Fannie and Freddie aren't threats to money funds

Edward in Brockton, Mass., got scared enough by the news headlines recently that he did the unthinkable. He read the paperwork for his money-market mutual fund.

What he found there made him more nervous, because the fund included a lot of paper from Freddie Mac and Fannie Mae.

By the time he asked me about dumping the fund, the U.S. Treasury's plan to boost confidence in the two mortgage giants was out and some of the worry was mitigated. But Edward still couldn't shake the feeling that maybe he ought to do something to keep his most conservative holdings completely safe.

While the Fannie Mae (FNM) and Freddie Mac (FRE) situation threatened the credit market, it's not actually a big worry for investors in money-market funds.

Money-market funds are ultrasafe investments, buying interest-bearing securities that mature within a year. The spectrum of investments runs from certificates of deposit to Treasury securities, from insured notes to asset-backed commercial paper such as the Fannie and Freddie paper.

With the government supporting the two agencies, traditionally they have been part of the upper echelon of money-market securities.

That perception is changing, due to the recent headlines. Since the subprime crisis took hold, money funds have been more talkative about what they do; several big firms have sent notes to shareholders about the Fannie and Freddie concerns — which most experts think have been resolved for a minimum of six months, thanks to Treasury support — because they don't want guys like Edward to bail out.

Consumers are not being completely irrational with their fears because of the way money-market mutual funds work. Unlike ordinary mutual funds, money-market funds maintain a constant price of $1. Each day, a fund's holdings are "marked to market," meaning the current market value of its holdings is checked.

If a fund has a big holding in an issue that goes kaflooey, the share price might "break the buck" and fall below $1. This dire money-losing scenario has never happened to a big retail fund, but that's no guarantee and, unlike money-market bank deposits, there's also no federal deposit insurance.

Connie Bugbee, managing editor at iMoneyNet, which tracks money-fund performance, says that panicky investors can go to funds that invest completely in Treasury securities, but that they will pay a price for that fear.

The average government-agency retail money fund — including Fannie/Freddie paper — was recently yielding 1.53 percent, compared with 1.08 percent for the average Treasury-only fund.

"You have to decide if it's Fannie and Freddie that are going to cost you, or your nerves," Bugbee says. "And in money-market funds right now, it's more likely to be your nerves."

Chuck Jaffe is senior columnist at MarketWatch. He can be reached at cjaffe@marketwatch.com or Box 70, Cohasset, MA 02025-0070.