In 54 days, at midnight on December 31, $1.4 trillion in US risk-free assets will lose their protected status when one of the emergency actions taken during the credit meltdown of 2008 expires. As the FDIC's unlimited insurance coverage on demand deposits runs out (first provided by the Temporary Liquidity Guarantee Program, which later became the Dodd-Frank Deposit Insurance Provision), monies in noninterest-bearing transaction accounts will only be insured up to $250,000, potentially throwing the short-term markets into negative interest territory.
"Come January, what was once a virtually 'risk-free' asset for investors will instantaneously become risky," said
PIMCO's Jerome M. Schneider. The expiration of this emergency coverage "adds to the uncertainty that looms over short-term liquidity strategies as global interest rates continue to be squeezed," Schneider said.
According to FDIC's record of total deposits as of June 30, 2012, an estimated $1.4 trillion in 100% insured bank deposits will revert to uninsured obligations of the bank.
If the situation in Europe is any guide, as those now-at-risk funds seek a home, interests rates could turn negative, effectively forcing investors to pay for the safekeeping of their monies. The European crisis was triggered when the European Central Bank cut its deposit rate on excess reserves to 0%. Euro money-market funds halted inflows or liquidated, repurchase agreements and T-bills began trading at negative yields. European banks have turned away client interest in CDs at any level as their liquidity positions remain flush.
Schneider said he believes that an instant replay of the ECB's action by the Fed, namely a cut on interest on excessive reserve to 0%, is a remote possibility, but it must be considered. "Now is the time to assess viable alternatives to traditional methods in liquidity management that can offer positive real-returns to first movers ahead of this changing dynamic," according to Schneider.
The most logical strategy includes moving to alternatives such as 2a-7 money funds. However, the current $2.3 trillion in taxable 2a-7 funds would likely be overwhelmed by an inflow representing over 60% of their current assets.
"At such time, liquidity investors will be forced to allocate between taking the additional credit risk of remaining as an uninsured depositor, accept the cost of near 0% yields offered by the pure liquidity and assured principal protection of US T-bills, or venture into more attractive risk/reward positive-yielding alternatives further out in the short-term space," says Schneider.
Even if the stated interest rate in one of these vehicles is positive, however, the average money-market fund would be, in inflation-adjusted terms, likely negative.
It's not likely that all $1.4 trillion in assets will move at once. Schneider and others say that they estimate about $550 billion in deposits will realistically be in play.
Nevertheless, the advantage will go to the first-movers willing to look beyond the "traditional playbook" of money-market funds.
No positions in stocks mentioned.