops. these regulations would not support bond prices - if people want out of bonds the etf's will be sold and their prices arbitraged against individual bonds, and of course individual bonds will be sold as well. long duration interest rates will rise. people or institutions who are invested in bonds through open end funds will be left holding a portion of the bag.
This (worry about outflows) has quickly become an ongoing story in the financial media.
Investors have piled more than $900 billion into taxable bond funds since the 2008 financial crisis, buying stock-like shares of mutual and exchange-traded funds to gain access to infrequently-traded markets. This flood of cash has helped cause prices to surge and yields to plunge.
Now, as the Federal Reserve discusses ending its easy-money policies, concern is mounting that the withdrawal of stimulus will lead to an exodus that’ll cause credit markets to freeze up. While new regulations have forced banks to reduce their balance-sheet risk, analysts at JPMorgan Chase & Co. (JPM) are focusing on the problems that individual investors could cause by yanking money from funds.
There’s a bigger risk “that when the the Fed starts hiking in earnest, outflows from high-yielding and less-liquid debt will lead to a free fall in prices,” JPMorgan strategists led by Jan Loeys wrote in a June 20 report. “In extremis, this could force a closing of the primary market and have serious economic impact.”
On close inspection it appears that these are in fact measures not to prevent bond holders from selling bonds but to prevent bond funds from suffering redemption runs that force the Fed into a liquidity provider role. Now if such rules were to apply to accounts with the Treasury Department directly then we'd have to conclude that the Fed is concerned about the liquidity of the Treasury bond market itself. Current interest rates indicate otherwise.
I don't understand the difference. The fed is worry about bond funds having a redemption run. Isn't that caused by individuals selling bonds?
Is the problem that the funds are obligated to return a certain nominal value to the customers, even though the invested in bonds may have gone below that value?
On close inspection it appears that these are in fact measures not to prevent bond holders from selling bonds but to prevent bond funds from suffering redemption runs that force the Fed into a liquidity provider role. Now if such rules were to apply to accounts with the Treasury Department directly then we'd have to conclude that the Fed is concerned about the liquidity of the Treasury bond market itself. Current interest rates indicate otherwise.
I don't understand the difference. The fed is worry about bond funds having a redemption run. Isn't that caused by individuals selling bonds?
Is the problem that the funds are obligated to return a certain nominal value to the customers, even though the invested in bonds may have gone below that value?
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