Harry Newton's In Search of The Perfect Investment
Technology Investor. Auction Rate Securities. Auction Rate Preferreds.
8:30 AM EST Tuesday, March 25, 2008: Prediction
is impossible, except after the event. But.... things presently look bad for
the economy. Think this way: If the Feds thought so ill of the economy to put
out a $117 billion "stimulus" package, they've done a terrible
job of ignoring the $360 billion of monies that can't be spent which
are locked up in failed auction rate securities. That $360 billion is over
three times the size of the "stimulus."
gets worse: Our capital markets are also locked, with company after company,
institution after institution locked out of raising the money they need for
their business, their expansion, their day-to-day operations.
news: Brazos Education, the fourth largest holder of bonded student loans has
quit providing student loans amid Auction Market Woes. ''We
sorrow this determination was necessary,'' Gilbert Murray Watson, president
and main executive director military officer of Brazos Higher Education Service,
said in a statement today (March 24). ''We hope this state of affairs with the
working capital marketplaces alters in the near future to allow us to re-enter
Add kids can't
go to college, to the houses and businesses that can't be bought or expanded,
the shares on Wall Street that can't be bought, the April 15 taxes that can't
be paid (and the resulting personal bankruptcies) because of monies locked in
failed auction rate securities. Things look glum.
Wall Street is
bracing for a massive layoffs, hurting the New York City and State economies.
Bear Stearns employs 14,000 people, most paid well. Most will now be fired.
Ditto with other investment banks and brokers.
I hate to be negative,
but things in the economy do look increasingly awful. John Cassidy has a piece
in the latest Conde Nast Portfolio titled, "The Economy of
Fear -- Why this recession is going to hit particularly hard--and
last longer than you think." He writes:
is most likely spiraling down, with unemployment rising, the stock market
tumbling, and corporate losses mounting. In economics, as in quantum physics,
nothing is certain, but falling housing prices and slumping consumer confidence
point to a deep recession that could last for two or three years. Psychology
is critical in economics, and right now it is battered. ...
past recessions, which were rooted in inflation problems, this one has been
triggered by credit and real estateboth of which have a lot to do with
how people perceive their financial well-being and, in response, how they
adjust their spending. ... For what is probably the first time since the 1930s,
home prices are falling sharply. Nationwide, housing prices have slipped about
10 percent in the past year, and the decline is accelerating, according to
the S&P Case-Shiller home-price index. As prices drop, more and more homeowners
discover that they owe more than their property is worth, at which point they
experience the temptation to hand the keys back to the bank or mortgage company.
Jan Hatzius, an economist at Goldman Sachs, estimates that by the end of 2009
up to 15 million households could be in a position of negative equity.
If Hatzius is right, the glut in houses for sale will only get larger, and
prices will fall a lot further. Just how low they could go is anybody's guess,
but a reading of data compiled by Yale economist Robert Shiller, which show
the evolution of inflation-adjusted home values since 1890, suggests an overall
drop of 30 or even 40 percent.
prices fall, homeowners feel poorer, which prompts them to spend less and
save more. Gross domestic product falls and unemployment increases. A slide
of 25 percent in home prices would wipe out about $5 trillion in household
wealth. Coincidentally, this is roughly how much was lost when technology
stocks collapsed in 2000 and 2001. Given that some predictions have home values
falling even more steeply, the pain could be severe.
homes are more widely owned than stocks, and they have a bigger effect on
spending. Simulations carried out by Frederic Mishkin, one of Bernanke's colleagues
at the Fed, imply that the typical American family will cut its spending by
up to 7 cents for every dollar in housing wealth it loses. Given a 20 percent
fall in prices, this adds up to a nationwide reduction in consumer spending
of about $350 billion a year, or 2.5 percent of the U.S.'s gross domestic
product. That's a big numbermore than big enough to tip the economy
into recession. (Harry's comment: Add the $360 billion locked up in failed
auction rate securities and you have over 5% of GDP.)
Just as consumers
are hitting the panic button, companies also are being squeezed, with many
of them unable to access money precisely at a time when they need it. It has
been nine months since the subprime crisis began, and it is now affecting
virtually all credit products, including two of the safest of all: municipal
bonds and corporate bonds issued by blue-chip companies. Now that
the credit bubble has burst, even some perfectly reputable and solvent businesses
are struggling for access to funds. Unless something happens to reverse these
trends, a big drop in G.D.P. is inevitable.
Summers know this, of course. They are relying on the stimulus package signed
by President Bush in February and lower interest rates to boost demand. From
September through January, the Fed cut the federal funds rate from 5.25 percent
to 3 percent. Cheaper borrowing costs make it attractive for families to refinance
their mortgages and take out home-equity loans. In the boom years of 2004
to 2006, refis and home-equity cash-outs boosted consumer spending; the Fed
is hoping to restart this game. Lower interest rates also bring down the value
of the dollar, making American goods such as Boeing airplanes and Apple computers
more competitive in world markets. In recent months, the one economic bright
spot in the U.S. has been a surge in exports.
I doubt whether
these policy changes will be enough to offset the slumping housing market
and its psychic multiplier. But a bigger weakness in the optimistic view is
its failure to fully address the crisis in the financial system. In the mild
recessions of 1990-91 and 2001, we didn't see anything like the dislocation
we are now witnessing. In some ways, the current situation more closely
resembles the ruinous credit busts of the late 1800s, which shepherded in
lengthy periods of economic contraction in that century's last three decades.
According to the National Bureau of Economic Research, the U.S. was in recession
from October 1873 to March 1879, March 1882 to May 1885, and January 1893
to June 1897 (with a brief respite from June 1894 to December 1895). The slump
of the 1870s, which was precipitated by a collapse in the value of railway
bondsthe era's subprime securitiesand the ruin of banker Jay Cooke,
lasted even longer than the Great Depression. ...
We are still
looking for market solutions to the credit crisis. First, there was the idea
of setting up a privately funded "super" investment vehicle to digest
the mess. In that scenario, bailout money would come from the banks themselves.
Then came the sovereign wealth funds, with their injections of Middle Eastern
and Asian cash into Citigroup and Merrill Lynch, and then a "voluntary"
rate freeze on subprime mortgages. Now the big banks and Warren Buffett are
vying to "rescue" the municipal-bond insurers. Behind the scenes,
the Fed and the Treasury Department have been quietly orchestrating a mortgage
bailout, using the Fed's lending facilities and other government-sponsored
institutions, such as Fannie Mae and Freddie Mac, but even these efforts
are too opaque and indirect to restore confidence, which is their ultimate
goal. Lost trust takes a very long time to recover. (Harry's comment:
The trust has evaporated. Emails I've received from failed auction rate securities
talk plainly about their distrust.)
You can read the
entire Portfolio magazine piece by clicking
capital markets bode ill for redeeming failed ARPs. There
is great touchy-feely talk by the ARPs issuers of redeeming their auction rate
preferred shares with different financing from capital markets. But I wonder,
with these markets largely locked, where will the money come from? I've had
several long conversations with Daisy Maxey, financial reporter for Dow Jones
Newswires. She's following this mess. Her latest piece from yesterday evening:
Investments May Refinance Some Preferred Shares
NEW YORK -(Dow Jones)- Evergreen Investments, the investment management arm
of Wachovia Corp. (WB), said it's looking into refinancing "a partial,
but material" portion of the preferred shares issued by its closed-end
funds through a commercial paper conduit.
Under the scenario
being considered, Evergreen would use the proceeds from a commercial paper
conduit borrowing to retire a portion of the preferred shares issued by its
closed-end funds, and replace the funds' leverage through debt borrowings,
Scott Couto, head of global product management for Evergreen, said on a conference
Three of Evergreen's
five closed-end funds - Income Advantage (EAD), Multi- sector Income (ERC)
and Utilities and High Income (ERH) - have issued auction- rate preferred
shares, and the firm has about $970 million in outstanding preferred
Couto said he
could provide no timeline for a resolution to the liquidity crisis now facing
holders of auction-rate preferred shares.
we're experiencing is unprecedented," and "very challenging,"
he told call participants, some of whom sounded quite frustrated by the current
lack of liquidity in the auction-rate marketplace. "We're working as
quickly as we can through a very complex set of issues."
funds issued preferred shares as a way to boost their returns through the
use of leverage. For years, those shares were considered by many investors
to be safe, liquid investments, and were routinely sold successfully at auction.
In fact, one participant on the Evergreen call said that when purchasing preferred
shares, they assumed they were purchasing a money market- like instrument.
In recent months,
however, such preferred shareholders have found themselves unable to sell
their shares as many potential buyers, including the banks that had for years
supported the auctions, stopped buying the shares amid a credit crunch.
shares fail to sell at auction, the dividend rate paid to the preferred shareholders
increases to a maximum rate set by an established formula, but they are essentially
locked into the shares.
management has received authorization from the fund's board of trustees to
proceed with negotiations on the "possible near-term" solution of
a partial refinancing, and to implement it subject to the trustees' review
and approval, said Couto.
But he cautioned
that there remains "much work to be done," and cited necessarily
negotiations, legal and regulatory requirements and any necessary shareholder
approvals as some of the hurdles remaining.
continue to work on this as well as other possible solutions, Couto said.
managing director of investment product management at Evergreen, said the
firm, in an effort to show its commitment to the closed-end fund business,
will combine the refinancing it is considering with advisory fee waivers to
keep costs down for the affected funds' common shareholders. If the borrowing
on any commercial paper funding exceeds the maximum rate being paid to the
preferred shareholders at that point, Evergreen will waive its advisory fees
to the level where the common shareholder would never pay more than the maximum
rate at that time less five basis points, she said.
also continue to explore the issuance of preferred shares with a conditional
put, which would be eligible for purchase by money-market funds, as a possible
solution, McColl said. It's something that several other closed- end fund
companies have also said they are considering.
But Couto said
that Evergreen doesn't believe the notion of money-market eligible preferred
shares has the "the near-term" possibilities that the refinancing
option offers. "We are aware of several different parties exploring"
such a possible solution, he said, but "I'm not sure anyone has solved
all of the outstanding issues at this point."
been working with financial intermediaries, large securities exchanges, trade
groups, ratings agencies and its competitors, among others, in an effort to
identify possible solutions, Couto said.
the firm pursues, McColl said, it will seek to preserve common shareholders'
ability to earn consistent yield through leverage, while also seeking to provide
liquidity for preferred shareholders.
The firm is
operating in "uncharted waters," and can offer no concrete timeframe
for any of the possibilities it's considering, but will provide periodic updates
as it progresses, she said.
Couto, in response
to a question, said "We regret that we will not be able to provide
liquidity by tax time."
There was no
equivocating about the state of the auction-rate securities market, however.
"We are not likely to see successful auctions any time soon, if ever."
Maxey, Dow Jones Newswires; 201-938-4048; email@example.com
fees are paid on failed auction rate securities. It
might be fun asking your broker if he and/or his firm is being paid a 12b-1
fee by the issuer of your failed auction rate security. Apparently, some (including
Nuveen) are. I'm guessing the issuers are paying this fee so your broker can
more easily withstand your complaints at having your money locked up indefinitely.
You could ask for the money to be transferred into your account. Good luck.
in Arizona plummets: Picture a large piece
of land containing 225 finished lots, ready for home building. A year ago, that
land would have sold for $100,000 a lot. It just went for $18,500.
That's an 81.5% reduction in one year. What's impressive about this reduction
is that it costs at least $25,000 to finish the lot, to make it ready for selling
as a home site. That $25,000 would include the roads, the electricity, gas,
water, etc. Even at $18,500 it's unlikely anything will be built. It will be
sat upon for five years, as the new owner prays for a return in new home demand.
of mine are nibbling at selective western properties, seeking bargains. Curiously,
they're not that easy to find, since many present owners are unwilling to part
with their properties. Stick around. Many are having difficulty paying for them
and will sell them soon.
the developers of western properties are having their own problems. One I know
had a certified net worth of $100 million two years ago. Today he is
broke, teetering on the edge of personal bankruptcy -- his personal guarantees
now completely and utterly worthless.
where all our Iraqi reconstruction money went? Basically
it went into the hands of Iraq's present crooked politicians and the insurgents
we're fighting. The latest issue of the ultra-respectable Conde Nast Portfolio
magazine has the story "The Betrayal of Judge Radhi." His
job was to figure where the money the U.S. had spent for Iraq's reconstruction
had gone. According to Portfolio, "billions of dollars were being
wasted or stolen outright in Iraq, including $8.3 billion that went unaccounted
for in 2003 and 2004. Many of Iraq's leaders were either directly participating
in the thievery or quietly supporting it through hired guns, who later waged
sectarian wars in the streets. Radhi was supposed to track down the criminals,
stanch the hemorrhaging of money, and put an end to the corruption that was
dubbed the 'second insurgency' by Stuart Bowen (the U.S. special inspector general
for Iraq reconstruction) and considered a principal source of funding for the
terrorist groups that the U.S. military was trying to crush."
the end, Judge Radhi was hounded out of Iraq and his investigations curtailed.
you're ready to be thoroughly depressed as to just how badly the war in Iraq
has been handled, read this article. I can't find it on Portfolio's web
site. Pick up the April issue on your local newsstand. Or better, get yourself
a subscription -- Click
Shamus and Murphy fancied a pint or two but didn't have a lot of
money between them, they could only raise one Euro.
Murphy said "I
have an idea." He
went next door to the butcher's shop and came out with one large sausage.
Shamus said "Are
you crazy? Now we don't have any money left at all!"
"Don't worry - just follow me."
He went into the
pub where he immediately ordered two pints of Guinness and two glasses of Jamieson
Shamus said "Now
you've lost it. Do you know how much trouble we will be in? We haven't got any
with a smile. "Don't worry, I have a plan, Cheers!"
They downed their
Drinks. Murphy said, "OK, I'll stick the sausage through my zipper and
you go on your knees and put it in your mouth."
The barman noticed
them, went berserk, and threw them out.
this, pub after pub, with Murphy and Shamus getting more and more drunk, all
At the tenth pub
Shamus said "Murphy - I don't think I can do any more of this. I'm drunk
and me knees are killin' me!"
Murphy said, "How
do you think I feel? I lost the sausage in the third pub."
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.
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is research for a book I'm writing called "In Search of the Perfect
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