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8:30 AM EST, Monday, August 27, 2007: In 1966 when I announced I was leaving Australia to study in the U.S, my boss said, "You'll love the Americans. They're just like you. They substitute enthusiasm for intelligence." At first, I thought that was a profound insult. A belittling statement motivated by jealousy (that I was going and he wasn't). But now I realize it was a profound compliment. We Americans (I'm one now) do things others don't. We go to the moon. We conquer the west. Enthusiasm is a defining characteristic of the American psyche. But enthusiasm bites us occasionally. It has let us define new financial instruments (from junk bonds to housing ARMs) and new financial measures (remember eyeballs in tech stocks) -- often without understanding the full extent of the risk. Years go by uneventfully. We consider ourselves geniuses. Then suddenly a Katrina comes along and all those years of handsome profits are wiped out and more.

You must read Michael's Lewis "In Nature's Casino," the cover story about disaster risk management in the weekend's New York Times Magazine. For your second read...

Where's Waldo? Where's W? Bill Gross, director of Pimco, is perhaps the most successful bond investor of this generation. He has often been referred to as "the Warren Buffett of the bond world". Gross manages the Pimco Total Return bond fund, which has had an average gain of around 6.07% for the past ten years. He's remarkably good with equities also. He called for a 5% to 10% pullback in equity markets just before the pullback. Here's his latest piece:

During times of market turmoil it helps to simplify and get basic explain things to a public and even yourself in terms of what can be easily understood. Goodness knows it's not a piece of cake for anyone over 40 these days to understand the maze of financial structures that now appear to be unwinding. They were created by youthful financial engineers trained to exploit cheap money and leverage who showed no fear and who have, until the last few weeks, never known the sting of the markets lash. They are wizards of complexity. I, however, having just turned 63, am a professor of simplicity.

So forgive my perhaps unsophisticated explanation to follow of how the subprime crisis crossed the borders of mortgage finance to swiftly infect global capital markets. What Citigroup's Chuck Prince, the Fed's Ben Bernanke, Treasury Secretary Hank Paulson, and a host of other sophisticates should have known is that the bond and stock market problem is the same one puzzle players confront during a game of Where's Waldo?

Waldo in this case being the bad loans and defaulting subprime paper of the U.S. mortgage market. While market analysts can guesstimate how many Waldos might actually show their face over the next few years, 100 to 200 billion dollars worth is a reasonable estimate no one really knows where they are hidden.

First believed to be confined to Bear Stearns hedge funds and their proxies, Waldos have been popping up with regularity in seemingly staid institutions such as German and French Banks that have necessitated state-sanctioned bailouts reminiscent of the Long Term Capital Management Crisis of 1998. IKB, a German bank, and BNP Paribas, its French counterpart, both encountered subprime meltdowns on either their own balance sheet or investment funds sponsored by them. Their combined assets total billions although their Waldos are yet to be computed or even found.

Those looking for clues to the extent of the spreading fungus should understand that there really is no comprehensive data to allow anyone to know how many subprimes actually rest in individual institutional portfolios. Regulators have been absent from the game, and information release has been left in the hands of individual institutions, some of whom have compounded the uncertainty with comments about volatile market conditions unequaled during the lifetime of their careers. And too, many institutions including pension funds and insurance companies, argue that accounting rules allow them to mark subprime derivatives at cost. Defaulting exposure therefore, can hibernate for many months before its true value is revealed to investors and importantly, to other lenders.

The significance of proper disclosure is, in effect, the key to the current crisis. Financial institutions lend trillions of dollars, euros, pounds, and yen to and amongst each other. In the U.S., for instance, the Fed lends to banks, which lend to prime brokers such as Goldman Sachs and Morgan Stanley which lend to hedge funds, and so on.

The food chain in this case is not one of predator feasting on prey, but a symbiotic credit extension, always for profit, but never without trust and belief that their money will be repaid upon contractual demand. When no one really knows where and how many Waldos there are, the trust breaks down, and money is figuratively stuffed in Wall Street and London mattresses as opposed to extended into the increasingly desperate hands of hedge funds and similarly levered financial conduits.

These structures in turn are experiencing runs from depositors and lenders exposed to asset price declines of unexpected proportions. In such an environment, markets become incredibly volatile as more and more financial institutions reach their risk limits at the same time. Waldo morphs and becomes a man with a thousand faces. All assets with the exception of U.S. Treasuries look suspiciously like every other. They're all Waldos now.

The past few weeks have exposed a giant crack in modern financial architecture, created by youthful wizards and endorsed as a diversifying positive by central bankers present and past. While the newborn derivatives may hedge individual institutional and sector risk, they cannot eliminate the Waldos. In fact, the inherent leverage that accompanies derivative creation may foster systemic risk when information is unavailable or delayed in its release. Nothing within the current marketplace allows for the hedging of liquidity risk and that is the problem at the moment. Only the central banks can solve this puzzle with their own liquidity infusions and perhaps a series of rate cuts. The markets stand by with apprehension.

But should markets be stabilized, the fundamental question facing policy makers becomes, what to do about the housing market? Granted a certain dose of market discipline in the form of lower prices might be healthy, but market forecasters currently project over two million defaults before this current cycle is complete. The resultant impact on housing prices is likely to be close to -10%, an asset deflation in the U.S. never seen since the Great Depression.

Granted, stock markets have periodically retreated by significantly more, but stocks have never been the savings nest egg for a majority of Americans. 70% of American households are homeowners, and now many of those that bought homes in 2005-2007 stand a good chance of resembling passengers on the Poseidon upside down with negative equity. A 10% hook in national home prices is serious business indeed. It's little wonder that Fed, Treasury, and Congressional leaders are shifting into high gear.

Housing prices could probably be supported by substantial cuts in short-term interest rates, but even cuts of 200-300 basis points by the Fed would not avert a built-in upward adjustment of ARM interest rates, nor would it guarantee that the private mortgage market flush with fears of depreciating collateral would follow the Fed down in terms of 15-30 year mortgage yields and relaxed lending standards.

Additionally, cuts of such magnitude would almost guarantee a resurgence of speculative investment via hedge funds and levered conduits which have proved to be the Achilles heel of the current crisis. Secretary Paulson might also have a bone to pick with this Bernanke housing put since it more than likely would weaken the dollar, even produce a run which would threaten the long-term reserve status of greenbacks and the ongoing prosperity of the U.S. hegemon.

The ultimate solution, it seems to me, must not emanate from the bowels of Fed headquarters on Constitution Avenue, but from the West Wing of 1600 Pennsylvania Avenue. Fiscal, not monetary policy should be the preferred remedy, one scaling Rooseveltian proportions emblematic of the RFC, or perhaps to be more current, the RTC in the early 1990s when the government absorbed the bad debts of the failing savings and loan industry.

Why is it possible to rescue corrupt S&L buccaneers in the early 1990s and provide guidance to levered Wall Street investment bankers during the 1998 LTCM crisis, yet throw 2,000,000 homeowners to the wolves in 2007?

If we can bail out Chrysler, why can't we support the American homeowner? The time has come to acknowledge that there are precedents aplenty in the long and even recent history of American policy making. This rescue, which admittedly might bail out speculators who deserve much worse, would support millions of hard working Americans whose recent hours have become ones of frantic desperation.

And for those who would still have them eat some Wall Street cake as opposed to Midwest meat & potatoes (The Wall Street Journal editorial page suggested they should get darn good and used to renting once again) look at it this way: your stocks and risk-oriented levered investments will spring to life like the wild flowers in Death Valley after a flash flood.

And if you're a Republican office holder, you'd win a new constituency of voters almost homeless homeowners for generations to come.

Get with it Mr. President and Mr. Treasury Secretary. This is your moment to one-up Barney Frank and the Democrats. Reestablish not the RFC or the RTC, but create an RMC Reconstruction Mortgage Corporation. If not, make some modifications in the existing FHA program, long discarded as ineffective. Write some checks, bail em out, prevent a destructive housing deflation that Ben Bernanke is unable to do. After all W, youre the Decider, aren't you?

Check. Check. Check. The Internet looks so serious and so accurate. But it's rife with information that's flat-out wrong. Search engine About.com says that Bill Gross's Pimco Total Return bond fund had an average gain of around 8.3% for the past ten years. Yet Pimco's own papers show a 10-year return of 6.07%

Dumb me. On Friday I guessed that housing sales would be down. I was wrong. The figures were for July. I suspect they will be down in August. But they won't be out until September 27. My friend Dan Good emailed me:

You just can't help yourself. There is no percentage in giving out estimates. Gut feel doesn't work, even (and particularly) in Las Vegas.

In anticipation, I had shorted Toll Brothers. By the end of the day it rose slightly, buoyed by the slightly higher numbers (870,000 versus 820,000 forecast in the consensus). I continue to feel comfortable with the short. We haven't seen the end of this housing problem.

Hearing aids, part 3: Reader Stephen Allen writes.

Harry,
One of my dear friends is profoundly deaf, and has become quite an expert in hearing aids, so I thought I would share your news with him, and he answered, most prodigiously as follows:

When I first got 2 hearing aids about 13 years ago - one audiologist wanted $4,000 but my guy charged me $2,300 PLUS I know my guy will do his best to see me quick when problems develop - the other guy would probably "see me" within a week - not good enuf!!

For whatever it is worth, I am most partial to the Oticon brand for behind the ear units! Siemens is NOT the premium brand.

I'm not certain what style he is looking for so I wouldn't know what is best for him.

BUT, I hope he isn't buying a hearing aid based on appearance ... if he's as bad as me, he won't get enough power out of an in the ear unit - I require behind the ear style - hopefully one day technology will enable a more powerful in the canal unit which I can use ... vanity aside, if i could get the whole damned thing inside the ear canal, water and perspiration wouldn't be as much a problem.

If he isn't as bad as me, a super small behind the ear Oticon Delta might be an alternative. They are practically invisible.

It Is very difficult to buy digital hearing aids over the Internet as they have to be programmed and periodically adjusted by an Audiologist. Programming requires numerous hearing tests and appropriate programming software. I tend to doubt that an audiologist will have interest in programming a hearing aid purchased elsewhere!

Trust me when I say that equally important as price is having a good audiologist in close physical proximity who will see you promptly when problems develop ... And they do!!!!

If I have serious hearing aid problem, I will probably be in my audiologist's office the same day. This is nothing to be taken lightly, especially if you are as lost as I am without them! Plus he almost always has a loaner for me to use if my hearing aid has to be returned to factory. Also remember that ear molds have to be made for all hearing aids whether in canal or behind ear!

AND all hearing aids don't work the same - all hearing problems are not the same! Certain type hearing aids are better/worse for various problems.

In days before digital when all hearing aids were analog, and you adjusted sound with a volume wheel, they were more of a commodity item .... Not so much anymore as they have to be fitted and reprogrammed regularly.

All that said, I was following an eBay auction for a pair of similar aids to what I have .... Used digitals probably from a dead person .... They sold for $200 bucks ... I was going to buy to use as backups until I found out their max output was slightly less than I used in my better ear -- so they would have been little help for me.

But I checked with my Audiologist who knew I wasn't trying to bypass his business -- just buy myself backup units on the cheap - he said he would program them for me if I bought them!

Interesting, but he has yet to come up with a backup unit for me .... I keep telling him to let me know when one of his clients kicks, I'll approach the undertaker first!!!

Whilst watching the eBay aids, I was surprised to see some prices offered by a seller in Manhattan for new Delta hearing aids - listed in ad is a programming session, but no mention of earmolds or subsequent reprogramming .... Even though the pricing is $1,000+ less per aid, I wouldn't want to rely on a high volume seller 140 miles away!!

Neat Web site: SteepandCheap.com. One killer gear deal, one item at a time until it's gone.

Death and taxes:

"We have long had death and taxes as the two standards of inevitability. But there are those who believe that death is the preferable of the two. 'At least,' as one man said, 'there's one advantage about death; it doesn't get worse every time Congress meets.'" - Erwin N. Griswold

Construction dust:

Construction dust is like Congress. It's always irritating and never goes away. -- Dan Good

The US Open Tennis starts today: Here's the TV schedule. Many hours of great tennis.

Kids in Church:
3-year-old Reese: "Our Father, Who does art in heaven, Harold is His name. Amen."

A little boy was overheard praying: "Lord, if you can't make me a better boy, don't worry about it. I'm having a real good time like I am."

After the christening of his baby brother in church, Jason sobbed all the way home in the back seat of the car.
His father asked him three times what was wrong.
Finally, the boy replied, "That preacher said he wanted us brought up in a Christian home, and I wanted to stay with you guys.."

One particular four-year-old prayed, "And forgive us our trash baskets as we forgive those who put trash in our baskets."

A Sunday school teacher asked her children, "And why is it necessary to be quiet in church?"
One bright little girl replied, "Because people are sleeping."


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. Thus I cannot endorse any, though some look mighty 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 Claire's law school tuition. Read more about Google AdSense, click here and here.
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