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Harry Newton's In Search of The Perfect Investment Newton's In Search Of The Perfect Investment. Technology Investor.

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8:30 AM EST, Wednesday, December 12, 2007: Yesterday, the Dow fell a hefty 294 points. You have two choices.

1. Commit suicide, now that the end of the world is at hand. Or,

2. ignore the pain. Keep living your life. Look for some "new bargains," e.g. Monsanto, BHP, Iron Mountain, Raytheon and some neat ETFs -- EWA (Australia), EZU (Europe), EWG (Germany) and EWC (Canada). Ditto for the Vanguard index funds I've talked endlessly about.

There are so many ETFs (index funds) out there that it's a serious waste of time to screw around with individual stocks. You can even use ETFs as part of your hedging strategy -- i.e. going short on some sectors, going long on others. And given how fast the world changes these days, hedging (and broad allocation) are the only way to go.

For example, I've written of my love for shorting an ETF called XLF. This ETF covers the financial sector. It's coming down nicely as the cockroaches in the financial sector increasingly pop out of the woodwork. Notice how quickly fashions have changed in the financial sector:

Here are my three favorite financial stocks -- Ambac, MBIA and Security Capital.

These three wonderful companies insure debt. They have a simple sales proposition: Pay me to insure your debt. You will pay less interest on your debt. Everyone will come out ahead. One of their longtime businesses is insuring muni bonds. If your town is worth only a single-A rating, go to these guys, pay them some money. Bingo your debt is now triple-A rated. That's what it means when you see insured muni bonds.

The first thing you should do today is to sell all your insured bonds (they were all up strongly yesterday after the Fed cut rates). You don't want to own bonds (or other debt instruments that are insured by the likes of these guys. I don't personally think we're going to see a wave of muni bond defaults -- but, on the other hand, you didn't buy muni bonds for the agony and the worry.

These financial insurance stocks have fallen not because they insured muni bonds, but because they insured CDOs (collateralized debt obligations) and SIVs (structured investment vehicles). And these things include subprime housing loans and a bunch of other loans about which little is known.

Remember, Wall Street is not in the long-term business any longer. They're in the product creation business for selling to someone else. The faster they can move their product to some other hapless person or institution, the less they have to worry about the quality of what they're selling.

There are hundreds of institutions who took the insurance as gospel and forgot to ask the question, "Does the insurance company have the money to pay me when things go awry?" Sadly, most also forgot to ask, What actually am I buying?"

Daily, we see financials discovering further writedowns, especially in subprime. Despite the gurus on CNBC arguing that the end of the writedowns is at hand, the end of the writedowns is not at hand. Simply because no one knows what they bought, whether the insurer has enough money to cough up the insurance money, etc.

Yesterday Bloomberg had a great piece:

Ambac, FGIC Commence Their Countdown to Armageddon: Commentary by Joe Mysak

Dec. 11 -- Buddy, can you spare a few billion?

That's the question the nation's bond insurers are asking after Moody's Investors Service put them on notice that it will conclude its analysis of the troubled business by Dec. 19. At stake are the insurers' AAA ratings. At stake is the future of the bond-insurance business.

In an update comment published Dec. 5, the rating company in a barrage of its usually tortured prose said that it saw FGIC Corp., Security Capital Assurance Ltd. and Ambac Financial Group Inc as ``somewhat likely to exhibit a capital shortfall.''

Of MBIA Inc., ``additional analysis of its direct RMBS portfolio leads Moody's to believe the guarantor is at greater risk of exhibiting a capital shortfall than previously communicated; we now consider this somewhat likely.'' RMBS means ``residential mortgage-backed securities'' for those not in the know.

The statement by Moody's really rocked the stock market, with MBIA falling 16 percent, while Ambac declined 8.9 percent.

The next day MBIA said it was ``pursuing capital contingency plans,'' and the stock rose $2 a share, as if saying it and doing it were the same thing. What did people expect the company to say? ``Sorry, gang, it looks like we're done''?

How Much?

On Sept. 25, you may recall, Moody's said that it expected ``a highly rated financial guarantor with a strong ongoing franchise would likely take whatever action is feasible to preserve its rating during times of stress.''

I presume here that Ambac, MBIA and FGIC (which isn't publicly traded) all consider themselves strong, ongoing franchises, which means they are all out there looking for money. They are looking for money, and lots of it, at a time when those who have it seem not particularly willing to part with it. MBIA, at least, found some, announcing yesterday that it would as much as $1 billion from private-equity firm Warburg Pincus LLC.

That's a nice start. How much do the insurers need? The answer seems to range in the billions to tens of billions of dollars. And of course the situation is pretty fluid. Have we seen the worst of the mortgage-market collapse, or are there more losses and write-offs to come? The news yesterday that UBS AG is going to write down some U.S. subprime mortgage investments by $10 billion suggests there is more pain brewing.

How much is the bond insurance franchise worth? Is it damaged beyond repair? At what point would a potential investor say, You know, this is a nice business, but I can use my $5 billion or $8 billion or $10 billion to set up my own new financial guarantor and not worry about the bad decisions these guys made?

Business Model

The funny thing -- if you can call anything about what's going on with the bond insurers right now funny -- is that the municipal bond market seems not to be especially concerned.

About half of all the new municipal bond issues sold in a given week are still being insured, and not just by FSA, the New York-based bond insurer that has so far avoided the subprime swoon, but by Ambac, MBIA and the rest of them.

In order for bond insurance to make sense, an issuer has to demonstrate that it is saving money by getting the insurance. If an issuer sells bonds at auction, the underwriter usually makes the decision and pays for the insurance.

In perilous times, logic dictates that the value of bond insurance goes up. Is that still the case with this bunch of insurers? Are investors still willing to accept lower yields in return for a AAA rating that may be downgraded to AA tomorrow?

Or are some of the insurers practically giving the stuff away, slashing premiums in order to stay in business, or to demonstrate that yes, it's all business as usual, don't worry about that iceberg.

As a potential investor, I would have to ask some serious questions about that business model.

Big Changes

Moody's says it will complete its review by next week. If, as it suspects, the insurers' capital falls below what a AAA rating demands, Moody's will then take a look at their ``capital remediation plans.'' Those plans, says the rating company, have to be ``reliable'' and ``credible'' and presumably take not longer than one quarter to put into effect.

Moody's assures us all it will ``communicate further with the market,'' when it is done; either with an affirmation or a real bombshell.

Look for big changes at the bond insurers no matter what. If someone rides to the rescue, that someone is going to insist on significant restructuring. Got your resumes ready?

(Joe Mysak is a Bloomberg News columnist. The opinions expressed are his own.)

Terrible news on Christmas from Washington
There will be no nativity scene in Washington, D.C. this year.

Despite extensive searching, residents have not been able to find three wise men and a virgin in the nation's capitol.

There is a modicum of good news: They have been able to find more than sufficient asses to fill the entire stable, and the surrounding states of Maryland and Virginia.

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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