Academic journal article ABA Banking Journal

Arsenic Is Low-Fat Too: Lessons from the Demise of Community Bankers U.S. Government Money Market Fund

Academic journal article ABA Banking Journal

Arsenic Is Low-Fat Too: Lessons from the Demise of Community Bankers U.S. Government Money Market Fund

Article excerpt

A bank owner of shares in CommuniBankers U.S Government Money Market Fund faxed me a spreadsheet of its holdings--shortly after it was announced that the fund would have the distinction of being the first money market to fold due to "derivatives" exposure. (A year or two ago, we called them "agencies.")

The two right-hand columns of the spreadsheet indicated the par amount sold to the fund's manager and the brokers who sold these securities to the fund:

$14.5 million, Smith Barney. $4 million, Government Securities Corp. $2 million, Vanguard Capital. $2 million, Merrill Lynch. $2 million, Sutro. $4 million, Kidder, Peabody. $2 million, Morgan Stanley. $1 million, Rodman Renshaw.

The left-hand column on the same fax--listing the issuers--carries familiar names like Federal Home Loan Bank, Federal Farm Credit Bank, Federal National Mortgage Association, Federal Home Loan Mortgage Corporation, and Student Loan Marketing Association.

What we read in the press points fingers at the investment advisors involved, and after looking at the securities in their portfolio we conclude that this may be appropriate. But what the press has not pointed out is that this situation is not unique to a few money market funds that "dabbled" in derivatives. We have also seen some of these same types of securities in the portfolios of community banks and large banks. They were almost always sold as being "agency" securities that floated but offered more "yield." Sound familiar?

What can investors learn from the undoing of this money market fund?

LESSON #1. You don't get something for nothing--EVER--in the bond market.

Investments that carry the promise of more "yield" and less "risk" usually are playing finance games that can only be brought to light effectively by the investor if he or she does some sort of scenario analysis.

Analysis must include income (as opposed to "yield"--see our June 1994 column), reinvestment of income, and market-value at a future date. (Our next column will focus on this.) Many of the investments that are blowing up silently in portfolios were bought without any such disciplined approach.

That's an important phrase--disciplined approach. The discipline of total return investing should be part of every institutional portfolio manager's routine. Virtually all of the "surprises" that investors are complaining about today could have been foreseen using a common-sense approach to future outcomes.

LESSON #2. "Adjustable" does not mean safe.

The manager of this money market fund was required by policy to only buy short-term investments, unless they "repriced" on a frequent basis. In other words, the manager bought these securities because they met a policy, without, apparently figuring out that the intent of the policy was to limit price volatility.

This is very similar to the bank president that ordered one investment officer banker to"only buy adjustables. We don't want any risk." As we pointed out in our column in September, adjustablerate mortgage securities can be as risky or riskier than many long-term fixed-rate securities. In the week of Oct. 17, we saw a bid indication on one of the few GNMA ARMs still carrying a 5.00% coupon (the exact security we wrote about last year) at 92 1/2--that's down ten points from last September.

Are you on a low-fat diet? Arsenic is low-fat. It may kill you, but you could eat it and not violate your diet "policy."

Actually a better analogy would be sugar. If you are the owner or the CEO of a bank and you are saying to your portfolio manager, "I want very little or no price depreciation in our investment portfolio," but you also say, "We still need more yield than fed funds or TBills, you are setting up your portfolio manager for a fall.

You are saying, in effect, "We need to have a low-fat diet, but can you pass the sugar please?" More "yield" and less "risk" is rarely achievable in an easily digestible, simple product. …

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