A New Cash Investment Landscape Emerges

I tend to liken the liquidity crisis to a hurricane that has hit the financial industry. Bear Stearns was swept away during the worst of the storm and now, as the weather subsides a bit, some treasurers are beginning to emerge from their shelters to assess the damage; what held fast and what may never be repaired.

As Treasurers review how their policies and programs held up, some are finding tattered investment programs that relied too heavily on rating agencies for their credit work, as well as proprietary products and pre-packaged portfolios that seem to have been the most vulnerable. However, now is the perfect time to assess those past practices to determine if they remain valid.
In surveying the investment landscape, corporate treasurers access three widely used product areas: money market funds; 3(c)(7) funds; and auction rate securities (ARS); all of which have experienced some degree of credit or liquidity problems. Why did this happen and how might these issues be avoided in the future?

First, ARS problems in the market appear to be based on an over-reliance on ratings, conflicted sales channels, and a lack of professional credit monitoring. While the asset class might disappear altogether, one would hope the investment lessons will linger. 3(c)(7) funds address all of the ARS shortcomings listed but, by prospectus, may also be permitted to invest in securities one likely wouldn’t approve of in a “standard” corporate investment policy (SIVs, CDOs and CMOs). In the end, these security classes were also proven problematic. Finally, money market funds, with parental bail outs, selectively suffered similar problems as 3(c)(7) funds but to a lesser degree.

The challenges money funds and 3(c)(7) funds face is that, while there is alignment of interest and professional credit staff, they are relatively inflexible in their investment scope. One buys into a basket of securities that offers limited transparency and over which there is little direct control. Additionally, as the environment changes, the funds may lack the ability to turn to more conservative or aggressive holdings and instead must aggressively push forward with what little investment latitude they’re afforded.

Certainly these investment vehicles were designed with capital preservation, high liquidity and ease-of-use in mind, but some clearly did not meet their objectives through the credit environment of the recent past. We find that under these circumstances that the intended advantages simply do not outweigh the drawbacks.

There are many Treasury functions that have weathered the storm well and it is interesting to look at the practices that contributed to their success. Common traits we’ve seen include control of specific security exposures, professional credit oversight and the ability to migrate risk exposures when necessary. As Treasurers now look to clean up the mess left behind by the storm, they will ideally respond to the difficult lessons they’ve recently learned and apply those lessons to future investment decisions.

Best Regards,

Ben Campbell
President & CEO