I trade occasionally, and I have followed the banking disaster with great interest. The road is littered with folks who have made and lost a fortune on bank stocks this year (mainly lost if you were long). In mid-July, after the Fannie and Freddie "bailout" and the Wells Fargo earnings, fianncials have rallied. I am not an expert of short-selling and short-selling practices, but I understand that at Lehman's insistence the SEC limited the ability of short-sellers to movea gainst the market, which has added fuel to the rally.

A popular way for shorts and longs to play the financials was introduced last year in the form of the Powershares SKF, a two-times levered short tracking stock. The volatility of this thing has been extraordinary. It came out at $71 a share in October, ran to $150 after the Bear collapse, ran back down to $100, then up to over $210 on July 15 which the selloff reached a crescendo. In less than two weeks, as bank stocks have surged, this has retreated all the way to $111.

And the movement is not straightlined. The thing can experience instant moves of more than $1 in a manner at any time.

According to my friends who trade and friends at hedge funds, this thing now represents the best way to move against the banks. I don't know if the bet against the banks is over (as some, including Sam Cass believe) or if this is just a snap-back rally. But, whatever your inclination is, you should be warned that the SKF is not for the faint of heart or the casual trader. It is, in fact, a heart attack waiting to happen.

Many Massachusetts savings banks have additional insurance for deposit amounts above $100,000 from the Depositors Insurance Fund (DIF). All deposits held in member banks above $100,000 are insured in full by DIF. The location of the depositor or the branch does not impact the coverage. Thus, a resident of California that wants to open an account at a DIF member bank in Massachusetts is fully covered. Out-of-state branches of a participating Massachusetts bank are also covered.

DIF not a government program but instead a privately funded program to protect the soundness of Massachusetts banks. The DIF website states:

"The DIF has over $300 million in assets, plus an additional $100 million of reinsurance. During the recession of the early 1990s, the worst financial period in the history of the Massachusetts savings bank industry, the DIF paid out more than $50 million to protect over 6,500 depositors in 19 failed member banks. Yet the DIF emerged from this period financially stronger than before the recession began."

DIF reviews the financial statements of its member banks on a quarterly basis to ensure their soundness and is "examined annually by the Massachusetts Division of Banks and audited by an independent auditor."

A list of DIF banks is here.

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.