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Sub-prime crisis infects $459b of money market funds

Some of the largest funds invest in debt packages backed by risky mortgage loans

LOS ANGELES – MONEY market funds were invented to offer investors better returns than bank savings accounts while providing a high degree of safety.

Most of the US$2.5 trillion (S$3.8 trillion) in these funds is invested in assets like United States Treasury bills, certificates of deposit and short-term commercial debt.

Unlike bank accounts, money market funds are not government- insured. They almost never fail.

But unbeknown to most investors, some of the largest money market funds today are putting part of their cash into one of the riskiest debt investments in the world: collateralised debt obligations (CDOs) backed by sub-prime loans.

CDOs are packages of bonds and loans, and almost half of all CDOs sold in the US last year contained subprime debt, according to a report by Moody’s Investors Service.

US money market funds run by Bank of America, Credit Suisse, Fidelity Investments and Morgan Stanley held more than US$6 billion of CDOs with sub-prime debt in June, according to fund managers and filings with the US Securities and Exchange Commission (SEC).

Money market funds with total assets of US$300 billion (S$459 billion) have invested in sub-prime debt this year.

The danger of owning even highly-rated CDOs containing sub- prime loans was thrown into sharp relief in June, when two Bear Stearns hedge funds that were holding sub-prime CDOs collapsed.

Global financial markets were rocked last month and this month, first by the collapse of the Bear Stearns hedge funds and again when banks and insurance companies worldwide disclosed their US sub-prime debt holdings.

On Aug 9, France’s BNP Paribas froze withdrawals on three investment funds with assets of two billion euros (S$4.1 billion) because the bank could not find a way to value its US sub-prime bonds and other assets. CDOs are not bought and sold on exchanges and their trading has little transparency.

There are 38.4 million money market fund accounts in the US, according to the Investment Company Institute (ICI). People use these accounts both to hold savings and serve as an account to buy securities and place the proceeds of sales.

Investors have sought safety during the sub-prime meltdown by moving their holdings to US Treasuries and money market funds.

On Aug 8, US money market funds’ total assets hit a record high of US$2.66 trillion, with investors putting US $49 billion into such funds in a week, said the ICI.

As a sign of stability, money market funds never allow their share price to rise above or fall under US$1 for each dollar invested.

A money market fund that invests in sub-prime debt increases the risk that its share price could drop below US $1. If 5 per cent of a fund’s holding is sub-prime debt, and in a worst-case situation that asset collapses, then the value of the fund could drop to 95 cents.

Mr Lynn Turner, chief accountant of the SEC from 1998 to 2001, says the regulator is likely to look into money market funds investing in CDOs, particularly because the value of sub-prime collaterals of CDOs can collapse suddenly.

‘I’m betting some people at the SEC will be concerned,’ he said. ‘They’ll be more concerned in six months. How quickly did the Bear Stearns hedge fund evaporate?’

Source: BLOOMBERG NEWS (The Straits Times 23 Aug 07)

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