The head of the Senate Banking Committee has indicated that the U.S. Federal Reserve has the authority to create a new 'debt fund' to buy, warehouse and dispose of distressed / bad debt resulting from the subprime mortgage crisis.

"The Fed has the authority to move in this area," U.S. Sen. Chris Dodd, D-Connecticut and chairman of the committee, told Bloomberg News.

Many economists and analysts argue that a step integral to stemming the cycle of foreclosure / housing price decline / bad bonds / stock run / collateral call / bankruptcy is for a special agency to buy up and strategically restructure, then sell, distressed / bad assets. Economist Peter Dawson is one of those economists who favors the tool.

"Ideally, you'd like to have a private-sector consortium of banks or other financial institutions to coordinate the effort, but right now there aren't exactly a lot of banks stepping up to the plate to take a swing," Dawson told BloggingStocks Thursday. "There's a considerable amount of fear in the market, frankly, and banks are hoarding cash. If this remains the case then we'll need a public sector effort to put this new institution in place."

How vulnerable is your mutual fund to the ongoing mortgage meltdown? In this series, BloggingStocks contributor Lita Epstein, author of more than 20 books including Trading for Dummies and The Complete Idiot's Guide to Improving Your Credit Score, digs into mutual funds' holdings looking for securities with exposure to the currently shaky credit markets.

The first inkling I got that Fidelity might be tied to the SIV bailout was a story last week in The Wall Street Journal that indicated Fidelity's Prime Money Market Portfolio owned $402 million medium-term notes in Gordian's Sigma Finance Inc. as of the end of August [subscription required]. Taking a closer look at Fidelity Funds, I found two broad market bond funds with significant exposure to the mortgage-backed and asset-backed credit categories now showing signs of trouble.

As of 9/30/2007 Fidelity Ultra Short Bond Fund holds 42.4% of its assets in asset-backed securities, 17.5% in collateralized mortgage obligations and 15.2% in commercial mortgage-backed securities. That's 75.1% of its assets in securities tied to the credit markets that are now showing signs of trouble. While I'm not saying that 75% of this fund's assets are in trouble, what I am asking is, do you really want that much exposure to these markets in this volatile time?

As of 9/30/2007 Fidelity Short-Term Bond Fund holds 23.1% of its assets in asset-backed securities, 13.5% in collateralized mortgage obligations, and 11.6% in commercial mortgage-backed securities. That's almost half of its assets in the most volatile parts of the credit markets. If you do hold these funds, you need to decide if you want this level of exposure to these risky credit markets right now.

In reviewing bond funds this morning, these two Fidelity bond funds were less-diversified than many of its peers. While their yields may be high, you must decide whether the risk is worth it.

Lita Epstein is the author of more than 20 books including the "Pocket Idiot's Guide to Investing in Mutual Funds."