July 11, 2008

Could the Unthinkable Happen- Could Money Market Funds Lose Value?

A review of recent market events suggests that there may be far more risk in money market funds than was previously thought. In an article in the Business section of today’s New York Times, Eric Dash reported that, during the last year, many of our country’s largest brokerage firms have been forced to contribute more than $10 billion to prop up money market funds that are threatened by the mortgage crisis. In recent months, the following firms, among others, have taken action to bolster their affiliated money market funds: Legg Mason, Credit Suisse, Bank of America, SunTrust, Morgan Stanley, Lehman Brothers, and Wachovia.

The Big Question is: How long will these firms be willing and able to provide this support? All of these firms have reportedly sustained billions of dollars in financial setbacks over the past twelve months. At some point, will their financials become so tenuous that they cannot afford to continue spending billions to support faltering money market funds? Is there risk associated with this $3.5 trillion market?

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April 12, 2008

Money Market Funds Still At Risk

After several months of silence, it is apparent that money market funds aren’t “out of the woods” yet. Some funds still have exposure to investments in structured investment vehicles (“SIVs”) or similar instruments that, in turn, invested in subprime securities. SIVs use short-term borrowing to buy higher-yielding long-term assets.

For example, Legg Mason Inc. has recently entered into a capital support agreement agreeing to provide up to $400 million to bail out an institutional money market fund from potential losses incurred on debt issued by SIVs. The move will cut Legg Mason’s profit by $316 million ($195 million net of taxes) for the quarter ending March 31.

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March 24, 2008

Bank of America: More Subprime Problems Ahead?

According to analyst Richard Bove, Bank of America may take a $6.5 billion loss provision in the first quarter of 2008. Bove anticipates that this loss provision would be established to cover possible future losses in Bank of America’s subprime mortgage portfolio and home equity portfolio.

Recent reports have predicted that both of these segments of the market are likely to experience serious difficulties in 2008 and 2009. In late January, Business Week published an article, “The Home Equity Crisis Ahead” by Mara Der Hovanesian which described the deterioration of the $850 billion home equity market. In this article, Amy Crews Cutter deputy chief economist at Freddie Mac, was quoted as stating “The home-equity lender is going to get hosed.” Similar opinions have been expressed regarding the subprime mortgage market. In its March 31, 2008 edition, Fortune quotes Princeton economist Paul Krugman stating “I think there’ll be $1 trillion of losses on mortgage –backed securities showing up somewhere.” To date, securities firms and banks have disclosed only about $195 billion in losses related to the mortgage markets.

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January 21, 2008

Is The Market's Doomsday Scenario Here?

An old Wall Street adage says that you should never plan to bring a new offering to market right after a three-day weekend because you never know what could happen from Friday night to Tuesday morning. US markets were closed today for the Martin Luther King, Jr. holiday but it was an event-filled weekend that will cause further market turmoil on Tuesday when the markets re-open.

On December 18, 2007, The Wall Street Journal wrote “Credit Crunch Could Worsen if . . . Bond Insurers Sink, ‘Buck Breaks’.” According to Dennis K. Berman of the Journal, the two events that are of most concern to Wall Street bankers, traders, and regulators are ratings downgrades of bond insurers and money market funds losing value below $1. Unfortunately, recent events suggest that this very scenario may be playing out.

First, on Saturday, January 19, 2008, Christine Richard of Bloomberg.com reported that Fitch Ratings announced that it had downgraded the credit rating of Ambac Assurance Corporation from AAA (the highest rating available) to AA after Ambac abandoned plans to raise new equity. This in turn caused a downgrading by Fitch of approximately 140,000 municipal and non-municipal bonds insured by Ambac.

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December 10, 2007

Moody's Downgrades SIVs; Money Market Funds At Risk; SIVs Unable To Meet Debt Obligations Without Selling Assets At Fire-Sale Prices

On December 4, 2007, Wall Street Journal reporter Shefali Anand reported that some money market funds may be invested in risky debt securities issued by structured investment vehicles, or SIVs, that were recently downgraded or put on review for possible downgrade by Moody’s Investors Service. These money market funds include Charles Schwab Advisor Cash Reserves, as well as similar funds from Morgan Stanley, Barclays PLC, UBS AG, Deutsche Bank AG, and others, according to the article. While these funds hold only 1% to 2% of their investments in such debt, even a small amount poses a risk that has analysts paying attention. If a SIV debt obligation held by a money fund lost all its value, that could cause the money fund to “break the buck” – i.e., violate a requirement to maintain a $1 per share value.

The review and downgrade of SIV debt was reported by Carrick Mollenkamp in the December 1st edition of the Wall Street Journal. Moody’s downgraded $14 billion in SIV debt and placed under review another $105 billion, according to the article. Moody’s said this action reflected “the continued deterioration in market value of SIV portfolios combined with the sector’s inability to refinance maturing liabilities,” reported Mollenkamp.

The liabilities in question are commercial paper. Commercial paper is a short-term debt obligation sold by banks and other businesses to investors. The proceeds are commonly used to meet short-term operating needs. Commercial paper is generally bought by money funds and has been regarded as very safe. SIV commercial paper is another matter, though.

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