Aug. 21 (Bloomberg) -- Ottimo Funding LLC, whose name is Italian for ``excellent,'' has the highest possible credit rating and doesn't own subprime mortgage bonds. That made no difference to investors who refused to buy Ottimo's $3 billion of short-term debt this month as losses on home loans to risky borrowers infect the global credit markets.

``It's pretty much a straight contagion,'' said George Marshman, chief investment officer of Stamford, Connecticut-based Aladdin Capital Management, which oversees about $20 billion, including Ottimo. ``We think the assets are good enough'' to attract investors, he said.

The $1.1 trillion market for commercial paper used to buy assets from mortgages to car loans has seized up just as more than half of that amount comes due in the next 90 days, according to the Federal Reserve. Unless they find new buyers, hundreds of hedge funds and home-loan companies will be forced to sell $75 billion of debt, according to Zurich-based UBS AG, Europe's largest bank.

Those sales would drive down prices in a market where investors have already lost $44 billion, based on Merrill Lynch & Co.'s broadest index of floating-rate securities backed by home- equity loans. That may hurt the 38.4 million individual and institutional investors in money market funds, the biggest owners of commercial paper.

`Uglier and Uglier'

``We're dumping all this collateral into the market and it becomes a death spiral for the assets,'' said Brian McManus, head of collateralized debt obligation research at Charlotte, North Carolina-based Wachovia Corp., the fourth-biggest U.S. bank by assets. CDOs contain pools of mortgage securities that have been repackaged and sliced into pieces.

Instead of commercial paper -- corporate debt that comes due in nine months or less -- money fund managers are running for the safety of government securities. Yields on three-month Treasury bills plummeted to 2.9 percent from 4.95 percent at the start of the month, even though central banks injected more than $200 billion into the financial system and the Federal Reserve cut the rate it charges banks for loans on Aug. 17.

The credit crunch, sparked by the highest level of defaults on subprime mortgages in a decade, is ``getting uglier and uglier,'' said Christopher Low, chief economist in New York for FTN Financial, the capital markets unit of Memphis, Tennessee- based First Horizon National Corp. ``This has moved beyond temporary. It's gotten beyond bailing out some hedge fund and into the broad economy.''

Refusing to Buy

Asset-backed commercial paper constitutes about half the total commercial paper market and has risen from $650 billion in 2003, according New York-based Lehman Brothers Holdings Inc.

Investors are refusing to buy short-term debt backed by any mortgage that isn't guaranteed by government-chartered companies such as Fannie Mae and Freddie Mac, Aladdin's Marshman said.

More than 20 companies including San Francisco-based Luminent Mortgage Capital Inc. and Thornburg Mortgage Co. in Santa Fe, New Mexico have been unable to roll over asset-backed commercial paper. Thornburg said yesterday that it sold $20.5 billion of securities at about 95 cents on the dollar to pay down commercial paper it couldn't refinance.

The amount of asset-backed commercial paper outstanding fell $50 billion in the week ended Aug. 15, or 4.3 percent, according to data compiled by the Fed.

No Help

Ottimo's bonds are backed by mortgages to people with credit scores of 708 and higher, compared with scores for subprime loans that average less than 620. The company's commercial paper has an A1+ rating from Standard & Poor's and P1 from Moody's Investors Service, the highest available.

Aladdin wasn't forced to immediately shutter Ottimo because the company exercised an option to extend the maturities on its commercial paper, providing 30 to 45 more days to find buyers.

No issuer had extended maturities in the 12-year history of the asset-backed market until Ottimo, Luminent and a unit of Melville, New York-based American Home Mortgage Investment Corp. did so within the past two weeks, according to S&P and Moody's. More than $100 billion of extendible commercial paper is outstanding.

``The unwind will not be denied,'' said Marshman. ``Whether it takes place overnight or over the course of several months, these assets have to be placed in different hands.''

A spokesman for Luminent, Robert Siegfried of New York-based Kekst & Co., declined to comment. Calls to American Home weren't returned.

Until this month, investors were willing to buy extendible commercial paper because it offered higher interest rates than standard asset-backed commercial paper.

`Financial Panic'

The short-term securities yielded 5.75 percent to 5.95 percent on average on Aug. 8, compared with 5.45 percent for asset-backed commercial paper that isn't extendible and 5.25 percent to 5.30 percent for corporate commercial paper, according to Lee Epstein, chief executive officer of Money Market One, a San Francisco-based broker-dealer of short-term securities.

Now, asset-backed commercial paper with a maturity of 30 days or less yields 6 percent on average, and corporate borrowers pay about 5.2 percent. Investors aren't buying extendible commercial paper.

Wall Street is in a ``financial panic'' and won't fund any mortgage bonds, even AAA rated bonds backed by prime home loans, said Garrett Thornburg, chief executive officer of Thornburg, which makes loans of more than $417,000 to people with good credit. The mortgages are known as jumbo loans because they exceed the limit on what Freddie Mac and Fannie Mae can purchase.

`Only Response'

Even the Fed's decision to cut the discount rate that it charges banks failed to revive demand. The rate for overnight borrowing in the asset-backed commercial paper market soared 0.39 percentage points to that price on Aug. 17, the biggest rise since the Sept. 11 terrorist attacks. Overnight yields fell 2 basis points to 6.01 percent today, while 30-day paper widened 9 basis points to 6.09 percent. A basis point is 0.01 percentage point.

``There's still a huge problem in the credit markets,'' Thornburg said in an interview. The market ``is unwinding because no one wants to own A1/P1 asset-backed commercial paper.''

Thornburg is using lines of credit for financing even though only 58 of its 38,000 mortgages are 60 days or more in arrears.

``That's just crazy,'' he said. ``If it's backed by subprime, all right. If it's backed by junk, get out. But if it's backed by high-quality receivables from Macy's or triple As from us, that market should be functioning and that market has stopped functioning.''

To contact the reporter on this story: Mark Pittman in New York at mpittman@bloomberg.net.

Last Updated: August 21, 2007 10:25 EDT