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9:00 AM EST Thursday, April 10, 2008: I've been reading a bunch of macro economic reports -- high-level overview statistics. They're depressing. Jobs lost. Dollar declining. Huge and growing government deficits. Corporate earnings stagnant (with occasional exceptions). Cost of living skyrocketing (fuel, food, healthcare). Pessimistic consumers. Pessimistic CEOs. And a declining stockmarket (particular gruesome in tech stocks). The whole megillah.

Then there are the company reports. We're moving into earnings season. It looks brutal, with only occasional glimmers in agriculture, mining and oil services. (Oil is now over $110.) Hence my continued recommendations -- gold (GLD), silver (SLV) and Australian mining stocks like BHP and Rio Tinto (and other smaller ones I've mentioned before).

The worst part of all this is what the Credit Crunch is doing to the economy. Lenders are not lending. Borrowers are not borrowing. And without money, they're not building, expanding and in some cases, even surviving. (This is obviously too harsh. But I'm making a point. Stick with me.)

Wall Street used to have two businesses -- investment banking and helping its clients make money. Note, I said "used to." In recent years, Wall Street has figured the way to make serious money is to gamble. This chart sums it all. Look at Bear Stearns (pre-collapse). It borrowed $30 for every $1 it had. .

Gross leverage ratio
Bear Stearns
29.9 to 1
Lehman Brothers
30.2 to 1
Morgan Stanley
32.2 to 1
Goldman Sachs
24.5 to 1
Merrill Lynch
23.2 to 1
Source: November, 2007 Conde Nast Portfolio Magazine

Think about what that means for little old you and me. We invest $3, borrow $90 and buy $93 of a surefire stock. One horrible day in the stockmarket (like the ones we've been having recently) our surefire stock drops $3 -- or 3.23%. Bingo, we've wiped out our entire net worth and we're broke. Stony broke. Now imagine it drops $4. Not only are we broke, but we owe $1. Fortunately, if you're Bear Stearns, the Federal Government (using your and my tax dollars) will step in and save you. If you're you and me, you'll stew for the rest of your life in debtors prison on some godforsaken island.

Who in their right mind would borrow thirty times their net worth only to invest it in some surefire thing? And Wall Street has the chutzpah to lecture me on risk management!

You think I'm crazy? I now want you to read this piece from April 14 BusinessWeek. If this doesn't make your hair stand on end, keep reading. I have another surprise below.

Death of a Bond Insurer

Wall Street used ACA to hide loads of subprime risk. It worked—until the tiny company collapsed

Here's another secret behind the mortgage mess: It turns out that Wall Street generally didn't buy insurance on subprime bonds to protect against default. Instead, many big banks used the policies to play one set of accounting rules against another.

The results of the game were bigger profits for banks, more money to continue cranking out securities built on risky subprime mortgages, and far less clarity about the banks' true exposure to the toxic investments. The mess left by insurer ACA Financial Guaranty (ACAH), which collapsed in December, is now revealing just how critical the bond insurers' role was in the mortgage market. In essence, ACA and the rest of the industry helped spur the boom to new heights, extending it far beyond its natural end point.

For years the bond insurers operated in relative obscurity. They mostly sold guarantees on basic municipal debt, paying out claims in the rare case a bond defaulted. But as competition increased, companies moved into more exotic products with bigger profits, including the risky securities known as collateralized debt obligations that invested in subprime loans and other assets. ACA—the fledgling outfit that got a new lease on life back in 2004 from an investment by Bear Stearns—took it to extremes. By 2007 CDOs and other types of exotic securities accounted for 90% of its portfolio, compared with 36% for MBIA, the nation's largest bond insurer.

With such an outsize exposure to hazardous debt, tiny ACA has become a focal point for the frenzy surrounding the bond insurers, which together guaranteed more than $800 billion in complex securities, including subprime assets. ACA's implosion in December sent shock waves across the market and forced big banks to take $6billion in losses. Regulators, in turn, feared that other insurers would suffer similar fates, triggering more losses and aggravating the credit crunch.

Today, ACA lies in ruins, its business under the watch of Maryland state insurance regulators. But the story of its rise and fall sheds much light on a little-known industry that continues to cause concern among regulators, investors, and rating agencies. A BusinessWeek analysis reveals the insurers' guarantees turned out to be little more than a subprime shell game, one that has prompted at least one lawsuit so far. ACA declined to comment.

Initially, the insurance promoted confidence among regulators. The deals appeared to be another way to spread the risk that borrowers would default on the underlying mortgages. It was the sort of rationalization that encouraged a host of bad lending decisions all along the mortgage food chain. "If the insurers weren't there, you would have questioned [CDOs] a lot more," says Nicolas Vassalli, managing director at hedge fund firm Structured Portfolio Management.

In retrospect, the bond policies only masked the inevitable subprime stink, until it became too overwhelming by late 2007. In November, ACA's parent company reported $1 billion in losses for the third quarter. Standard & Poor's (MHC) put the insurer under review, slashing its credit rating from A to CCC a month later. The downgrade forced the insurer to come up with more collateral to show it could pay potential claims, under the terms of its agreements with banks. ACA didn't have the funds to make good on those deals, prompting Merrill Lynch (MER), UBS, CIBC (CM), Australia & New Zealand Banking Group, and other clients to take big losses on the policies. Australia & New Zealand Bank said its bonds remain solid, even without insurance. UBS and CIBC declined to comment.

What's more, Wall Street may face a fresh round of losses. That's because ACA also insured $43 billion worth of securities backed by risky corporate loans and bonds, like the ones used to fund the flurry of buyouts in recent years. Those investments could be the next in line to sour, a turn made more likely by the weak state of the economy. If those securities go bad, banks would have to take more writedowns, squeezing the credit markets even further.

ACA barely figured on the financial scene four years ago. The company, which was called American Capital Access when it was founded in 1997 by a former executive of credit-rating agency Fitch Ratings, searched in vain for a profitable niche. For years ACA largely wrote insurance on low-rated municipal bonds for projects like nursing homes and Native American casinos.

After taking losses from troubled mobile home bonds, it scrambled to raise more capital through an initial public offering in 2004. But the insurer had to abort the plan when it came to light that then-CEO Michael Satz had a lingering personal income tax issue from a previous job. Bear Stearns seized on the opportunity, stepping in to buy roughly one-third of the insurer for $105 million. The bank then installed one of its own executives as chairman and hired Alan S. Roseman, a bond insurance veteran, as chief. Almost immediately, Roseman began to push ACA into CDO insurance, an area his predecessor, Satz, had only begun to explore.

Why would banks buy insurance on AAA securities, especially from ACA, which had only an A rating? That would be akin to homeowners at the top of the hill purchasing flood insurance from a company at the side of a river. If a flood did happen, the insurer wouldn't be around to pay any claims.

The explanation lies in the complexities of accounting rules. Both banks and insurance companies report earnings to investors under what's known as generally accepted accounting principles (GAAP). But insurers also follow another set of guidelines, used by state insurance regulators and applied in key areas by credit-rating agencies.

In the case of CDO insurance—technically called credit default swaps—part of the appeal lies in the differences between the two accounting regimes. GAAP tends to require companies to value securities at prices in the market. Under those so-called mark-to-market rules, banks have to report losses on the investments each quarter even if they're only on paper. Insurance rules, by comparison, make firms only declare losses if it looks as if the bond is permanently damaged and they'll have to pay a claim.

Insurance turned out to be a sort of accounting arbitrage, allowing banks to take advantage of that different set of rules. By using it, they could offload the price risk to insurers' books to avoid suffering a hit to earnings if the bonds dropped in value. "Bond insurance was an accounting strategy," says former ACA chief Satz, now the founder of an online startup called BarterQuest. "It reduced banks' mark-to-market worries."

Insurance offered banks another advantage: It allowed them to execute what's known as a negative-basis trade, a strategy that essentially lets banks book profits on CDOs up front, even though they haven't collected the money yet and might never do so.

Here's how it worked: Say a bank bought a security that paid an interest rate that was 0.5 percentage points above a benchmark rate. Then it went out and purchased insurance on the bond that cost 0.2 percentage points above a benchmark rate. After doing so, the bank could book the difference between the interest payments and the insurance premiums, the 0.3-point spread, across the life of the bond—usually 5 to 10 years. Banks recorded those illusory profits in the quarter they took out the insurance.

Overall, the deals boosted banks' profits and reduced the amount of capital they had to set aside on their books for the securities. That freed up money for banks to funnel back into subprime securities. Merrill, which churned out more CDOs than any other Wall Street firm during the last two years of the boom, was a big ACA client. "It's another example of the moral hazard that people behave differently when they have insurance," says Frank Partnoy, a former Wall Street derivatives trader who is now a professor at the University of San Diego School of Law. "The banks kept making CDOs because they had the ability to hedge with insurance."

As players like Merrill rushed to do deals in the final months of the mortgage binge, they began to take out multiple insurance policies from different vendors for the same CDO pool. For example, according to industry sources, Merrill purchased guarantees in 2007 from both MBIA and ACA on pieces of a $1.5billion CDO called Forge ABS High Grade I, one of Merrill biggest's deals. At least seven other Merrill CDOs from that year were insured by different companies.

In doing so, Merrill and other banks created yet another set of entanglements, giving an increasing number of players a stake in the fate of a single CDO. Those interconnected relationships are the subject of recent lawsuits between Merrill Lynch and another bond insurer the bank used, Security Capital Assurance. "Merrill Lynch aggressively marketed [pieces of its] CDOs up and down Wall Street...desperate to get these off its books," the insurer says in a Mar. 31 counterclaim. The suit also quotes an e-mail from a Merrill salesperson that calls the insurance "a very nice deal and a big help to [Merrill]." Merrill, which is suing SCA over a contract dispute, says the counterclaim is without merit and "makes assumptions that are very simply wrong."

The insurance deals made everyone happy at first. Fees from the complex investments ran high for risks that seemed remote. The debt ACA guaranteed was the cream of the crop, with top-quality, AAA ratings that signaled the bonds would rarely, if ever, stop making payments. In fact, the bonds were designed to make their regular interest payments even if the underlying loans lost 30% to 50% of their value. "Most people saw this as a risk-free business," says Christopher Whalen, managing director of consultancy Institutional Risk Analytics.

ACA ramped up its coverage of CDOs to the very end. It was practically the only type of insurance the firm sold in 2006; that year, ACA wrote $25 billion of coverage on CDOs, compared with $1 billion on munis. Nearly a third of its total CDO portfolio had the taint of subprime.

When the credit market began to retreat, ACA charged ahead. In the first six months of 2007, ACA wrote $22 billion of insurance on CDOs, nearly double the amount in the same period a year earlier. Roseman remained undaunted, even after the bankruptcy of two Bear Stearns hedge funds sparked a global credit crisis last summer: "We're looking pretty positively on structured credit throughout the remainder of the year," Roseman said in an Aug. 1 conference call. "Pricing opportunities have expanded dramatically."

But as mortgage delinquencies mounted, the accounting arbitrage began to grow poisonous for ACA. By insurance industry standards, ACA showed a $20 million gain in the first half of 2007 as well as the third quarter of that year. The earnings statements of ACA's parent company, which reports to shareholders under GAAP, told an entirely different story. Those losses hit $82 million in the first half and totaled $1 billion in the third quarter.

The last remnants of the accounting illusion vanished on Dec. 19. That day, nearly a year after the housing downturn began, S&P cut ACA's credit rating. The losses from subprime securities, which once seemed to be only market gyrations, had become inevitable by S&P's standards. The insurer is currently on life support, alive only through the concessions of its clients, who have not enforced the terms of the deals and forced the insurer to cough up more money. The banks have given ACA a reprieve through Apr. 23 while they reassess whether to pull the plug.

The ARPS disaster. $360 billion is tied up in failed auction rate securities. That's more than three times the economic boost Congress is about to send us to save the economy. On my web site,, I've asked people for stories of how their locked-up monies are affecting their lives. I've received dozens of emails. Most repeat a familiar story: They asked their broker for an ultra-safe, cash-like place to temporarily store their money. Brokers lied to them and dumped them into ARPS. And their now locked-up monies are now affecting their ability to buy a new house, a new business, expand the existing one, etc. I've received dozens of stories. The most heartbreaking came in this morning:


Thank you for your web site.

I am a single women who by good fortune was able to purchase a home 10 years ago with money from my mother's estate. I have worked in the non profit sector my whole professional life - in service to others. I sold my home in 2007 because I was getting nervous about the economy and as a single woman wanted to be cash strong and debt free. I made a very nice gain on the house and put the cash with Wachovia -- all the money I have and it truly was/is my financial future and retirement. I wanted to buy a new house with cash and have no mortgage, so I put the money with Wachovia while I looked for a house.

I specifically and strongly told the brokers that I wanted the money to be in cash only, money market. Seven days after I had placed my money at Wachovia I got a call. "You have a lot of cash and I can get you a better interest rate and the only difference is you just have to give me up to 7 days notice to access the cash" I was repeatedly assured that this was a totally safe, totally cash placement with the only differences being a slightly higher interest rate and 7 day notice.

I never gave my brokers ANY other information except SAFE, CASH, ACCESSIBLE. I never was informed of ARPS, auctions, put options, and the potential of failed auctions. Does this sound familiar? I repeatedly asked the broker if this was cash, as I only wanted cash with total safety of the principal. Well, as you know I was not in cash I was in ARPS. Yes,my statements said I was in Short Term Preferred (that is Wachovia's justification for not doing anything). I thought it meant a money market like CD. I am not the professional - I thought they were but I was very wrong.

It is interesting that you congratulate Wachovia as I have received nothing but double talk, denial and silence from the branch manager I am involved with and their corporate attorney. I filed a formal complaint and Wachovia's attorney who just let me know (without interviewing me - just the branch manager and brokers) that the brokers did nothing wrong and it was all because the market collapsed without any ability of the brokers to predict the failures and my statements said Short Term Preferred so Wachovia's judgment is that it was beyond their control and my statement showed Short Term Preferred - too bad so sad for me.

In December I retired from non profit work to go back to school for a teaching degree. So, as far as your question goes here is what I have stopped doing and have given up beside being in a constant state of panic especially with a tax bill due by the 15th (what a joke huh - I have to pay capital gains on money I can't access!) So here is what I have given up or stopped doing:

+ I have canceled my land line phone
+ I have stopped going out to eat ( I have gone out to eat 1 times since February 22nd it is now April 9th)
+ I have not bought a book, a piece of clothing or any other non essential item
+ I have canceled by golf membership
+ I canceled a medical procedure because I did not want to spend the $100 copay
+ I canceled a large week long vacation to celebrate my 50th birthday
+ I am seriously considering whether I can continue with my graduate school work (I will have to make that decision by the end of April)
+ I am not going to the movies
+ I keep all of my lights off as much as possible to save on electricity, I literally use candles more than the lights
+ I was in the market for buying a home but have stopped looking
+ I was in the market to buy a new car but have stopped looking
+ I have cut back on driving and only drive when I absolutely must
+ I have cut back on food and only buy what I need to survive (vegetables, dairy etc). I have cut my food bill by 40% since February
+ I have moved out of a paid storage unit and am now storing my belongings temporarily in a friend's garage
+ I have stopped buying family/friends presents and only get cards
+ I changed my hair cutting place (3 years going to the same person) to go some much cheaper and I go only 1x every 2 months
+ I stopped going to the chiropractor (I have a bad back from a sports injury)
+ I stopped getting weekly massages (I have a bad back from a sports injury)

Basically my life has stopped! I do nothing except the minimum to survive. I just want my life back - thanks for everything that you are doing. It is the only place I have found any real hope or help.

How to download a YouTube video: This is the dumbest thing. YouTube don't want you to download their videos to show to your friends. They want you to send them the URL address and make your friends watch it on YouTube's web site. Dumb. You'll find a zillion"video download" software on the Internet. But none works. Except... Harry to the rescue ... Go to TechCrunch, drop the YouTube address in and hit Get Video. It will drop the video onto your hard drive. You then add the extension .FLV onto the end of the file's name and use a video player program called VLC Media Player.

This system doesn't work for other video sites. I'm still looking. Anyone got any ideas?

No tell
A patriotic man was boasting about his sister who disguised herself as a man and joined the Marines.

"But wait a minute," his friend interrupted, "She will have to dress with the boys and shower the boys."

"Sure," the man admitted."

"Well, won't they find out?"

The man shrugged, "Who'll tell?"

The best insurance company
Two old ladies are sitting on the porch at the old folk's home. One turned to the other and asked "Martha, you were married a long time, did you and your husband have mutual orgasm?"

The other little old lady sat and rocked for a minute and said, "No, no, I think we had State Farm."

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads on this site. Thus I cannot endorse, though some look interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Michael's business school tuition. Read more about Google AdSense, click here and here.

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