Non-Treasury MM Sweep Account

Discussion of the Cash portion of the Permanent Portfolio

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Tortoise
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Non-Treasury MM Sweep Account

Post by Tortoise » Sat Apr 16, 2011 3:29 pm

If this question has been answered in a previous thread, then I apologize.

I have seen a number of people on this forum ask where they should park their cash when no Treasury money market funds are available (e.g., because they are closed to new investors, as many of them currently are).  One of the most common recommendations is to use SHY or SHV, which are both short-term Treasury ETFs.

However, a thought just occurred to me the other day:  In a brokerage account having a non-Treasury MM "sweep" fund, how would simply parking all the cash in the sweep fund entail any more liquidity risk in a financial crisis relative to, say, holding the cash in SHY/SHV?  I agree that SHY/SHV are lower-risk funds, but isn't that irrelevant given the fact that one must buy and sell the SHY/SHV shares via the riskier MM sweep fund anyways?

In other words, what good is an ultra-safe ST Treasury ETF if one can only access it via a not-so-safe MM sweep account?
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Re: Non-Treasury MM Sweep Account

Post by MediumTex » Sat Apr 16, 2011 3:34 pm

The sweep account may only be holding funds for a few days, whereas the Treasury MM funds may be holding funds for years.

The probability of something going wrong with the sweep accounts during the short period your funds are moving in or out of them is, IMHO, pretty low.
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Re: Non-Treasury MM Sweep Account

Post by HB Reader » Sun Apr 17, 2011 11:08 pm

Tortoise --

You are technically correct.  There is no way to insulate US dollar holdings completely from a collapsing bank or financial system. 

As a practical matter, however, MT is right.  The best you can do is hold Treasury securities or funds that invest directly in Treasury securities.  Anything beyond a very short disruption in that market would result in a cascading collapse of all US dollar denominated liabilities, eventually including even Federal Reserve liabilities (i.e., bank notes and bank reserve deposits).  This is possible, but very unlikely.  Insuring an "orderly market" for Treasury debt will always be given the highest priority by both the Treasury and Federal Reserve.  This was undoubtedly one of the primary concerns that compelled Secretary Paulson and Chairman Bernanke to rescue so many money market players in the fall of 2008.  Many of those entities were important intermediaries in the payments system that supports the Treasury debt market. 
       
           
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Re: Non-Treasury MM Sweep Account

Post by Tortoise » Tue Apr 19, 2011 4:36 am

MediumTex wrote: The sweep account may only be holding funds for a few days, whereas the Treasury MM funds may be holding funds for years.

The probability of something going wrong with the sweep accounts during the short period your funds are moving in or out of them is, IMHO, pretty low.
Yes, but during that time where something is going wrong with the sweep account, it seems to me that one would potentially be "locked out" of all of one's brokerage holdings.  Specifically, if one needed cash for any reason, one would be unable to redeem shares of, say, SHV to obtain that cash until the MM sweep storm blows over.

In other words, the risk I'm talking about here isn't the risk of completely losing one's cash (I understand how the Treasury vs. non-Treasury distinction is critical there).  What I'm talking about is the risk of not being able to access one's cash on the particular date on which one needs it (e.g., due to a non-Treasury MM meltdown).  For that latter type of risk, it doesn't seem to me like owning a Treasury ETF like SHV via a non-Treasury sweep fund avoids the temporary liquidity risk inherent in the sweep fund (i.e., potentially not being able to withdraw the cash in time or urgent need).  If I'm mistaken, I'd just like to understand why.
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Re: Non-Treasury MM Sweep Account

Post by Gumby » Tue Apr 19, 2011 6:50 am

Tortoise wrote:What I'm talking about is the risk of not being able to access one's cash on the particular date on which one needs it (e.g., due to a non-Treasury MM meltdown).
Yes, it's entirely possible that you wouldn't be able to access cash on a particular date. This is why HB recommended keeping an emergency supply of cash nearby.
Nothing I say should be construed as advice or expertise. I am only sharing opinions which may or may not be applicable in any given case.
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Re: Non-Treasury MM Sweep Account

Post by AdamA » Tue Apr 19, 2011 7:24 am

Tortoise wrote:
Specifically, if one needed cash for any reason, one would be unable to redeem shares of, say, SHV to obtain that cash until the MM sweep storm blows over.
I've wondered about this quite a bit myself.  I think it's a valid question to ask about anything held in a brokerage account b/c proceeds from anything sold in a brokerage account go into a MM sweep when you sell them (GLD, SPY, TLT, Treasuries bought at a secondary auction, mutual funds...basically anything...). 

How would that play out?
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Re: Non-Treasury MM Sweep Account

Post by MediumTex » Tue Apr 19, 2011 9:21 am

When thnking about this scenaro, consider that everyone else would be selling as well.

In other words, there would be enormous political pressure to make sure that sweep account bottlenecks were not impeding investors' access to cash.

In practice, there might be a few days during which sweep accounts were malfunctioning, but it seems like this is the kind of thing that would be fixed (one way or another) pretty quickly.

Also, just because there is a financial crisis, that doesn't mean you are going to be liquidating any of YOUR holdings.  That's why it's a good idea to keep some emergency cash on hand.

Ultimately, we can't be prepared for every imaginable permutation of doom, but the overall structure of the permanent portfolio, IMHO, puts you miles ahead of most other investors during periods of crisis.

***

One thing that I like about I-bonds for periods of illiquidity is that in any city there are countless financial institutions at which you can redeem paper I-bonds for cash.  In this way, I-bonds are a lot more like cash than other financial instruments that exist only as an electronic entry in someone's system.  Could something go wrong with this plan?  Sure, but it's just one more option that might come in handy one day.
Last edited by MediumTex on Tue Apr 19, 2011 9:35 am, edited 1 time in total.
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Re: Non-Treasury MM Sweep Account

Post by HB Reader » Tue Apr 19, 2011 12:58 pm

If the conditions are such that a Non-Treasury Sweep Account is not functioning, then it is highly unlikely banks would be operating normally.  If banks aren't operating, no Treasury security of any kind could be negotiated (because there would be no mechanism to convert it to cash).  Only physical bank notes you already hold could bridge that period.  There is no direct way for the Treasury or Federal Reserve to interface with the market if banks aren't functioning.

As I mentioned above, the Treasury and Federal Reserve would be under enormous pressure (as they were in 2008) to do anything they can to ensure "orderly market" conditions for the purchase and sale of Treasury debt.  Their FIRST ORDER of priority would be the payments mechanism for Treasury debt (in addition to the Federal Reserve acting as "buyer of last resort" for Treasury debt, if necessary).  If it means "bailing out" or offering "temporary guarantees" to banks and other money market participants, so be it.  Most large banks and money market funds (even Non-Treasury money market funds) are players in the Treasury market.  In short, I think it is safe to assume that if you hold Treasury debt your holdings would be the first to experience the "rescue" measures.

The only short-term glitches that I could see to a quick fix would be the physical destruction of the infrastructure or an unusual legal impediment (like a limit on the debt ceiling, after Treasury had exhausted all available temporary accounting gimmicks to get around it).  Of course, almost any quick fix will likely bring with it longer term costs or problems.           
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Re: Non-Treasury MM Sweep Account

Post by Tortoise » Tue Apr 19, 2011 2:50 pm

Thanks for the info, everyone.

Sounds like I'm probably over-analyzing this particular permutation of doom.  I do keep some emergency cash at home, so hopefully that would provide a cushion against any temporary illiquidity in the money markets.
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