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State Street props up stable value funds - another crack in the foundation?

There is good news and bad news. The good news is that State Street (STT) decided to provide support to their stable value funds in the face of potential losses. The bad news is that they had to.

Here is what they said in their 8-K and referred to in their recent conference call:
"In some very limited circumstances, and consistent with applicable regulatory requirements, we may compensate investment pools for all or a portion of the pool’s losses even though we are not statutorily or contractually obligated to do so. For example, during the fourth quarter of 2008, we elected to provide support to stable value accounts managed by SSgA."
They go on to provide a little detail:
"...we elected to purchase approximately $2.5 billion of securities from these accounts that had been identified as presenting increased risk in the current market environment and to contribute an aggregate of $450 million to the accounts to improve the ratio of the market value of the accounts’ portfolio holdings to the book value of the accounts. This resulted in a fourth quarter net charge of $450 million. In addition, in January 2008, we contributed $160 million to the accounts."
So that would be a total of $610 million that State Street pumped into their stable value funds.

Stable value funds generally invest in conservative instruments and guarantee principal as well as a modest rate of return. In the event the underlying investments decline in value such that it would reduce the value of the fund below the guaranteed amount, the shortfall is generally covered by insurance contracts ("wrappers") held by various third parties. Some of the investments held by the State Street funds must have had a toxic odor to them as some of the insurers opted to (legally) bail on their obligations. To quote the 8-K again:
"These financial institutions have the right, under certain circumstances, to terminate this guarantee with respect to future investments in the account. During 2008, the liquidity and pricing issues in the fixed-income markets adversely impacted the market value of the securities in these accounts to the point that the third-party guarantors considered terminating their financial guarantees with the accounts."
That's right, the guarantors can demand that the fund hold higher quality investments or they will decline to continue insurance. I sincerely hope this serves to restrain stable value fund managers and discourage them from reaching for yield at the expense of taking on too much risk.

I applaud State Street for making their stable value fund investors whole. Another firm may not be so generous and concerned with maintaining their reputation.

Has anyone run into problems with their stable value fund yet? Let us know in the comments.

Disclosure: none

Other posts by TradeRadar on stable value funds and 401k plans:
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