Wednesday, August 15, 2007

Credit Market Fall-Out #22 – Effects in the Short Term Market

The excerpts below from an article in the WSJ indicates just how tangled the web is in the financial markets. Illiquidity in the one market effects a money market, which in turn can effect the commodities market or the mutual fund market.

By the way, this link, which I found on Market Watch, gives a beginners description of Sentinel Management. Beginners views are good. As my graduate advisor once told me, “it is always nice to theorize, but you should know some facts first”.

Turmoil in the credit markets is spreading to one of the most conservative kinds of investments, causing a small money-management firm to freeze its clients' assets.

Yesterday, Sentinel Management Group Inc. -- citing "panic" conditions in the market -- prevented its clients from withdrawing money from their cash accounts. Sentinel manages money for hedge funds and commodities traders in what are loosely akin to money-market accounts: short-term investment vehicles that are supposed to behave something like a bank account.

Sentinel said in a letter to clients dated Monday that an inability to easily buy and sell securities in the credit markets was making it tough to price its holdings. "We are concerned that we cannot meet redemption requests without selling securities at deep discounts to their fair value and therefore causing unnecessary losses to our clients," the letter said. Sentinel didn't respond to requests for comment.

It is the latest sign that the bond-market turmoil is hurting even investments considered among the most conservative places to temporarily park cash.

Buyers for some debt instruments -- particularly in asset-backed securities and some subprime securities -- have dried up in recent weeks. A general lack of liquidity such as this in global markets is what prompted central banks in the U.S. and elsewhere in recent days to open up emergency lending windows to help investors that suddenly found themselves squeezed by a shortage of cash.

The illiquidity is also hurting a handful of institutional funds and mutual funds that are marketed as "enhanced" money-market products, or funds that are slightly riskier than regular money-market funds and aim for higher yields.

Firms such as Sentinel play an important role in the commodities markets. It is one of a few niche providers of short-term cash-management services for clients in the commodities-futures trading business. It took in clients that included so-called futures clearing firms, which are institutions that execute a client's trades on an exchange and stand behind the client's obligations. Clearing brokers give futures traders confidence that they will be paid if they are owed money when a contract expires.

In commodities, traders (and their clearing firms) need to keep a large amount of cash on hand. Traders can make wagers by putting up only a small amount, say 10%, of the value of a trade, but they have to be prepared to cough up much more cash if their bets go the wrong way. Their clearing firms demand cash collateral, known as "margin," that changes daily based on the changing value of their position. Sentinel managed some of that cash for clearing firms and commodities traders.

If commodity traders or clearing firms need cash that Sentinel is unwilling to give over, they could be forced to liquidate other investments to raise cash. Yesterday, the Chicago Mercantile Exchange said all the clearing firms registered with its exchange were in good financial standing.

The liquidity problems affecting Sentinel have also caused pain at some mutual funds as well as funds that cater to institutional investors. These so-called enhanced cash funds, also known as "ultra-short" or "yield-plus" funds, have about $850 billion in assets, including investment from governments, institutions and mutual funds, according to research firm iMoneyNet Inc. Still, that's only about a third of the total assets invested in traditional money-market funds.

A company official says the fund's holdings are primarily rated triple-A and double-A, and they have no credit problems. They are being hurt in the short-term because of lack of liquidity in the market, which makes them hard to price, she said.

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