Wealth International, Limited (trustprofessionals.com) : Where There’s W.I.L., There’s A Way

W.I.L. Finance Digest :: June 2009, Part 2

This Week’s Entries :


Barron’s annual survey of the Top 100 Women Financial Advisors reveals a wide range of opinions on the outlook for the U.S. stocks. One thing they have in common: A talent for weighing opportunity versus risks.

Barron’s performs an annual ranking of top women financial advisers. In this article they got responses from numbers 5, 6, 14, 23 and 25 to the question which one might roughly equate to “So, what do you think of the market?” Responses vis a vis the U.S. stock market ranged from “no thanks” to, in so many words, “this seems like too strong rally to be a fakeout.”

“It is about humility, being aware of everything that can go wrong, and knowing that it is impossible to outsmart the market,” was one sensible answer. The same woman continued, “Some people are champing at the bit to get back in, but this gives us a way to talk about all our core beliefs. Our job is not to make home runs for our clients. That is like going to Vegas with their money.”

In our view the job of a financial advisor is to assess the risks of the available investment opportunity set and balance them against the clients’ marginal utility of money. This is not an easy job, but that is why they usually get paid well. Too many people discovered too late after last year’s crash that not only were they engaged in a riskier strategy than they had imagined, but that there was an unappreciated asymmetry between gains and losses: While an extra couple thousand would have been nice, the lost tens of thousands was crushing. Retirement plans got delayed. They had risked cake for a shot at some icing. This is a bad bet unless the odds are stacked in your favor to an extraordinary degree.

When financial advisors get together with their clients these days, the No. 1 conversation – at times the only conversation – is what to make of the stock-market rally. The Dow, after all, is up 36% from its March lows.

In view of the epic financial crisis and crushing recession, some are deeply skeptical of the run-up. Dawn Bennett, who runs her own advisory firm in Washington, firmly believes it is nothing but an ephemeral bear-market rally. She has pared clients’ U.S. stock exposure to exactly zero. “Until they clean up this mess, we are not going to be investing in the United States,” says Bennett, who is one of the top 100 women financial advisors in Barron’s latest ranking. [See table: Top 100 Women Advisors]

There is hardly unanimity among the top 100 on the outlook for U.S. stocks. Lorna Meyer of Merrill Lynch says she is much more hopeful now than she was at the beginning of the year. “We can see a day when the Chinese consumer will help pull us out of our recession,” Meyer says.

She adds: “This seems like a stronger rally than we would see if it was a dead-cat bounce or a short-covering rally.”

But Meyer and other upbeat advisors have their work cut out for them in convincing clients to step up to the plate. For the past two years, every rally has been a deceptive signal, one investors learned to view with fear and suspicion.

“Changing that mindset is going to take time,” says Jeanette Garretty, who advises wealthy clients in Silicon Valley from her office in Palo Alto, California. A former economist, she says many models tell her that an economic recovery is in the cards for later in the year, and that the market rally probably is reflecting that optimism.

“The bigger issue,” Garretty muses, “is what a recovery is going to look like in the environment in which we find ourselves today.” There is enough uncertainty about what lies ahead for the economy and markets during the next two years that Garretty, at least, is not going to let herself or her clients be swept away on a tide of optimism.

Indeed, for many women on this year’s Winner’s Circle list, the strategies that have kept their clients loyal are the ones they plan to cling to for the rest of 2009.

“It is about humility, being aware of everything that can go wrong, and knowing that it is impossible to outsmart the market,” says Garretty.

Rather than use the ongoing rally as a reason to jump back into the market to recoup some of last year’s losses, these advisors are using the rally as a way to get their clients to think hard about the kind of returns they really need and the kind of risk they can tolerate.

“Some people are champing at the bit to get back in, but this gives us a way to talk about all our core beliefs,” says Vanessa Anderson, who also works with Silicon Valley millionaires as an advisor for UBS. “Our job is not to make home runs for our clients. That is like going to Vegas with their money.”

The ranking, which Barron’s publishes annually, reflects the volume of assets overseen by the advisors and their teams, revenue generated for the firms and the quality of the advisors’ practices. This year’s list includes a reshuffling of the top five, including a new No. 1 – Rebecca Rothstein of Smith Barney – and two new members: Karen McDonald of Smith Barney at No. 4., and Bennett at No. 5.

The top 100 come from a mix of major securities firms and independent operations. This year Barron’s is excluding private bankers from this list, because their business is significantly different. Private bankers will appear on their own list in the fall.

The following five profiles show just what it takes to reach the upper echelons of the financial-advisory business, and how some of the industry leaders are viewing today’s market.

Vanessa Anderson
Private Wealth
Palo Alto, California
Assets: $2 billion
Rank: 23

The last year may have been a nightmare for financial markets. For Anderson, however, it has also generated a flood of new clients, as they have flocked to the advisory business she and teammate Jean Gannon have built up over the last decade.

“We have talked to a lot more people in the last six months than ever before in any six-month period,” says Anderson. “Some have lost money working with other firms. Some are turning to professionals to get a comprehensive overview of where to go from here.”

Many of these new clients, she says, have become cynical about Wall Street and the financial markets in general,and are demanding more information before acting on any recommendations. “A big part of our job is providing our clients with transparency and understanding,” says Anderson, who works mostly with individuals or families with $10 million or more in assets.

Another task: limiting exposure to problems at other firms. As Wall Street struggled with counterparty credit risk in the wake of the troubles at AIG and the collapse of Bear Stearns and Lehman Brothers, Anderson has examined her counterparty relationships to identify potential risks. Says she: “The degree to which everyone is linked to everyone else at all levels of the financial system, not just at the top, is something that we are really just beginning to understand.”

Dawn Bennett
Bennett Group
Washington, D.C.
Assets: $1.1 billion
Rank: 5

Growing up in Asia and learning to speak Mandarin Chinese helped Bennett develop a truly global perspective. Her interest in international investing, and her willingness to consider expanding asset allocation for her clients to include everything from gold to zero-coupon bonds, has helped her post returns that are significantly higher than the market. At the same time, Bennett insists this approach is lower-risk than that of many of her peers. “I am competitive, but I am not going to chase the greed,” she says. “You have to keep a keen eye on where the smartest money is going.”

These days, that means looking well beyond the U.S. “We are transitioning to a new economic era, and the international liquidity is not necessarily going to be automatically in the U.S. markets any more.” That means Bennett’s clients will not be as heavily invested here, either. Indeed, she shifted a significant percentage of her clients’ assets into the emerging-markets arena in the final weeks of 2007 and the first weeks of 2008; to this day, a typical portfolio has a 50% emerging-markets allocation, she says.

They also have a heavy exposure to gold and other natural resources, which she began boosting when U.S. stocks were close to their highs in 2006 and early 2007. “These are long-term trends,” Bennett explains. “These decisions will get my clients across the finish line in first place years from now.”

Jeanette Garretty
Wells Fargo Bank
Palo Alto, California
Assets: $840 million
Rank: 14

Garretty’s training as an economist has paid off nicely. Each economic data point that she studies, she says, helps her get a clearer understanding of both the opportunities and the risks that lie ahead as the U.S. struggles to leave the financial crisis behind.

“There are a lot of people saying that today everything is different, that buy-and-hold strategies do not work. But I am reluctant to just toss out historical precedents without good reason,” she says.

That does not mean the 55-year-old investment advisor, who has been working with Silicon Valley entrepreneurs and financiers for a decade, is without worries. On the contrary, she is increasingly concerned that the current wave of government spending may fuel inflationary pressures as the economy begins to recover.

“A lot of changes are likely to follow all this chaos, many of which we cannot anticipate,” Garretty says. “We need to prepare for uncertainty.”

In that kind of environment, she adds, most opportunities are strategic in nature.

“This is a breathing space; a chance for me to talk with my clients about what their goals are over the short, medium and long range and how to go about achieving those,” she says. “We can start thinking about some of the tradeoffs that may confront them in a high-inflation environment, for instance, or the best way to increase our exposure to emerging markets.”

The world has changed since investors last had to deal with an environment in which inflation was their biggest concern. As a result, she says, “I think having an economist’s analytical mindset is going to be a big asset as we see what comes next.”

Trudy Haussmann
Haussmann Financial
Newport Beach, California
Assets: $416 million
Rank: 25

Haussmann is only 44 years old, but next year she will celebrate her 25th anniversary in the business. “I kind of fell into it,” she recalls. A UCLA dorm neighbor told her about a part-time job at a financial planner’s office, and she quickly proved she could do it. She began working as a paraplanner even before she graduated; by the time she finished her studies, Haussmann was ready to abandon her dream of working in international trade.

Now running her own firm, she still thrives on the challenge of helping investors set goals and manage risks. These days, that involves helping her clients – many of them affluent corporate employees who stick with Haussmann after they retire – understand that “while things are dreadful today, they cannot stay out of the market forever, that it is not going to stay that way.”

To be sure that her clients will have the patience to ride out the storm, she took the proceeds from sales of some bond-fund holdings and is keeping them in cash.

“If my clients have two years’ worth of cash needs, then there will not be any pressure to sell any of their other holdings at the lows and that will give them a chance to recover,” she says.

Lorna Meyer
Merrill Lynch
San Francisco
Assets: $1.6 billion
Rank: 6

The stock market may be showing signs of life, but veteran investment advisor Meyer is not quite ready to become a believer.

“I would rather continue to sleep well at night, and move only slowly back into U.S. stocks,” she says.

Meyer, 64, is one of the first women to build a long-term career within the world of Wall Street investment-brokerage firms. She joined E.F. Hutton’s training program in 1976 and has since helped her clients navigate everything from hyperinflation and the 1987 stock-market crash to the dot-com boom and bust while working for firms such as Drexel Burnham, Hambrecht & Quist and Alex Brown.

At Merrill since 2001, Meyer finds herself steering her clients through yet another crisis. “The real way to add value in times like this is not by coming to them with some new idea for making some more money, but just by being in touch with them more frequently to tell them you are watching what is happening and watching their portfolio,” she says.

With the crisis receding somewhat, Meyer is thinking hard about where to invest next. The answer, increasingly, is the bond market. Investment-grade bonds have been a linchpin of client portfolios for most of the last year, while high-yield bonds are emerging as an attractive alternative to stocks, she argues.

“This year, I am starting to put some money back into commodities and emerging markets,” she adds. “That is where we feel the growth story will be most appealing, so that is where we want our clients to be.”


Jobs report: no cause for celebration. Housing faces another big wave of foreclosures.

Alan Abelson tries hard (not really) to find signs of a recovery in the May jobs report and comes up empty. Signs that the Obama stimulus program is working are entirely absent. If one adjusts the official unemployment rate for the “discouraged worker effect” and for part-timers who would work full-time but cannot find enough work, one gets a real unemployment rate of over 16%. Very high indeed.

Abelson follows that up with a look at the latest report from housing market analysts T2 Partners. Their conclusion is that any apparent upturn in the housing market is temporary and that there is at least another 5-10% worth of price declines to go, with a real risk of more. T2 characterizes the losses as coming in 5 waves. In the first two waves the losses derived from outright fraud, feckless speculation, and “mortgage payment shock” from resets when teaser rate periods ended – i.e., the unwinding of the most egregious of bubble excesses. But, says T2, there are major losses still ahead for the last three waves, whose sources include prime loans; jumbo primes, second liens and home-equity lines of credit; and non-housing property loans, including commercial.

Even if one’s outlook is less dire there is clearly a lot of asset shuffling and liability assigning ahead. Ideal would be for the government to grease the skids of the adjustment process by doing whatever it can to make workouts and negotiations between loan holders, debtors and would-be loan buyers as quick and cheap as possible. This would concomitantly minimize losses to the taxpayers. (Not that we expect the federal government to care about such things. ... We’re just saying.) We are not holding our breath. Expect the workout to be protracted.

Last week, Mr. Obama voyaged to Egypt and delivered a truly remarkable speech. It was not so much the nicely crafted rhetoric or deftly glossed content that stirred our admiration. Rather, it was that he could speak for nearly an hour and verbally cover the globe, with its profusion of combustible hot spots threatening conflagrations that might consume continents, without once uttering the word “terrorist.”

Guess from now on, we will have to call those guys in Iraq and Pakistan who get up the in morning, brush their teeth and proceed to blow up themselves and everyone else who happens to be within spitting distance “misguided pyrotechnists” and the 9/11 bunch “malign tourists.”

While Mr. Obama’s trip to the land of the Pyramids got most of the play (for some reason, he neglected to take Joe Biden along and introduce him to the Sphinx to show him what a model vice president is like), the week was also newsworthy as providing still another example of a CE0 failing to follow the iron rule to never send an e-mail and never destroy one.

The culprit in this case is Angelo Mozilo, the man who founded and ran the infamous Countrywide Financial, which made a real contribution to the decline and fall of housing, the deep freeze of the credit market and all the calamitous things that issued from them. After the roof fell in, he walked away with $130 million, the fruits of opportune stock sales. That is not a record for being compensated for making a mess, but it still represents a decent payday.

Mr. Mozilo made the mistake of properly referring in e-mails to the loans his company was making as “toxic.” And the SEC awoke long enough from its slumbers to charge him with fraud.

Mr. Obama, as it turns out, could not have picked a better week to be abroad, since his absence coincided with release of the May jobs report. It showed a leap in the unemployment rate to 9.4% from 8.9%, the highest in a quarter of a century. Apparently, that stimulus program unveiled with so much hoopla is not doing much in the way of stimulating employment.

While payrolls slid by 345,000, much below the consensus guess, it was the usual hokey number, getting a lift from the wonderful birth/death model, which somehow summoned up 220,000 jobs and did so, magically, out of thin air.

The realisticly calculated unemployment rate is 16.4%.

The harsh truth is that, using the regular payroll data, a rather formidable 14.5 million people are out of work. Moreover, if we look at the category we feel gives a more accurate picture – the so-called U-6 tally – which includes people too discouraged to keep looking for a job and those working part-time because they cannot find full-time slots, the unemployment rate shot up to a new high of 16.4%. That means that something around 25 million folks are effectively on the dole. Ugh!

Call us ornery (it will probably shock you to learn we have been called worse). Or, if you are in a forgiving mood, call us grumpy, mulish, obstinate. But, with a willful tenacity that we fear approaches obsession, we find ourselves clinging to the notion – in the face of the mounting insistence in Wall Street, Washington and other seamy precincts that less bad is the equivalent of good – that the impaired economy is still a long way from anything worthy of being called a recovery. And what is more, it will stay in that sorry state until housing, whose collapse triggered the chain reaction that threatened to all but demolish the economy, pulls itself up from the depths.

Ah, we can hear the fluttering flocks of cheerful chirpers scolding us for not opening our eyes and catching the luminous signs of a turn in housing’s fortunes. Well, our eyes are wide open, and what we see is something quite different: the mother of all head fakes.

Our dour perception coincides with that of Whitney Tilson and Glenn Tongue of T2 Partners, from whose latest tome – on housing, mortgages, meltdown and all that – we have filched that superlative. And we could not be in better company. For, as perhaps you recall, we have used this space to quote extensively from their earlier warnings, which proved right on target.

Their latest effort runs a mere 75 pages and is adorned with an array of attractive graphics that help make its reading not only informative but relatively pleasurable. In it, they argue persuasively that recent indications of stabilization in housing are the product of some short-term and seasonal factors, and emphatically not, as the wild bulls have been snorting, a true bottom.

In particular, the lifting of a temporary moratorium on foreclosures has prompted Fannie Mae and Freddie Mac and the other usual suspect lenders to move quickly to save homeowners who can be saved – but foreclose on those who cannot. Tilson and Tongue see this as necessary if we are ever going to lay to rest what the bubble and its dreary aftermath have wrought. But it also seems destined to produce exactly what we need least – a surge in housing inventory later this year. And, alas, that in turn means further pressure on prices.

As any poor soul who has been trying to peddle his abode can mournfully attest, prices are plenty weak already, having declined for 33 months in a row. They are down some 40% from their peak, the T2 pair reckons, and have at least 5%-10% more to go, with a real risk of falling even further than that, owing to homeowner frustration and despair and a continuing ample oversupply of shelter because of the tidal wave of foreclosures, millions more of which they think are in the cards over the next few years.

No housing bottom until mid-2010, and a weak recovery afterwards.

Tilson and Tongue do not see housing bottoming until the middle of next year, and the recovery, they suggest, will be conspicuous by its lack of vigor.

One of the scarier charts in the report – but which, we think, brings into jarring focus mortgage credit’s current perilous condition – lists how much each of the various types of loans is severely underwater. To wit: 73% of option ARMs, 50% of subprime, 45% of Alt-A and 25% of prime mortgages are in that uncomfortable category.

T2 posits five waves of losses, two of which have crested, while the remaining three have yet to peak. In the first two waves, the losses of which appear largely behind us, the chief causes of distress were rooted in fraud, feckless speculation and payment shock induced by mortgage resets.

The last three waves, the big losses of which have still to come, include prime loans (mostly owned or guaranteed by Fannie and Freddie); jumbo primes, second liens and home-equity lines of credit (most of these are on banks’ books); and loans outside housing, notably the tidy $3.5 trillion of commercial real estate.

Toward the end of their report, as a kind of second opinion, the T2 duo cite some observations last month by Mark Hanson of the Field Check Group, a seasoned research outfit that specializes in real estate and mortgages. And not surprisingly, he is at one with their downbeat analysis. In fact, if anything, he is even more bearish and puts a lot of the blame squarely on ill-conceived attempts to ease the plight of troubled homeowners by tinkering with their loans.

More specifically, he cites all of those “terrible kick-the-can-down-the-road modifications that leave borrowers in five-year teaser, ultra-high leverage, 150% loan-to value balloon loans” that when they start adjusting upward will “turn millions of homeowners into overlevered, underwater, renters, and ensure housing is a dead asset class for years to come.”

Field Check’s data, he says, show “that the mid-to-upper-end housing market is on the precipice of the exact cliff that the market fell off of in 2007, led by new loan defaults. What happens to the economy when you hit the mid-to-upper-end earners the same way the low-to-mid end was hit with the subprime implosion? We will find out soon enough.”

And he concludes on this grim note: “When we look back at the end of 2009, anyone that made positive predictions this year will not believe how far off they were.”
We earnestly hope that should he chance to glance at these scribblings, Timothy Geithner is not disconcerted to the point that he is unable to give his undivided attention to the serious business of running the Treasury. We would feel just awful if we thought that something we have written had distracted Mr. Geithner from formulating another way to reward the banks for their gross imprudence.

Our concern here springs from a report by the AP last week that Mr. Geithner, who has a house in a posh part of Westchester County in New York, has been unable to sell it, even though he cut the price below the $1.602 million he paid for it in 2004.

Since he has new digs in Washington, but has to shell out $27,000 a year in property taxes, plus the payments on $1.2 million in two mortgages on his old home, he likely figured if he sold it, at the very least he could begin to have a decent lunch instead of the baloney sandwich his missus has been preparing for him to haul to the office.

He was able to rent out the 5-bedroom Westchester Tudor for a mere $7,500 a month, but we are afraid, given his mortgage payments and all, he will probably still have to make do with baloney for quite a spell. Oh, and don’t be surprised if the administration unveils a new program to aid those deserving upper-end homeowners whose suffering has gone largely unremarked.

Bargain Hideaways

Snag swanky summer digs at a discount while you can, before the sector snaps back. And, frustrated sellers resort to creative means to move their mansions.

We would recommend that U.S. citizens who can afford swanky second homes – especially those who can afford swanky second homes – look abroad. It may come in handy when the expropriators decide to seize your property “in the name of the people.”

For those who insist on staying close to home, Barron’s has some coverage of the luxury second home market that may interest you. The property pictures are interesting to look at in any case.

Last-minute shoppers, take heart: Plenty of swanky summer digs are yours for the taking. From Carmel, California, to Newport, Rhode Island, second homes with yachting docks, tennis courts, golf courses and infinity pools – to say nothing of the obligatory spectacular view – are languishing on the market. Prices are down an average of 20%, and as much as 30%, from their 2007 peak. Cash-strapped sellers, anxious to find buyers by summer, are slashing prices still further and often accepting low-ball offers, according to brokers across the country.

“This kind of price cutting is a first for the luxury second-home market.

Among the latest price choppers: Kenneth D. Lewis, embattled chief executive of Bank of America, who just cut the price on his 5,700-square-foot Spring Island, South Carolina, vacation home by 13% to $3.3 million. – “This kind of price cutting is a first for the luxury second-home market – it has always been relatively insulated in downturns,” says Jack McCabe, CEO of McCabe Research & Consulting, a real-estate consulting firm in Deerfield Beach, Florida. “People who own these kinds of second homes have always been very well-heeled financially, enough to withstand tough times.”

But this downturn is different. Financial executives have seen multimillion bonuses go up in smoke, and wealthy folks everywhere saw part of their fortunes evaporate on the stock market last fall – losses that, for the most part, have not been recovered.

Prices for luxury summer homes – generally defined as houses of $3 million and up – could come down another 5% or 10% before bottoming with the broader realty market by the end of this year, many professionals say. That would still leave the segment less bruised than the overall housing market; prices there fell 24% from mid-2007 through the end of last year and are likely to fall another 15% this year, according to Fiserv Lending Solutions, a research firm in Cambridge, Massachusetts.

The luxury summer-home market has also held up somewhat better than the total market for luxury homes, mainly because there are relatively few summer mansions in the battered winter meccas of Florida, Southern California, Las Vegas and Arizona. Thanks to exposure to those locales, the overall deluxe market is off about 25%, experts estimate.

The question that summer-home buyers face is whether to act immediately or wait for prices to drop still more.

The question that summer-home buyers face is whether to act immediately or wait for prices to drop still more. It might be wise to start shopping, for trying to time the bottom of this specialized market is a dangerous game. Once confidence returns among would-be buyers, the top-tier market is apt to snap back quickly, making it easy to miss out on discounts if you have not already started a home search.

“In the past, the lower end of the market has recovered faster in terms of price appreciation, but I think this time around it is going to be different,” says Celia Chen, director of housing economics for Moody’s Economy.com. The lower end of the market will continue to be constrained by tighter lending standards.

In contrast, the mayhem in mortgages has had less of an impact on the luxury market. Wealthy buyers traditionally pay cash for properties, and when they choose to borrow, their asset levels often make it easy to qualify. True, prospective buyers have been subjected to the same job and market losses as sellers, and many may have to sit out the market no matter how low prices go. But there is a lot of pent-up demand for high-end real estate, and that will drive the market as confidence in the economy returns, Chen says.

Some buyers have already started venturing back into the market. Real-estate purchase volume among U.S. Trust clients, who have net worths of at least $5 million and investable assets of at least $3 million, increased 60% in March and April over the last two months of 2008, says Jan Reuter, managing director of residential real estate at U.S. Trust, Bank of America’s private banking unit. For second homes, volume increased by 200%, she says, “and we are seeing a big increase in inquiries.”

Many brokers also say they have had a sharp increase in calls and showings in recent weeks. “There is definitely a pulse,” says Melanie Delman, broker at Lila Delman Real Estate in Newport. “It was quiet at the end of September and through the beginning of this year, but we are out there with clients seven days a week now.”

With sellers so eager to strike deals, it is entirely possible for a buyer to sign the closing papers today and move in by the Fourth of July. “It can be done in 30 days, easy,” says David Bindel, a broker at John Saar Properties in Carmel, California. If no financing is involved, the turnaround can be even faster, he says.

While some signs of life can be chalked up to a change in season, sales in the upper echelons of the second-home market tend to be less cyclical than the rest of the housing market, Reuter says. “Our clients see residential real estate as an asset class no different than any other investment they would make. So when they find something they think makes a good investment, they get in,” she says.

More foreclosed mansions are for sale. Prices are down throughout the luxury sector.

Perhaps not surprisingly, more and more foreclosed mansions are for sale. In the first quarter, there were 1,214 foreclosures of homes worth $3 million and up, compared with just 279 in all of 2008. Last week in Telluride, Coloorado, a 6,150-square-foot stone and timber home hit the foreclosure list. During more than a year on the market, its price was cut from $4.995 million to $4.250 million, and the final price is likely to be significantly lower, says Corie Chandler of Peaks Real Estate in Telluride.

But foreclosures are hardly the only game; prices are down throughout the luxury sector. Some of the sweetest deals on summer homes can be found along the North Atlantic coast in areas like the Hamptons, Newport, and Nantucket and Martha’s Vineyard in Massachusetts. These are typically homes-away-from-home to the Wall Streeters who have been so hard-hit by the recession.

“A lot of second-home sales, especially in the New York area, are generated by Wall Street bonuses,” McCabe says. The financial-services industry has shed 447,000 jobs since the start of 2007, says Economy.com. And those still employed are likely to see their bonus checks slashed. Last year’s bonuses were down as much as 50%, and little improvement is expected this year.

Buyers in the Northeast who decided last year to wait for further price cuts may like what they see. Sharon Smith Purdy, president of Sandpiper Realty in Martha’s Vineyard, points to a 3,000-square-foot contemporary home that sits on a bluff on Chappaquiddick Island and has 360-degree views of the island and ocean. It went on the market last year for $6.85 million. Last week its price was reduced more than 30%, to $4.48 million.

For an impeccably restored 1891 oceanfront mansion in Newport, “we will consider any offers,” says owner Candy Keefe. “Anything, anything.” Keefe listed the 22-room house at $14.5 million four years ago. Now, despite extensive renovation in the meantime, the offering price is $12.8 million. “We are a family that wants to move on,” she says.

As Nasdaq goes, so goeth Northwest Coast vacation homes.

On the Northwest Coast, the deluxe vacation market is driven more by the technology industry than the financial field. “Our biggest group of buyers are from Northern California, so we had huge appreciation in the late 1990s, and then a softening” when the tech bubble burst, says Tim Allen, a broker in Pebble Beach, California. Prices regained ground – and then some – through the earlier part of this decade, but as the Nasdaq plunged again late last year, so did prices.

For the most part, price reductions in the area have been a result not of financial distress on the part of the seller, but rather a desire to free up some capital to direct to other investments or simply to do some belt-tightening, brokers and sellers say.

“I am paying all of this insurance and property tax, and I rarely use the property,” says Bill Hutchinson, a Dallas-based commercial-real-estate investor who is selling a 1920s Mediterranean-style villa that overlooks the Pacific Ocean in Carmel Highlands, Calif. Anderson bought it as a vacation home in 2005 for $6.2 million “on a whim,” he says. The home was listed a year ago at $7.45 million and has since been reduced to $6.45 million. “I will walk away before I take a loss on the property. But if I find a buyer, it will probably be a wash after closing costs,” he says.

Rocky Mountain retreat prices down less due to smaller speculative booms previously.

In Rocky Mountain retreats such as Telluride and Aspen, Colorado, known for expansive lodge-style estates and celebrity draw, prices have come down about 15% – not as dramatic a dip as either coast because the areas did not see a great speculative boom earlier this decade. “We see some spec builders who are offering significant discounts to rid themselves of debt, but it is not commonplace,” says T.D. Smith, president of the brokerage Telluride Real Estate. “We have seen an extreme slowdown in sales, however.”

In sleepier upscale vacation markets such as Jackson, Wyoming, and Big Sky, Montana, average prices on upscale homes have not declined by much, but sales have plummeted and inventories are up. In Jackson, sales in the first quarter of this year were down 52% from a year earlier, says Clayton Andrews, a local broker.

As activity starts to pick up, buyers are sure to be crunching the numbers more carefully than they used to. For example, while many have the means to pay cash, they may choose to get mortgages anyway, Reuter says. The reasoning is that, with interest rates so low – 6.3% on a 30-year fixed jumbo loan – it makes great sense to finance a purchase and maintain liquidity as opportunities for other investments arise, she says.

Make no mistake, this is not cookie-cutter financing. “We might structure $5 million on a first mortgage with a 7-year term, another $2.5 million mortgage behind it on a 3-year term, then a remaining amount in a balloon mortgage,” Reuter says. “We structure loans to fit with their overall situation – a client could be trying to hedge interest-rate risk, or they may know they are unwinding a business or having some kind of liquidity event that is going to allow them to pay off part of the loan soon.”

Regardless of how they pay for their houses, buyers are insisting on value as never before.

“People are saying, ‘Do I really need a $5 million house? Maybe a $3 million is fine,’” says Jacquie Persons, a realty broker in Big Sky. “They are also actually sticking to their price ranges – they did not worry about price range so much before. And they are looking closely at the price per square foot.”

Persons knows whereof she speaks: She put her own home on the market for $3.5 million four months ago and recently lowered the price to $2.99 million to get it into the under-$3 million range.

Doug Newhouse, a Weston, Connecticut, resident who works in finance, says he and his wife carefully compared the kind of property and amenities they could get for their money in different resort towns in the Northeast. “I always figured we would buy in Nantucket, but we found the value proposition in Newport to be substantially better than in Nantucket and the Hamptons,” he says. “We were able to buy a property in Newport that we wouldn’t have been able to buy somewhere else.”

Today’s market may not be much fun for sellers. Rather than escaping to their summer homes, they are doing all they can to escape from them. But for discerning buyers like Newhouse, that can mean the opportunities of a lifetime.
When the Going Gets Tough, the Tough Hold Raffles

As mansions sit on the market for months, a growing number of frustrated sellers are trying their luck with raffles and auctions.

Miles Brannan of Fort Lauderdale, Florida, has a 6,000-square-foot home with a billiard room and water frontage that has been on the market for a year at $3 million. Burdened by mortgage payments and the cost of upkeep, Brannan is selling 300,000 raffle tickets at $10 a pop, and offering the home as the prize.

“When times get tough you do what you have to do,” says Brannan, a real-estate agent whose business has been hit by the housing slump. He has sold about 15,000 tickets so far.

But a raffle or auction is no easy out. It takes aggressive marketing, and there are legal matters to consider, which vary by state. Typically, a homeowner must team up with a nonprofit organization, which gets funds from the raffle in excess of the property’s appraised value.

Dean Kent, a real-estate investor planning to raffle his $2.6 million oceanfront home in Norfolk, Virginia, with 30,000 $100 tickets, hopes to minimize the hassle of the auction by hiring Raffle Mansion Charity Promotion, one of a handful of new national organizations to crop up lately to facilitate raffles.

The risk to homeowners in raffling a home is failing to sell enough tickets. Owners typically hope to raise enough to cover the appraised value of their home. If the proceeds fall short, there are usually two options, depending on how the raffle was structured: Give refunds to ticket holders, or award a cash prize for the amount raised in the raffle.

Ticket buyers face a danger of their own: “The fair market value of the property muamp; Co., a Hagerstown, Maryland, accounting firm.

For Dennis Weaver, winner of a successful raffle of a $380,000 home in Hagerstown last year, the tax hit was $135,000. Weaver, the circuit-court clerk of Washington County, Maryland, took a second mortgage on his primary home to cover it, then sold the property for a deeply discounted price of $279,000 and still managed to pocket $100,000. “My first question when I won was, ‘Do I have to take it?’ But it turned out OK,” Weaver says.

When a property won through an auction is ultimately sold, the cost basis on the home is its fair-market value when the prize was awarded, not the raffle price, Oswald says.

Auctions can be equally difficult. Fire-sale auctions in which there is no reserve price – the minimum for which an owner will sell – typically draw bargain-hungry shoppers, but when there is a minimum price, few bidders show up, says Elizabeth Blakeslee, associate broker at Coldwell Banker Residential Brokerage in Washington.

IBidcondo.com, a company founded early this year, plans to be the first to offer no-reserve auctions on the Internet. Conceivably, bidders will be able to bid as little as $10 for a property. The company, which is holding its first auction – a $690,000 condominium in Austin, Texas – on May 26, is selling seats at $100 each to cover the price of the property. Of the money that comes in from the bidding, IBidcondo.com keeps 10% and, after certain expenses, the rest goes to charity.

Eugene Marchese, IBidcondo.com’s founder, said he has already received inquiries from owners looking to unload multimillion-dollar homes. “We are going to start with condos and possibly move on from there,” Marchese says. “This is a revolution, and all revolutions take time.”


Web entrepreneurs these days are getting the wrong idea that all that matters are users – not revenue.

In an echo of the dot-com mania era, Web-based companies are worrying about acquiring users but not about whether those users are profitable. Believe it or not that kind of thinking is a sufficiently engrained piece of orthodoxy that an entrepreneur who claims the emperor has no clothes – that you should charge enough to cover costs if you want a viable business – is shunned by industry peers.

You can tell a lot about a culture by the sort of person it ostracizes. David Heinemeier Hansson, 29, a successful tech entrepreneur, is something of an outcast in Silicon Valley. Here are the pronouncements that have earned him his banishment: Companies should not be ashamed to charge for their products. They should expect to be able to make money off their customers. Finally, they cannot use volume to turn losses into profits.

Odds are you have not heard of Hansson, but you have been on Web sites that have used his products. His Chicago company, 37Signals, is responsible for one of the software world’s most innovative recent advances, a Web-development package known as Ruby on Rails.

An established engineering trend has involved taking advantage of faster computer processors to create programming languages that are easier to use. Ruby on Rails is another step along that path, but one that works for whole Web sites rather than just for individual programs. Many popular Web applications – Twitter, for instance – have used Ruby on Rails to get up and running in a hurry.

37Signals charges for use of the main Ruby on Rails products and has become a success story. It has attracted a minority investment from Amazon’s founder and chief executive, Jeff Bezos. The company does not disclose numbers but says it is profitable. Its revenues are probably between $5 million and $10 million a year.

This is not Google, not by a long shot. But it has a level of success that eludes all but a wee sliver of the programmer-entrepreneurs who enter the Web lottery. Which is where the controversy comes in. Hansson has used his modest celebrity in the tech world to launch something of a crusade against some of that world’s most popular ideas.

In speeches, on panels and in blog postings, he mocks the widespread notion that new technology ventures should not worry about business plans or revenues but should instead work on acquiring customers, even if it means giving away their products. Get people using your stuff, entrepreneurs are told, and profits will somehow come. The paragon of profitless volume is Facebook: 200 million users but no net income. It looks like it sells stock to pay bills.

“Startups these days are getting all the wrong lessons,” says Hansson. “[They think] that all that matters are users, that they should take on plenty of debt from venture capital investments because something magical will come along at some point and everything will be okay. But you cannot make up something in bulk that is a losing prospect to begin with. Isn’t that self-evident?”

Thanks to the popularity of Facebook and Twitter, bubble-style thinking remains strong in tech.

Apparently not. Thanks to the popularity of Facebook and Twitter, bubble-style thinking remains strong in tech. Consider the companies recently named by Facebook as finalists in a competition it runs for companies wanting venture funding. RunThere.com seeks to link up joggers who want running partners for their daily trots. It should not be confused with RunMyErrand.com, which lets customers find people for chores like picking up the dry cleaning.

There was a time when the standard put-down of a frothy tech startup was “That’s not a company. It’s a feature in an application program.” Today the critique would be “That’s not a company; it’s a message board on Craigslist.”

Hansson’s Web 2.0 apostasy has earned him notoriety. One tech blog suggested he was to blame for a company’s demise, since the company followed Hansson’s advice and charged for its product.

He is especially unpopular with venture capitalists, since he argues that abundant VC money allows companies to avoid figuring out what their business is or if they even have a business besides finding a greater fool to one day buy them out.

Hansson says there is a high probability that Twitter will never be profitable. I think it is safer to say Twitter will not ever make profits commensurate with the current interest in it. In a similar vein YouTube, despite its popularity, may not ever make profits commensurate with the $1.6 billion Google spent to acquire it plus the considerable (undisclosed) sums Google spends to keep it open.

Hansson would say that YouTube’s financial hole is there not despite its popularity but because of it. When you give away your products, users are a cost center instead of a profit center, and so each new one puts you further behind. Facebook is spending so much money to store users’ pictures that it is not clear that the company can ever make a profit.

Hansson is to some degree biting the hand that feeds him, since 37Signals would not be as successful if so many aspiring entrepreneurs were not using it for harebrained endeavors. Hansson acknowledges as much but says there are enough legitimate uses for Ruby on Rails that 37Signals will prosper long term. That itself is something of a bubble-era refrain, but in this case, it just might be right.


Your mutual funds and pension plan likely settled for crumbs when Wall Street was minting money lending out their securities. Now that the business has blown up, Wall Street wants to stick you with the bill.

During the late great credit bubble, investment funds attempted to augment their returns by lending out their securities to short sellers. Rather than lending to short sellers directly they would use securities lender-brokers to find borrowers. When the securities happened to be ones in high demand by short sellers the lending rates got pretty high. For example, Citigroup currently costs the equivalent of 60% per year to borrow. So what are the problems with this, if any?

The risk/reward ratio. The funds themselves got only small incremental returns for putting their sometimes valuable securities up for rent, while the brokers kept most of the interest received. No problem if the risks for doing such were small. They were not. If the collateral posted to assure the shares would be returned was flakey as, e.g., commercial paper turned out to be once the meltdown commenced, the lender sustains losses. Which lender, one might ask? The fund who put up the shares. The brokers figure it is not their problem, even as they made the decision to lend the shares out to the firms which could not repay.

This is similar to the risk/reward calculus enjoyed by so many financial alchemists while the bubble was in the runup phase: Take a cut for creating the box of candy-coated kaboom and pawning it off on buyers; when the value implodes remind the buyers of the caveat emptor clause that was stamped on the box. Really and truly, no one forced the buyers to buy, so they really do have themselves to blame.

Joseph Diebold, 70, of Prairieville, Louisiana, spent three decades toiling in an Exxon chemical plant. He socked away savings in a 401(k), much of it going into index funds. Last fall his nest egg got crushed, like everyone else’s. Even so, it struck Diebold as odd that many funds seemed to do a bit worse than the indexes they supposedly tracked. His S&P 500 fund, for example, lagged its benchmark by 11 basis points (0.11%), even before fees. A mortgage-backed securities fund lagged by 53 basis points.

The cause of the lag: Sizable losses in securities-lending programs that, at best, provided funds with incremental revenues in good times in exchange for what many managers say was sold to them as minimal risk. In contrast, the middlemen who managed the lending programs, and who walked away with fat slices of the profits in the salad days, are now sticking small investors like Diebold with the losses.

No question the red ink pales in comparison to the wealth vaporized by the financial crisis. But with securities lending losses conservatively estimated in the billions of dollars, they have incited legal battles between big Wall Street clients, including the pension plans of FedEx Corp., BP and Imperial County, California, and middlemen like JPMorgan Chase, Bank of New York, State Street and Wells Fargo.

Diebold filed a complaint in U.S. District Court for the Northern District of Illinois on April 1. It accuses Northern Trust, his funds’ securities lending manager, of prohibited transactions and failing to prudently and loyally manage plan assets. His attorneys are seeking class status, without which designation the case is probably not worth their time. The Chicago bank denies wrongdoing.

Stocks are borrowed so that they can be sold short. The short-seller borrows the shares, replaces them with cash collateral and promises to both return the shares on demand and cover dividends paid out in the meantime. If the shares are liquid and easy to borrow, the lender gets a modest fee for its cooperation. It keeps an agreed-upon percentage of the interest earned on the collateral. There is not a lot of loot to fight over.

Things get interesting when supplies of lendable shares are scarce, or the collateral is put into sketchy investments. Then there is money to fight over.

Citigroup, which is in high demand among shorts, currently costs the equivalent of 60% per year to borrow. Lenders of Citi shares are in the catbird seat. They could wind up with the same capital gain or loss they would have without a stock loan, plus an extra 60% return. Why are lendable shares sometimes scarce? One reason is that some institutions (pension funds, endowments) cannot or will not lend shares. Another is that retail brokers are permitted to lend only shares from their customers’ margin accounts, not cash accounts. And the third is that some investors on the long side of the stock withdraw their securities from the lending pool precisely to make life miserable for their enemies, the short-sellers.

Securities lending peaked in 2007, with transactions totaling $5 trillion, according to the consulting firm Finadium. That gave rise to a $17 billion pot of money, consisting of interest on collateral plus surcharges for scarce shares.

Where did the money go? In some deals, short-sellers themselves laid claim to about half the revenue. Their brokers pocketed another 30% or so. The custodial banks that managed the lending programs, and the mutual funds and other institutions that owned the securities, split the rest of the booty. That is calculated using estimates by David Downey, chief executive of OneChicago, a futures exchange. Northern Trust made $221 million from securities lending last year. In deals involving hard-to-borrow stocks, prime brokers appear to have gotten the bulk of the profits, leaving banks and investors with 1% or less.

Securities lending is sufficiently profitable that it has spawned its own underworld of unsavory activity.

Securities lending is sufficiently profitable that it has spawned its own underworld of unsavory activity. In the past two years 28 people, including traders at Morgan Stanley, A.G. Edwards and JPMorgan Chase, have pleaded guilty to crimes involving the business. Darin Demizio, former head of Morgan Stanley’s domestic securities lending desk, was convicted of securities fraud for funneling business to firms that paid $1.6 million in kickbacks to his father and brother, who were purportedly acting as “finders” in the securities lending trade.

The recent dustup centers around the fact that, in a bid to squeeze out a bit more profit, securities lending managers got exotic in how they invested the short-sellers’ collateral. Instead of tucking it safely into T-bills and T-bill repos, they bought higher-yielding but highly rated commercial paper and other corporate debt.

When Lehman Brothers collapsed last fall, it caused sufficient losses in the $22 billion (assets) Institutional Cash Reserve that sponsor Bank of New York had to step in to prevent it from breaking the buck. The ensuing panic from such losses prompted investors to yank $1.4 trillion out of short-term instruments, including commercial paper, where some short-selling collateral was unwisely invested. Some of that collateral, now mostly asset-backed securities, is so illiquid that it has yet to be unwound. Government bailout programs have been primarily available to financial institutions and issuers, not to securities lending pools.

The question now is who is going to eat the losses. In Diebold’s case, like many others, his 401(k) plan appears to be contractually on the hook for any decline in the value of collateral received in exchange for the securities it lent out. If Northern Trust prevails it will have been a great deal for the bank: When things were good, it scooped up a fat share of the profits, but after they turned bad, it would be the pensioners picking up the tab. Northern Trust would seem to have had ample motives to invest in riskier assets. The bank says losses “were due to unprecedented global market conditions – not risky investments” and that investors do not have to participate in securities lending.

If there is any good news here it is that small investors need not worry about getting stuck with losses when brokerages lend out securities they purchased on margin. The retail brokers we talked to assure us they will bear any losses on securities lending collateral. (Only fair; they hand over none of the revenue from the lending operation.)

Even so, the red ink could trickle down to investors and taxpayers. The $3 billion (assets) Policeman’s Annuity & Benefit Fund of Chicago earned $3 million lending out securities in 2007. It is now sitting on a $5 million loss from illiquid collateral it cannot unwind. That is on top of a $700,000 loss realized from Lehman Brothers paper. The fund is working with custodian Northern Trust to maximize its returns, according to chief investment officer Samuel Kunz. Many other plans seem to have thought twice about the entire securities lending process. Seven of 34 plans contacted in January by Finadium said they had given up on lending out securities.

Vanguard, the penny-pinching index fund giant, has handled its own lending for years, cutting out middlemen and shunning doggy collateral. It says it returns all profits to its funds’ investors. They were equal to ten basis points last year in its Mid Cap index fund, or a total of $17 million – better than a stick in the eye.


Anticipating the worst, Wall Street marks down stocks before a Democrat is elected – and is pleasantly surprised afterward.

Ken Fisher brings our attention to a phenomenon which has been noted by many others: Stocks on average do well the first year of Democratic adminstrations and crappy the first year of Republican administrations. Counterintuitive? Not really. The market anticipates bad-for-business laws from Democrats and the reverse for Republicans, and things never turn out to be as bad/good as originally anticipated. Both parties are equally good at not meeting their rhetoric and selling out on their nominal principles. The puzzle is why anybody believes promises made by presidential candidates of either party. After all, they are politicians.

When Fisher wrote this piece the market was flat, leaving seven months for the Democrats = up-market pattern to be realized.

Call me an eccentric, but one reason I am optimistic is that Barack Obama is in the White House. No, I am not enamored with him – never am with a politician. It is strictly a matter of numbers. Statistics favor a bull market in 2009. As I write this (with the S&P at 888), the market is flat in the year to date. There are seven months left for the pattern to be borne out with a rally.

Here are the stats: S&P 500 returns (including dividends) for the first year of first terms for Presidents fit a neat pattern. Since 1926 five of six Republican first years have been negative, the lone exception being 1989 under George H.W. Bush (when the market was up 32%). Of six Democratic first years, five show double-digit gains, the lone exception being 1977, under Jimmy Carter (off 7%).

The pattern is not so strange when you think about what the market is and is not. It is not a register of current business conditions. It is an anticipator. Anticipating the worst from a populist presidential candidate, Wall Street marks down stocks before a Democrat takes office – before, in fact, he is even elected. After the inauguration there is a good chance for a rebound.

With Democratic politicians the big fear is about how antibusiness and anticapitalist they will be. Obama says lots of stupid, scary things. That fear hit markets early in the election cycle. But once he is in office the overwhelming motivation of a left-of-center President slowly morphs toward getting reelected. Achieving that means pandering more to the independent voters and liberal Republicans, less to the Democratic power base. Obama’s concern now is the recession and the job creators that can take us out of it. That means slowly backing off soak-the-rich, anticorporate talk over time.

The reverse happens with Republicans. They come in riding high expectations for pro-business, pro-growth policies – and inevitably disappoint investors as they drift away from their power base. Optimism fades, depressing stocks.

Right now I am focusing my optimism on four sectors: consumer discretionary, materials, energy and industrials. Here are five stocks I like now:

At a price not much more than a fourth of their 2006 peak, Harley-Davidson (17, HOG) shares are suffering from recessionitis. A bike is the ultimate big-ticket consumer discretionary stock; you can always postpone buying a Hog. As the economy bounces back, Harley sales will, too. It is a prestige purchase the way a Tiffany earring, Rolls-Royce sedan or Davidoff cigar is, just different buyers. The stock is moving now, ahead of the economy. But it remains cheap at 11 times depressed 2009 earnings and 70% of revenue – with a 2% dividend yield.

Mattel (14, MAT), America’s premier toymaker, should bounce back similarly. It owns big brand names like Hot Wheels, American Girl, Fisher-Price and Barbie. Like a Harley, an expensive toy is deferrable. Ultimately baby boomers will spend much more money on their grandkids than they did on their kids, providing growth. At 90% of annual revenue, 10 times likely 2009 earnings with a 5% dividend yield, the stock should rally well before the economy does.

Halliburton (22, HAL) is a leader in oilfield services like exploration, well construction, drilling and pressure pumping. It recently spun off its government-contractor subsidiary, making the company more sensitive to the economy and to the price of petroleum. The March quarter sales reflected the depressed state of oil exploration (with the North American rig count at 33% of what it was in November 2008). The price of oil is rebounding (to a recent $63 a barrel, from the December bottom at $34), and demand for Halliburton’s skills will come with it. The stock sells at 17 times depressed earnings and one times revenue and has a 1.6% dividend yield.

Owens-Illinois (27, OI) is the world’s largest bottlemaker, with a monopoly position in eight countries. You would not think this business would be cyclical, but it is. At 8 times 2009 earnings and 60% of annual revenue, the stock has a lot of room to run up. I think it should sell at twice its price/sales ratio.

Parker-Hannifin (42, PH) makes components, equipment and systems for a wide array of industries. The recession-sensitive earnings were off 79% in the most recent quarter; sales were off 26%. This stock, too, should bounce nicely, ahead of the economy. It sells at 17 times depressed 2009 earnings and 60% of annual sales, with a 2.6% dividend yield.


The world’s monetary and fiscal authorities appear by their feckless policies to have resuscitated a financial services bubble that came close to wrecking the world economy, and may still do so on a delayed-action basis.

Thanks to the reflationary policies of governments and (where distinct) central banks, notes Martin Hutchinson, there will be another crash. There always is. “But before it happens, some very unpleasant people will have made further speculative billions – and doomed the U.S. economy to a decade of stagflation.”

You might almost think that this – the speculative billions and the crash – is by intention. Indeed if you do actually think you will arrive at the conclusion that this is the hypothesis that fits most squarely with the facts.

Citigroup has been restructured with $50 billion of public money without significant reform to its operations, the hedge fund industry had its best month in nine years in May and Goldman Sachs is said to be considering giving up its banking license. The world’s monetary and fiscal authorities appear by their feckless policies to have pulled off a feat that I did not think was possible: resuscitate a financial services bubble that came close to wrecking the world economy, and may still do so on a delayed-action basis.

John Allison, chairman of BB&T Group (about the best-run major U.S. regional bank), spoke ... to the Competitive Enterprise Institute, saying that apart from a Gold Standard (which he thought unlikely), the financial services business and the country in general needed to change its motivations from short-termism and altruism to enlightened long-term self-interest. While his altruism/self-interest point is a long-standing one (which to the extent that it means not making “affordable housing” loans to people who cannot afford housing, I agree with), the long-term/short-term point is different. It is a product of environment, not of innately bad philosophies. If a country’s government engineers market conditions that lavishly reward foolish short-termism, foolish short-termism is what that country will get. Only by changing market structures, rules and incentives will behavior be changed.

In a well-run financial system, the free market automatically rewards prudence and punishes short-term greed and folly. That is not the system the United States has had since at least 1995.

In a well-run financial system, the free market automatically rewards prudence and punishes short-term greed and folly. That is not the system the United States has had since at least 1995, and it is certainly not the system that has been produced by the multiple bailouts and stimulus packages since last autumn.

For a start, examine the housing market, the cause of the initial debacle. The combination of commission and other incentives to lend to borrowers who could not afford to pay and effective state guarantees of the loans they did not pay produced a tsunami of toxic “subprime” lending. In a normal market, subprime loans would be a self-liquidating problem, because lenders who made them would quickly go bust. Here, lenders who made them were guaranteed by Fannie Mae and Freddie Mac, who themselves were guaranteed by the taxpayer, as it turned out. Any losses that remained were passed off to foreign innocents through securitization.

This system of pass-the-parcel would have broken down last year, except that the government has now ensured its continuance by taking over Fannie Mae and Freddie Mac, making them major conduits for its efforts to “help” the mortgage market, handing out tax subsidies to new homebuyers and attempting to perpetuate the thoroughly unsound securitization market through purchases of up to $1 trillion of dodgy mortgage paper, again at the expense of the taxpayer.

A system that would have collapsed, forcing the reversion to the old, much sounder practice of making home loans directly through local institutions, has been artificially perpetuated. Not only will this cause repeated crises in the home loans market going forward, it will also be considerably more expensive for homebuyers – as I demonstrated in a previous column the cost of home loans, expressed as a margin over the relevant Treasury securities increased by about 0.2% as a result of the invention of the new and supposedly more efficient securitization market. Wall Street’s rent-seeking has been subsidized, in other words.

Credit default swaps (CDS) were the most dozy [dopey] extreme of all the dozy new products Wall Street invented during the period it pretended to believe the Efficient Market Hypothesis. Structurally, they were a simple offshoot of derivative technology, although it is notable that they did not come into frequent use during the first 1980s flowering of that technology, because it was clear even then that there was no sound way to crystallize the credit swap obligation created by a default. The “auction” procedure used in the Lehman and other bankruptcies is obviously inadequate, because it uses an auction of a few million dollars to determine the fate of obligations worth billions.

It became clear in the Lehman bankruptcy that CDS could be used to force a company into insolvency, particularly a financial institution with high leverage. The large amount of CDS outstanding and the low cost of credit protection against a good quality borrower give “shorts” seeking to push a house into bankruptcy an immensely useful tool that they previous lacked. The obvious step at that point would have been to ban CDS, since they generate such a destructive conflict of interest. Instead, the Fed subsidized the market, by bailing out AIG, the least intelligent of the CDS writers, to the tune of $180 billion, thus allowing Goldman Sachs and other houses to profit on the various bankruptcies sufficiently as to pay out everybody’s bonuses for the year. Naturally, since none of the majors lost significant money through CDS, the market went on playing the game. CDS were used to accelerate the bankruptcies of General Growth Properties and Abitibi-Bowater within the last few months, and played a significant and negative role in the prolonged restructuring of General Motors.

Now a small house, Amherst Holdings, has beaten the Wall Street titans at their own horrid game, according to the Wall Street Journal. It found a pool of $29 million of particularly repulsive California subprime mortgages, then sold $130 million notional of CDS on them, pocketing around $100 million in premiums, since this waste was so toxic the big houses were prepared to pay up to 80% to insure against it. Clear so far? It sold insurance for 4 1/2 times the maximum possible loss, but hey, that’s finance.

Then it quietly went round and paid all the debts of the lucky homeowners owing the $29 million. At that point, since there were no defaults, it was able to keep the $100 million in premiums (net of the loan repayments, a $70 million profit). Simple, really! Wall Streeters are furious and, inevitably, suing, but in fact Amherst’s coup was a perfectly legitimate use of this corrupt and foolish structure, far more so than many of the shenanigans undertaken by the likes of Goldman Sachs – after all, Amherst’s operation PREVENTED a number of defaults and foreclosures.

George Soros says CDS should be banned. I worry about the periodontal damage caused by teeth-grinding when I find myself agreeing with Soros, but in this case, he is right (he was right on the pound in 1992 as well; fortunately for my dental care, he has been right on no other occasion that I can recall). However, not only have the feds made no move against CDS, they have subsidized the market to the tune of $180 billion of our money, thus ensuring the toxic technique’s return to luxuriant growth.

Juicy bonuses in good times and slaps on the wrist when the structure comes crashing down in bad.

The Troubled Asset Relief Program (TARP) bank capital injections have also contributed to the market’s further degradation. They totally failed to discriminate between good and bad banks, so that the worst banks received the most money, without any steps being taken to remove their management or shut down their operations. Essentially, $50 billion of our money has been invested in Citigroup and $45 billion in Bank of America (the perpetrator of the two most foolish acquisitions of the last decade, in Countrywide and Merrill Lynch.) By rewarding incompetence in this way (for example allowing Vikram Pandit to keep both his job and the $600 million with which Citi purchased his failing hedge fund), the government has insured that we will get more of it, since the benefits from the juicy bonuses in good times are so great and the slaps on the wrist when the structure comes crashing down so painless.

Jeff Skilling of Enron was given a 25-year jail sentence for Enron’s failure. That was grossly disproportionate to his offense, but did ensure that future Enron perpetrators would be discouraged. The fate of Pandit, Ken Lewis of Bank of America and the AIG honchos offers no such deterrent to incompetent looting of the financial system.

A further effect of the TARP process has been to cause a number of perfectly healthy banks to slash their dividends – notably US Bancorp and Allison’s BB&T. Should management of those banks, which have now repaid TARP, fail to restore their dividend forthwith while engaging in empire-building acquisitions of battered competitors, the “widows and orphans” who traditionally invest in bank shares because of their reliable income will be further discouraged, and shareholder control of banks will be left still more tightly in the hands of hedge funds and other cowboys.

If the monetary system is managed so that leverage is perpetually rewarded, it is not surprising that intelligent and aggressive bankers will devise new and ever more unsound means to create excessive leverage.

Finally, we come to monetary and fiscal policy during the crisis. Monetary policy, which had been far too loose for the preceding 13 years, bore a large part of the responsibility for the period’s excesses. If the monetary system is managed so that leverage is perpetually rewarded, it is not surprising that intelligent and aggressive bankers will devise new and ever more unsound means to create excessive leverage. However, monetary policy has been loosened unimaginably further since the crisis, with the monetary base being more than doubled. It is very clear that only evidence of rampant inflation – which we can expect the Bureau of Labor Statistics to suppress for as long as possible – will cause the Fed to return to an appropriately tight monetary policy.

Why dawdle along with only 15-to-1 leverage when you have tasted the heady joys of 30-to-1 at taxpayer expense?

Thus the incentives for Wall Street to indulge in endless speculative games will still be present, complete with the implied taxpayer bailout when it goes wrong. No wonder Goldman Sachs is thinking of abandoning its banking license – why dawdle along with only 15-to-1 leverage when you have tasted the heady joys of 30-to-1 at taxpayer expense. It is also unsurprising that hedge funds have enjoyed their best month for 9 years – for dodgy short-term speculators, Happy Days are indeed Here Again!

As for fiscal policy, it is now clear that President Obama’s initial “stimulus” was one of the most counterproductive policy initiatives ever perpetrated, both economically and politically. That stimulus pushed the U.S. budget deficit definitively above 9% to 10% of GDP, at which there is no firm assurance of financing it. Thus, it is likely that Obama will spend most of his presidency fighting to restrain an excessive budget deficit, while suffering the adverse economic effects of higher interest rates and “crowding out” that it brings.

Had he held back initially, Obama could probably have pushed through his expensive health-care reform and his expensive “cap and trade” environmental policy without the bond markets taking too much notice, with any adverse effects of large deficits on the economy postponed until his favored policies were safely and irreversibly in place. As it is, he will have a much more difficult task to push them through, and will do so against a much more skittish bond market and a much more uncertain economic environment. Such a waste of a presidency, just to give Nancy Pelosi her lavish helping of pork! (Of course, those of us who oppose both his health-care and his environmental policies will rejoice, but from the viewpoint of Obama and his supporters he has risked his Presidency becoming a colossal failure.)

There will be another crash of course, there always is. But before it happens, some very unpleasant people will have made further speculative billions – and doomed the U.S. economy to a decade of stagflation.


We were never big fans of the NORFED/Liberty Dollar, a provider of private coinage and currency and alternative transaction medium. We could never see why we should buy a precious metals bullion coin at a big premium to its metal content. Call us cheapskates. But we certainly had no objection to the provision or use of the coins, and the currency based on the coins, because everything was disclosed up front. No fine print either.

We might also add that we found the organizers to be naïve. While we did not necessarily think events would play out as they have, we did think that the NORFED setup was at risk for a quick forfeiture type action where the feds might walk in and grab everything of value – perhaps based on some bogus reason like some money launderer was apprehended with a couple of Liberty Dollars in his pocket. When you live in kleptocracy you protect yourself. Offering such protection is W.I.L.’s business, after all. Keep the precious metal in safekeeping offshore, for crying out loud. Do not advertise that you are a sitting duck. But no. Like many a “patriot” before and probably since, the NORFED people thought they had the law on their side and did not take such precautions. As we said before: naïve. Not to mention negligent.

And exactly such a raid happened. Small as the NORFED initiative was in the scheme of things, evidently it was seen as a threat to the ruling Federal Reserve regime. In late 2007 the feds raided the NORFED offices and stole everything of value. Now they have actually indicted four NORFED principals. For what crime, one might ask? William Grigg looks at the indictment and can find no crime to speak of mentioned, even by the low standards U.S. federal government. The crime was daring to compete with a the fraudulent monetary existing order.

The original raid was pretty much pure theft. We expect such actions from governments. Their very foundation is theft. The indictment, however, reveals, to our minds, a certain desperation. Why else would they bother, except to intimidate anyone from competing with – an ultimately criticizing – the Federal Reserve system?

Rancher Seaborn Tay (after several of his employees became rustlers): “What do you reckon it is that makes a man go to hell like that?

Faithful Ranch Hand: “It’s the money, Mr. Tay.

Conn Conhager (disgustedly): “The money. ... God help us if that’s all it is.

What is it that turns a man into a specimen like Acting United States Attorney Edward R. Ryan, whose name is inscribed on the tissue of lies and totalitarian assertions called a “Bill of Indictment” against four key figures in NORFED, aka the Liberty Dollar organization?

To at least some extent, it must be the money (or at least the officially sanctioned similacrum of the same) that provides for Ryan’s material comforts and subsidizes whatever squalid vices he enjoys. Since Ryan is a servant of the kleptocracy we can assume that vice, of some kind, plays a significant role in his discretionary time: Someone who steals for a living is not likely to be a moral paragon when he is off the clock.

As a tax-feeder, Ryan, like the rest of us, is paid in the innately worthless scrip and slugs that the Regime insists on calling “money.”

The chief difference is that he, like others in the Regime’s employ, gets first, best use of the currency at the beginning of the debasement cycle. He enjoys a slew of benefits that are funded by the labors of the honest and productive. And he – unlike those in the productive sector – can reasonably expect that his salary will more than keep pace with inflation. For the Regime and its clients, and those who serve that system, inflation is as beneficial as it is baneful for those of us trying to make an honest living.

Ryan really should be shunned by those who know him as if he were the carrier of a lethal disease, and the epicenter of an unbearable stench, two traits immediately recognizable to people with a rudimentary sense of right and wrong. Long ago, acting on motives known only to himself and his Creator, Ryan sold his soul at a steep discount by taking a job in the employ of the world’s deadliest, most powerful criminal syndicate.

Now, bearing the august title of U.S. attorney, Ryan is protecting criminals whose deeds impoverish and threaten all of us, by prosecuting innocent people whose acts of legitimate commerce threaten nobody but those very same apex-level criminals.

Until late 2007, when the Feds invaded its offices and stole the company’s assets, the Liberty Dollar organization marketed platinum, gold, silver, and copper coins, and issued colorful, finely wrought warehouse receipts that were redeemable in specific amounts of precious metals.

The Liberty Dollar was a private currency of the type that was very common in the United States prior to the bankster coup de main that left us with a centralized, politically controlled fiat pseudo-currency. It was offered and accepted on a purely volunteer basis, with fully informed people on both sides of the transaction.

One could take issue with the premium charged by the company for its coins, or dispute the strategic wisdom of its campaign, but it is impossible for honest, rational people to perceive a criminal conspiracy in which people were bartering for goods and services using the only substances recognized by the Constitution (Article I, section 10) as a legal currency – gold and silver.

Bernard von Nothaus, the founder of Liberty Dollar and one of four people mentioned in the federal indictment, routinely made clear his belief that the re-introduction of competing hard-money currencies would eventually bring down the Federal Reserve’s bogus-money monopoly. (One is tempted to call it a “Monopoly Money monopoly,” but this would be unfair: Monopoly “money,” which provides amusement and education to those who use it, has more innate value than the Regime’s ugly, worthless scrip.)

According to Edward Ryan and the people who fill his trough and determine the length of his leash, it is a crime to seek the overthrow of the Federal Reserve System by the peaceful, cooperative methods employed by Nothaus and his associates.

Query: Is it likewise a crime to seek the overthrow of that system through legislative means – say, through an audit of the sort pursued by Rep. Ron Paul and a growing number of his congressional colleagues, or through a measure summarily dismantling the institution?

If the means employed by Nothaus and the Liberty Dollar movement were not criminal – and there is nothing in the indictment demonstrating that they were – then the objective must be the real focus of the prosecution. That is why I suspect there are contingency plans to devise additional spurious prosecutions of anybody who embodies any potential danger to the Federal Reserve System’s continued existence.

(Color me cynical, but I also suspect that scripts are being finalized for a few more melodramas like the one that took place today at the Holocaust Museum, all the better to invest the opposition to official counterfeiting with an image of irrational and potentially violent prejudice.)

The 13-page federal grand jury indictment of Nothaus and his associates is densely cluttered with legal sophisms. Its treatment of the alleged acts of those involved in the NORFED/Liberty Dollar organization fall hopelessly short of describing the elements of a crime.

There is no mention of a victim, or an injury to anyone.

Paragraph 24 of the document states, in part:
“Some purchasers [of Liberty Dollar coins] knowingly and willingly accept the Liberty Dollar currency as change. Other purchasers however [sic] do not know that have have been provided Liberty Dollar currency as change for a purchase because the Liberty Dollar currency appears to be official U.S. currency. Thus, in this instance, the unknowing customer has been provided coinage which cannot legally be used as U.S. currency, nor can it be deposited into the U.S. banking system because it is not U.S. currency.”
If there are “some” people anguished over receiving constitutionally legal currency – such as silver coins – as change for a purchase made in constitutionally spurious currency – Federal Reserve Notes or officially minted pig-metal slugs, or legally negotiable instruments denominated in the same – why is not at least one of them mentioned here as a plaintiff in a criminal fraud prosecution?

One suspects that the Feds either were unable to find someone suitably distressed to find real money in his change, or that they did not even bother to look for someone of that description.

Paragraph 28 of the indictment mentions a statement issued by the United States Mint, one of the Federal Reserve System’s key partners in crime, “warning ... American citizens that the Liberty Dollar was ‘not legal tender.’”

This is true. It is also irrelevant. The Liberty Dollar was never advertised as legal tender – meaning a form of state-issued currency that people are required by “law” to accept. It was circulated on the principles of barter, used only where both parties to a transaction would be satisfied. Generally, people were delighted to receive real money in payment for a sale rather than the Regime’s dull and useless counterfeit, and where merchants were not interested in the Liberty Dollar, none was forced upon them.

“Legal tender” laws testify to the fraudulent nature of an official currency, since the state forces people to accept it. The Liberty Dollar – which, unlike the Regime’s ersatz issuance, had innate value – required no such compulsion in order to win acceptance.

Ryan’s indictment (paragraph 33) takes a limp-wristed stab at establishing a legal basis for protecting the monopoly enjoyed by the fraudulent FRN (Federal Reserve Note):

“Article I, section 8, clause 5 of the United States Constitution delegates to Congress the power to coin Money and to regulate the value thereof. This power was delegated to Congress in order to establish and preserve a uniform standard of value. Along with the power to coin money, Congress has the concurrent power to restrain the circulation of money which is not issued under its own authority in order to protect and preserve the constitutional currency for the benefit of the nation. Thus, it is a violation of the law for private coin systems to compete with the official coinage of the United States.”

Even though he is too dishonest to acknowledge it (and, most likely, too dim-witted to understand), Ryan has done something ironically worthwhile: Apart from his unwarranted assertion that Congress has the authority to “restrain” the circulation of money (since it is not mentioned by the Constitution, that power does not exist), Ryan has drawn up an article of indictment that applies perfectly to the Federal Reserve System, a private entity issuing a spurious, unconstitutional currency that has all but destroyed the value of the dollar.

Those truths are neatly inverted by being filtered through the prism of the indictment’s next lie:
“In accordance with the U.S. Constitution, Federal Reserve Notes (FRNs), obligations, and securities of the United States which are issued by the U.S. Bureau of Engraving and Printing, and coins which are issued by the U.S. Mint, are the current money of the United States.”
Had Ryan amputated the first six words from that statement, it would have been true, in a positivist sense. By invoking the authority of the Constitution, however, those words become patently false. Nothing in the Constitution authorizes Congress to alienate its power to coin money from gold and silver into the hands of a private cartel that issues its own spurious “money.”

Additionally, note how the indictment descibes FRNs together with federally issued “obligations” and “securities” as “money.” Apart from the fact that all of these instruments are issued by the government’s Bureau of Engraving and Printing, what do they have in common?

(Insert theme from Jeopardy here.)

The answer, which I will not phrase in the form of a question, is this: All of these forms of money are instruments of debt, rather than instruments of value. They are, in a word, I.O.U.s – pieces of paper promising that money will someday be paid. This means that they cannot be considered money themselves, no matter how loudly our rulers insist that they must.

But there is no money behind any of those I.O.U.s, and there has not been since August 15, 1971. The document we are told to call a “dollar” is backed only by the Regime’s force and fraud; the same is true of the dollar-denominated Treasury Bills it issues in order to fund its rapacity. (There was a time, incidentally, when Treasury Notes, like dollar bills in various denominations, were redeemable in gold or silver; see the examples on this page. [Large image of example here.])

Yet the indictment describes the production and circulation of gold and silver coins as “counterfeiting.” This makes as much sense as treating any form of mutually beneficial barter as criminal “fraud.”

I am also left to wonder just how far the Feds are willing to go in pursuing the premises of this prosecution: If it is a “crime” to offer and accept privately minted silver coins in private transactions, would it be a “crime” for a merchant to accept only pre-1965 U.S. coins, which were 90% silver in composition? I do not see how the former could be considered criminal, without the latter also being treated as such.

But then, of course, I strive to be honest and logical. Which means that I am not good enough for government “work.” Unlike, for example, Edward R. Ryan.

The foundation of the indictment is composed of sedimentary layers of inconsequential detail supporting not a single overt criminal act. It is a comprehensive description of a premeditated plot to provide something of value – gold and silver – to people who wanted it.

In defense of a criminal clique engaged in stealing what remains of our property and earnings, Ryan and his minions are trying to imprison at least four Liberty Dollar associates. They also seek to seize through “civil forfeiture” – that is, to steal – all of the company’s assets, wherever they are found – including, one presumes, from customers who bought gold, silver, platinum, and copper coins from the company.

Which means, I suppose, that in the most vulgar sense, It’s (All About) The Money, after all.


A Fund Where Sin Is In

In trying to do well Mutual Global Discovery Fund buys bad.

By the looks of it, Anne Gudefin’s international stock fund has the makings of an epic party. Six of her top ten holdings are booze or tobacco outfits, ranging from the distiller of Jameson Irish Whiskey to Japan’s biggest cigarette maker.

The wildest part is that Gudefin, a 42-year-old French native, did not set out to create a socially irresponsible fund. What she is after at $11.3 billion Mutual Global Discovery Fund is value. She defines that as companies with products whose prices are sturdy enough to sustain steady cash flows from operations and high dividends. Gudefin says a lot of sin stocks just happen to fit the bill.

“It might be badly perceived in the U.S. and western Europe, but these companies have incredible pricing power,” she says.

Unusual among funds that focus on dividends, Discovery is not big on utilities, which make up 2% of its portfolio. Governments exert too much say over their pricing, and there are no compelling restructuring stories in the sector, Gudefin says. Instead, half of Discovery’s equity holdings are in consumer goods, followed by financials at 17% and industrial materials at 10%. Geographically, the U.S. accounts for 12% of the fund, with France and the U.K. at 6% each.

The Franklin Templeton-distributed fund’s go-anywhere approach has served investors well lately. Concerned with lofty valuations for U.S. and western European banks, Gudefin began unloading them 29 months ago and moving into cash. The fund lost 27% last year, which was 17 percentage points ahead of the broad MSCI world stock index. It has outperformed the index in three of the last five years and is ahead by an average of eight percentage points annually during the past half-decade, according to Morningstar.

One big helper: cash, which composes half of Gudefin’s portfolio. She scoffs at the notion that this is contrary to the mission of a stock mutual fund or that it will cause Discovery to miss out on bargains.

“People were saying [late last year] when the market reached a low that this was a buying opportunity, but considering the outlook for earnings in general, I don’t think there are many screaming buys,” she says.

For a stock to be a buy in Gudefin’s eyes, a company needs a clear path to growth and pricing power. She likes Link, the first Hong Kong real estate investment trust, because it recently took over from sluggish government managers malls that are situated near transport hubs. To increase foot traffic, Link relocated restaurants that were stinking up higher floors. With patrons logging more mall time, the company has managed to raise rental rates 20% on prime commercial space. It also pays a 6% dividend.