Friday, September 26, 2008

How Safe Are Money Market Funds?

As you may have heard, the Federal Reserve has said that it will guarantee investors have in money market funds (MM) for the next 12 months. This was prompted by one of the largest and oldest money market funds ‘breaking the buck’ = i.e. the net asset value of the fund dropped from $1.00 per share to $0.97 per share last week. In the past, MMs have diligently maintained the net asset value at $1.00, even when they had to add their own funds. Due to this limited drop, many investors became concerned about the money they had invested in MMs and started withdrawing funds. To avoid a run on these account the Feds stepped in less than 24 hours later and issued the guarantee.

The question is: is this guarantee enough?

I am personally concerned that the ‘bail-out’ package now before Congress is being politicized by both sides of the aisle. I think much of the problem is caused by media-generated hysteria magnified by politicians on both sides during this election cycle. There is nonetheless a serious problem which demands action by our leaders. Government regulation is tricky: if too little, it doesn’t address the problems adequately; if too much they trigger the ‘Law of Unintended Consequences. ‘There are two dangers: 1) that delaying the bill beyond the end of the week will precipitate a liquidity freeze and market impact; and 2) by adding too many provisions to the bill will lessen the ability for the Fed to address the liquidity issue. Personally, I have more confidence in Paulsen, Bernanke, & Co. than in Congress.

Based on research Jason and I have done, I believe that Schwab is very sound, since they have avoided investing in sub-prime mortgages and related products. We have reviewed the holdings of the regular MMs offered by Schwab. They are well diversified and not exposed to the default risks other brokerages have taken on to increase yield. They will be participating in this new guarantee of MM funds offered by the Feds, as it will be funded by the brokerages who participate.

There are some unanswered questions, however.

How much of an investor’s deposits will be covered? We assume the minimum coverage will be $100,000, similar to FDIC coverage, but it may be more like $500,000 similar to current SIPC coverage (not gov’t. guaranteed).

Will this cover deposit by foreigners? Generally the Fed’s don’t guarantee funds of foreigners. If that is true, it may be expected that foreigners will withdraw funds from the MM funds which could trigger a run.

How much will be covered? Right now, there is $50 billion set aside to cover these guarantees. The problems is that the total amounts in MM funds is $3.5 trillion, so less than 2% is covered. It is likely that the bailout bill would give the Fed more flexibility, which is one reason for the urgency expressed by Bush and his economic advisors.

What are the alternatives for clients? Schwab offers a Treasury Money Market, which invests only in Treasuries. The current yield on this MM is 0.56% as compared to 2.04% on the regular money market.

The answers to these questions will be more clear once the bailout bill is worked out. For now our recommendation generally is that Schwab’s regular MM fund is suitable for our clients. However we are aware that a number of clients are very concerned about absolute safety, so the Treasury MM fund is recommended if you are losing sleep over the safety of your savings. Also, if you have over $100,000 in MM funds, we recommend you consider moving the amount you have in excess of $100,000 to the Treasury MM.

If you would like us to make a change in the money market in your account, please send an email to your Cambridge Team, and we will handle it for you. Also, let us know if you have any further questions regarding this.

Bert Whitehead, MBA, JD

Saturday, September 20, 2008

Holding Down the Fort When It's Raining Shoes

I started to write this update every day this week, and then another shoe or two would drop, so I keep starting over. Since this is a very fast-moving financial transition, I’ll strip this to the important details. Pam is also composing another email to all clients with a more general review of the situation.

Dangers: The biggest danger to clients individually is to panic. Mistakes of the past are unraveling, but this downturn is actually normal for a functioning economy with global growth. On average we have a recession every 5.5 years. We went through this in the 70’s with the S&L crisis, the market fell 25% in one day in the 1987, there was a real estate and international meltdown in 1992, then the dot-com bust in 2000-2002. Now, 5-6 years later, it’s time for another one. We have successfully survived financial upheaval before and we will survive this one.

For Wealth Management Clients, we are monitoring specific risks to your portfolio and acting when necessary. For example, when financial stocks are on the brink of collapse, we take discretionary action to sell them before they stop trading to assure that you will have a tax loss (if the bank goes into bankruptcy, you can’t take the loss until the stock is totally worthless which may be a couple of years). We have sold Fannie Mae stock, Lehman and Merrill Lynch in the past week in clients’ portfolios accordingly.

Other stocks, such as AIG and various money market funds, are being analyzed to determine what action is called for. At the current time, we are keeping Fannie and Freddie bonds in portfolios, as will as annuities, insurance, etc. held by AIG, and money market funds as it appears the feds are taking action to support these securities.

We are ‘watching your back’ continually, so you don’t have to worry about this, and we will continue to update you as needed.

Opportunities: We are generally recommending that clients with extra cash start Dollar-Cost-Averaging into the market. While we don’t know how low the market will drop, most assuredly we will look back in five years and recognize that today’s market was a terrific buying opportunity. It is not appropriate for all clients to be buying stocks now as individual situations may call for more liquidity (see below). Dollar-Cost-Averaging is overwhelmingly more profitable than trying to do market timing.

While US markets are down ~17% this year, international markets are down 25-30%, with virtually every country down over 25%. The Cambridge Global Growth Portfolio by comparison (down 18% YTD) demonstrates the advantages offered by FIM money management. The Cambridge Index Portfolio is tracking the US large-cap markets (such as the S&P 500) as they were designed to do. Unless there is a substantial market turnaround, we will likely have losses to reap which will carryover to future years

We are also cautioning clients in general to maintain liquidity by avoiding illiquid investments (e.g. real estate, partnerships, paying off mortgages, etc.). Because of the credit crisis, some banks are cancelling lines of credit and credit cards, not because the customer has been at fault, but because financial institutions themselves are having difficulty raising capital. We expect this will continue for the next 6-18 months and will advise clients on this individually.

Strengths: U.S. financial and economic foundations are strong, despite what the press says. Foreign markets in general have dropped twice as fast as ours as their economies adjust to new global realities. As Americans, we have unparalleled strengths in terms of education, innovation, and perhaps most importantly = experience. We have been through these crises before and have the leadership in economic matters (e.g. Paulsen, Bernanke, etc.) to respond appropriately. The solutions they have been implementing will not bankrupt the US – keep in mind we have had government intervention in the financial markets before, e.g. during the Great Depression, the RTC to buy assets of S&L’s in the 80’s, the loan to Chrysler in the past decade.

Of course it is a political football, which heightens public paranoia to attract votes. I don’t think that the politicians have a clue about these economic matters = interesting that no one on either side of the aisle saw this trainwreck coming a year ago! While our financial and economic leaders aren’t elected, they aren’t totally immune from political pressure. One of our society’s strengths is that we have very capable people in these key positions who are generally supported by both parties.

As your fee-only financial advisors, we are experience and knowledgeable, and know your personal situations. We have been planning for this possibility all along, which is why virtually all of our clients have US Treasuries in their portfolios to assure them of ample cash flow for 15 years. Interestingly, Treasuries have increased in value by a staggering 15.7% year to date during this market chaos as investors worldwide flock to them as the ultimate in safety. Yes, they have very low yields, but for this part of your portfolio, “Safety Trumps Yeild!”

Using Functional Asset Allocation concepts, you will also be in good shape to profit from the rebound. We do not sell off equity positions during market downturns, so when the market turns around, you will be poised to participate in the following prospertity. It is important to realize that market turn-arounds typically are leading indicators and begin 9-18 months before the economy starts to recover. Thus it is folly to try to guess when the market will shift: by the time you see the change in economic measures the market will have already bolted ahead.

We hope this update is helpful and comforting for you. If you have any questions please call us…we sell sleep, and if you’re losing sleep over this, we’re not doing our job!

Bert Whitehead, MBA, JD

Friday, September 12, 2008

Another Shoe Drops

The failure of Fannie Mae and Freddie Mac has resulted in an interesting bailout. Basically , the feds are now explicitly backing the bonds which Fannie and Freddie have issued, and throwing the shareholders under the bus.

Not to worry: none of our clients held any of their stock, at least in Schwab portfolios. If you have these stocks at another brokerage company you should call them. The shares dropped over 80% this week.

The feds actually had to back up the bonds because so many of them are held by foreigners, especially the Chinese, who were concerned about the safety of the bonds. Previously , the feds only provided an ‘implicit’ guarantee of the bonds. So to keep all the foreigners from dumping their bonds on the market, which would create major chaos, the feds have agreed to ‘explicitly’ guarantee the bonds.

We became wary of these agency bonds over five years ago, and have not purchased any for clients’ accounts. However, some clients have Fannie and Freddie bonds which were purchased earlier. With the ‘explicit’ guarantee, we are recommending that clients keep those bonds for now. There is a wide spread currently, which would mean a 10-20% loss if sold now, whereas the feds are on the hook for the full face amount if the bonds are held to maturity.

We will review this on an ongoing basis, and review your individual situation at your next appointment. At some point we expect that the spread will narrow enough to enable us to swap these bonds for treasuries, once the markets settle down.

If you have any questions about the current market situation, feel free to call your Cambridge Advisor. If you are in the Detroit area, you might be interested in a live seminar I am giving for PBS on Saturday, October 11 th , at their new Wixom facility. The seminar will address: “Yikes! What Do We Do Now?” Call Carrie if you want to attend = there is a $40 donation to PBS.

This is at least the third shoe to drop during this economic upheaval…how many feet do Financial Grinches have?

Bert Whitehead, MBA, JD