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8:30 AM EST Wednesday, January 23, 2008: "When in doubt, stay out." Also expressed as "Don't buy anything you don't understand." The first mantra is mine. The second is Warren Buffett's. They convey the same message. Now I want you to read this story and ask yourself three questions:

1. How could these idiots buy something without asking questions, without having the vaguest clue as to what they were buying?

2. Can Merrill Lynch actually get away with this nonsense?

3. What does this mean for me when I deal with brokers and investment bankers?

From The Wall Street Journal:

Springfield, Mass., Takes Aim at Merrill Over Subprime Losses

In November, officials in Springfield, Mass., got a rude surprise. One of their main investments had plunged in value by more than 90%.

The even bigger shock: This fund was stuffed with risky securities backed by subprime mortgages.

The investment's collapse is now at the heart of a bitter dispute between the city's financial adviser, Merrill Lynch & Co., and Springfield officials who say Merrill violated state law by not properly informing the city what it was buying.

Springfield's losses, because of the collapse in subprime-related debt, follow other hits taken by government-run funds around the country, from Florida to Montana. They underscore how cities and states are emerging as the most recent -- and some of the hardest-hit -- victims of the subprime-mortgage crisis.

"I believe Merrill Lynch is responsible and will be obliged, in the end, to restore the city's money," says Christopher Gabrieli, chairman of the Springfield Finance Control Board, which oversees the city's finances.

Mark Herr, a spokesman at Merrill, said "Springfield has raised these issues with us, and we are taking them very seriously."

At issue is Springfield's investment in a type of security known as collateralized debt obligations, which are pools of debt that include subprime mortgages. The city's stake in three CDOs, valued at $13.9 million as recently as July, plunged in value and are now valued at $1.2 million, according to Merrill's account statements.

The problem, Springfield officials say, is that Merrill fully informed them of the nature of the investment only months after the sales. In November, the firm sent Springfield a document describing the largest CDO, issued by Centre Square, a Cayman Islands-based company. That document revealed that some of the CDOs could be backed by subprime mortgages and might not be easy to sell.

Mr. Herr, the Merrill spokesman, said Springfield officials weren't given the CDO's prospectus last spring, during the sale of the CDOs, because Springfield had purchased them after the initial offering. Under those circumstances, "There was no requirement for a prospectus at the time of the purchase," he said.

The Springfield Finance Control Board argues that state law limits cities to investing in government securities or other safe, short-term and easily tradable investments. While the CDOs were triple-A-rated, they aren't necessarily easy to trade: If there are no buyers for them, then the CDO holder can be stuck with the securities for an extended period.

Some analysts say the brokerage firm shouldn't have sold the city the securities in the first place. "Merrill has to know its customers and sell them what's suitable and appropriate," says Janet Tavakoli, president of Tavakoli Structured Finance Inc., a Chicago-based consulting firm. For Springfield, "These CDOs are not," she said.

Unlike many of the hedge funds, banks and brokerage firms burned by their purchases of shaky mortgage-backed securities, local governments usually lack the staff and resources to make informed decisions on complex investments.

Instead, they lean heavily on ratings firms and their advisers for guidance. Florida officials were forced to close down temporarily the state's short-term-cash fund late last year after local governments withdrew billions of dollars because the fund had invested in subprime-related securities it couldn't sell.

The Montana state fund also said it had suffered more than $300 million in withdrawals. The consequences of a government fund losing money can have a direct impact on schools, police and safety, and other public services. Over time, a municipality might have to raise taxes or cut spending if it loses access to some of its cash.

Massachusetts securities regulators are probing Merrill Lynch about the sale, asking questions about the timing and whether the brokerage firm did enough to warn the city about the risks. The secretary of state has subpoenaed brokers responsible for the sales. The Massachusetts attorney general is also conducting an investigation.

Additionally, the Massachusetts secretary of state has opened a separate investigation of brokers in Merrill's Quincy, Mass., office related to the sale of securities known as structured investment vehicles, or SIVs, to clients in the state. The securities, commercial paper issued by Mainsail II, collapsed in value after Standard & Poor's cut the credit rating from the highest rating to "junk" status.

The office of securities for the state of Maine is also investigating Merrill's sale of Mainsail II paper, sold by the same Merrill Lynch brokers in Massachusetts, to the state treasury.

The losses in Springfield have been particularly disheartening to government officials, as the city has been struggling to reverse a dire financial situation. The city had a $37 million deficit at the beginning of 2004, and six months later the state created the Springfield Finance Control Board to oversee the city's finances. The Board stepped up collection of back taxes and imposed cost controls. These efforts helped turn that deficit into a $30 million surplus by the end of fiscal 2007.

2008, the year of the Rat. The Chinese calendar proclaims this as the Year of the Rat.

Who would you rather have running your economy?

Bernanke

Trichet

Inflation no longer the concern in the U.S. This is good news. From Bloomberg today:

Jan. 23 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke has decided inflation concerns have faded enough to let him cut interest rates further and faster to keep the U.S. from tipping world economies into recession.

"Now they are free to move very aggressively,'' said New York University professor Mark Gertler, a research co-author with Bernanke and policy consultant at the New York Fed. "They want to avoid asset panic. They don't want the declines to disrupt credit flows.''

The Fed's emergency rate cut yesterday signals a dramatic shift by policy makers from inflation to growth concerns. It indicates they now see a risk of lower home and stock values feeding back into tighter credit conditions that threaten to choke off growth, economists said.

A decline in oil prices, lower readings on expected inflation, higher unemployment and slowing factory production all helped convince the Federal Open Market Committee that it can lower interest rates more and quicker.

"The action by the Fed is welcome because it's going to pull us out of this much faster,'' Cerberus Capital Management LP Chairman and former Treasury Secretary John Snow said in a Bloomberg Television interview today.

Futures trading suggests the Fed may follow up with a cut of as much as another half-point Jan. 30, bringing the decrease to 1.25 percentage points in eight days. Such a reduction, forecast by analysts including Jan Hatzius, chief U.S. economist at Goldman Sachs Group Inc., and Dean Maki, managing director at Barclays Capital Inc., would be the deepest since the Fed started using the federal funds rate as its main monetary policy tool around 1990.

"Fighting inflation can follow a plan; combating weakness requires improvisation,'' said Vincent Reinhart, former director of the Fed's Division of Monetary Affairs. "Now, they've switched gears'' and "will keep easing'' until they sense the economy has reached a turning point.

For Bernanke, 54, that's an about-face from the past five months, when inflation formed the ballast of every policy decision, and forecasts, not markets or near-term data, drove changes in interest rates.

Until yesterday, the Fed had lowered the benchmark lending rate just 1 percentage point in the face of economic weakness, and had used separate tools to deal with liquidity problems in credit markets.

Futures contracts on the Chicago Board of Trade show an 80 percent chance the central bank will reduce the rate by 50 basis points on Jan. 30 to 3 percent. A week ago, traders saw no chance the Fed would cut the target below 3.5 percent this month.

The inflation-wary pattern of rate moves under Bernanke befuddled investors who criticized the central bank for treating the symptoms of tighter credit without diagnosing the eventual impact it would have on the economy.

"This should have been done months ago,'' said Steven Einhorn, vice chairman of New York-based Omega Advisors Inc., a $5 billion hedge fund, in response to yesterday's rate action. 'I have a lot of respect for capital markets, and they have been unambiguous in their view of the Federal Reserve: Up until now, every debt instrument out there told you they had been tame, timid and tardy.''

Gertler, who co-wrote a series of papers with Bernanke on how asset prices influence lending, said the Fed had good reason to rely on tools other than monetary policy to address turmoil in credit markets during the last five months of 2007, a strategy he termed "masterful.''

In August, Fed officials reduced the cost of direct loans from the central bank, and continued to fine-tune ways banks could use the so-called discount window to boost the flow of credit to financial markets. In December, the Fed introduced the term-auction facility, aimed at distributing cash throughout the banking system, to remedy the increasing wariness of financial institutions to lend to each other.

As policy makers acted three times between September and December to lower the federal funds rate, none of their statements suggested they had begun a sustained campaign of rate cuts.

"They seemed to not fully to understand the implications of the seizing up of credit,'' said Einhorn, former head of global research at Goldman Sachs. "They weren't preemptive, and the capital markets gave them ample evidence they were behind the curve.''

Gertler said the Fed could ill afford to move too quickly to cut rates last year, with the economy growing 4.9 percent in the third quarter, oil marching toward a record $100 a barrel and unemployment below 5 percent until December.

If Fed officials had cut rates in August, "markets would have been screaming, `Helicopter Ben!''' Gertler said, a reference to Bernanke's 2002 quip about fighting deflation with a "helicopter drop'' of money.

Gertler said "the whole key'' to creating conditions for aggressive easing "is anchoring inflation expectations,'' even if that must come at a cost of slower growth. "If the Fed had dropped rates like a rock at the first hint of bad news, they seriously risked the danger of losing credibility,'' he added.

While the Fed has two mandates from Congress, low inflation and sustained growth, current Fed officials have made stable prices the essential condition on which their ability to offset growth risks is based.

They tolerate monthly movements in the consumer price index. What those measures mean to the public's view of future prices, a concept economists call "expectations,'' is what really counts.

"They have been closet inflation targeters,'' said Reinhart, now a resident scholar at the American Enterprise Institute in Washington. "Hence, they were grudging in delivering policy ease last year and had trouble explaining their action.''

In contrast Europe is still focused on fighting inflation and the markets are responding today with huge declines this morning -- 6% in Germany and 4% in England. From Bloomberg today:

Jan. 23 (Bloomberg) -- European Central Bank President Jean-Claude Trichet said he's committed to fighting inflation even after stock markets plunged and the U.S. Federal Reserve cut interest rates to avert a recession.

"Particularly in demanding times of significant market correction and turbulences, it is the responsibility of the central bank to solidly anchor inflation expectations to avoid additional volatility,'' Trichet told the European Parliament in Brussels today.

Investors shrugged off Trichet's comments and increased bets that the ECB will be forced to follow the Fed and cut interest rates. Yields on June rate futures dropped 16 basis points to 3.72 percent. The U.S. central bank cut its benchmark rate by three quarters of a percentage point to 3.5 percent yesterday after global stock markets tumbled on concern a recession in the world's largest economy will curb global growth.

"Europe is not going to get special dispensation from a global slowdown,'' Stephen Roach, chairman of Morgan Stanley in Asia, said on a panel discussion at the World Economic Forum in Davos, Switzerland. "Europe is not this dynamic, rapidly growing economy.''

Europe's service industries this month grew at the slowest pace in more than four years after credit tightened and the euro neared a record, an industry report showed today.

Trichet on Jan. 10 threatened to raise the bank's key rate from 4 percent if unions push through wage increases that take the jump in inflation into account. Euro-region inflation was 3.1 percent in December, the fastest in six years and well above the ECB's 2 percent limit.

He suggested today that slowing growth may give the Frankfurt-based ECB more room for maneuver on rates. While the bank is sticking to its base scenario that the economy of the 15 euro nations will expand about 2 percent this year, there are "downside'' risks to the outlook, Trichet said.

"We'll see how the real economy develops in the future because it can have an effect on inflation,'' he said.

That remark "suggests any cut in rates by the ECB will only come on the back of poor economic data,'' said James Nixon, an economist at Societe Generale in London. The Fed's "concerns of a credit crunch appear to be absent in Frankfurt, even though European bank stocks have been hit just as hard as in the U.S.''

European stocks extended declines. The Dow Jones Stoxx 600 Index shed 1.6 percent to 310.56 as of 11:35 a.m. in London after rising as much as 1.6 percent earlier.

"It's going to be a difficult year for the world economy,'' Nouriel Roubini, founder of New York-based Roubini Global Economics LLC, said in Davos today. "There is a risk of outright recession in the U.K., Spain, Portugal and other countries. The ECB is realizing this is happening. Once there is a slowing, inflation is going to be the least of their concerns.''

ECB council member Axel Weber said last night that while a U.S. slowdown would "certainly affect the world economy,'' any impact in the euro area "could emerge with a time lag'' and may "be less strong than in former times.''

ECB Vice-President Lucas Papademos and Executive Board member Juergen Stark also said yesterday that economic fundamentals in Europe remain sound.

Europe's manufacturing industry unexpectedly maintained its pace of expansion in January. A gauge of manufacturing held at 52.6, beating economists' forecasts for a decline to 52.1, a report from Royal Bank of Scotland Plc showed today.

"Our mandate consists of ensuring price stability for European citizens in the medium term,'' Trichet said. The ECB has to be "credible in guaranteeing price stability.'' Policy makers next meet to decide on rates on Feb. 7 in Frankfurt.

As if you hadn't figured this out already:

Jan. 23 (Bloomberg) -- Billionaire investor George Soros said the fallout from the U.S. subprime crisis will bring about the end of the dollar's status as the world's reserve currency.

"The current crisis is not only the bust that follows the housing boom, it's basically the end of a 60-year period of continuing credit expansion based on the dollar as the reserve currency,'' Soros said in a debate today at the World Economic Forum in Davos, Switzerland. "Now the rest of the world is increasingly unwilling to accumulate dollars.''

The dollar's share of global foreign-exchange reserves fell to a record low of 63.8 percent in the third quarter as demand for U.S. assets waned after the collapse of the U.S. housing market, according to International Monetary Fund data. It accounted for 65 percent three months earlier. The euro's share rose to 26.4 percent from 25.5 percent. IMF quarterly figures go back to 1999, the year the euro was introduced.

The U.S. currency has dropped 11 percent against the euro and 13 percent against the yen in the past year. It has declined in five of the past six years.

Soros made $1 billion in 1992 betting against the pound, forcing the British government to abandon a peg to a basket of European currencies. He was also the biggest financial backer of the failed effort to deny President George W. Bush a second term in office. The euro has gained 55 percent against the dollar since Bush entered the White House on Jan. 21, 2001.

"From the 1980s we had the belief in the magic of the marketplace, and the authorities were so successful that they started to believe in this market fundamentalism,'' he said. "That's gone too far.'' In times of crisis, ``they suspended the rules and they bailed out the banks. That created an asymmetric incentive system, a moral hazard, that allowed the expansion of credit.''

Rising defaults on U.S. subprime mortgages sparked a rout in the credit markets in August, leading banks to cut money for consumer lending, hurting the U.S. economy's main engine. The Fed yesterday lowered its benchmark rate in an emergency move for the first time since 2001 after stock markets tumbled from Hong Kong to London amid signs the world's largest economy is sliding into recession.

Soros has used past appearances in Davos to predict the dollar's decline. In January 2004, he said the U.S. currency would drop for a third year. It then fell 7 percent, according to a Federal Reserve trade-weighted index of the currency.

Stephen Roach, chairman of Morgan Stanley in Asia, said in Davos that while he remains a "dollar bear,'' the U.S. currency's slide may be reversed in the first half of this year as other economies in Asia and Europe are hurt by the U.S. slowdown.

Random reading:
+ Iran: After the 1979 revolution, mullahs seized businesses owned by foreigners or controlled by the deposed shah and placed them under the umbrella of state-chartered bonyads: public charities established, at least in theory, to benefit all Muslims. Iran's supreme religious leader, Ayatollah Ali Khamenei, picks the clerics who will lead the bonyads, thus bestowing C.E.O. powers on them. The bonyads, which control as much as a third of Iran's economy, don't report financials, don’t pay taxes, and answer only to the supreme leader. The bonyads do give away most of their profits, but largely to members of a dozen or so powerful families. This limited competition has led Iran to huge disparities in income distribution. -- from Portfolio Magazine, Feb 2008.

Asian markets bounced back today

You Don't Have To Own A Cat To Appreciate This.

We were dressed and ready to go out for the New Years Eve Party. We turned on a night light, turned the answering machine on, covered our pet parakeet and put the cat in the backyard.

We phoned the local cab company and requested a taxi. The taxi arrived and we opened the front door to leave the house.

The cat we put out in the yard, scoots back into the house. We didn't want the cat shut in the house because she always tries to eat the bird.

My wife goes out to the taxi, while I went inside to get the cat. The cat runs upstairs, with me in hot pursuit. Waiting in the cab, my wife doesn't want the driver to know that the house will be empty for the night. So, she explains to the taxi driver that I will be out soon, 'He's just going upstairs to say Goodbye to my mother.'

A few minutes later, I get into the cab. 'Sorry I took so long,' I said, as we drove away. 'That stupid bitch was hiding under the bed. I had to poke her with a coat hanger to get her to come out! She tried to take off, so I grabbed her by the neck. Then, I had to wrap her in a blanket to keep her from scratching me. But it worked! I hauled her fat ass downstairs and threw her out into the back yard!'

The cab driver hit a parked car .

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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