Politicians and bankers aren't the only ones worried about the strength of the thrift insurance fund. Investors are also getting nervous.
The yield on Financing Corp. bonds has edged up to about 40 basis points over comparable Treasury securities, from about 30 basis points 18 months ago. That indicates that investors are demanding greater compensation for the risk of holding the instruments.
"It looks like the bonds are getting dinged a little because people are aware of the problem," said Mark Wright, a fixed-income analyst at Morningstar Inc., a Chicago firm that tracks mutual funds.
The fear is that the Fico bonds could default if the thrift deposit insurance fund shrinks so far that its premium income can no longer pay the $800 million annual interest owed on them. The instruments, floated in the late 1980s in the first phase of the thrift-industry bailout, are not fully backed by the government.
With about $8 billion of the bonds outstanding, investors are clearly watching closely as Congress, regulators, and banks wrangle over capitalizing the Savings Association Insurance Fund.
"I'm a little bit skeptical they'll get anything done," said David Capurro, a portfolio manager at Franklin Templeton Group, a San Mateo, Calif.-based mutual fund giant that has invested about $150 million in Fico bonds.
But Mr. Capurro added: "I think ultimately there will be some" legislative solution.
Merrill Lynch & Co. has told its customers that it does not expect a default. But the brokerage company is monitoring the situation closely, said Merrill economist William Kan.
Small investors are also jittery. Whenever a news story outlines the threat to Fico bonds, Financing Corp., a tiny agency that isn't even listed in the phone book, gets lots of calls from retirees and small brokers.
Though rising yield may be the most telling sign of investor unease, Mr. Capurro played down its importance. The spread over Treasuries would be much greater if the market were really alarmed, he said.
When investors were worried about the solvency of the Farm Credit Administration, he noted, its paper was trading at 200 basis points above the rate on comparable Treasuries, or about four times the spread for other government agency paper.
Who holds the Fico bonds? No one is quite sure. Early in their lives, about 80% of the bonds were stripped - sold in pieces offering either principal payments or interest payments. The instruments have since traded briskly in the secondary market.
Financing Corp. assumes that the current holders include pension funds and mutual funds, but it has scant information. The Federal Reserve Bank of New York has the names of the holders of record but doesn't release this information.
Some experts speculate that foreign investors hold a big chunk of the bonds.
"The biggest holders are the Japanese," said Lance Brofman, chief portfolio strategist for Fundamental Investors, a no-load mutual fund based in New York City. Fundamental has about 10% of the assets of its U.S. Government Strategic Income Fund invested in Fico bonds.
When the bonds were sold in the late 1980s, many Japanese banks bought them and stripped them, he said. Buying stripped bonds offered Japanese investors a tax advantage at the time.
The bonds do not have the full faith and credit of the Treasury behind them. But repayment of principal is assured by a zero-coupon Treasury bond.
And when the bonds were issued, M. Danny Wall, then head of the Federal Home Loan Bank Board, came close to promising full government support for them.
Wall Street sold them with zest. Goldman, Sachs & Co. and Merrill Lynch both concluded that the bonds were virtually riskless. "I'd feel safe placing my life savings in these bonds," a First Boston Corp. official said at the time.
Wall Street continues to believe in the bonds, if not quite so fervently. The thinking is that the government would not allow a default because the fallout would be too damaging.
For one thing, a Fico default could trigger a loss of confidence in other bonds that lack the government's full faith and credit, such as instruments issued by the Federal National Mortgage Association and Federal Home Loan Mortgage Corp.
If the Japanese don't get their Fico interest payments, they could start "dumping all their" U.S. government bonds, Mr. Brofman said. And the cost to the Treasury in higher interest rates would exceed the annual Fico interest bill, he said.
"A Fico default is inconceivable," he said.
