Your 'safe' money isn't so safe

Many for some reason were named after stars, and there were plenty other flashy names for these seemingly dull businesses. Dresdner Kleinwort, the investment arm of Germany's giant Dresdner Bank, created SIVs with names such as Beethoven Funding and Brahms Funding. American International Group (AIG, news, msgs) has several, including one called Curzon Funding that you will see in many prospectuses.

When the smart look dumb

When the subprime-mortgage delinquency rate began to rise to unprecedented levels last summer, Moody's and its peers began to downgrade the ratings of the CDOs in which the SIVs were invested. Due to contractual rules, the SIVs then had to exit the downgraded CDO investments, sometimes at very large losses, yet they were still obligated to pay your money fund 5.25%. Meanwhile, demand for SIV products has been falling, and the market for commercial-backed paper sank to its lowest levels in a year last week.

If they hadn't been so filthy greedy to begin with, we could perhaps pity the SIV managers: Their merchandise is becoming worthless, and their customers are drying up. Yet their problems are money market fund holders' problems. The need to recognize losses at SIVs has generated much of the multibillion-dollar write-downs that you have heard about recently at Citibank, Merrill Lynch (MER, news, msgs), Wachovia (WB, news, msgs) and elsewhere.

It's only getting worse, as knock-on effects reverberate. A week ago, Atlanta financial services company SunTrust Banks (STI, news, msgs) announced it would take a $1.4 billion in SIV exposure onto its balance sheet and write down $400 million just this quarter on its soured money market investments. The bank's SIV catastrophe emerged from its need to plug holes in its $4 billion Classic Institutional Cash Management Money Market Fund (CICXX) and its $10 billion Classic Prime Quality Money Market Fund (SQIXX). It also shut down a $967 million institutional cash fund.

Even the folks at BlackRock (BLK, news, msgs), widely regarded to be one of the smartest institutions in the world, announced last week that its BlackRock Cash Strategies Fund would stop allowing redemptions after it had lost half of its customers in the wake of a downgrade to "junk" status by Moody's. Bank of America closed an "enhanced" institutional money market fund at its Columbia unit at a loss this month after $25 billion in sudden withdrawals caused its net asset value to fall to $0.994 a share from its expected perch at $1. Over in Europe, Rabobank Groep said it would bail out its own SIV, Tango Finance, by taking responsibility for its $7.6 billion in fast-diminishing assets.

Said the company in a prepared statement: "There is no immediate prospect of the funding situation for SIVs improving in 2008. To prevent a potential fire sale of high-quality assets, the bank has announced that it is prepared to take the remaining assets of Tango onto its balance sheet.''

Only one U.S. money market fund has ever "broken the buck," or failed to return a dollar for every dollar invested, and that was more than a decade ago. Schwab spokeswoman Sarah Bulgatz said her company is "very comfortable" with its money market holdings and their underlying credit strength. She said all of the company's funds "maintain the highest short-term and long-term ratings available" and that none has been downgraded. Bulgatz says that as the commercial paper in question matures and rolls out of Schwab's funds, it is not being replaced, and that the percentage of the funds in SIVs has declined sharply.

Yet other institutions may not have been as proactive as Schwab, so no one really knows whether any bank will find itself forced to rip off its cash customers over the next year.

The only way to keep yourself completely safe is to switch into money market funds that are 100% invested in U.S. government obligations. At Schwab, the safest with a reasonable 3.9% yield is the Schwab U.S. Treasury Money Fund (SWUXX), which contains all Treasury bonds and T-bills, while the next safest is the Government Money Fund (SWGXX), which contains government-guaranteed Freddie Mac (FRE, news, msgs), Fannie Mae (FNM, news, msgs) and Ginnie Mae bonds, as well as government repurchase agreements issued through brokerages such as Bear Stearns (BSC, news, msgs).

Yet there's one little catch: Schwab has closed both of these to new investors, so you have to call their fixed-income department and request an exception to get in. Good luck with that.

Fine print

One outrageous thing about money market funds is that they charge incredibly high fees. Schwab Value Advantage has an expense ratio of 0.45%, which is more than triple the cost of S&P 500 SPDRs (SPY, news, msgs), the exchange-traded fund that tracks the S&P 500 Index ($INX). I guess you have to pay a lot to get the kind of fund managers who will throw money at SIVs. . . . To learn more about Schwab, visit its Web site . . . The blog Calculated Risk covers some of these issues. . . . Another blog following the mortgage-related security business is Housingwire.

To see Schwab's full response to this article, click here. At the time of publication, Jon Markman did not own or control shares of any companies mentioned in this column.

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