For today's column on Auction Rate Preferreds.
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8:30 AM EST Monday, March 31, 2008: "Don't fight the Fed" is an old tired cliché. It means if the Fed is boosting the economy, the stockmarket will go up. The Fed is doing everything and more to boost. The Fed is spending taxpayer money like a drunken sailor. The BIG move was the Bear Stearns bailout. Two parts were critical (and new):

1. The Fed agreed to take on its books $30 billion of bad, worthless "securities" Bear Stearns had on its books.

2. The Fed agreed to open its lending window to unregulated investment banks. Previously, this window had only been available to regulated commercial banks -- like the ones you see on every corner.

The Fed is now entering uncharted territory. It seems to be willing to do anything and everything to unlock financial markets and get the stockmarket moving.

As a result, my friend, a brilliant security analyst on the buy side, emails me:

I'm actually becoming relatively bullish on the stock market. You write every day about doom and gloom. Everyone is focused on the financial meltdown. The thing is, the stock market hasn't made a meaningful bottom since January and you'd never know that by the way people talk about the market. I agree that the economy is getting worse. I don't believe in "decoupling" of the non-US economies, but I believe that the recession is already near its deepest point and that it won't be that deep. If the Fed is proving anything it's that it will go to great lengths to keep a financial crisis from becoming an economic depression and I think they have the tools to do so. Margins are probably too high, but they'd have to be WAY too high for stocks not to be cheap here.

Am I making a "jump back in" call? Not yet. I am saying it may be time to nibble a tiny bit. Stockmarkets tend to be forward-looking animals. Will things be better in 12 months time? I'm praying so.

ARPs fallout is broad: I already have stories of brokers leaving their companies because they are disgusted with the way their employers (UBS, etc.) are handling (or, more precisely, not handling) the auction rate preferreds disaster which they foisted on their clients. I have email after email from brokers who tell me they put their clients in ARPs because they genuinely thought they were doing the best thing for their clients, and they weren't doing it for the money / commissions (which were negligible, anyway).

But I have been bombarded by investors who are furious (in fact, beyond way furious) with their brokers. They claim the brokers mislead them, lied to them, did not invest the money in the safe, liquid securities they were instructed to. And the investors are looking at all sorts of paybacks -- including formal SEC complaints. According to one reader who emailed me, "The last thing a broker wants is a blemish on their SEC account for inappropriate advice with clients, as new clients will not work with someone who has a soiled SEC record. A soiled SEC record limits a broker's ability to transfer to new firms and pick up new clients. ... I know in my case I was clear with my broker I wanted no risk. He never took a customer profile of me as required by the SEC when working with a new customer and should be done on an annual basis to see if things with their customer has changed. Also he never sent me a prospectus."

There are obvious long-term implications -- like never believing a broker, (or anyone on Wall Street), and for many people, never ever using a broker again. I'm reminded of an old nugget: Some people are alive because it's illegal to shoot them.

Short-term Nuveen has promised a big announcement by the end of the month, which is today.

There's plenty more on auction rate preferreds -- including the weekend's extensive news and latest recommendations -- on my sister site www.AuctionRatePreferreds.org.

Hot news: From Forbes this morning:

UBS holds $5.9 bln auction-rate securities; news on capital hike by Wednesday
ZURICH (Thomson Financial) - UBS AG said it held auction-rate securities of $5.9 billion as of December, 31, 2007 but declined to comment on whether the bank's own positions are also subject to reevaluation.

'The reevaluation of auction-rate securities of clients do not allow any conclusion on our own holdings,' a spokeswoman said.

Over the weekend, the Swiss bank confirmed that it is cutting the value of auction-rate securities in its brokerage customers' accounts adding to speculation of further writedowns and a fresh capital hike.

The group declined to disclose the total value of auction-rate securities held for clients.

Any news of a capital hike is expected to come in by Wednesday, the legal deadline for the bank to send out the AGM invitation along with the order of business for the day.

UBS is one stupid bank. UBS gives stupidity a whole new meaning. There's more on the web site Auction Rate Preferreds.

Explaining what the Fed is doing: Roger Lowenstein wrote the best-selling book, "When Genius Failed, The Rise and Fall of Long-Term Capital Management." On Sunday he had this piece in the New York Times Magazine.

Bleakonomics
Since the bank runs of the 1930s, federal protection of retail depositor institutions has been a hallmark of American capitalism. The Federal Reserve, in a sweeping extension, has now extended the privilege to gilt-edged investment firms.

Its flurry of interventions has prompted a double dose of unease. The central bank offered a lifeline to Wall Street investors who, seemingly, deserved a worse fate. And it arguably interrupted the cycle of boom, bust and renewal that leads to a durable recovery.

What is the true value of Bear Stearns? If the government-orchestrated takeover of Bear goes through as planned, we will never know. As with Bear, so with the billions of dollars of mortgage securities for which the central bank has suddenly become an eager customer. So, too, perhaps, with the nation’s stock of residential homes — the prices of which, instead of reverting to more realistic values, will get a boost from the Fed’s repeated rounds of interest rate-cutting.

Government interventions always bring disruptions, but when Washington meddles in financial markets, the potential for the sort of distortion that obscures proper incentives is especially large, due to our markets’ complexities. Even Robert Rubin, the Citigroup executive and former Treasury secretary, has admitted he had never heard of a type of contract responsible for major problems at Citi.

Bear is a far smaller company, and, it would seem, far simpler. But consider that as recently as three weeks ago, it was valued at $65 a share. Then, as it became clear that Bear faced the modern equivalent of a bank run,

JPMorgan Chase negotiated a merger with the figure of $10 a share in mind. Alas, at the 11th hour, Morgan’s bankers realized they couldn’t get a handle on what Bear owned — or owed — and got cold feet. Under heavy pressure from the Fed and the Treasury, a deal was struck at the price of a subway ride — $2 a share.

It is safe to say that neither Jamie Dimon, Morgan’s chief executive, nor Ben Bernanke, the Fed chairman who pushed for the deal, know what Bear is really worth. For the record, Bear’s book value per share is $84. As Meredith Whitney, who follows Wall Street for Oppenheimer, remarked, “It’s hard to get a linear progression from 84 to 2.”

Capitalism isn’t supposed to work like this, and before the advent of modern finance, it usually didn’t. Market values fluctuate, but — in the absence of fraud — billion-dollar companies do not evaporate. Yet it’s worth noting that Lehman Brothers’ stock also fell by half and then recovered within a 24-hour span. Once, investors could get a read on financial firms’ assets and risks from their balance sheets; those days are history.

Firms now do much of their business off the balance sheet. The swashbuckling Bear Stearns was a party to $2.5 trillion — no typo — of a derivative instrument known as a credit default swap. Such swaps are off-the-books agreements with third parties to exchange sums of cash according to a motley assortment of other credit indicators. In truth, no outsider could understand what Bear (or Citi, or Lehman) was committed to. The thought that Bear’s counterparties (the firms on the other side of that $2.5 trillion) would call in their chits — and then cancel their trades with Lehman, perhaps with Merrill Lynch and so forth — sent Wall Street into panic mode. Had Bear collapsed, or so asserted a veteran employee, “it would have been the end: pandemonium and global meltdown.”

Perhaps. Or perhaps, after some bad weeks or months, Wall Street would have recovered. What is scary is the degree to which the Fed assimilated the alarmism on the Street: “These guys are so afraid of an economic cycle,” a hedge-fund manager remarked. And without public airing or debate, it stretched the implicit federal safety net under Wall Street.

To question intervention is not to dispute that markets need rules. But for nearly two decades, Washington has trimmed its regulatory sails. The repeal of Glass-Steagall, which once separated banks from securities firms, and the evolution of new instruments that circumvent disclosure rules have loosened the market’s moorings. Huge pools of capital have been permitted to operate virtually unregulated. Mortgages have been written to the flimsiest of credits. Swelling derivative books have made a mockery of disclosure.

The relaxation of oversight has implied an unholy bargain: let markets operate unfettered in good times, confident that the feds will come to the rescue in bad. In 1998, the Fed intervened to cushion the collapsing hedge fund Long-Term Capital Management; dot-com stocks immediately began their dubious ascent. Then, when the tech meltdown led to a recession and the Fed cut rates to 1 percent, adjustable-rate mortgages became as hot as the iPod. One rescue begets the next excess.

It is true that Bear’s shareholders have suffered steep losses. But the Fed went much further than in previous episodes to calm the waters. Notably, it announced it would accept mortgage securities as collateral for loans — enlarging its role as lender of last resort. (Wall Street jesters had it that the Fed would also be accepting “cereal box-tops.”) Then the Fed extended a backstop line of credit to JPMorgan to tide Bear over; finally, it agreed to absorb the ugliest $30 billion of Bear’s assets.

Government rescues are as old as private enterprise itself, but we are well beyond the days of guaranteeing loans to stodgy manufacturers à la Chrysler and Lockheed. Those cases were contained; the borders of finance are more nebulous. However pure of motive, Bernanke & Co. are underwriting overleveraged markets whose linkages, even today, are dimly understood. The formula of laissez faire in advance and intervention in the aftermath has it exactly wrong. Better that the Fed, with Congress’s help if need be, ensures that regulators and markets have the tools to know what companies are worth before the trouble hits.

The frog -- part 1
Question: Where do you find a frog with no legs?
Answer: Precisely where you left him.

The frog -- part 2
A friend conducted a scientific experiment:

He took a healthy frog and said, "Jump frog." It jumped 20 feet.

Then he removed one leg and said "Jump frog." The frog jumped 15 feet.

Then he removed two legs and said, "Jump frog." The frog jumped 10 feet.

Then he removed three legs and said, "Jump frog." The frog jumped 5 feet.

Then he removed all four legs and said, "Jump frog." The frog didn't move.

My friend concluded logically, "Frog with no legs can not hear."

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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