In last month's issue, Bloomberg Markets featured several articles detailing the various rip-offs and shenanigans taking place in one segment of the financial services industry, which I noted in "Bloomberg Outs the Insurance Industry."
With this month's issue, which includes a similarly hard-hitting report on money market funds, "Unsafe Havens," it seems that compelling, no-holds-barred investigative reporting of issues with broad-based appeal has become a staple feature of a publication that once seemed little more than a marketing giveaway for the media conglomerate's main business of providing market data to financial professionals.
U.S. money market funds have invested $11 billion in subprime debt, much of it managed by Bear Stearns.
Money market funds were invented 37 years ago to offer investors better returns than bank savings accounts while providing a high degree of safety. Most of the $2.5 trillion sitting in these funds is invested in such assets as U.S. Treasury bills, certificates of deposit and short-term commercial debt.
Unlike bank accounts, money market funds aren't insured by the federal government. They almost never fail.
Unbeknownst 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: collateralized debt obligations backed by subprime mortgage loans.
CDOs are packages of bonds and loans, and almost half of all CDOs sold in the U.S. in 2006 contained subprime debt, according to a March report by Moody's Investors Service.
U.S. money market funds run by Bank of America Corp., Credit Suisse Group, Fidelity Investments and Morgan Stanley held more than $6 billion of CDOs with subprime debt in June, according to fund managers and filings with the U.S. Securities and Exchange Commission. Money market funds with total assets of $300 billion have invested in subprime debt this year.
The danger of owning even highly rated CDOs containing subprime loans was thrown into sharp relief in June, when two Bear Stearns Cos. hedge funds that were holding subprime CDOs collapsed.
At the center of that storm was Ralph Cioffi, a senior managing director at Bear Stearns who ran the hedge funds. Cioffi, 51, wore another, less publicized hat. He managed more than $13 billion of CDOs, according to Fitch Ratings -- and money market funds and other investors bought all of it.
Cioffi-managed CDOs filled with subprime debt have been purchased by money market funds run by Invesco Plc's AIM Investment Service, Marsh & McLennan Cos.' Putnam Investments and Wells Fargo & Co.
In August, New York-based Bear Stearns fired Warren Spector, the firm's co-president for fixed income and asset management. Cioffi stayed with the bank. Bear Stearns spokesman Russell Sherman says Cioffi's stewardship of the bank's CDOs ended in late June.
"There is a team of portfolio managers running them now," Sherman says. "Ralph still serves as an adviser." Cioffi didn't respond to telephone and e-mail requests for comment.
Under SEC rules, money market managers must invest in securities with "minimal credit risks." Joseph Mason, a finance professor at Drexel University in Philadelphia and a former economist at the U.S. Treasury Department, says subprime debt in money market funds is far from safe.
"This creates tremendous risk for today's money market investors," says Mason, who wrote an 84-page report on CDOs this year. "Right now, I'm not comfortable investing anything in CDOs."
Global financial markets were rocked in July and August, first by the collapse of the Bear Stearns hedge funds and then when banks and insurance companies worldwide disclosed their U.S. subprime debt holdings.
On Aug. 9, BNP Paribas SA, France's biggest bank by market value, froze withdrawals on three investment funds with assets of 2 billion euros because the bank couldn't find a way to value its U.S. subprime bonds and other assets. CDOs aren't bought and sold on exchanges and their trading has little transparency.
During the first two weeks in August, central banks in Europe, Japan and Australia and the U.S. Federal Reserve lent more than $300 billion to banks to stem a collapse in credit markets.
On Friday, the Federal Reserve lowered the interest rate it charges to banks to 5.75 percent from 6.25 percent in an attempt to contain the subprime mortgage collapse.
Money market funds have become a staple for investors. There are 38.4 million money market fund accounts in the U.S., according to the Investment Company Institute.
People use a money market both to hold savings and serve as an account to buy securities and place the proceeds of sales. Bruce Bent, who in 1970 created the first money market fund, The Reserve Fund, says no money market fund should invest in subprime debt.
"It's inappropriate," Bent, 70, says. "It doesn't have a place in money market funds. When I created the first money market fund, I said you have to have immediate liquidity, safety and a reasonable rate of return. You also have to have a situation where you're not giving people headline risk."
Investors have sought safety during the subprime meltdown by moving their holdings to U.S. Treasuries and money market funds. On Aug. 8, just after the Bear Stearns hedge funds filed for bankruptcy protection, U.S. money market fund total assets reached a record high of $2.66 trillion, with investors pouring $49 billion into such funds in one week, according to the ICI.
As a sign of stability, money market funds never allow their share price to rise above or fall under $1 for each dollar invested.
A money market fund that invests in subprime debt increases the risk that its share price could drop below $1. If 5 percent of a fund's holding is subprime debt, and in a worst-case situation that asset collapses, then the value of the fund could drop to 95 cents.
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I actually have a significant sweep into the Institutional / Primary at The Reserve. Late this summer, I scheduled withdrawals as aggressively as possible to relocate the funds into FDIC insured accounts. However, I have been trickling funds back into The Reserve after reading many reassurances about that company such as the founder's comments in the article above. The Reserve also posted several PDFs to their web site, one of which is a check list of hot-button items that they do not invest in, such as MBS, CDO, etc.. But I am still a bit uneasy as I recall the original PDF for that list headlined as being "DIRECT" exposure to those vehicles. That left me to wonder about indirect exposure, which might even be more scary since that fund is not FDIC insured (understanding that even FDIC coverage has its flaws). Though at present I see the PDF on their site now simple says "Reserve's Exposure to the Subprime Mortgage Market" without any caveats about indirect/direct. I still think they are an excellent company, but how far afield is "direct" vs "indirect" exposure in that biz?
Posted by: dukeb | September 28, 2007 at 08:46 AM