Tuesday, October 21, 2008

Another possible blotched attempt to fix the economy

The Federal Reserve introduced... a new program to finance the purchases of assets from money market mutual funds as the government continued to search for ways to battle a severe credit crisis.

"The short-term debt markets have been under considerable strain in recent weeks as money market mutual funds and other investors have had difficulty selling assets to satisfy redemption requests," the Fed said in an announcement of its new effort.

JPMorgan Chase & Co. was chosen to run five special funds that will buy certificates of deposit, bank notes and commercial paper from money market mutual funds. The Fed will lend up to $540 billion to the five funds to support the effort.

Fed officials said that about $500 billion had flowed out of prime money-market funds since August as investors began to worry about their ability to redeem their investments. On Sept. 18, the Treasury Department announced it was tapping a $50 billion Treasury fund to provide guarantees for the assets in the funds. The new Fed initiative is designed to bolster the funds further.

This is just another blotched attempt to fix the credit crisis. we all know that many banks, insurance, and financial institutions offer money market and annuity products - which were at one time considered relatively safe investments - at higher interest rates than CDs and savings accounts. Have you ever wondered why the interest rate is higher on these investment products? They're backed by high-yield government bonds, corporate bonds, and mortgage-backed securities. Many of these high-yield government bonds are from developing countries, such as Brazil, or are traded in currencies where the future foreign currency prices are expected to jump higher than the US dollar. A good chunk is invested in FNMA while a tiny percentage is thrown into US Treasury notes. The investment in high yield corporate bonds - although small - is often made in companies with an investment grade AA, B or lower (in finance terms, AA or B would be comparable to a mid-to-high 600 to low 700 credit score). Let us not forget the mortgage backed securities from the big lenders. Banks and investment companies loved buying these loans, cashing in the high interest, and sharing the rewards with holders of annuities and money market accounts. In other words, some of these investments made by banks and investment companies would yield 11-13%, give investors of annuities and money market accounts 5-7%, and pocket the difference.

So, how do I know this? You might be wondering, so I'll tell you. Before 9/11, I worked for an investment/insurance company managing the operations staff responsible for pricing securities. Our department worked closely with the traders, so I learned all the trade secrets of the big investment companies currently seeking bailout.

With the exception of the moderate investment grade corporate bonds and the US T-notes, the investments made by these banks were poorly made, but the people who could afford to buy annuities and money market securities enjoyed the high interest rate while it lasted. Now they're trying to sell off their annuities and money market accounts for fear that they will lose their shirts... and the Fed wants to buy these investments and repackage them as something else.

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