Fannie and Freddie Problems Could Impact Money Market Funds

Everyone at this point knows that Fannie Mae and Freddie Mac excercise a tremendous influence on the morgage market. But they also play a large role in generating returns for money market funds. One of the dangers of a collapse in either institution is that money market funds that invest in short term bonds from Fannie and Freddie could suffer losses. Such losses would significantly undermine the financial system.

Money market funds, unlike money market accounts, are not FDIC insured. They are short term investment vehicles and their money is invested in short term (typically less than 1 year) assets that are continued extremely safe - T-Bills, CDs, and Mortgage backed securities (generally bonds issues by Fannie and Freddie). Because the government has implicitly backed both insititutions, the bonds from Fannie and Freddie are considered almost as safe as T-Bills, which are backed by the US government.

Marketwatch reports that:

"Peter Crane of Crane Data, publisher of the Money Fund Intelligence newsletter, noted that paper issued by government agencies represents about 11% of the roughly $3.5 trillion held in money funds. Paper from Fannie and Freddie is roughly one-fifth of that government-related paper. In absolute terms, it's a huge amount of dollars, but it means that just 2% of the average money fund portfolio is tied up in Fannie and Freddie."

Of course, that's just an average. Some money market funds hold substantially more and some hold less. And even a 2% loss in a money market fund is unacceptable to an investor who expects that there money is completely safe.

For now, Money Market funds appear to be safe. As Peter Crane wrote on my previous post on money market funds: "But no retail investors has ever lost money in one [money market funds].

But, as we learned with Auction Rate Securities, it's always wise to understand what's in your portfolio. I personaly plan to take a look at my money market funds to see much exposure they have to Fannie, Freddie and other real estate related investments. Since I believe housing will come down further, I want to make sure I understand my risks.