It isn't just the mortgage market

And in your dreams, you can see yourself, as a prophet. Saving the world, the words from your lips: "I AM NOT A CROOK."  I just can't believe you are such a fool.

These are the words from a song by Frank Zappa, "Son of Orange County," an apt backdrop for the news coming out of this sunny Southern California territory. Reportedly, the Orange County government invested in structured investment vehicles (SIVs) exposing them to some unplanned losses.  

Orange County

Orange County isn't the only investor to come up short in this latest rendition of the same old story. Investment pools in Florida, Connecticut and Montana are faced with similar situations. This is especially ironic for Orange County, having gone through bankruptcy in the early 90s for the very same reason.
After you wade through it all, the problem is very simple: SIVs are nothing more than borrowing short and investing long. This was fine so long as you could roll over your short term borrowing to refund your debt, but when the short term funding dried up they got caught in a liquidity vice.
The media has been reporting this credit crunch as the "sub-prime" mortgage meltdown. This is really a misnomer. Yes, sub-prime mortgage defaults are a contributing cause but they are not the primary driver. The main driver of this credit crunch is financial alchemy gone bad. SIVs were a banker's concoction. In pursuit of off balance sheet fee income, the banks created SIVs.
SIVs are pooled illiquid long term investments like home mortgages, credit card receivables, and collateralized debt obligations, packaged up with bond insurance and then getting rating agencies to hang investment grades on them. Presto-chango, they turn sub-investment grade paper into AAA securities that could now be sold to money funds and other investors restricted to AAA investments. 
Money funds like Orange County can only invest in safe low risk investments.
The investments are intended to be cash equivalents. Fortunately, they are required to invest no more then 10% of their money in any single investment so the problem is manageable.  

In their dreams investment bankers see themselves as prophets, saving the world- for a fee. I can believe they are such fools. It looks so easy, borrowing money overnight at 4% and re-lending it for 30 years at 7%, pocketing a 3% spread along the way for pushing paper. Well, if it were this easy, everyone would be a millionaire. At the end of the day, the bond insurance and the AAA ratings were just garnishments on the same old spam.