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Clearly,
individual investors should have been asking whether their money was safe
time and time again over the past year, rather than listening to the pundits
on CNN. Many investors thought they had invested their money wisely and
relied solely on the advice of their brokers. But now they're emotionally
distraught because they realize they were misled big time. But how were they
misled?
First,
many investors over the past four years invested in some real funky hedge
funds that were heavily into mortgage and asset-backed securities, CDO's, CLO's, and long-term
illiquid assets. They were led to believe they would be able to get their
money out in as little as three to six months if they needed to. But instead
of ready-access to cash, the Bear Stearns funds (as one example) delivered
losses of almost 100 percent. Presently, there are a number of hedge funds in
total "lock down" where the money checked in, but it won't be
checking out for a very long time. Like a roach motel! (At least the asset
managers will continue getting their fees!)
Over
the past five years, Wall Street introduced Structured Investment Vehicles (SIV's) to the world. These SIV's
were a way for major banks to fund hundreds of billions in asset-backed and
mortgage-backed securities with short-term commercial paper off the banks'
balance sheet. In the past year, SIVs basically
collapsed. Some investors in SIV's were lucky
because they cashed out when banks brought the assets back on-balance sheet. Others
were lucky, but it was bad luck.
Worse
yet, over the past several years, Wall Street brought Auction Rate Securities
("ARS") to Main Street.
They were sold as a higher-yield substitute for safe money market funds. Small
investors were stuffed with over $330 billion of ARSs
invested in longer term tax-exempt municipal bonds, preferred stock, and
student loans. They were told they would have ready-access to their money
without loss, for a small pick-up in yield. But when the auctions failed,
many unsuspecting people (who thought they had a simple money-market fund)
found out their money was locked away and couldn't be touched. Who knows how
long they'll have to wait before they can get their cash. Main Street has met Mean Street.
The
moral of the story is you just can't always fund long-term assets safely with
short-term hot money. I estimate that investors in the Hedge Funds, SIVs and ARSs, mentioned above,
have already been denied access to close to $1 trillion dollars that they
thought was readily available cash they could withdraw on short-notice. Total
losses have yet to be determined, but being denied access to your cash can
feel devastating even if there is a chance you can make some of it back in
the future. Holding cash is like having an umbrella for a rainy day. For
those misled by a trusted broker, the umbrella is now broken just in time for
monsoon season.
Unfortunately,
what's done is done and you can't look back and undo what has happened, but
the government taxpayer bailout of Fannie Mae and Freddie Mac, and the
government takeover of IndyMac Bank, should be a
wake-up call. The worst problems in the financial markets aren't over;
they're just getting started. These failures are huge events, and the smoke
signals they created suggest there are many more financial fires around. Many
banks will fail! Some large and medium-sized broker/dealers and finance
companies are likely to be merged out, or file for bankruptcy.
So,
what can you do to protect your money? The FDIC offers iron-clad insurance up
to $100,000 per account. If you have a lot of money, spread it around between
different banks. For individuals and companies with a lot more than a few
hundred thousand dollars, a large portion of the cash should be held in a
money-market fund that only invests in short-term US Treasuries. If you are a
small investor and like to keep money safe for a little longer - and don't
particularly like the rates offered on bank CDs - think about buying I-Bonds
from the US Treasury. The Treasury is now limiting the purchase of I-Bonds to
only $10,000 a year per person. It used to be that the Treasury allowed
you to purchase $30,000 per year per person, but they now want to try and
keep money in the banks. I-Bonds pay the CPI which, of course,
underestimates the true rate of inflation and guarantees you will be robbed
by the government, but you'll receive a better rate of return than on a bank
CD for the time being. (The current rate for an I-Bond is 4.84% through
October 31 (Go to www.savingsbonds.gov).
Most
of us probably have our money safely tucked away, but don't get caught
napping in the middle of the afternoon. The failures tend to come in slow
motion, and there are signs you should be watching for, such as: 1) if a bank
shows up on a list of troubled banks, move fast (it only took 10 days for IndyMac Bank to fail); 2) if a bank, brokerage firm or
finance company has a stock price of $10 a share or less, try and cut your
exposure; 3) if the stock price is $5 or less, proceed as if the company's
days are numbered and get your money out; 4) if a bank or brokerage firm has
publicly denied rumors more than three times,
consider them desperate and run; and 5) if you ever hear a government
official come out and say that an institution is fine, you know it's time to
get your money out because history shows they're likely lying. Look what
happened with Fannie and Freddie. The government said everything was fine
right up to the day the US Treasury dropped the biggest government bailout of
all time on the American taxpayer. The bill for Fannie, Freddie and the bank
failures could cost the taxpayer over $400 billion. (That's your money, of course.)
By : Richard Benson
SfGroup.org
Richard
Benson is the founder of The Specialty Finance Group ("SFG") was founded
in 1989 as a financial broker to private finance companies, introducing them
to major financial institutions that would provide them with equity,
subordinated debt, and senior credit facilities using the Capital Market.
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