Can Banks and Pension Clients be Friends When It Comes to Valuation?
In his November 11, 2007 blog entry, New York Times reporter Floyd Norris describes an interesting tidbit of information, tucked inside the just filed 10-Q by Wachovia Corporation. On page 27, it reads "In the third quarter of 2007, we purchased and placed in our available for sale portfolion $1.1 billion of asset-backed commercial paper from Evergreen money market funds, which we manage. We recorded a $40 million valuation loss on this purchase, which is included in our market disruption-related losses." As Norris explains, while the regulatory filing adds that Wachovia is "not required by contract to purchase these or any other assets from the Evergreen funds" they manage, a loss of that magnitude would "break the buck." When the $1 Net Asset Value typically associated with a money market fund no longer prevails, Wachovia or any other financial institution in a similar position is arguably obliged to stem the financial tide or risk loss of investors or worse. Click here to access the 10Q report.
In today's article entitled "SEI, Rival Money Funds Go on Offense to Avoid 'Breaking the Buck'," Wall Street Journal reporters Diya Gullapalli and Tom Lauricella write that money manager SEI Investments has said "it would provide financial guarantees for some of the funds' holdings of SIVs." CEO Alfred West explains the rationale for voluntarily providing credit support, in the aftermath of a threatened downgrade of SIV Cheyne Finance, LLC paper. Held by several SEI funds, "managed for SEI by Columbia Management, the money-management arm of Bank of America Corp," the funds' rating could likewise be compromised. Click here to listen to the recorded November 12, 2007 presentation to SEI investors.
A recent IMF presentation, entitled "Regional Economic Outlook - Europe" stresses the importance of improving "risk assessment models, market and liquidity risk management, due diligence, and transparency regarding the loan origination process and counterparty risk exposure."
Color me confused. Haven't many banks held themselves out to be leaders in the area of risk control? What about the fact that banks are highly regulated? Doesn't that contribute to good oversight? What is the role of Basel II, looming right around the corner and meant to reflect robust risk management activities on the part of banks in the U.S. and abroad?
For those banks with pension clients, what is the process in place to vet all recommended money market funds, including their own? Is the process conflict-free? Conversely, are pension funds directly (or through pension consultants) asking sufficient questions about the safety of recommended short-term capital pools?
As the mysteries unfold, don't be surprised what we learn about the importance of good fund selection and risk review process.
Note: Wikipedia defines a structured investment vehicle as "an evergreen credit arbitrage fund, similar to a CDO or Conduit. They are usually from around $1bn to $30bn in size and invest in a range of asset-backed securities, as well as some financial corporate bonds. An SIV is formed to make profits from the difference between the short term borrowing rate and long term returns." Click here for more information.
