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AIG Toxic Debt Coming to a Money Fund Near You: Street Whispers

NEW YORK (TheStreet) -- Before congratulating the New York Federal Reserve on turning a profit on the bailout of insurer American International Group (AIG) and unloading billions of subprime debt back onto Wall Street bankers, think again.

You are likely going to own that once toxic paper in your sleepy money market fund in the near future.

New data from Fitch Ratings signals that the subprime securities removed from AIG's balance sheet via Maiden Lane II and Maiden Lane III as part of the 2008 bailout are being prepared by money managers for a return to the financial system, with big risks that touch main street investors and savers.

Both the U.S. government and AIG have been crowing over the success of Maiden Lane as part of the insurers' financial redemption, arguing the assets unloaded by AIG during the financial crisis and hoisted onto the New York Fed's balance sheet are a major triumph.

AIG will likely pitch the recent repayment of the Fed's bailout loans to investors as a success in its second quarter earnings due after the market close on Thursday. The Fed is also keen to note that it has already a realized net gain of nearly $4.5 billion on the sale of Maiden Lane loans to some of the biggest Wall Street banks like Goldman Sachs (GS), Credit Suisse (CS), Barclays (BCS), Citigroup (C), Bank of America Merrill Lynch (BAC) and Royal Bank of Scotland (RBS).

But banks didn't hold onto those assets, which are made up of subprime residential mortgage backed securities [RMBS] and collateralized debt obligations [CDO's]. Instead, they broke them up, stripped them down and quickly sold them off.

And in the ever present ironic Wall Street circle of life, those assets are now moving into prime money market funds, who are accepting them as collateral for short term loans as they begin to add riskier and higher yielding securities to portfolios, according to Fitch Ratings.

Prime money market funds are a seemingly safe way for savers and corporations to lend out money for short periods, earnings a higher yield than near zero interest rate savings accounts. The funds subsequently use those loans to hold high rated debt like government, agency and corporate bonds, equities and - at times -- securities like RMBS and CDOs through repurchase agreements, earning a yield that is returned to individuals and corporations with their principal when repo agreements expire.

During the crisis, structured finance securities like RMBS and CDOs fell out of favor for prime money market funds and comprised 0% of their overall repurchase holdings. Now they're back, consequently so too are the constituent assets of Maiden Lane.

A coincidence? Likely not.

After vanishing from money market holdings in the first half of 2009, Fitch Ratings calculates that structured securities now comprise 18% of total holdings - matching 2006 levels and eclipsing the 11% that funds held in the first half of 2008. In the second half of 2008, money markets and repo markets froze with the failure of Lehman Brothers, in large part because of the opacity of the underlying assets within RMBS and CDO securities - and because of the counterparty risks that come with taking repo collateral from investment banks.

It's the reason some might want to sound an alarm bell on AIG and the Fed's Maiden Lane exit.

Stock quotes in this article: AIG, GS, BAC, CS, BCS 

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