The recent problems with Fannie Mae and Freddie Mac roiled the mortgage markets but they also had the potential to impact many money market funds. The government acted to prevent a bigger problem in both.
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.
"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.
Five days ago I reported that Bank of America's dividend was at 11% and that the stock might present a good buy. Did I listen to my own advice? No. Today, BofA was up more than 20%.
Five days ago I reported that Bank of America's dividend was at 11% and that the stock might present a good buy. Did I listen to my own advice? No. Today, BofA was up more than 20%.
"So who is an investor to believe? I personally think Bank of America is a pretty savvy operation and that they knew what they were buying with Countrywide. They probably were able to model a range of losses that they would experience with their porftolio and included that in their business projections. Surely, their data is more accurate than the models created by Wall Street bankers who have no first-hand experience with the mortgage markets.
I also believe that if you look at Bank of America's stock, it is back to its 2001 values. That means that all of the gains of the last seven years, the height of the mortgage and housing bubbles have been wiped out. I also think that's reasonable."
I still believe that. I expect a few more bumps in the road with financials. I don't think the mortgage or overall credit crisis is fully over. Maybe sixth or seventh inning and banks will take a few more hits. But I also believe that markets have priced most of this in. The near insolvency of Fannie and Freddie certainly lowered future expectations.
Is the BofA still a good buy? Maybe, but not as good as it was a week ago. I'm still kicking myself for not buying.
If the market is open, the financials are down 10%. This will continue until we have another Bear Stearns-like failure. Bernanke has told us as much. Don't try to bottom-fish. These are failed business models.
The business model of leveraging credit upon credit has failed. It wasn't a Bear Stearns model, it was an industry. There were many culprits, banks without the intellectual capital to grow the business of the basis of investment banking or trading like Goldman, Morgan Stanley or JP Morgan, that just leveraged their balance sheet and kept leveraging and leverage. A crazy credit environment, a housing bubble and a strong economy all contributed to the environment. But, when you build with leverage on leverage, it doesn't take too much to bring down the house.
The house is falling now. These banks are down 10% every day. The model has failed and there is nothing left. This will continue until we see a major failure.
I believe that Citi will be bailed out by some middle eastern prince or sovereign wealth fund. I am less certain of Lehman, Merrill and Wachovia. I think that one of these banks will fail and fail soon.
However, I could be wrong so I wouldn't dream of shorting one of these.
