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Jitters seep into money funds

The credit-market crisis has some questioning one of the safest places to keep cash.

August 16, 2007|Tom Petruno and Kathy M. Kristof | Times Staff Writers

Wall Street's deepening worries about who owes whom in the credit markets now are touching one of investors' most trusted places to keep cash: money market mutual funds.

The $2.7-trillion money fund business was thrown on the defensive Wednesday on fears that some corporate and financial-company issuers of short-term IOUs could have trouble making good on their debts. Money funds are big investors in those IOUs, such as so-called commercial paper.

Many fund-industry experts quickly advised against overreaction, noting that the rules governing money funds generally require them to stick with the highest-quality securities and to limit how much they own of any one issuer's debt.

What's more, even if a money fund loses money on a particular IOU, its parent company would most likely bail it out to avoid shareholder losses, said Russ Kinnel, director of mutual fund research at investment research firm Morningstar Inc.

"A sizable financial institution is not going to let that happen," Kinnel said, because of the potential damage to the parent company's reputation.

In the stock market, the spreading turmoil in credit markets triggered another heavy sell-off Wednesday. The Dow Jones industrial average ended down 167.45 points, or 1.3%, to 12,861.47, its fifth straight decline.

The broader Standard & Poor's 500 index fell 1.4%, wiping out the last of its gains for 2007.

Todd Clark, director of trading at Nollenberger Capital Partners in San Francisco, said battered markets had entered a stage in which "a lot of what we're dealing with now is emotional" rather than rooted in reality.

What is clear is that the credit-market crisis that began months ago with rising defaults on so-called sub-prime home loans has spread deeply into financial markets, with investors now questioning the likelihood of getting paid back on all sorts of loans and bonds.

The latest wave of fear pushed short-term Treasury bill interest rates dramatically lower as some investors sought to park money in a security with an ironclad guarantee of payback.

"There are so many unknowns, people are going for the highest-quality assets you can get," said Scott Gewirtz, head of Treasury bond trading at Lehman Bros. in New York.

The buying wave drove the annualized yield on three-month T-bills down to 4.07% from 4.63% on Tuesday, a huge one-day decline.

A key focus of nervous traders was the health of Calabasas-based Countrywide Financial Corp., the nation's biggest mortgage lender. The company's shares plunged $3.17, or 13%, to $21.29 after an analyst at brokerage Merrill Lynch & Co. slashed his rating on the stock to "sell" and said the company could face bankruptcy if its creditors yanked financing.

The risk that Wall Street could cut off crucial funding to Countrywide just worsened the mood of the credit markets.

Jitters persisted even though the Federal Reserve again injected money into the banking system to try to calm the waters. The central bank added $7 billion to the system via transactions with banks.

Worries about short-term debt have been front and center in recent days. On Tuesday, a Canadian issuer of the short-term IOUs known as commercial paper said it was having trouble finding buyers for certain securities, although it later said it succeeded in selling $600 million of the debt.

Also Tuesday, an Illinois firm that provides cash management services to commodity trading companies halted investor redemptions from its $1.5-billion fund. The firm, Sentinel Management Group, said credit market tumult made it impossible to trade certain securities without incurring a loss.

On Wednesday, KKR Financial Holdings, a unit of giant buyout firm Kohlberg Kravis Roberts & Co., said it would record losses of as much as $290 million on mortgage-backed bonds it owned. As part of that announcement, the firm said it was seeking to delay repayment of $5 billion in short-term securities.

The Wall Street Journal reported that the investors who held the debt included some money market funds.

Money funds have long been considered extremely safe by many investors. The funds are designed to keep their share prices steady, typically at $1 a share, and pass through to investors the interest they earn on short-term debt securities.

The average seven-day yield on taxable money funds was 4.76% as of Tuesday, according to fund tracker IMoneyNet Inc.

But the funds don't explicitly guarantee investors' principal in the way that banks offer the guarantee of federal deposit insurance on their accounts, up to certain limits.

Fund industry experts noted that money funds face strict requirements regarding the quality of the securities they buy. What's more, the average fund's portfolio turns over in 40 days -- meaning the securities mature very quickly. That also reduces the risk of loss.

"Money market funds have pretty tight restrictions," Morningstar's Kinnel said. "It would be tough to get them in a ton of trouble."

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