Fed fails to calm money markets as commercial paper dump continues

Fed Fails to Calm Money Markets

By Krishna Guha, Francesco Guerrera, and Saskia Scholtes
Financial Times, London
Monday, August 20, 2007

http://www.ft.com/cms/s/0/699699f4-4f21-11dc-b485-0000779fd2ac.html

Money market investors staged a dramatic flight to safety on Monday, knocking down yields on short-term US government debt, as top Treasury and Federal Reserve officials continued behind-the-scenes efforts to maintain confidence in the credit markets.

The yield on the three-month Treasury bill fell 66 basis points to 3.09 per cent after being down by 125 basis points during the day -- a greater plunge than during the October 1987 stock market crash. The yield on the one-month Treasury bill fell 62 basis points to 2.33 per cent after being down 175 points. US equities closed mixed following gains in European and Asian stock prices.

The frantic scramble to obtain short-term government paper at almost any price suggests the Fed's move on Friday to make credit available to banks on more attractive terms has yet to stabilise the markets.

This in turn encouraged speculation the central bank would have to cut the federal funds rate, its main interest rate. In a sign of growing political attention to the crisis, Ben Bernanke, Fed chairman, and Hank Paulson, Treasury secretary, were to meet on Tuesday with Sen. Christopher Dodd, the Senate banking committee chairman.

Analysts said the plunge in T-bill yields was driven by money market funds, which hold $2,700 billion in assets, shifting away from asset-backed commercial paper, which promises investors the cash flows from mortgages and other loans.

In response to investors' pressure, funds that previously had sought to boost returns with more aggressive strategies have been selling asset-backed commercial paper and raising their holdings of government securities. At the same time, money is piling into traditional funds that buy only government debt.

"We had clients asking to be pulled out of money market funds and wanting to get into Treasuries," said Henley Smith, fixed-income manager at Castleton Partners. "People are buying T-bills because you know exactly what's in it."

Data from Dealogic showed companies in Europe failed to refinance more than 80 per cent of asset-backed commercial paper that matured on Monday.

Separately, people close to the situation said Deutsche Bank had taken advantage of new terms offered by the Fed on Friday by borrowing at the "discount window." They said the move was taken to show support for the Fed's actions.

Mr Paulson and senior Fed officials were talking to large institutional investors and banks in an effort to calm markets, but policymakers denied they were trying to talk up prices.

One investor said he had been called over the weekend by a senior Fed official seeking to "explain" Friday's decision to lower the discount rate.

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