FISCAL/MONETARY UPDATE – RECESSION PERHAPS, BUT THERE ARE NO SYSTEMIC RISKS, RIGHT??
The great recession of ’08-’09 is not so long ago, and it is generally agreed that, were it not for the multi-trillion dollar intervention of the U.S.Federal Reserve, the risks were “systemic” and inaction could have led to a collapse of the worldwide financial system. Among other elements, a properly functioning financial system is largely dependent on liquidity and credibility between transactional counter parties.
Two important flashpoints come to mind in recalling the events leading up to the financial crisis that climaxed in late ’08.
The market for Auction Rate Securities grew to over $200 Billion dollars by early ’08, as investors reached for a little extra yield. The ARS market consisted of funds holding long term debt instruments that were repriced by their underwriters on a regular basis, typically 7, 28, or 35 days. Interest was paid and the underwriters “guaranteed” purchase at par. However, in February, 2008, redemptions overwhelmed the liquidity within these funds and redemptions were suspended. It was something like eighteen months, after many lawsuits and settlements between regulators, investment banks, and investors, that most investors were made whole.
Money market funds have long been a safe haven for investors that want unquestioned quality in short term instruments, tolerating a modest yield in return for reliable liquidity. On Sept. 16, 2008, the Reserve Primary Fund “broke the buck” when its net asset value (NAV) fell to $0.97 cents per share. It was one of the first times in the history of investing that a retail money market fund had failed to maintain a $1 per share Net Asset Value. Investors fled the fund and caused panic for money market mutual funds in general. Following the 2008 financial crisis, after essentially backstopping the money market fund industry, the government instituted protective legislation. Since then, money market funds can no longer have an average dollar-weighted portfolio maturity exceeding 60 days with better credit ratings necessary as well.
Fast forward a quick fourteen years to late 2022:
It has now been over a decade that interest rates have been suppressed to the lowest level in history. Investors of all stripes: equity, debt, derivatives, cyrpto-currencies, have reached for yield, ignoring the predictable hangover from the fiscal/monetary party. Once upon a time, investments were considered a search for high reward with minimal risk. Too often lately the equation has amounted to reward-free-risk.
We may have recently had a glimpse of several “canaries in the (systemic) coal mine”
Just two months ago, in early October, the Bank of England had to backstop $ 355 billion of British pension funds which had been leveraging their assets to better meet benefit obligations. When interest rates were minimal, and borrowed funds could be invested with a “positive carry”, returns could be amplified, but the rapid recent rise in rates turned a positive into a negative and required liquidation that markets could not accommodate.
Last Thursday, 12/1, the $69B Blackstone Real Estate Income Trust (BREIT) announced it will limit redemptions, after requests exceeded the fund’s monthly and quarterly limits of 2% and 5%, respectively. It had met only 43% of November redemptions, leaving only 0.3% of net assets available for redemption in December. Unmet requests will need to be resubmitted in the first quarter of next year. We can then understand why Blackstone also announced the sale of its 49.9% stake in two Las Vegas hotels, in exchange for $1.3B and assumption of $3B of debt.
Yesterday, 12/5, the $14.6 billion Starwood Real Estate Income Trust, announced it is also limiting redemptions. November requests amounted to 3.2% of net asset value, above the 2% monthly limit, so only 63% of requests were met.
As Warren Buffet might say: “As the tide goes out, we are just beginning to see who is swimming naked.”
THE BOTTOM LINE
Nobody covers fiscal/monetary affairs better than Jim Grant’s Interest Rate Observer. Yesterday’s column reiterates my point above that “the recent fast-moving U.K. pension fund crisis underscores the potential systemic pitfalls presented by the widespread usage of leveraged investment strategies. More broadly, years of ultra-accommodative policies have fomented a financial system that is ill-suited for the withdrawal of monetary stimulus.”
Grant then quotes the Bank for International Settlement (the Bank for Central Banks), concisely put, and this is profound!
“Financial stability risks from high leverage and inadequate market liquidity are not confined to the pension fund sector. Indeed, long periods of low interest rates have incentivized a reach for yield and leverage build-up by financial institutions across the spectrum, including more innovative forms of securitization, such as those of private equity funds. With rapid increases in interest rates and receding liquidity in core markets, simultaneous deleveraging can generate liquidity demand pressure, which could lead to market dysfunction.
“When these risks materialize and the attendant economic costs are substantial, there will be pressure on central banks to provide backstops – as market-makers of last resort.”
I don’t make this stuff up.
Roger Lipton