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8:30 AM EST Wednesday, February 6, 2008: Yesterday Dow down by a whopping 370 points (2.9%); Nasdaq down by a whopping 3.1%; S&P 500 down by even more -- 3.2%. And Asian markets even worse -- 4% and 5%. I'm so pleased I told all my readers to get out and stay out! I don't know why it fell yesterday, just as I don't know why it rose last week. How difficult is this market? A very talented, and a very honest man runs a hedge fund which has risen a whopping 5,994% since its inception in 1995. He writes:

The fourth quarter of 2007 continued what has been one of the strangest and most difficult years for me. In August of 2007 several banks indicated there were significant problems with sub-prime mortgages and other risky loans. Very often in years when there are earnings disappointments, companies will announce them in September and October... We prepared for these earnings disappointments and a bear market by going net short in September and October. However, September 2007 was a solid month up ... and October saw the prices finish near their highs. ... December was a tough month. There we managed to lose money on the long and short side. ... One consultant told me in November 2007 that I sounded frustrated the same way I did throughout 2002. He was right: 2007 felt a lot like 2002. ... I would say that volatility in 2007 felt even greater than it did in 2002 and that 2007 was the year of incredible reversals. ...

As I write now, the US stockmarket is in a bear market and the economy likely is heading into a recession. We have been in this situation in the past and we do have a clear game plan for what to do. Our average position is a bit smaller and we adhere to our stopping positions even more tightly. ...What we are attempting to do is a bit like sailing a boat in a hurricane... I am not pleased with the performance in 2007 (i.e. 7%). In the end, our percentage return beat external benchmarks, but came nowhere close to the internal benchmark I set. My contract with you says I am allowed to charge a 1% management fee on assets and a 20% incentive fee on profits, but I cannot in good conscience charge these fees for 2007. For 2007, I have charged a 1/2% management fee and no incentive fee.

The financial crisis explained in simple English. My favorite financial writer, James Surowiecki, explains in the latest New Yorker magazine.

Bonds Unbound

If the ongoing turmoil in the world’s financial markets has made anything clear, it’s that the list of things that can go wrong in those markets is a very long one. Month after month, it seems, another potentially disastrous problem rises to the surface. The latest looming crisis is the possible implosion of a group of companies called monoline insurers. If you haven’t heard of monoline insurers, don’t worry: until recently, few people, even on Wall Street, were all that interested in them. Yet their problems have become a serious threat to global markets. Rumors that monoline insurers, like M.B.I.A. and Ambac, were in serious trouble helped spark the vast market selloff that prompted the Federal Reserve’s interest-rate cut two weeks ago, and, only a few days later, rumors of a government-orchestrated bailout of these companies set off a six-hundred-point rally in the Dow.

Monoline insurers do a straightforward job: they insure securities—guaranteeing, for instance, that if a bond defaults they’ll cover the interest and the principal. Historically, this was a fairly sleepy business; these companies got their start by insuring municipal bonds, which rarely default, and initially they confined themselves to bonds with relatively predictable risks, which were easy to put a price on. Unfortunately, a sleepy, straightforward business wasn’t good enough for the insurers. Like everyone else in recent years, they wanted to cash in on the housing and lending boom. In order to expand, they started insuring the complex securities that Wall Street created by packaging mortgages, including subprime ones, for investors. This was a lucrative business—M.B.I.A.’s revenues rose nearly a hundred and forty per cent between 2001 and 2006—but it rested on a false assumption: that the insurers knew how risky these securities really were. They didn’t. Instead, they gravely underestimated how likely the loans were to go bad, which meant that they didn’t charge enough for the insurance they were offering, and didn’t put away enough to cover the claims. They’re now on the hook for tens of billions of dollars in potential losses, and some estimates suggest that they’ll need more than a hundred billion to restore themselves to health.

Obviously, this is bad news for the insurers—at one point, M.B.I.A.’s and Ambac’s stock prices were down more than ninety per cent from their all-time highs—but it’s also very dangerous for credit markets as a whole. This is because of a peculiar feature of bond insurance: insurers’ credit ratings get automatically applied to any bond they insure. M.B.I.A. and Ambac have enjoyed the highest rating possible, AAA. As a result, any bond they insured, no matter how junky, became an AAA security, which meant access to more investors and a generally lower interest rate. The problem is that this process works in reverse, too. If the insurers lose their AAA ratings—credit agencies have made clear that both companies are at risk of this, and one agency has already downgraded Ambac to AA—then the bonds they’ve insured will lose their ratings as well, which will leave investors holding billions upon billions in assets worth a lot less than they thought. That’s why so many people on Wall Street are pushing for a bailout for the insurers. It may be an abandonment of free-market principles, but no one has ever accused the Street of putting principle above profit.

Normally when companies make bad decisions and fail to deliver value, it’s just their workers and investors who suffer. But monoline insurers’ desire to grab as much new business as they could, risks be damned, quickly radiated across global markets and will have huge consequences for millions of people who have never heard of M.B.I.A. or Ambac. The situation illustrates a fundamental paradox of today’s financial system: it’s bigger than ever, but terrible decisions by just a few companies—not even very big companies, at that—can make the entire edifice totter.

In that sense, the potential collapse of monoline insurers looks like a classic example of what the sociologist Charles Perrow called a “normal accident.” In examining disasters like the Challenger explosion and the near-meltdown at Three Mile Island, Perrow argued that while the events were unforeseeable they were also, in some sense, inevitable, because of the complexity and the interconnectedness of the systems involved. When you have systems with lots of moving parts, he said, some of them are bound to fail. And if they are tightly linked to one another—as in our current financial system—then the failure of just a few parts cascades through the system. In essence, the more complicated and intertwined the system is, the smaller the margin of safety.

Today, as financial markets become ever more complex, these kinds of unanticipated ripple effects are more common—think of the havoc wrought a couple of weeks ago when the activities of one rogue French trader came to light. In the past thirty years, thanks to the combination of globalization, deregulation, and the increase in computing power, we have seen an explosion in financial innovation. This innovation has had all kinds of benefits—making cheap capital available to companies and individuals who previously couldn’t get it, allowing risk to be more efficiently allocated, and widening the range of potential investments. On a day-to-day level, it may even have lowered volatility in the markets and helped make the real economy more stable. The problem is that these improvements have been accompanied by more frequent systemic breakdowns. It may be that investors accept periodic disasters as a price worth paying for the innovations of modern finance, but now is probably not the best time to ask them about it. ?

How the Microsoft bid for Yahoo! stacks: The bid makes zero sense. Steve Ballmer is no Bill Gates. He has none of Bill's intelligence, understanding or charm. He's a loudmouthed, uncouth hammer with zero accomplishments (except somehow getting in Gates' good books). Microsoft's stock will continue to fall. Google's stock will rise as it garners even more lucrative search business. I wouldn't gamble on Yahoo! stock. Ballmer may dumbly raise his bid. The man is pigheaded and rude.

Ask your friends two questions: Have they placed ads with Google and Yahoo! Which work?

The answer will not surprise you. Google works. Yahoo! doesn't.

When your cordless says "move closer," it's telling you it needs a new battery.

10 great free downloads for your network -- home or office. From Computerworld magazine. Click here.

I hesitated before I published this cartoon: I do now want to nag. But it;s true. Exercise keeps your body alive and your brain off the stockmarket.



Favorite spending of state money. From today's Bloomberg:

Feb. 6 (Bloomberg) -- Nasser didn't think much of Iran's Islamic regime -- until it paid for him to become a woman. Growing up in the city of Mashhad, Nasser knew he was different from the other boys, sneaking around in his aunt's skirts and experimenting with makeup. At age 14, he told his parents he wanted to have a sex change.

"I realized that I had a problem and that I needed to solve it through an operation,'' Nasser, now 18, says at a downtown Tehran clinic two days after he became a she called Hasti. "Even if lots of negative things are said about the regime, they also do things that are good.''

In Iran, where men and women are segregated, and homosexuality is punishable by death, the government plans to spend 6 billion rials ($647,000) this year to help pay for sex-change operations.

Makes sense to me. In all conscience, I admit I have a male friend who also became a female. The National Health in England paid for his operations. He/she has size 12 man's shoes. Feet that large on a woman look weird, but not a weird as I felt the first time I met her, after knowing him for all those years.

Stupid old person joke -- 1
An elderly couple had dinner at another couple's house, and after eating, the wives left the table and went into the kitchen.

The two gentlemen were talking, and one said, 'Last night we went out to a new restaurant and it was really great. I would recommend it very highly.'

The other man said, 'What is the name of the restaurant?'

The first man thought and thought and finally said, 'What is the name of that flower you give to someone you love? You know... The one that's red and has thorns.'

'Do you mean a rose?'

'Yes, that's the one,' replied the man. He then turned towards the kitchen and yelled, 'Rose, what's the name of that restaurant we went to last night?'

Stupid old person joke -- 2
Hospital regulations require a wheel chair for patients being discharged. However, while working as a student nurse, I found one elderly gentleman already dressed and sitting on the bed with a suitcase at his feet, who insisted he didn't need my help to leave the hospital.

After a chat about rules being rules, he reluctantly let me wheel him to the elevator.

On the way down I asked him if his wife was meeting him.

'I don't know,' he said. 'She's still upstairs in the bathroom changing out of her hospital gown.'

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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