Tuesday, December 30, 2008

Book Review

At times the book gets a little tedious and repetitive, however it provides a background to the subprime meltdown that just isn't available anywhere else. It fully blames Wall Street, for some reason leaving out the politicians that also allowed things to happen, but on par is an excellent read.

What you will read in this book will be insightful and will completely piss you off. The characters that walk off with hundreds of milllions of dollars while completely ruining our economy and totally screwing over the little guy are not in jail and at this point are not even targets of any prosecution. The shadow banking industry (or non-banking industry) that arose and went unregulated makes no sense to the average person - why? The average person knows that if you make loans to people with no ability to pay them back and a history of not paying back debts - you are going to have a lot of defaults. Wise is that the school teachers, plumbers and construction workers that I've conversed with everyday for the past seven years understood this and Hubris Street didn't?

My biggest regret is not fully understanding what was going on. After all, I lived in the middle of all of it - Orange County, while it was happening. Every day I marveled at what I saw. 125% loans, Option Arm loans, Stated Income Loans, loans to people who had no job and no income (for $600,000). I called the housing bubble and told people not to buy homes unless they had a ten year time frame. I figured a 20% drop is around the corner....little did I know that things were even worse than I could have ever imagined. Now, in some places (including where I live in Murrieta) prices have dropped more than 50% from their highpoint. The market was flooded with easy money that was lent to people who could never pay it back and it created a huge false demand for real estate that drove prices up to a bubble point - creating victims of the people who COULD afford the homes they bought.

This will take awhile to unwind and will lead to needed regulation. However, in all likelihood the regulation will be written poorly and hurt any recovery rather than help. In the meantime, Stanley O'Neal, Angelo Mozilla, Roland Arnall, Robert Cole, Ed Gotschall, Steven Holder, Davide Loeb, Brad Morrice and many, many others are cozy in their mansions with bank accounts in the millions (some in the hundreds of millions and even billions) when they should be in prison (with the exception of Roland Arnall who died of cancer after serving as an ambassador).

Don't get me wrong, I don't begrudge people for making money, even lots of money. What bothers me is that these people were and are crooks. They helped to create the current mess and are not being held to account. There is something wrong with that.

Scott Dauenhauer CFP, MSFP, AIF

Hussman: The Dollar Crisis Begins

Interesting commentary. I don't know if he is right, but he did a pretty good job in 2008.

Scott Dauenhauer CFP, MSFP, AIF

Wesbury: Fed Balance Sheet Expansion Is Not Hyper Inflationary

What is interesting about the title of this piece is Wesbury doesn't say "inflationary", he says "hyper-inflationary". I think him and James Grant are more or less on the same page (see Grant article previous to this post), but Grant apparently sees more inflation than Wesbury.

As you can see we have a huge range of opinion on where money is going - its a range that is from hyper-deflationary to hyper-inflationary and everywhere in the middle. I'm on the inflationary side.

Scott Dauenhauer CFP, MSFP, AIF

James Grant: WSJ: Is the Medicine Worse Than the Illness?

James Grant writes about the current mad printing of money by the Federal Reserve. This is a must read. In another post I'll link to a Wesbury piece that partially disagrees with Grant.

Scott Dauenhauer CFP, MSFP, AIF

Coping with Craziness

Feinberg sums up the frustration that many of us in the financial services industry have faced this year:

"Losing my cool. The last week of September and the first week of October were particularly bone-chilling for me. Spastic drooling had never been one of my problems. Now, I ask for the dribble cup along with the Wall Street Journal. The market's incredible volatility has made me a shell of my former, long-term-oriented self. I now think and trade like a hedge-fund guy. Recently, my cash and short positions totaled 40%. Three days later, they totaled 10%."

"Oh, my clients. They are unhappy and scared. Some sound like kids who have been stiffed on their birthday presents. They expect more from me, much more, and are now bombarding me with e-mails asking when the carnage will end. Each message feels like a kick in the gut. I know I've let them down, that I should have seen this maelstrom coming. I didn't."

"I don't know what will stop it -- and that's one of the things that drives me bonk-ers about the current market. I see a value, I buy some shares, and the sucker goes lower. Then it's rinse and repeat and repeat and repeat. Oh, the horror."

Its been a rough year for everyone.

Scott Dauenhauer CFP, MSFP, AIF

2009 Conventional Wisdom

I'm not making any predictions about 2009, but I will say that recent predictions that I've been reading regarding 2009 are giving me a small reason to be upbeat. It isn't what you think. I can find few economists or financial "guru's" who are upbeat about 2009...and that is exactly why 2009 just might turn out to be o.k. Conventional wisdom is usually wrong. Again, 2009 might turn out to be a stinker and its certainly the safe opinion to be bearish, but just remember that all of these same guru's (well 99% of them) were completely wrong about 2008 and never predicted what actually happened.

The great philosopher Yoda once said "Difficult to predict. Always in motion, the future is." He couldn't have been more right.

So there it is, 2009 may or may not turn out to be a good year, and no, you shouldn't be worried that I'm quoting from a non-existent alien philosopher.

Scott Dauenhauer CFP, MSFP, AIF

Monday, December 29, 2008

Another Idea On Solving the Foreclosure Problem

Banks and financial institutions that hold bad mortgages are not negotiating. They say they are, but they are not. Until they do, the foreclosure problem will only get worse. The main problem is that these banks and institutions are most likely insolvent and can't negotiate. Perhaps they need an incentive, one might be to offer then a double deduction on the principal that they agree to write down with borrowers. In addition, allow them to take those deductions and losses against previous profits in the past four years and as far forward as they need. Its not perfect, but the fact remains that until principal write downs happen, the foreclosure crisis will continue.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, December 23, 2008

Opinion: Seniors Victimized By Low Rates

With the Feds lowering short term rates to zero and attempting to lower long term rates by buying Treasury bonds homeowners with equity and good credit are doing handstands. Perhaps all of this maneuvering will help, perhaps not, only time will tell. What is left out of the story however are those who are effectively subsidizing this policy - Seniors who rely on reasonable interest rates for income.

While the meltdown in the stock market has been epic, at one point a tad over 50%. The meltdown of interest rates has been complete. Last year a senior could get a rate of 5 - 6% on their money with little, even no risk in most places. I even have a few clients who locked in a risk free rate of 7% for five years in a 457 plan they had access to. For seniors who were earning 5%, they would get about $5,000 per $100,000 invested. Today that rate is now nearly zero. You can shop around and get 2 or 3% in a CD, though you may even have to go out five years to do that. That would be around $2,000 per year of income for every $100,000 invested a drop of 60%.

What is worse is that the inflationary forces that have appeared to disappear and even reverse into deflation (which does actually make the $2,000 go farther......until you factor in that seniors are not experiencing deflation) are short term. The return of inflation is inevitable. This will further decimate the savings, though it will probably raise rates.

These low interest rates will push seniors to look for higher rates, not thinking about the higher risks. They will be marketed to by weasels who will attempt to lure them into their faux products promising higher returns with little or no risk - a combination that doesn't exist (can you say Madoff).

Be vigilant out there and stay on your guard.

Scott Dauenhauer CFP, MSFP, AIF

Thursday, December 18, 2008

Inflation or Deflation: A Tale of Two Economists?

It's the tug of war of the century - who will win out. Everyday I read another economist predicting deflation and everyday I read another economist predicting inflation. I side with the inflation folks long term. Either way the Fed has its hands full and only time will tell if what they are doing is right. Below are links to two articles, one predicting inflation the other deflation.



Scott Dauenhauer CFP, MSFP, AIF

Wednesday, December 17, 2008

Humor Break: Dilbert

Couldn't resist posting this. If we don't laugh we'll cry, right?

Why I Don't Buy Into Active Management

Humor Break: Bailout Application

A History of Bear Market Recoveries

Great chart. I urge you not to put a lot of stock in it (pun intended) as this recovery may not follow the previous ones.

Scott Dauenhauer CFP, MSFP, AIF

The Long View: Essays on the history of business: A Fiasco That Fed The Great Depression

I'm about to start reading John Steele Gordon's book, An Empire of Wealth, but am finishing up Amity Schlaes The Forgotten Man first. This article is a preview of his book and draws close parallels to the Lehman failure. What I find interesting is that we have an opportunity to avoid a depression and especially a great depression - but we must look to our history to ensure that the wrongs of those times are not revisited. These books give us a glimpse at what we did wrong, let's hope someone in Congress and the White House are reading such things.

Scott Dauenhauer, CFP, MSFP, AIF

Inflation is the Real Danger, Not Deflation

I rarely make market forecasts since if I'm right people will expect me to make more forecasts which is a pressure I'd rather not deal with and if I'm wrong I look like a fool (which, interestingly enough isn't a stretch). I'm going to go out on a limb and say that I'm not buying into the Deflation scenario. I'm not saying we can't or won't have some deflation, simply saying that it won't be long term. Yes, I am aware that we just had two straight months of deflation, however if you strip out energy and commodity prices we actually had steady or slightly increasing prices. Why do I think we will have inflation?

First, the Fed chairman has basically said he would do anything possible to avoid deflation, so that is one.

Second, the Fed is printing so much money to address the crisis that it has to be inflationary, I don't believe that the fed can "mop" up this money as quickly as it thinks. Neutralizing is not nearly as easy as people are playing it up to be.

Third, interest rates are zero which doesn't bode well for the dollar. There was major flight from the dollar yesterday when the announcement came. While the dollar is the reserve currency of the world - at some point people might want to earn something on their money. I know, I know, right now people are more concerned about return OF their money rather return ON their money - this will change. A falling dollar is great for exports, but it can be inflationary and very well may inflate commodities again. I'm not saying oil will hit its highs of earlier this year, but that a doubling of oil at some point isn't out of the question. Don't get too used to paying $1.50 a gallon for gas.

Fourth, the banks still are not lending and that is because they still have impaired balance sheets. The Fed is going to print money to buy their bad assets - more printed money will cause inflation.

Again, I could be wrong, but my textbooks tell me I'm not. For what it is worth I'm recommending Treasury Inflation Protected Securities. New issue's are best as they protect against the possibility of deflation, but secondary are fine as well if you have a decent time period.

Gold is probably an option as well, but I'm not going there just yet and to be frank, I just don't know what's going to happen.

The Fed is walking a tight rope and I'm not saying it isn't doing the right thing, I really don't know, but I don't believe we can print this much money and have this low of interest rates without long term inflation.

O.K., there you have it, my prediction. I've got a 33% chance of being right - there will either be no inflation, deflation or inflation, my chances aren't too bad!

Keep in mind that this is not a blog that gives investment advice (you must pay for that as a client of mine), these are just my current views, if you invest on your own based on my views and lose money - tough.

Stay tuned.

Scott Dauenhauer CFP, MSFP, AIF

Humor Break: Twas The Night Before Christmas (The Year of the Grinch)

’Twas the Night Before Christmas
(The Year of the Grinch)
By David H. Resler

’Twas the night before Christmas, my shopping was done
I’d gotten great bargains, gee, aren’t low prices fun!
But less costly gifts are but small consolation
For my four-o-one K’s brutal devastation.

This year of o-eight ranks surely one of the worst!
It all started when the housing bubble did burst.
How could such a mess happen? And, who should we blame?
The fault lies with culprits far too many to name.

But my rhyme needs a villain, and for me that’s a cinch.
It’s none else but that vandal — the nasty old Grinch,
Who’d slinked into town for some real mischief making
And our long expansion he planned to be breaking.

From that first day on, he was brewing up trouble,
Aiming his sights first on the housing price bubble.
So the Grinch posed first as a home mortgage lender
His too easy loan terms sent some on a bender.

Prudence and judgment the Grinch deemed simply passé
Neither income nor job would stand in his loans’ way.
For a Grinch-loan nothing had to be verified.
‘Cause in MBS bundles these risks would he hide.

When agencies scored these loan pools triple-A sound
Investors chased his high yields like fox-hunting hounds.
All this was part of the Grinch’s mean little scheme,
Popping the bubble, he wrecked the home owner’s dream.

With his handiwork done, the Grinch felt elated
He knew what came next as these assets deflated.
The fortunes amassed in the boom years just vanished,
And Wall Street’s wizards from their boardrooms were banished.

Then the Grinch plot did from Wall Street so quickly spread
As surging gasoline prices deepened the dread.
And though the oil price upsurge had no lasting cause,
It surely led soon to a severe spending pause.

When Lehman House failed and the markets did seize
Nothing the Fed did could halt the deep credit freeze.
Though the Treasury and Fed tried ev’ry trick,
Nothing could stop the markets from growing more sick.

There’s not any doubt we’re the grip of recession
That doomsayers warn we’ll lead soon to depression.
With bus’nesses shutting ’and big banks a-failing,
The Grinch felt pure joy and his spirits were sailing.

But that nasty old Grinch shall not our Christmas steal,
We’ll drive him from town or we’ll cut him a deal.
We’ll line up for some help from Tim, Ben and Hank..
We’ll use the might of the Federal Reserve Bank.

Since not all the problems are to Wall Street confined
Some fiscal injections too must now be designed.
The president in waiting has named his new team
And shown us the outlines of a grand fiscal scheme.

A middle class tax cut plays a very key part
In hopes it will give spending a hefty jump-start
On new infrastructure too much more must we spend
“This plan will bring” so he says, “this slump to an end.”

New regs for markets will stop all Grinch-like deceivin’
“This,” says Obama, “will be change you can believe-in.”

In the end we know too the Grinch will change his way,
So a brighter future will start this Christmas Day.

Monday, December 15, 2008

Hall of Idiots: "Top Banks"

If you bother to read the above linked to article you will find that the following banks are just plain idiots:

Royal Bank of Scotland
Insurer AXA
Societe Generale
Credit Agricole
Banco Populare
Reichmuth and Company

Ironically I haven't been able to find any direct US banks involved. I say ironically because many of the international banks that have exposure (some in the billions) have complained about the US regulatory scheme and how it failed. While I don't think I can argue with that, it seems this is simply shifting the blame from people who SHOULD have known better.

This is such an easy scam to spot that these banks will end up making every client whole as no court in their right mind will find that there was not a massive breach when it came to due diligence. This pyramid scam was so easy to spot and yet so many people and institutions were suckered into it.

There were many hedge funds, charities and even a senator who invested millions.

All of these banks and any bank that pops up later are idiots. It wasn't enough that our US Banks and regulators failed to police the massive mortgage fraud that was perpetrated on this nation, this is just icing on the cake. Will new regulations really make a difference when old one's clearly are not enforced?

I actually believe there needs to be a new set of regs, I'm just not sure its going to help, so much trust has already been lost.

Scott Dauenhauer CFP, MSFP, AIF

Friday, December 12, 2008

Don't Buy Into the Deflation Delusion

Excellent article that goes against the grain of the economist's that are making news today. Deflation, Tamny argues is a delusion. This article is a pretty easy read given the complicated concepts involved and I encourage you to read it.

I see inflation, not deflation over the next five years. Sure, we could have short term deflation, it is a real possibility, but I still think the long term threat is inflation.

Please read this article.

Scott Dauenhauer CFP, MSFP, AIF

How To Solve The Foreclosure Crisis

Barron's finally is offering some decent idea's on how to solve the foreclosure crisis that in reality has caused our banking system to be basically insolvent. While I don't agree that it can be done for only $100 billion, I do believe this is the start of a constructive conversation about the real issue plaguing our economy - the massive debt and leverage tied to mortgage securities.

What I find interesting and kind of appalling is the fact that all those mortgages held by Fannie and Freddie are not being worked out. Freddie is more willing to take a $250,000 loss and foreclose a property than actually work it out with a principal and interest reduction - this is costing the taxpayers money because they are on the hook for 100% of the loss.

On a separate note. The Oil crash has been a huge stimulus to America and the longer it stays down the bigger that stimulus will be (much bigger than the government could do this quickly), however as the crisis storm clouds begin to clear and the dollar becomes less needed as a risk haven we could see the dollar fall again and we could see a lot of inflation due to the printing of money by the Federal Reserve - this has the affect of hurting the dollar and this will in turn bring the price of oil (and gold) back up. I'm not saying it will hit $143 again, I have no idea what it will do in the short term, but there are risks and I don't think you should get to used to paying $1.60 per gallon for gas........though I certainly hope it stays that way for a long time.

Scott Dauenhauer CFP, MSFP, AIF

Top Broker Accused of $50 Billion Fraud

Note: This link is only good for 7 days.

Somehow, despite numerous warning signs and many complaints this famed stockbroker got away with a Ponzi scheme of mammoth proportions. The recent turmoil in the markets and massive redemptions finally broke this scheme and now the operator is about to face the music after being turned in by his sons (who are surely attempting to get out of criminal prosecution themselves).

How do you protect yourself from these types of scams?

First, don't ever write a check or send money directly to the company servicing you. For example, the only check I would ask a client to write to me and my company (Meridian Wealth Management) would be for fees relating to my service. I would never ask you to send your money directly to Meridian Wealth Management. If you are working with a broker or an advisor and have sent your money directly to them as opposed to sending it to your own account at a major brokerage custodian like Schwab, Fidelity, TD Ameritrade or others, you should start investigating right away. Your money could be at risk.

You should receive monthly or at least quarterly statements FROM a reputable broker/dealer like the one's mentioned above - not from the company itself. While my company provides quarterly consolidated statements they are in addition to, not a replacement of the statements from the custodian (Fidelity, Ameritrade and TIAA).

Lastly, check to make sure your advisor is registered as either an Investment Advisor or a Registered Representative. You can start at www.finra.org.

Ronald Reagan used to say "Trust, but Verify". This is good advice and I encourage you to do it, even if you're a client of mine.

You should be able to log in to your accounts online at the institution to see your accounts. If you can do all the above you should be safe from a ponzi scheme, though of course not from regular losses in the stock market.

Scott Dauenhauer CFP, MSFP, AIF

Ripe for an Attack

I'm not trying to scare anyone and no, I don't know something that no one else knows, but.....is it me or are we ripe for another terrorist attack?

American has been brought to its knees financially, Oil has fallen by $100 a barrel and we are in the midst of a change over to a new President. Nobody has terrorism on their mind other than feeling bad for those over in India.

The terrorist we know are patient and have to be thinking that an attack now could be the final death blow. Let's hope and pray that our government keeps their eye on the ball, while we can never afford a terrorist attack, now is perhaps the worst time.

Scott Dauenhauer

Thursday, December 11, 2008

'Fannie and Freddie Were Lenders' Written in 2002

Some people thought this guy was nuts in 2002, now he looks like prophet.

Scott Dauenhauer CFP, MSFP, AIF

Wednesday, December 03, 2008

Humor Break: Your House, As Seen By......

A client sent me this, gotta love it!

Your House as seen by yourself

Your House as seen by your home buyer:

Your House as seen by your lender:

Your House as seen by your appraiser:

Your House as seen by the County Tax Assesor:

Will Anybody Actually Address the Problem?

It appears that while everyone has acknowledged that our problems began with the Real Estate meltdown, no one seems to be willing to actually deal with that meltdown. Program after program has been rolled out, but none of them are actually helpful - they just nibble around the program (the purveyors hope that announcing a program will make them look good and make the markets move, even if the program is just a waste).

Housing needs to be addressed and losses need to be taken by everyone involved. This means mainly the banks and the consumers, but perhaps the government (though not the McCain route). Until the vast majority of loans are renegotiated, there will still be problems.

For some reason the banks hold a lot of "toxic assets", helping the underlying collateral will help these toxic assets become less toxic, but getting them off the balance sheets will do more to help the banks move forward from this calamity. TARP was supposed to do this, but the idea was a failure from the beginning in terms of how it was supposed to be ran. For a few weeks I've been pondering how to get these assets off the balance sheets. The idea I came up with was to create a government pool that would accept the assets from the banks in exchange for some equity and future income rights, as well as some loan loss guarantees by both the bank and the government. This would effectively do what TARP was supposed to do, but without purchasing the assets outright. The pool would be run for the long run which would mean that "mark-to-market" rules would have no affect. This morning I was reading that this is in fact the approach that the Swiss took with UBS (or something like it).

The Treasury and Fed are walking some pretty fine lines right now, but they've got to do something about this toxic asset problem that starts with housing. The longer we delay, the more costly and harmful it will get. Just last week we found out that in addition to the 1/3 trillion of bad assets Citigroup has on its books, they have another 2/3 of a trillion of their books. We need a Toxic Asset Pool and housing to be addressed.

Scott Dauenhauer CFP, MSFP, AIF

Wednesday, November 26, 2008

Happy New Year? Not for Some - 403(b) Plans will have fewer investment options

An article in which I am widely quoted on CBS Marketwatch about the new 403(b) regulations.

Scott Dauenhauer CFP, MSFP, AIF

Friday, November 21, 2008

What Now? Is This the Bottom?

Since the Presidential election the stock market has fallen 20% plus, bringing the total carnage to close to 50% domestically (and slightly worse internationally). REIT's are down 60%. As far as I know, this is the first time a stock market has dropped by 50% twice within a seven year period - making it the most difficult time to be a stock investor since the Great Depression. While the economy was not heading off a cliff back in August, the events of September brought everything to a screaching halt.

The failure of Fannie, Freddie, AIG and Lehman (specifically Lehman) was like a freight train running at full speed and suddenly hitting an immovable wall. The train is still there and so is the wall, but there won't be any progress for a long time. Not only does the train (what's left of it) have to be removed from the tracks, but before a new one can be put back on, the tracks have to be repaired, the wall has to be removed and somebody needs to ensure that there aren't any more walls built on a train track.

I believe the problem we are facing is a lack of confidence in any elected leadership. We have nobody who anybody trusts giving us any signs that they have the ability to lead us out of this. My hope is that the President-Elect makes a wise decision with his Treasury Secretary choice - if he does, this will go a long ways toward the process of restoring confidence.

The good news is that oil is down substantially and this will serve as a monstrous stimulus to the American People, their gas prices being cut in half right before the holiday season. The bad news is that we could easily see $4 gas again if we don't address our energy problems.

We have a $10 Trillion deficit and will probably add another $1 Trillion next year. That is small potatoes compared to the $53 Trillion in future deficit we have with Social Security, Medicare and Medicaid.

The problems we face seem insurmountable and for many nations they would be. However, we happen to live in the greatest nation in the history of the world and the people, who have faced much greater adversity and come out stronger will again save this great nation. Our greatness is not derived from our politicians, but from our people.

We are entering a deep recession that may see unemployment rise to 9%, very similar to the 73-74 and 80-81 recessions. Things aren't good, but America has come out of every recession in its history and gone on to become stronger than before. We need to take this opportunity to strengthen our nation fiscally. We need to be careful not to over-regulate and in fact de-regulate some industries. Finally, we need to enact greater regulations on the financial industry that got us into these problems to begin with. Those on Hubris Street (my name for Wall Street) can no longer do whatever they please because they think they are smarter than everyone else in the room, these emperors have certainly been proved to be without clothes.

This all brings us to the question of the day - what now? What do you do with your money that is invested in stocks? Many have started to look at other avenues beside Buy and Hold, they are looking at both Active Management and Market Timers.

I've looked into both and both have failed in their mission at just the moment they were supposed to shine. What follows are how some of the best in the Active Management world have fared:

• Warren Buffett (Berkshire Hathaway): -43%
• Ken Hebner (CMG Focus Fund) -56%
• Harry Lange (Fidelity Magellan): -59%
• Bill Miller (Legg Mason Value Trust) -50%
• Ken Griffin (Citadel): -44%
• Carl Icahn (Icahn Enterprises): -81%
• T. Boone Pickens: Down $2 billion since July
• Kirk Kerkorian: Down $693 million on his Ford shares alone

As for the Market Timers, the number #1 newsletter as ranked by Mark Hulbert for the past ten years is Bob Brinker's and he still had a bullish signal as of November according to a blog that follows Brinker, a quote from that blog as follows:

"Bob Brinker's Marketimer: Bullish. In his most recent issue, which was published in early November, editor Bob Brinker writes: "We continued to believe that there is no risk of a cyclical bear market (a decline of 20% or more as measured by the S&P 500 index (S&P500 chart) in the months ahead ... We expect the stock market to set a series of new record highs into next year." His model portfolios are fully invested.

Mark covers nine of his top market timers and concludes Bob Brinker is not a "lone voice in the wilderness" with his bullishness. "None of these nine top timers is bearish. The average equity allocation among all nine is 83%. This is down only slightly from where this average stood in recent months."
The best news is the worst market timers Mark Hulbert covers are quite bearish with an average recommended equity weighting of only 9%:

This 83% average is good news for the stock market in its own right, of course. But it's particularly bullish relative to the average forecast of the ten stock market timing newsletters with the very worst risk-adjusted performances over the last decade. The average recommended equity exposure among these worst performers right now is just 9%.

In other words, the worst market timers are quite bearish right now, while the best timers are quite bullish. Rarely are we presented with a contrast this stark."

My point - there is no safe harbor from the storm in terms of investing in stocks. They are risky and the only way to capture the total return of them over the long run is to be fully invested in them, not jumping around. Of course, this assumes a diversified portfolio and that you don't have money invested in stocks that you need within ten years.

Bottom line - this is bad, it hurts, its emotional and I have no words that can make you feel any better except that this too shall pass and stocks will rise again, it just might take awhile. Good things come to those who wait and patient, long term investors in stocks have always been rewarded with excess returns.

I'm on a vacation up in Oregon and heading back home this weekend, I'll be available part of Tuesday and all day Wednesday and Friday (no, I won't take calls on Thanksgiving!!!).

If you want to send me an e-mail, I will respond.

Scott Dauenhauer CFP, MSFP, AIF

Wednesday, November 12, 2008

The Bailout...err Rescue...err..We Just Need $700 Billion

On September 29th I wrote about The Bailout and said that I thought the bailout would have a positive affect, obviously in the short term that was wrong. However I was referring to the long term.

I also wrote that buying the "troubled assets" was nothing more than a recapitalization program and that it amounted to overpaying for securities. I argued the banks need more capital and this was a backdoor way to get it. Turns out I was right and instead of buying the securities (which would take forever to do) the government opted for a direct infusion.

Now the government has decided to abandon this program all together - they will not buy troubled securities (which by the way have a market and are traded everyday). Instead they will use the money for other stuff.....perhaps bailing out student loan and credit card lenders....uhh, what is next?

Is it me or did we just spend $150 billion in pork to give a lame duck $700 billion to fool around with?

Perhaps, perhaps not. It is possible that the government is trying to actually get ahead of issues instead of fighting them after they've occurred. The real problem is still not addressed, though there are hints that this money will be used to help guarantee mortgages.....we'll see.

Aren't you glad at least somebody stopped this behemoth and added some oversight (and pork)?

Its time for Paulson to be given the boot......and just where the hell is Bernanke? He's the Depression expert. Paulson will be gone as soon as Obama takes office, given the lack of leadership by Bernanke, I'd be surprised if he gets another term.

I'm starting to think Congress needs to be bailed out......of their jobs.

Scott Dauenhauer CFP, MSFP, AIF

WSJ: Is Now The Time To Buy Stocks?

Contrary to what the title may indicate, this is not a market timing piece. The author goes through a bit of historical data (which you will find interesting) and then gives you different scenario's for who should buy, sell or continue to hold stocks. A very reasoned piece that is well written and timely.

Scott Dauenhauer CFP, MSFP, AIF

Tuesday, November 11, 2008

Hall of Idiots: FHFA & Federal Government

Today the government announced what they hope will be the "standard" for loan modifications in the U.S. The "standard" they set out has formerly given them entrance into my Hall of Idiots (shared by Robert Kiyosaki and Jim Cramer).

With big fanfare, on Veterans day a host of governMental (emphasis on Mental) entities lead by the FHFA announced a plan that will fail. How do I know? Its been tried and is already failing, plus, it doesn't actually solve any problems. What is going on here is that the lenders are trying to get out of these loans with as little pain as possible while portraying themselves as the white knight saviors of our society.

What we have are lenders who made lots of bad loans and now they don't want to share in the losses that these loans will inevitably bring (and already have). You have lenders who made loans to people who had less than $20,000 in income, yet were able to take on a $600,000 mortgage - but they think they shouldn't feel any pain.

Todays announcement amounts to playing "kick the can".

Here is what they want to do:

First, you must be three months behind in your payments.

Second, they will try to work with you to lower your payment by temporarily lowering the interest rate or increasing the term of the loan (to 40 years).

Escrows for real estate taxes and insurance must already be set up.

38% is the threshold debt level.

Must sign an affidavit that you are in a hardship.


The whole program is going to force people who can make payments or are struggling to make payments in order to protect their credit stop making payments and decimate their credit. Anyone who participates will see their FICO score plummet. I know that FICO scores aren't public, but should someone be punished for potentially the next five years in order to get in line for a program that may NOT even help them? This is just stupid.

Temporarily lowering the interest rates to 1 or 2% and or increasing the loan term to 40 years (which doesn't lower the mortgage by much but increases interest by a ton) sounds very similar to the crazy, ridiculous loans that were offered that got us into this situation in the first place. It doesn't solve the problem, it kicks it to the future a few years. What happens when the rate adjusts back to the original rate? This isn't a fix.

Why in the heck would you require that someone already have escrowed real estate and insurance? This makes no sense and I'm hoping its being misreported. Think about it - exclude someone because they chose to pay their taxes and insurance on their own........yeah, real smart. They could simply require that taxes and insurance are escrowed as part of any loan modification.

The last thing is what is really stupid - a signed affidavit of hardship. Listen to the circular logic here:

The economy is in a free fall because of housing. Housing is in a free fall because of foreclosures. Foreclosures are accelerating because housing is in a free fall and people owe a lot more than their home is worth. In order to stop foreclosures and help the economy we've got to help homeowners.......errgo..........lets only help those who will sign an affidavit of hardship.....what?

How about this - owning a home worth half what you paid for it is a hardship - think that is acceptable, they will tell you no.

So if you can make your payment, but are disgusted by the mortgage industry that gave tons of people loans that they never should have been given, which artificially drove up the price of the home you bought in good faith (and could afford) you are not eligible for help. Forget the fact that you could walk away and the lender would be stuck with a huge loss. Forget the fact that these people are more than willing to negotiate, but will walk if ignored and forget the fact that they are the best hope for the lenders long term.

It seems the brightest people in the room are really just a bunch of emperors with no clothes.

When you make a bad loan you should pay the price - that way you don't do it again. The lenders don't seem willing to admit that they are responsible for this mess and its high time they take that responsibility, share some of the loss and start cleaning things up. This "standard" that FHFA put forth is the typical of government standards - Mediocre.

The lenders don't want to face the music and the government is trying to prevent them from facing the music because of capitalization issues.

Today's announcement will be soon forgotten as the government quickly finds its a stupid solution that will put more people even closer to foreclosure. Three months from now they'll put forth another stupid solution, then maybe a year from now they'll actually do what is needed........of course they could just listen to Sheila Bair now.


Scott Dauenhauer CFP, MSFP, AIF

Friday, October 31, 2008

Stewart: What If We Were In A Great Depression?

James Stewart of the Wall Street Journal and Smartmoney writes an interesting article that posits how the outlook for stocks would be if we were actually in another Great Depression - in other words, at this point during the beginning of the Great Depression how would have asset classes performed going forward. Stewart answers this and the results are quite stunning.

I'd have to say at this point that we aren't in a Great Depression and aren't even close to one. At least part of that feeling is anecdotal, the malls are packed every time I go there.

The linked article is very interesting and hopefully provides additional perspective.

Scott Dauenhauer CFP, MSFP, AIF

Finally, October Is Over

Halloween is upon us, though it seems we got the trick or treat themes early this year and it certainly wasn't a treat. This October has been the worst on record since 1987 and before this weeks rally was on track to be the worst since 1931. My hope and that of most people is that we can put October behind us and move forward.

There are still fundamental issues that we need to deal with in this economy, but hopefully those issues are now reflected in the current market (and perhaps overblown).

On the bright side, GDP was barely down for the third quarter, coming in at -.3%, better than expected and if gas prices stay where they are or go lower (yes oil is down over 50% in price) we may not even see negative growth for the 4th quarter. Given the devastation and the freeze up in credit, I think the safe bet is that we will have a negative GDP in the 4th quarter - but the average American will have more money in their pocket and more to spend at precisely the time they need it - the holidays (due to falling gas prices).

Things won't be easy going forward and nobody has dealt with the fundamental issues that are causing much of the problems (housing), but I still believe the long term will reward patient stock investors and now presents a good buying opportunity. Certainly for those people who are accumulating for a retirement that is 10, 20 or 30 years away, this is the best thing that could happen to you. This market has taught a lot of people a lot of lessons about risk and diversification.

Thinks aren't rosy, but they may not be as bad as predicted either - remember, the economist are almost always wrong, how many of these geniuses predicted what happened this year in stocks? Very few.

Scott Dauenhauer CFP, MSFP, AIF

Wednesday, October 22, 2008

Life Preserver for Homeowners Under Water

Finally someone outlines the real problem in housing (besides myself)...of course the problem does not easily find a solution. I don't have a silver bullet, but I think there needs to be a combination of government, homeowner and banking industry help. A program where the government provides an incentive for banks to write down the loans, but not a complete bailout. Homeowners (myself included - down 40%) need to share in the pain. I bought a house and it has gone down in value, I could easily walk away - but I won't, the problem is others will. We need to give them an incentive to stay - this has to be a combination of payment relief, mortgage write-down and perhaps some government assistance with the write-down.

Lets say that someone has a $500,000 loan on a home now worth $250,000 - they can make the payments and are not struggling, but they have a huge loss that they don't see a way out of, they walk. If instead of owing $500,000 on this property they owed $325,000 - still under water - but not nearly as bad (and a good possibility of being above water within 5 years - versus 15) and the bank agreed to share the $175,000 loss with the government, say 70% the bank, 30% the government. I don't know, just thinking off the top of my head here - but the banks never should have lent this money to most of the people - the fact that they did led to many people paying inflated prices (which was the banks doing). Stupid should hurt and the banks NEED to feel some pain when they do stupid things. I really don't like the government involvement part, perhaps there is a better answer - or maybe an equity kicker for taxpayers if things recover quickly.

My point is not to present a comprehensive plan, Lord knows I've got more important things to tend too - like my family and my clients. However, smart people should be able to come together and address this problem - until they do.....the recovery will be slow and painful.

Scott Dauenhauer CFP, MSFP, AIF

WSJ: Bernanke Is Fighting the Last War

This interview with Anna Schwartz is perhaps the most important interview you will read. Anna worked with Milton Friedman on a well respected book and is in the same mold as Friedman. She doesn't appear to be happy with the way Bernanke is handling this crisis - she believes that things are different now than during the great depression and thus different things need to be done, Bernanke (a huge student of the Great Depression) is fighting today's problems with the solutions to yesterdays problems.

This is actually a little scary, but I know Ben reads the Wall Street Journal and has a deep respect for Anna....perhaps this is her way of letting him know he needs to make a few adjustments.

This is a fascinating interview.

Scott Dauenhauer CFP, MSFP, AIF

A Conversation With Robert Arnott

I don't agree with everything Arnott says and I'm not a perma-bear, but I think the following paragraph from this article was very interesting and quite telling about how different this stock market downturn has been versus others:

"The nature of this crash has been so sweeping. In September, 15 of the 16 asset classes we track were down. That hasn't happened over the past 30 years. In October it has gotten worse. Most people look at this and feel devastated. The more sensible approach is to look at it as a buying opportunity."

I also read that something like 91% of all mutual funds were down for the year.

Scott Dauenhauer CFP, MSFP, AIF

Friday, October 17, 2008

Buffet, NYTimes: Buy America, I Am

"THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks."

There is a lot more to this Warren Buffet Op-Ed, if he's buying.........

Scott Dauenhauer CFP, MSFP, AIF

Third Quarter Commentary

Winston Churchill once said "Democracy is the worst form of Government ever attempted in the world. The only exceptions to this are all the other ones tried." Nick Murray once said something similar (paraphrased) "Buy and Hold is the worst form of investing ever attempted in the world. The only exception to this are all the other ones tried"

Some have questioned the wisdom of holding stocks when they are going down and that is understandable, why would we want to continue to subject ourselves to this form of punishment? The answer is that there isn't a better way to capture the long term superior return of stocks, except by holding them during the good and bad times. Keep in mind that the allocation to stocks should be within an acceptable range of risk for your goals. I've always told my clients about the 2000 - 2002 period when stocks dropped by 49% from their high (and the NASDAQ 80%) and that you should expect a 20% drop in stocks about once every five years and a 10% drop every two years. So when the market drops by over 40% twice in an eight year period, that seems to me to be excessive and a difficult way to earn money. While I agree its a difficult way to earn money, there hasn't appeared on the horizon a better way and don't expect one to come along.

Sure there will always be the people out there who tout their market timing strategies that supposedly get you out before the market drops and in before it goes up, but that's not really investing and it doesn't work over long periods of time. You may not lose as much during downturns, but you certainly won't make as much during the inevitable upturns.

Warren Buffet talked about market timing as one of those things that hurt your performance in his 2004 annual shareholder report:

"Over the 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job.

Instead many investors have had experiences ranging from mediocre to disastrous. There have been three primary causes: first, high costs, usually because investors traded excessively or spent far too much on investment management; second, portfolio decisions based on tips and fads rather than on thoughtful, quantified evaluation of businesses; and third, a start-and-stop approach to the market marked by untimely entries (after an advance has been long underway and exits (after periods of stagnation or decline). Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful."

He wrote just today (October 17th in the New York Times) the following:

"Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over."

If the greatest investor (who in January was Bullish on the American economy) in the history of the world can't predict short term movements, what makes you think your neighbor or some investment guy down the street can?

The hardest thing to do right now is the wisest thing to do, buy stocks. Warren also said in his New York Times piece "A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now."

If Warren Buffet is buying, perhaps our fear, while real, is a bit misplaced.

The key to a good portfolio is to set your asset allocation to a level where you are comfortable with the inevitable short term downward fluctuations (comfortable being a word that is relative). Most people aren't comfortable losing money at all, however the total return available to them after taxes and inflation will be about 2% if they're lucky if they take no risk (and right now if you buy treasuries you are guaranteed a negative return after taxes and inflation). Stocks should be expected to return two to three times that and provide a good hedge against inflation long term. Your biggest enemy in retirement is not stock fluctuation, but inflation. The slow killing off of your purchasing power in retirement will turn that golden nest egg to copper in the span of just a few decades.

These are tough times, there is no doubt about it, but America has faced such times before and come out of them better and stronger than before. A few months ago most people were fretting about the possibility of $200 oil...now oil is at less than $70 per barrel, a 50% decline. Things change and prices cycle, that is the nature of free markets (ok, somewhat free markets). We still have fundamental problems in our economy that no one is addressing (Social Security, Medicare, Medicaid, Energy) and things aren't perfect, but things will never be perfect.

Buy and Hold may be the worst form of investing ever attempted, but is much better than all others ever tried.

Hang in there, this too shall pass.

As always, I'm available to talk.

Scott Dauenhauer CFP, MSFP, AIF

Suze Orman: Hall of Idiots?

I've elected Jim Cramer and Richard Kiyosaki into the Hall of Idiots over the past few years primarily because they promote behavior and give advice that is either foolish or self-serving. The Wall Street Journal did an article today about Suze Orman and how this financial panic is making her more of a star than ever. I can't stand watching or listening to Suze Orman, it drives me up the wall and batty. I think the most annoying sound in the world is Suze Orman saying "girlfriend". The article featured a couple people complaining about Suze, mainly advisors who said she was a fear monger (to be fair, a few things she has said I think could be considered just that) and profited unduly from her celebrity by doing endorsement deals.

I think this is all just professional jealousy. Lord knows Suze bugs me, but she is no idiot. Her books are great and have helped a lot of people. There generally gives good advice and her books are probably the best way a financial neophyte (even Men, not just Woman) should begin to learn about personal finances.

I won't be watching Suze or listening to her on the radio........but I also won't be adding her to my Hall of Idiots, she doesn't deserve that, she's done to much good.

Scott Dauenhauer CFP, MSFP, AIF

Thursday, October 16, 2008

What Happened to $200 Oil?

On June 16th I posted a story, "Expensive Oil's Days Are Numbered". Today only dropped under $70 per barrel, a more than 50% decline. Now if we would only see lower prices at the pump. If I recall correctly I paid at least $4.50 at one point, which means I should be paying around $2.25 pretty soon......prices yesterday were about $3.30, still have a ways to go.

I'm not saying oil won't go back up, it could, especially if we have a weak dollar. I just think that its important to point out that almost all experts where wrong.

Scott Dauenhauer CFP, MSFP, AIF

FDIC ChairWoman and Me....How To Put An End To This Mess.

I think I've found my hero, Sheila Bair, the FDIC Chairwoman. In an interview with the Wall Street Journal she said:

"Why there's been such a political focus on making sure we're not unduly helping borrowers but then we're providing all this massive assistance at the institutional level, I don't understand it," she said. "It's been a frustration for me."

The fatal flaw in the plan's being pushed by the Treasury and the Federal Reserve is that none of the plans address the underlying issue - housing prices and foreclosures.

This is not to say the government isn't doing a lot, they are - which is different (despite what is being misreported) than during the Great Depression. The government became hands off and protectionist during the Depression and held onto the Gold Standard for too long. Things didn't start improving until the government stepped into help - its not that things wouldn't have naturally improved, they would have, but it could have taken even longer.

This time the government (and world governments) have taken measures to help prevent what happened in during the Great Depression, so far they have been unsuccessful, but I suspect that many of the measures are simply a matter of time.

Of course the one thing nobody has addressed directly is housing and foreclosures. Congress did pass a $300 billion "Hope for Homeowners" package earlier this year, but that was a smokescreen to make you THINK they were doing something about the little guy when in reality they were passing legislation to bail themselves out of the Fannie and Freddie mess (the bill was modified to allow for the conservatorship of the two mortgage giants). The Hope for Homeowners program is in a word...non-existent. The program was meant to encourage lenders to lower the loan amount to 90% of the current home value and then refinance the loan off the books into the FHA - because it required such a massive write down, there has been very few if any takers for this program. In fact, it is nearly impossible to get a lender to even talk about the program, IF they even know about it. Heck, I called Freddie Mac the other day and an employee of 20 years didn't know he was now a government employee!

John McCain has actually taken a very good stab at this underlying problem, yet has gotten zero credit for it....most likely because his proposal is a complete giveaway. He proposes to refinance underwater homeowners out of their loans - basically buying the loans at full price from the institution who owns the loan. The problem with this proposal is it is TOO MUCH government money being spent. You may think me crazy to say that considering the $700 billion "rescue" package that congress passed (at a treasonous cost of $150 billion in extras), however there is a high probability that the entire $700 billion will come back plus more, so in reality it isn't really a giveaway, its an investment that should (that's a big should) bring more into the treasury than is expended.

Its easier to propose a $700 billion dollar program that will make the Treasury (and thus the American people) money than it is to propose a $300 billion program that is a direct giveaway to banks and taxpayers. Readjusting the mortgages by reducing principal is a good idea and will help to stem the current crisis and get housing back to stability, but it shouldn't be done as a complete giveaway.

For those of you who are wondering just why the heck I would propose rewarding those who got themselves in over their head you must remember that you are being affected by this crisis precisely because of these people's situation and THEY now hold the power over all of us. What do I mean? Let me give you a personal example, myself:

Four years ago my wife and I decided that it was just too expensive to buy the home we wanted in Orange County. We wanted to have more children and I wanted her to stop working (for at least a few years), the problem was that I felt the housing market was overpriced, in fact, I was featured in a June 14, 2004 Bloomberg article by John Wasik titled "Is U.S. Housing Boom Coming To An End?". The opening to the article is as follows:

"Is the long, ascending march in U.S. home prices reaching a summit?

Scott Dauenhauer, a fee-only financial planner in Laguna Hills, California, for one, isn't sanguine about home prices in Southern California, where double-digit increases are common.

Having sold his 1,000-square-foot, two-bedroom home six months ago for $350,000 -- he paid $170,000 in 2000 -- Dauenhauer says he's not really timing the market, yet found home prices in his area ``ridiculous.'' He's looking for a three-bedroom home with a yard for his wife and three-year-old son in Orange County. For now, he's renting while prices continue to soar.

As rising mortgage rates chasten the housing boom, it's time to consider whether you should buy new property or borrow against your home based on the presumption that home prices will ascend endlessly.

``A friend who lives about mile away who has a four-bedroom, 2,500-square-foot home said a home similar to his just sold for over $900,000,'' Dauenhauer said. ``I think there's a bubble. It's similar to the Nasdaq (stock market) several years ago. I tell any clients who come to me who want to buy a house that there's more downside than upside now to the home market.''

To buy the home we wanted in Orange County would end up costing up at least $1.2 million (this was 2004), this is an interest-only payment of $6,250 per month, add in taxes and HOA dues and the monthly cost rises to about $7,800. I pride myself on living within my means and being able to offer a great financial planning service at a reasonable cost, it was clear what I had to do - either double my fees to my clients (which I wouldn't do) or move out of Orange County and buy where I could afford.

We decided to move to Murrieta, CA - a town an hour east of Orange County. We were able to buy a brand new home just like the one we wanted in Orange County for $470,000, that is a 60% savings. We saw the bubble coming and did what we thought was best, buy what we could afford. The problem is that Riverside county (where Murrieta is located) got hit hard by the bubble, much harder than I would have ever expected. Murrieta's rapid growth came from people who worked in Orange, Los Angeles, and San Diego Counties - they commuted (sometimes the husband and wife). When gas prices nearly tripled to close to $5 per gallon, it was too much to take - they were spending upwards of $1,000 or more per month on gas and living in a home that had fallen dramatically in value.......many left. This caused an even further decline in housing prices. I had my home appraised in February 2007 at $555,000. I knew this was a sham appraisal, there was no way it was worth that - I saw this happening everywhere (I called them pick-a-price appraisals). My house is now worth probably $270,000 (though I doubt I could sell it for more than $250,000). There were a lot of people buying houses that never should have been in the market in the first place and this artificially inflated prices, when those people left the market......the merry-go-round stopped and prices fell dramatically - in my case 55% from its high.

Unlike many of the homeowners, I've got a great deal on my mortgage. I've always believed in being conservative when it came to a mortgage - thus I got myself a 30 year loan with a 5.875% interest rate. The payments are affordable and there are no adjustments to come. The problem though is my house is worth a heck of a lot less than what I owe. The power has shifted dramatically to me - if I walk, the owner of my loan is going to have major problems. The second trust deed would be completely wiped out and the first trust deed would have a foreclosed home that will sit on the market for 6 - 12 months or longer with no income and will probably sell for $250,000 if they're lucky. This is a minimum 40% loss for the first trust deed holder. I've got every incentive to walk away and if I do.....you suffer. By the way, I'm not walking away - but there are a lot who would.

You suffer because the downward spiral will continue in housing, we'll see more houses on the markets due to foreclosures, less buyers because the banks will continue to NOT loan money as their balance sheets deteriorate even further (and need even more government infusions) and the mortgage backed securities will be worth even less....which creates even further problems. Just as in the great depression, the banks have stopped lending (71% of home lending during the great depression was government). They won't start lending again until they see safety. Washington Mutual has a huge amount of Option Arm loans coming due in the next 24 months and this will put further pressure on homeowners to walk away. The more that walk away the further the decline goes and the more everyone suffers - Trillions have been lost because Billions were walked away from. One other thing.....do you think I'm going to put a dime into my house while its worth about half what I paid? Not a chance, my wife wants hardwood floors and crown moulding.......there is no way I'm putting money into this thing.......and I can tell you that my neighbors feel the same way, this further hurts the economy.

My main point is the FDIC Chairwoman is right, we need to give an incentive to homeowners who can afford to stay in their homes to actually stay in the homes and not walk away. As much as I hate government intervention, desperate times call for desperate measures and a program that combines government incentives, direct infusions, government guaranteed loans and a loss sharing provision with the banks and owners of the loans is what is needed. Banks shouldn't be made whole by the government, however if they have to take too much of a loss they simply won't take it.

I'm not saying all of this as an effort to get a government bailout, if it helped I'd forgo principal reductions if it meant others could get them. My clients stock portfolio's are hurting right now and the underlying causes are not being addressed - that is my main concern.

It is time we moved past this housing/credit/financial crisis and the way to do it is to address the underlying problem - housing.

Scott Dauenhauer, CFP, MSFP, AIF

Friday, October 10, 2008

Warren Buffet Interview

Warren Buffet had a conversation with Charlie Rose about the economy and the current financial crisis, what follows is an excerpt from that conversation that I think you may find interesting. This is a small excerpt from an incredible interview with Buffet and I think you should read it. It's long and if you'd rather watch it the video link is below. He speaks in plain language and is well balanced. Its not all roses (not pun intended), but it is real straight talk.

"Oh, I think confidence will come back. I will tell you this. This country is going -- be living better ten years from now than it is now. It will be living better in 20 years from now than ten years from now. The ingredients that made this country, you know, the miracle of the world -- I mean we had a seven for one improvement in the average American standard of living in the 20th century. Now, we had the great depression, we had two world wars, we had the flu epidemic. You know, we had oil shock. You know, we had all these terrible things happen. But something about the American system unleashed more and of a potential to human beings over that hundred years so that we had a seven for one improvement in -- there's never been any -- I mean, you have centuries where if you've got a 1 percent improvement, then it's something. So we've got a great system. And we've got more productive capacity now than we ever have. The American worker is more productive than he's ever been. We've got more people to do it. We've got all the ingredients for a sensational future. It's just that right now the athlete's on the floor. But we -- this is a super athlete."

Link to Video

Scott Dauenhauer CFP, MSFP, AIF

Monday, October 06, 2008

Is This a Replay of 1929?

In short, no. Paul Samuelson gives us a good look at the history of recession and depression. He outlines the big differences between now and 1929. This is a short article, worth your time reading today.

Scott Dauenhauer CFP, MSFP, AIF

Friday, October 03, 2008

What is Mark-to-Market and Did It Cause A Panic?

Lately you've been hearing a lot about an esoteric accounting rule called "Mark-to-Market" (here in out referred to as M2M). Your eyes probably glaze over, but this accounting rule is partially to blame for the recent panic. Don't get me wrong, the underlying problems of this financial crisis are loans made to people who couldn't afford to pay them back (as well as credit agencies and appraisers), but the actual panic and seizure of the credit markets may be due more to M2M than anything.

What exactly is M2M? Its actually a reasonable method of valuing assets during normal times - it requires a company to value their assets at current prices on their books. Sounds reasonable. The problem is that it goes further than that, it has an effect on the capital structure of a company and recently has caused several companies to become insolvent......on paper.

Let me give you an example (I'm adopting this from Brian Wesbury):

You own a home worth $300,000 and you have a $250,000 loan in which you are making payments. Under Mark-to-Market rules if the value of that home drops to say $230,000 the bank will call you up and say "the value of your home has dropped, you need to pay us $20,000 (the difference between the loan value and home value) or we're going to kick you out". Needless to say most Americans would end up losing their homes and exacerbating the problem. Most Americans can't just come up with $20,000. Most Americans however can continue to make payments on that loan (about 95% are right now current). Yes, their is more risk and if liquidated right now a loss would occur - but you don't need to liquidate your home right now, you can wait years to do so and with a high probability the home will be worth more than the loan.

The M2M accounting rules work to require institutions to come up with money for no other reason than because a security is suddenly valued lower, sometimes for no good reason. A security that the institution may in fact hold until maturity and have a reasonable expectation of receiving most of the money back.

This insolvency test put Fannie and Freddie into government hands and each was given a line of credit of up to $100 billion.......of which they've used none of it - they both have positive cash flow. Of course, both entities were destined to fail, but that's another story.

I'm not making the arguement that we shouldn't use Mark-to-Market to help us understand liquidation values - but when its use causes a potential time bomb and leads to panics......it makes very little sense.

Most of the panic of these past few weeks has been caused by Mark-to-Market rules, the other to the Lehman failure (which may not have failed if these rules had been eased). The Lehman failure led to a money market fund "breaking the buck" which caused even more fear and panic and let to a complete seizing up of the credit markets.

Today's passage of the bailout bill and the SEC's easing of the mark-to-market rules will hopefully create an environment where we can work on the true underlying problems we face.

Scott Dauenhauer CFP, MSFP, AIF

Monday, September 29, 2008

WSJ: Jason Zwieg: What Should Investors Do Now?

The Intelligent Investor: When the Dow drops 778 points in one day, it seems like there's nowhere to hide.

Jason Zweig gives us some great perspective on today's events, a couple excerpts from this excellent article:

On whether we are heading for another Great Depression:

"First, when you spend time studying the Crash of 1929 and the depression that followed, what stands out the most is the dearth of doomsayers. Even Roger Babson, the economist known to posterity as "the man who called the crash," did no such thing; he forecast only a 15% to 20% drop, not the apocalypse that actually occurred. Depressions start not when lots of people are worried about them, as we have today, but when no one is worried about them, as in 1929.

Second, the Great Depression and the Panic of 1873 (which triggered what arguably was the worst depression in U.S. history) both occurred before the Federal Reserve Bank had aggressively grown into its role as "lender of last resort." In the wake of 1873, after a railroad-building boom had swept the nation and then gone bust, companies and consumers alike were left gasping for capital. Nothing but the passage of time could supply it; the Fed would not be established until 1913. After the crash of 1929, when the Fed was still weak, years passed before the federal government could flood the economy with cash.

Today, however, the resolve of the Fed is not in question; nor is there any doubt that the Treasury department is willing to provide the financing it takes to get the economy moving again. Furthermore, U.S. non-financial companies have just under $1 trillion in cash on their books."

I encourage you to read the whole article.

Scott Dauenhauer CFP, MSFP, AIF

Bailout Fails - Investors Bail

Well, well, well......yesterday everyone was told that congress was ready to play nice with each other and actually work for the American people. In the end we found out that in fact, they just didn't have it in them. They couldn't hold themselves back from playing the same political games that are partially responsible for the mess we are in now. I don't know if it was Pelosi's speech that threw Republicans into a tizzy (if it was, how utterly ridiculous and thin skinned of those Republicans), but the speech was certainly not needed. Regardless, the bailout package failed and investors bailed on stocks - giving us the worst one day point loss in two decades.

Where do we go from here? I can only imagine that the two parties will come back together, curse each other out, blame each other then come back to the American people with a package that works....and actually pass it. This will not be the final measure, but it would be a good start - it is a bank bailout or a partial recapitalization of the banks (after all, we are overpaying for the assets).

The bottom line is that America is suffering from a lack of leadership, Paulson and Bernacke are attempting to step in, but so far are not making necessary progress. President Bush is a lame duck with a low approval rating and congress has the worst approval rating in history - we are in a leadership vacuum. We need strong leadership and we need more transparency in our markets, we also need a solution to the housing/foreclosure problem - without this, nothing will change.

This doesn't mean you should be eternally pessimistic about stocks. Stocks are on sale, they may go on sale further (I guess that might be a clearance?) but they are not going to go down forever. History shows us that stocks recover and those that hold on should be well rewarded.

Hang in there and read my next post with Jason Zweig.

Scott Dauenhauer CFP, MSFP, AIF

WSJ: Calling JP Morgan

I've been reading "The Panic of 1907" as a way of better understanding our financial crisis history. Its amazing the parallels of today and back then. The panic happened over 100 years ago (there were 13 previous ones) and yet, America survived. We will survive this panic as well.

Today's events are a little unbelievable, but not unprecedented. If you want a fascinating read about how JP Morgan solved the Panic of 1907 in just eight weeks and what we can do now to get through this crisis......you've got to read this article.

Scott Dauenhauer CFP, MSFP, AIF

Historical Market Reaction to Financial Crises

I realize that these graphs may be difficult to read, but if you click the above link it will take you to a page that will allow you to download them and those are very easy to read. The main point....stocks have always rebounded after a crisis.

Scott Dauenhauer CFP, MSFP, AIF

MBS, CDO's and CDS's In Layman's Terms......

You've probably been hearing a lot about securities that you've never heard of before. I bet you never thought it would be important to know what an MBS or CDO or CDS was......now you may be wondering. I'll try to give you a brief synopsis of each.

MBS - Mortgage Backed Security

This is in its simplest form a bond. The bond is backed by a pool of mortgages that are being paid by homeowners across the United States. Each month a homeowner makes a payment, that payment basically sent to the holder of this bond. If one were to buy a Mortgage Backed Security (MBS) they would receive an interest payment and a partial repayment of their principal (since some of a homeowners payment is interest and principal). These securities are issued by Fannie Mae, Freddie Mac and Ginnie Mae - but can also be issued by other institutions. When an investor buys a Fannie Mae bond, they are essentially buying the cash flow from different homeowners as they make their monthly mortgage payments. If a homeowner defaults on their mortgage or misses a payment, the MBS holder suffers....of course this is where Fannie, Freddie and Ginnie step in and make them whole. With so many people in foreclosure and not making payments......you can see why Fannie and Freddie had to be bailed out.

O.K. - as if MBS was not hard enough - Collateralized Debt Obligations or CDO's.

These are tough to understand and I won't bore you with the internals, but think of this as a Mortgage Backed Security on steroids. Instead of one investor owning the cash flow of a mortgage - multiple investors could own it. Here is an example of how a CDO might work:

Pretend that you have a mortgage (okay, most of us aren't pretending) and you make principal and interest payments each month - these payments are made to your loan servicer and then split up as follows:

Investor A - Gets all of the interest payments from years 1 - 4
Investor B - Gets all of the principal payments from years 1 - 4
Investor C - Gets all of the interest payments from year 5
Investor D - Gets all of the principal payments from year 5
Investor E - Gets the interest and principal payments from years 6 - 10
Investor F - Gets interest payments from years 11- 24
Investor G - Gets principal payments from years 11 - 24
Investor H - Gets the remainder of principal and interest payments, if made from years 25 - 30

Imagine you are the borrower - your payments don't just go to your local bank anymore - they get split up depending on the year you are making a payment and how much is principal and interest. All of these investors who are in line to receive these payments have bought into a trust - called a CDO. The trustee of the trust has a fiduciary responsibility to each of these investors. Now you know why when someone who is having problems paying their mortgage and is on the brink of foreclosure is having such problems trying to get their loan modified - if the trustee changes the interest payments, one of multiple investors may get hurt at the expense of another, same goes for principal changes. The trustee is in an impossible situation and thus does nothing........the house forecloses even though a workout was entirely possible.

CDO's were purchased by investors who were told by "creditable" ratings agencies that these securities were "investment grade". Some of these investors obviously didn't believe the credit agencies and decided to seek insurance in the case that their CDO defaulted. They went out and bought.........Credit Default Swaps or CDS.

There is nothing wrong with a Credit Default Swap - it is basically an insurance policy against the failure of a specific asset. The reason these have been in the news is because some companies - like AIG, Lehman and Fortis (and many others) found these insurance policies to be very lucrative business. AIG in particular issued Credit Default Swaps on CDO's so that institutions that held CDO's would be made whole if the CDO defaulted. The problem is that AIG didn't foresee that ANY of these would default - they thought this was a risk free operation. AIG took in a ton of money to insure the CDO's through Credit Default Swaps - but never reserved for losses. As we all know now, AIG made a huge mistake as there were and is risk with CDO's. Credit Default Swaps are basically just insurance policies for securities.

Consider this a 101 class on mortgage derivatives.....its probably boring to you, but it might help to explain a little of what is going on right now.

If you're an expert in these derivates please don't e-mail me telling me how I botched these explanations.....they are correct enough to ensure normal people understand the basics of what is going on!

Scott Dauenhauer CFP, MSFP, AIF

The Bailout

The link above will take you to an article that gives some details about the bailout agreement reached by congress yesterday. What follows are some of my thoughts:

It has become conventional wisdom that this bailout must pass or all hell will break loose. I'm not much for conventional wisdom, however I do believe this bailout will go a long ways toward softening the hit to the global economy that would occur if we didn't have this bailout. The idea is to create a market for securities that banks hold on their balance sheets so that the banks have some breathing room, can recapitalize (hopefully using the private markets) and begin lending again. Lending is at the heart of this crisis - without lending (reasonable lending) our economy cannot function. Be aware that the government IS participating in re-capitalizing these institutions by purchasing the so-called "toxic" assets. While you may not be hearing this, the government IS going to overpay for the securities they are buying.....despite what we are being told. Remember that there is always a market for virtually anything one has to sell, the toxic assets held by these banks CAN be sold right now and there are willing buyers. If you don't believe me you need only to look up a transaction that occured just a few months ago when Merrill Lynch offloaded their toxic assets for 22 cents on the dollar. The banks CANNOT do this - they would be insolvent, thus the government will purposely overpay for these assets in order to re-capitalize the banks and give them some room.

While the government will be recapitalizing these banks, it won't be paying so much for the securities that they will fully re-capitalize the banks, the banks need more capital. The hope is that institutions will have confidence in the balance sheets of these banks again and make investments in them.

I do not believe this plan will add to the deficit, I do believe it has the ability to make money for the Treasury. I'd be happy if it was just cost neutral over the long run.

What does this mean for you? We'll just have to wait and see. I don't think it will lead to higher taxes. Higher taxes will kill or severely maim any possible recovery. In the short term things will continue to be painful, this is not a silver bullet - but perhaps it is a silver covered bullet.....which is the first step in the right direction.

I do not and will not speculate on what the markets will do in the short term - I do not know. A brilliant man once said when asked what he thought the market would do "It will either go up or down." Those are my thoughts exactly. I do believe in the long term prospects of the stock market though. This financial crisis might seem like something new, and for most of us it is, however American has faced such crisis before and weathered the storm.....and came out stronger than before.

Did you know that their were financial panic's before the Great Depression? Yep, we had a severe panic in 1907 (I'll be writing more on that later) and previous to that we had at least 13 panics that led to runs on banks (including one partially owned by one Ulysses S. Grant). The hope is that we've learned from these panic's and have the tools in 2008 to ensure that they don't lead to Depressions, I believe we have those tools.

Scott Dauenhauer CFP, MSFP, AIF

WSJ.com - Lehman's Demise Triggered Cash Crunch Around Globe

When Lehman went bankrupt I applauded the government for finally letting an institution fail. Had I know what they should have known, I would not have allowed Lehman to fail. Lehman was also a big player in the Credit Default Swap market, the failure created shockwaves that led to the panic and exacerbated the credit crunch and accelerated the downfall and eventual bailout of AIG. Had we structured something for Lehman, similar to that of AIG - we may not have had to bailout AIG.

This Wall Street Journal article, though a bit technical gives you the background on the collapse of Lehman and why it had such a profound effect on the markets.

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Sunday, September 28, 2008

Fortune: How it got this bad

Here is another brief synopsis of how we got to where we are. It is not comprehensive, but should give you an idea.

Scott Dauenhauer CFP, MSFP, AIF