While the details of the plan will be determined by Congress in the coming week, the proposed bailout mostly is developed around the Government purchasing mortgage backed securities from troubled financial institutions in an attempt to keep them afloat.  But there is one proposed provision that I find extremely beneficial to the everyday consumer and that is insurance on money-market funds.

Money-market funds basically serve as savings accounts (which are federal insured) but are actually comprised of investments, hence the word “funds.”  In wake of the complete dry up of the auction rate securities market, many investors are left wondering if money-market funds will be the next failed investment product.  These worries may be overblown, but are well warranted.  Our markets have seen a substantial amount of money being pulled out of money-market funds during the past week because investors were acting on their fears.  If money-market funds were to dry up, the effect on our economy and to individuals, is hard to fathom.  I’m very pleased to see the proposed bailout to include Federal insurance for money-market funds; this action will protect individual consumers in addition to restoring confidence in the markets.

We will continue to eye the bailout as it works its way through Congress next week and will report any specifics that will directly affect everyday consumers.  $

The president has recently signed into law a new overhauling housing measure designed to help the housing market by preventing future foreclosures as well as addressing the problems that helped spur the foreclosures.  A vital piece to this legislation is the creation of a new independent regulator for Fannie Mae and Freddie Mac, so why hire Morgan Stanley to essential be a risk regulator for the housing market?  Primarily a business focused on investments, I do not see a lot of specific experience Morgan Stanley brings to the table to justify the Treasury hiring them to do it’s own job.  Keep in mind, Morgan Stanley is task with keeping an eye on evaluating the risk of the GSE’s of which they and their customers are financially invested in.  Moreover, they weren’t so hot at evaluating their risks of the housing market previously as they are currently writing down billions of dollars in mortgage-related assets.

Lastly, Morgan Stanley is going to buy back billions of dollars to customers in the wake of the Auction Rate Securities (ARS) scandal, of which they mislead their investors into believing investing in the ARS market was as liquid as a money market fund.  Although they are settling this issue, don’t forget the fact this was fraud and although not being litigated, should be remembered as such.

Just so everyone has this straight, the U.S. Treasury Department has hired Morgan Stanley to advise them on the actions of the GSEs in relation to their threat to our economy as whole, with total disregard to the fact that:

• Newly enacted legislation has created a new regulator for the Fannie Mae and Freddie Mac

• Morgan Stanley is financial invested in the GSEs, which poses a huge conflict of interest

• Morgan Stanley has proven to not be up to the task of evaluating the risk GSE pose to our markets by writing down billions of dollars in mortgage-related assets – a clear sign that they aren’t capable of judging the true value of housing related risk
  

• Morgan Stanley had action taken against them for committing fraud by purposely misleading their investors to invest in unsuitable products

• Investment banks, like Morgan Stanley, have recently been granted access to the Fed’s discount lending window.  Meaning, if Morgan Stanley misjudges the GSEs and it cost them financially, they can just borrow from the Fed at a discount – not to mention they can now borrow to help pay for their ARS failures
  

Is it just me, or is something wrong with this picture?   It’s probably best to avoid such problems like our current housing market has, by not letting those that helped fuel the crisis help prevent another.  $

Those reaching retirement are starting to take large sums of money out of their current securities/savings and purchasing variable annuities to secure their retirement – the problem, fine print.  Variable Annuities are incredibly expensive; fees can total as much as 3.5% a year.  Remember, a fee of just 1% can reduce earnings by 17% over a twenty year period.  In addition, if a variable annuity holder decides to liquidate their entire policy, they will be faced with high surrender charge around 6-7% of the entire policy.  As you can see, the insurance against terrible markets is extremely costly.

There is a major problem with this current setup of variable annuities – how can the insurance companies guarantee returns?  As the number of dollars keeps flowing into this relatively new market, the number of dollars needed to make these guaranteed minimum payments also increases.  If the current market were to double, triple or quadruple in size, I’m not so sure the insurance companies would be capitalized enough to withstand a bear market.  In other words, if the investments the insurance companies make with our initial buy in don’t meet their original expectations, there could be a lot of retirees waiting for their money.

The parallels to our recent auction rate securities markets and subprime problems share scary similarities to the growing variable annuities market.  If these insurance companies don’t properly evaluate and handle their risks, we could have a repeat performance of our current market.  With the variable annuity market being relatively new, there isn’t a strong track record of success and or failures.  Nobody really knows how well the industry will hold up.  Is it possible this insurance against bad markets is too good to be true?  Only time will tell, only this time I hope our regulators can keep pace. $

As we all sit around, glued to our bank accounts, waiting for our stimulus check, the country is hurdling towards an unknown that won’t officially be settled until July. Once the magic “R” word comes out, I would imagine that there is going to be a new shock to the system as a whole. Thats going to happen even without considering when the monstrous ARS issue thats going to hit the federal government to the tune of about $330 billion dollars.

It brings up another important issue that millions of Americans are currently facing. What to do about their home. If you bought your house in the past 3 or 4 years and it has a jumbo loan or more amount on it, then you are probably seeking as much information as possible about what to do to remedy your situation. Let’s discuss some of your options and see what is out there that can help you…

Renegotiate
If you have an ARM and its about to reset, or you just got some bad terms, one option you might look into is simply calling your mortgage company and begin some discussion about reformatting your loan. Many times, they have done things that aren’t even legal anymore and you were grandfathered in and they are taking money unfairly. Granted its every buyers responsibility but it takes two to tango. Lenders should now be in the position of trying to appease their customers and bending over backwards to keep you. In theory, they should be more than willing to renegotiate your terms and have everyone come to a new agreement. In theory.

Refinance
A more specific goal in the renegotiation process, would be to refinance. But, you are thinking, Isn’t it too late? No. No it is not. Rates have never been lower and banks have never wanted your business this bad. I can only imagine that given the right circumstances, they would want to keep you in your house as long as possible because at least its consistent. And if you are still the owner, the probability of you trashing it on your way out is much lower. In addition to going back to your original lender and telling them the deal, shop around. Where one lender might have a crazy scheme that sounds like a fool proof plan, find out if that is best-practice. See if you can get hold of someone knowledgeable and that you trust and ask them about the terms of your new loan. Refinancing is little expensive but it beats selling right now. Its very similar to when you consolidate a credit card: one card company basically pays off all your debt and you owe a new group at, hopefully, a more favorable rate.

Government? Help?
So what is the US Government doing to help out these home owners? Well they are trying to do quite a bit. I am not going to muddy things up and start an endless, irrelevant discussion about my personal politics here in this venue so I will stick strictly to the facts. The Democrats have been cranking away on a bill that would rescue quite a few homeowners at risk of foreclosure. Their ultimate goal is to slow the rate of foreclosures and trying to do something about the “sliding of home prices.” Not only has Barney Frank (D-Mass, the author of the Bill) made every effort to appease the current administration, but there is a majority of Republicans that are in favor of it as well. Even Bernanke is a fan of it and would like to see it go through. But President Bush would not. In fact he has threatened to veto this Bill “if and when it reaches his desk.” The reasoning for him is that it would constitute a “bail-out.” Bear-Stearns got a $30 billion bail-out, why not the taxpayers and hard working people of America? “It would reward speculators and lenders,” is Bush’s reply. There must be another reason that we don’t know about. Without tipping my hand as to what side of the political fence I am on, thats all I have to say about that. I can see both sides of the aisle.
[UPDATE: The House officially passed the Mortgage Bill...Watch as Bush vetoes it.]

Selling
It boils down to a sludge. If none of the above options are available, then it still might be best to due what you can to increase your income and muscle through it. I think that option is better than selling. Selling right now just seems to difficult and too expensive. If you are having a local financial crunch, and have paid a small fortune already, and would end up selling at a loss, THEN on top of that paying a realtor 5% of your selling price…You have lost much more money than if you refi/reformatted OR got another job and scrimped through this mess. Its hard to say that selling is even a last resort at the moment. Give it a year and see what happens…

As we move ahead with this diabolical ARS issue, its becoming more and more clear to me that the way Americans might be best suited for investing is a little more robotic and a lot less emotional. At least on some level. I am guilty of making decisions within my portfolio that are less than admirable and some I am even embarrassed about. But I have also had a few times where I really nailed something and I have seen it pan out really well. This whole thought process is an evolution, at least, it seems that way as financial are so improperly addressed in formal education settings. This all became very well illustrated in a little blurb in Money Magazine that I would like to paraphrase and expound on for a few…

Print this list out and put it in a place that you see frequently on a daily basis:

1. Step out and you miss the point- Had you invested in an S&P 500 index in August 1997 and done nothing 10 years, you would have realized an 88% return. Had you missed just 20 days out of all of that, you would had a 20% loss. Market returns come in bursts. Be patient and weather the storm.

2. Remove your emotions- Invest automatically. Start with a small amount and have it automatically transfer. ING is doing it, Sharebuilder is doing it, and since they have merged, you can even get a deal on trade fees by doing both. Check with your bank, they all do it. If not, change banks because this has been around almost since money has been invented and if your bank doesn’t do it then they are doing something wrong and you should not have your money with them. Fire and forget and take a look in a few months and when you do, leave a comment here and tell us how surprised you are.

3. Focus your control- It is impossible to time or predict the market. There are about 300 million variables that you simply cannot account for. The one thing that you CAN control is fees and costs. Minimize them and do research so that you know you aren’t getting hosed. Assuming an 8% annual return, if you invest in an actively managed fund with a 1.5% expense ratio versus an index fund that charges 0.2%, you will give up almost 20% of your profits.

4. Give yourself a taste of power- Set aside a small portion of your investment monies, like 5% perhaps, and have that be diverted to the wild hunches you get. It will feed the craving of being rewarded (or punished, depending on who you talk to) and your gut feeling will be exercised without a huge blow to your whole portfolio.

5. Seek help- If you start jerking your money around every time the market flinches, get a pro to help you. You need advice and it will be cheaper for you in the long run to have a financial planner fee rather than taking your money out and you miss an opportunity when you should have been sitting tight.

These sound harsh and a little extreme but think about it…If you are cautious and take a good hard look at what you are putting your money in, you will be fine and it will all be worth it.

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Undeniably, the mortgage lending crisis has spilled over into our broader economy and is now affecting nearly everyone’s pockets. 401(k)’s, which undoubtedly hold many financial stocks, are taking a beating. Foreclosures are plaguing neighborhood property values and gas prices, mixed with a pinch of a declining federal funds rate, are raising the likelihood of drastic inflation. This perfect recipe for recession doesn’t stop here, starting in February, our under the radar market of Auction Rate Securities (ARS) began to freeze up and now many investors of all walks of life have started to panic.

Now, the investors are demanding answers, and regulators are starting to make noise. How could this happen? How could investments sold with the pitch of being safe and liquid suddenly freeze up? Why weren’t investors warned that this was a possibility and more importantly, why were these products sold to people without proper warning and disclosure.

While industry leaders, regulators, and Congress put their thinking caps on to think of a creative ways to pump some life into this dead market, it’s important for those with money tied up in these investments to understand what exactly these ARS are and what, if anything, can they do about it.

What is an Auction Rate Security (ARS)
An auction rate security is basically exactly what it sounds like, a debt instrument bought and sold through Dutch auctions. They consist of bonds sold by municipalities and mutual funds. They were intended to be long-term maturing securities with the “option” to sell to others at an auction. At these auctions, brokers would sell your shares to other investors, which would allow you to completely get our of the market and use your money for other purposes, like a down payment on a home.

Auction rate securities were so appealing to investors because they offered what appeared to be a very liquid investment that enjoyed returns that were higher than traditional money market funds. These “cash equivalent” investments, or so they were sold as, sound like a no brainer at the surface, which is why so many investors chose them. However, for the most part, ARS were sold to investors, not the other way around, without warnings of possible losses.

The problems began in early February when investors stopped bidding on these at auctions. Typically, when investors stopped bidding on ARS in the past, investment banks would swoop in and buy up the unsold securities, which kept the market liquid. However, major financial institutions currently find themselves strapped for cash, which stopped them from being this bidder of last resort. Although this is somewhat of an oversimplification, the market of ARS has frozen, simply because there are no buyers.

Some investors are selling their part in what is called the Secondary Market for ARS. In this secondary market, sellers are willing to sell their shares in between auctions to others at a discount. Meaning, they take a hit, just to get some of their money back.

What Can I Do, What Are My Options?
1) Your first option is to wait with hopes of eventually finding a buyer.
2) If your situation is more immediate you can call your state securities regulator and an investigation could start depending how the security was sold.
3) You can file a complaint with the Financial Industry Regulatory Authority (FINRA) or the Securities and Exchange Commission (SEC).

The Auction rate securities market is yet another sign that our markets have innovated further and faster than our oversight – leaving investors with little protection. Any product sold as something as safe as cash, had better be as safe as cash or the broker and the firm should be held responsible. Hopefully, our financial leaders find a way to give people confidence to buy into this market again and quickly. $

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