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Five Things You Need to Know: Money Market Funds Require "Shoring Up"; But Aren't Money Market Funds Safe?; What Would it Mean to "Break a Buck"?; Homebuilders Avoid Pawn Shop... for Now; Mortgage-Fraud Task Force Opens Command Center


What you need to know (and what it means)!


Kevin Depew's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Money Market Funds Require "Shoring Up"

Both Legg Mason (LM) and SunTrust Banks (STI) are propping up money-market funds to cushion them from possible losses on debt issued by structured investment vehicles, according to Bloomberg.

  • The Bloomberg story reports that Legg Mason invested $100 million in one of its money funds and arranged $238 million in credit for two others, while SunTrust received regulatory approval in October to act to protect two of its money market funds that bought debt from Cheyne Finance if the Structured Investment Vehicle (SIV) is unable to repay the bank.
  • How widespread is this issue among money market funds?
  • The 10 largest managers of U.S. money funds have $50 billion in SIV debt, according to Bloomberg.
  • Legg Mason and SunTrust are two of at least four companies, including Wachovia (WB) and SEI, that have stepped in to prop up money market funds to keep them from "breaking a buck," the article says.
  • Now, money market funds are considered among the safest places for investors to park money.
  • But, as the competitive hunger for yield among money market managers heated up, thanks in large part to excessive Federal Reserve credit creation that forced interest rates to artificially low levels, the consequences of this "extra" risk-taking paved the way for these types of blow-ups.
  • This is what happens when credit stalls in an economy that is dependent on its expansion for economic growth.

2. But Aren't Money Market Funds Safe?

Money market funds are touted as being among the safest of all possible investments. Why? What makes them so safe?

  • Money market funds are a type of mutual fund required by law to invest in low-risk (NOT no-risk) securities.
  • Money market mutual funds are different than money market deposit accounts at your local bank that are federally insured.
  • Money market mutual funds are not FDIC insured.
  • (See SEC Q&A on money market funds here.)
  • Money market funds typically invest in government securities, certificates of deposits, commercial paper of companies, and other ordinarily highly liquid and low-risk securities.
  • The problem these days is that some of these "ordinarily highly liquid" securities are now extraordinarily illiquid.
  • Or, in some of the most extreme cases, the cash flow paid to investors in these short-term "ordinarily highly liquid" vehicles has become impaired requiring additional investments from the parent companies or sponsors to avoid losses in the funds.

3. What Would it Mean to "Break a Buck"?

Don't these Legg Mason and SunTrust episodes illustrate that money market funds may not be quite as safe as they appear?

  • Yes and no.
  • It partly depends on what your definition of "safe" is.
  • Again, low-risk securities are not no-risk securities.
  • Investors in money market mutual funds who dig out the prospectus for their fund will see where it says very clearly that investments in these low-risk securities could potentially result in a loss of principal.
  • But, in practical terms, as the episodes with Legg Mason and SunTrust illustrate, these investments are quite safe.
  • They are safe because, although losses can occur, as long as the companies sponsoring them are able to they will make every effort to pour money into these funds to avoid "breaking a buck."
  • Why? Because any company that does "break a buck" would be in essence forfeiting participation in the money market industry entirely.
  • The larger danger is what might happen if instead of four money market mutual funds running into trouble, 40 run into trouble.
  • The reality is that as long as you trust that the company your money market mutual fund is held with wants to be in the money market business, you can pretty much rely on that company to inject whatever capital is needed to hold a buck.
  • And if, for some reason, 400 money market mutual funds run into trouble?
  • Well, if 400 money market funds find themselves in trouble the reality is at that point that's going to be the least of your worries; a bit like jumping out of a helicopter into the mouth of an active volcano and worrying about not having a parachute.

4. Homebuilders Avoid Pawn Shop... for Now

Look, there's a reason pawn shops are the kind of places most of us haven't spent a lot of time in; unless you are in dire financial straits, they're pretty bad deals! So no wonder banks are pushing for this Super-SIV. It avoids a trip to the pawn shop equivalent for CDO assets. And no wonder homebuilders are apparently now putting a "no sale" sign on their inventory. The alternative is the equivalent of a housing inventory pawn shop.

  • According to the Wall Street Journal, Lennar (LEN) is among homebuilders opting to simply not sell properties in their inventory until the market improves.
  • The practice is called "mothballing" the projects until business conditions improve, and more builders are expected to give it a shot before being forced to pawn the houses off at steeply discounted prices.
  • "We are better off holding off on sales at this asset and not discounting as steeply as the market is discounting right now," Emile Haddad, Lennar's chief investment officer told the Journal.
  • Uh. Yeah!
  • Who isn't better holding onto granddad's 24k gold pocket watch and not discounting it to sell to the pawnbroker?
  • Oh, right, the guy who is six months behind on his mortgage payment and who needs the money today.
  • For builders, that means companies such as Beazer (BZH) (see yesterday's Five Things Number 4), Hovnanian (HOV) and Standard Pacific (SPF).
  • Lennar Chief Executive Stuart Miller recently called some price cuts offered by builders "unrealistic and maybe even ridiculous."
  • But then, few have ever left granddad's gold pocket watch at the pawn shop and walked away happy with the sale.

5. Mortgage-Fraud Task Force Opens Command Center

Headline from the Cleveland Plain Dealer:

According to the Plain Dealer, "The office, opened within the last two weeks, is the only one of its kind in Ohio. It is in downtown Cleveland, but officials asked that the location be kept secret."

Good lord, is this really what it's come down to? Is mortgage fraud in the Cleveland area so rampant they have to form a special Mortgage Fraud Task Force to conduct tactical counter-mortgage-fraud operations out of a command center in a top secret location? What are they using, smoke bombs and tear gas to fight off mortgage fraud? Do the accountants really wear gas masks and carry automatic weapons when they rappel down the sides of the buildings they raid, or do they just hang out and analyze the mortgage documents in the secret command center?

On the one hand, characterizing mortgage fraud investigators as a task force operating from a secret command center probably goes a long way toward assuaging public outrage over the problem. But on the other hand, it also conjures up our image of that helicopter hovering over the mouth of an active volcano. "But I don't have a parachute?" I screamed, the hot wind from the rotors blasting my face and hair, the volcanic vapors burning my eyes. "What difference does it make," he replied, smiling. Then with his boot he shoved me out the helicopter's door. Halfway down, I realized he had a point.

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