Fed looks at exit fees on bond funds

Fed tries to fix what Fed helped create by making things even more fucked up than they already are, and putting possible "gating" on bond funds. This will end well.

http://www.ft.com/intl/cms/s/0/290e...44feabdc0.html?siteedition=intl#axzz34qIShMQ6

Federal Reserve officials have discussed whether regulators should impose exit fees on bond funds to avert a potential run by investors, underlining concern about the vulnerability of the $10tn corporate bond market.

Officials are concerned that bond funds are becoming “shadow banks”, because investors can withdraw their money on demand, even though the assets held by the funds can be hard to sell in a crisis. The Fed discussions have taken place at a senior level but have not yet developed into formal policy, according to people familiar with the matter.

“So much activity in open-end corporate bond and loan funds is a little bit bank like,” Jeremy Stein, a Fed governor from 2012-14 told the Financial Times last month, just before he stepped down. “It may be the essence of shadow banking is ... giving people a liquid claim on illiquid assets.”

In the wake of the financial crisis, tougher rules on capital and the abolition of in-house trading operations at major US banks have resulted in Wall Street pulling back from helping big funds buy and sell corporate bonds. Bank inventories of bonds have fallen almost three-quarters from their pre-crisis peak of $235bn, according to Fed data.

At the same time, US retail investors have pumped more than $1tn into bond funds since early 2009. This has created a boom environment for fixed income money managers, but raises the prospect of a massive disorganised flight of money out of the industry should interest rates rise sharply in the coming years.

Exit fees would seek to discourage retail investors from withdrawing funds, thereby making their claims less liquid and making a fire sale of the assets more unlikely.

Introducing exit fees would require a rule change by the Securities and Exchange Commission, which some commissioners would be expected to resist, according to others familiar with the matter.

Such fees could be highly unpopular with retail investors unable to access funds without paying a fee. But some in the industry would welcome them; BlackRock, the world’s largest asset manager, has called for international rules setting exit fees on some funds.

Even as regulators worry about the potential of a sharp correction in the bond market, some investors are building a war chest to take advantage of it. BlueMountain Capital, the New York-based alternative asset manager, has stockpiled funds ready to be deployed when bond prices fall.

“If credit markets were to become stressed due to heavy mutual fund outflows, our funds with patient capital and flexible mandates would be in a position to capitalise on any dislocation,” said Andrew Feldstein, co-founder and chief executive of BlueMountain.

Investors like Mr Feldstein and regulators like Mr Stein have a similar vision of how the dislocation could arrive. “A big theme post-crisis is a significant shift of credit risk from banks to mutual funds,” said Mr Feldstein.

“Mutual funds aren’t leveraged like banks are, so they probably don’t create the same degree of systemic risk. But they do offer daily redemptions, and so they engage in a maturity transformation similar to banks, which could result in significant market stress in heavy outflow scenarios.”

 

A Horror-Show Called “Fed-Gate” May Be Coming To Your Bond Fund Soon

http://davidstockmanscontracorner.c...ed-gate-may-be-coming-to-your-bond-fund-soon/

The Financial Times is not exactly a rumor mill—-so its recent headline amounts to a thunderbolt:

“Fed Looks At Exit Fees On Bond Funds”

And so the shoes begin to fall. Owing to the Fed’s brutal financial repression since December 2008 (i.e. zero yield on short-term funds), there has been massive scramble for yield that has driven trillions into corporate and high yield bond funds.

What this means is that liquid funds which would have normally been parked in bank deposits or money market funds have been artificially displaced. That is, they have been chased by the dictates of the monetary politburo into far more illiquid and risky investment vehicles owing to zero yields in their preferred financial venues.

But now it is dawning on at least some of the more market savvy occupants of the Eccles Building that they have created a monumental financial log-jam waiting to happen. In their jargon, the migration of trillions into bond funds since the financial crisis has resulted in a sweeping “maturity transformation”. As former governor Jeremy Stein succinctly put it,

“It may be the essence of shadow banking is … giving people a liquid claim on illiquid assets.”

What Stein means is that the traditional money markets existed for a reason—even if returns were inferior to what could be obtained in longer duration fixed income securities or investments with equity-like features such as junk bonds. Corporations and individuals who invested in money market instruments, including bank CDs, were willing to absorb the yield penalty in return for the assurance of absolute daily liquidity that the funds in question required.

But zero return is not a market driven liquidity penalty; it is an arbitrary prohibition imposed on the market by the monetary politburo. So now we have a giant anomaly. Trillions of daily liquidity demanding investments are potentially stuck in bond funds which could not provide it during a crisis. In effect, any attempt by bond funds managers to meet a surge of redemptions calls would make the crisis surrounding the Reserve Prime Fund’s “breaking the buck” in September 2008 seem like a Sunday School picnic.

The reason is that the Fed created a massively artificial demand for bond fund investments during the 6-year stretch of ZIRP. Accordingly, in the event that liquidity-seeking investors call their funds, which they are entitled to do by bond mutual funds, there would be a massive imbalance in the market. This is especially true because traditional Wall Street market makers have significantly shrunk their balance sheet positions and available capital owing to Dodd-Frank.

So drastically imbalanced markets under crisis conditions would gap down and potentially go even bidless for many higher risk, less liquid corporate issues. As mark-to market losses mounted, of course, investor demands for liquidity would sky-rocket, begetting even more fire sale dumping of corporates and junk bonds and even deeper discounts and losses.

In short, in its mindless drive to manipulate financial markets and generate artificial demand for credit, the Fed has created the potential for a massive run on bond funds should a new financial crisis be triggered by one black swan or another. And once again it is evident that the market’s natural process of “price discovery” has been destroyed in favor of ham-handed “price administration” by our monetary central planners.

Yet the monster they have already created—-a massive log-jam at the bond fund exit gates—-would pale compared to the deformations and anomalies that would result from the imposition of a government dictated exist fee on unsuspecting investors. Even the announcement of a rule-making would potentially trigger the very kind of sell-off that it would be designed to prevent. And if corporate bond prices took a tumble, it would not take long for equity markets to recognize that the massive flow of new debt capital which has been used to fund record stock buybacks could suddenly dry up.

Not surprisingly, the big bond houses are lining up in favor of government imposed exits fees and gates. They would like nothing better than to keep investors captive, collect the fees and blame Washington for the inconvenience to investors.

The next round of crony capitalism is already underway.

Exit fees would seek to discourage retail investors from withdrawing funds, thereby making their claims less liquid and making a fire sale of the assets more unlikely.

Such fees could be highly unpopular with retail investors unable to access funds without paying a fee. But some in the industry would welcome them; BlackRock, the world’s largest asset manager, has called for international rules setting exit fees on some funds.

 

These bond funds, as well as the money-mkt funds, are a scam to begin with... The fund managers who market these as "liquid" shouldn't be allowed to do so (this applies especially to the money funds), as I have mentioned a few times. I don't believe that a centrally imposed "exit fee" is the solution, however. People should generally take responsibility for their financial decisions. If they have invested in junk bonds and want out when the sh1t hits the fan, they have to bear the consequences. Claiming that the Fed has somehow "forced" you into illiquid junk ain't gonna fly.

 

Sure, the Fed's actions had nothing to do with a rush into bonds or high yield garbage.

/sarcasm

 

Well, did you personally rush into bonds or high yield garbage?

 

No, but I am hardly the sample to go by. I wasn't forced to find yield in places where I normally would have avoided if risk was priced correctly.

 

Well, I didn't either... Doesn't this suggest that, Fed or no Fed, it's an individual decision to hunt for yield or not? If so, shouldn't it be an individual responsibility?

 

Indefensible.

 

Liar liar, pants on fire:

 

It appears that this is a moot point, anyways... From the Yellen presser today:
> Thank you. Greg Robb from Market Watch.
There was a report this week in a salmon-colored newspaper I won't mention that
the Fed is thinking about and regulators in Washington are thinking about an
exit fee for bond mutual funds. This has sparked a lot of comments. Would you
care to comment on this?
>> CHAIR YELLEN: I am not aware of any discussion of that topic inside the
Federal Reserve, and my understanding is that that is a matter that is under
the purview of the SEC.
>> Okay. Thank you very much.