Cash equivalents, seemingly the most boring and lifeless of financial products, are in a state of ferment. And where there is change, there is opportunity.
Since late last year, one short-term funding market after another has all but shut down. First it was asset-backed commercial paper and its kissing cousins, structured investment vehicles. Next came auction-rate securities. Recently even Libor - the survey-based bank rate benchmark that underlies a large proportion of financing contracts the world over - has fallen under suspicion as insufficiently transparent, which can be a death-knell in today's fearful markets.
The opportunity lies in the development and marketing of new funding channels to replace those that seized up. Creative minds with knowledge and experience of money markets who can present well-conceived alternative vehicles should find an attentive audience in banks, buy-side institutions, government and corporate America, in our opinion.
Damage More Widespread Than Sub-Prime and Derivatives
Like the parallel implosions of sub-prime mortgages, leveraged loans and credit derivatives, the crisis in money markets is ravaging profits, balance sheets, reputations and careers. There is an important difference, however. The world can get by without collateralized debt obligations. Other than perhaps contributing to higher mortgage rates, the CDO collapse affects very few people beyond the investment world. Similarly, life outside Wall Street will go on without leveraged lending to households (sub-prime mortgages) or businesses (private equity-led buyouts). But for a broad range of public and private institutions far removed from Wall Street and the City of London, the absence of reliable short-term funding markets interferes with their basic ability to do business.
The fate of auction-rate securities is a case in point. After the weekly auctions started failing early this year, local governments and quasi-public agencies across the country saw their funding costs soar into double digits, even for tax-exempt debt. Municipal borrowers large and small - even blue-chip ones like the Port Authority of New York and New Jersey - scrambled to issue new long-term bonds or other vehicles so they could redeem outstanding auction-rate debt whose rates had become exorbitant overnight.
The auction-rate market's disappearance also hit college students in the pocketbook. Deprived of ability to finance, student-lending agencies in Michigan, Missouri, New Hampshire, Texas, Pennsylvania and Iowa cut back on new loans for college education or ceased lending altogether, according to an April 4 blog posting by plaintiff's law firm Aidikoff, Uhl & Bakhtiari. Auction-rate securities backed by student loans made up about a quarter of the $330 billion auction-rate market, the law firm said.
Defining the Opportunity
That is where the opportunity lies. Last November, a former colleague related that short-term debt markets were "pretty dead, but the need for short-term financing hasn't gone away." The banks, he continued, would have to develop and market new products to replace asset-backed commercial paper and the like. He suggested that laid-off fixed-income professionals with experience in short-term debt should think about how to market that experience to either the sell side or the buy side. "Everyone has regarded this as the most boring market imaginable, but at least for the next couple of years they're going to be paying more attention to it," he wrote.
His advice, clearly prescient then, is just as valid today. If you have experience in structuring, pricing or trading innovative securities, then develop a proposal and shop it to banks and other institutions. Or get in touch with one of the handful of existing trading platforms that specialize in making markets for illiquid securities.
In March, Restricted Stock Partners began trading auction-rate securities on its Restricted Securities Trading Network - an electronic trading platform launched in 2005 to bring together buyers and sellers of restricted stock and other illiquid assets.
And Icap, one of the world's largest inter-dealer brokers, is about to launch an alternative to Libor. The new rate product, called the "New York Funding Rate" or NYFR, "is aimed at giving banks and market participants a new gauge of what it costs banks to borrow money," The Wall Street Journal reported Thursday. Icap intends to start publishing the NYFR as soon as next week, the Journal said, citing Lou Crandall, chief economist at Icap's Wrightson unit. The figures will be compiled from a survey of some 40 banks about one-month and three-month borrowing costs.