Sub-prime woes may hit bond funds

Could the housing market’s woes spread to bonds held in mutual funds by millions of ordinary investors?

Some experts -- and hedge fund investors who have made big bets that the mortgage crisis will worsen -- are saying that’s exactly what will happen. Some bond funds that invest in riskier short-term debt already have been whacked by soaring default rates on bonds backed by sub-prime loans made to borrowers with weak credit.

Critics charge Standard & Poor’s, Moody’s Investors Service and Fitch Ratings with routinely giving triple-A ratings -- the safest rating -- to far too many bonds backed by sub-prime home loans.

“The rating agencies just completely missed the boat in their methodology for rating these things,” said Janet Tavakoli, president of Tavakoli Structured Finance, a Chicago consulting firm.

About 80% of debt in bonds backed by sub-prime loans is rated triple-A, the same rating on virtually risk-free U.S. Treasury bonds, experts said.

If that seems shocking, there are bonds backed by delinquent credit card accounts -- one of the riskiest forms of debt -- in which as much as 40% of the accounts in the security are rated triple-A, Drexel University finance professor Joseph Mason said.

The Securities and Exchange Commission said Friday that it had launched a review of what the three companies’ ratings meant and whether conflicts of interest were created if they gave advice to sellers of mortgage debt. Credit rating companies say their role is to rate the creditworthiness of securities, not advise buyers or sellers of bonds.

Congress also has pledged to hold hearings on the role the rating firms played in the sub-prime mortgage mess.