Fundmastery Blog

Kurt Brouwer September 17th, 2008

This is an important story from the Wall Street Journal on the decline and fall of insurance conglomerate, American International Group.  This piece is a great example of why journalism — real investigatory journalism — is so important.  The piece was linked at the Drudge Report so it will get wide exposure. I’ve excerpted the most important parts [emphasis added], but it is well worth reading the whole thing.

U.S. to Take Over AIG in $85 Billion Bailout (Wall Street Journal, September 16, 2008, Matthew Karnitshnig, Deborah Solomon, Liam Pleven, Jon E. Hilsenrath)

The U.S. government seized control of American International Group Inc. — one of the world’s biggest insurers — in an $85 billion deal that signaled the intensity of its concerns about the danger a collapse could pose to the financial system.

The step marks a dramatic turnabout for the federal government, which had been strongly resisting overtures from AIG for an emergency loan or some intervention that would prevent the insurer from falling into bankruptcy. Just last weekend, the government essentially pulled the plug on Lehman Brothers Holdings Inc., allowing the big investment bank to go under instead of giving it financial support. This time, the government decided AIG truly was too big to fail.

The U.S. negotiators drove a hard bargain. Under terms hammered out Tuesday night, the Fed will lend up to $85 billion to AIG, and the U.S. government will effectively get a 79.9% equity stake in the insurer in the form of warrants called equity participation notes. The two-year loan will carry an interest rate of Libor plus 8.5 percentage points. (Libor, the London interbank offered rate, is a common short-term lending benchmark.)

The loan is secured by AIG’s assets, including its profitable insurance businesses, giving the Fed some protection even if markets continue to sink. And if AIG rebounds, taxpayers could reap a big profit through the government’s equity stake.

“This loan will facilitate a process under which AIG will sell certain of its businesses in an orderly manner, with the least possible disruption to the overall economy,” the Fed said in a statement.

This is a very big deal and it represents an amazingly quick time line.  Apparently, two factors are in play.  First, the Federal Reserve and the U.S. Treasury decided it would be too disruptive to let AIG fail.  As you will see later in the piece, the end was near — probably today — for AIG.  So, the Federal Reserve authorized the Federal Reserve Bank of New York to make the $85 billion loan to AIG.  Here is a link to the release from the Feds.  Second, the Feds had so little faith in the management of the company that it let the newly-hired chief executive go as part of the deal:

As part of the deal, Treasury Secretary Henry Paulson insisted that AIG’s chief executive, Robert Willumstad, step aside. Mr. Paulson personally told Mr. Willumstad the news in a phone call on Tuesday, according to a person familiar with the call.

Mr. Willumstad will be succeeded by Edward Liddy, the former head of insurer Allstate Corp.

Essentially, the Feds own AIG and they are now running it and taking the risk of figuring out what it is worth and what to do with it.  With all that going on, they wanted their own guy in charge. This background on Mr. Liddy appeared later in the piece, but I put it here because it illuminates why the Fed’s selected Liddy:

..By tapping Mr. Liddy as AIG’s next CEO, the government is turning to someone with deep experience in the insurance industry, having served as chief executive of Allstate from 1999 to 2006. He stepped down as chairman earlier this year. Allstate is a different type of insurer than AIG, focusing on selling car and home insurance to Americans, whereas AIG sells an array of insurance policies to individuals and businesses world-wide.

Mr. Liddy also has experience pulling apart empires, having helped dismantle Sears, Roebuck & Co. (from which Allstate was spun off) in the 1990s. Before joining Sears, Mr. Liddy worked under Donald Rumsfeld at drug maker G.D. Searle & Co. Mr. Liddy is on the board at Goldman Sachs Group, the investment bank that Mr. Paulson led before becoming Treasury Secretary.

Treasury Secretary Paulson obviously knows Liddy and just felt more comfortable with him in charge.  No doubt Paulson did this reluctantly, but it is still astounding that it had to do so. The Wall Street Journal piece continues:

…In bailing out AIG, the Federal Reserve appeared to be motivated in part by worries that Wall Street’s financial crisis could begin to spill over into seemingly safe investments held by small investors, such as money-market funds that invest in AIG debt.

Indeed, on Tuesday the $62 billion Primary Fund from the Reserve, a New York money-market firm, said it “broke the buck” — that is, its net asset value fell below the $1-a-share level that funds like this must maintain. Breaking the buck is an extremely rare occurrence. The fund was pinched by investments in bonds issued by now collapsing Lehman Brothers.

…AIG’s board said in a statement that the deal would “protect all AIG policyholders, address rating agency concerns and give AIG the time necessary to conduct asset sales on an orderly basis.”

The final decision to help AIG came Tuesday as the federal government concluded it would be “catastrophic” to allow the insurer to fail, according to a person familiar with the matter…

…For one thing, banks and mutual funds are major holders of AIG’s debt and could take a hit if the insurer were to default. In addition, AIG was a major seller of “credit-default swaps,” essentially insurance against default on assets tied to corporate debt and mortgage securities. Weakness at AIG could force financial institutions in the U.S., Europe and Asia that bought these swaps to take write-downs or losses.

Fortunately, AIG’s financial services are legally separate from its insurance functions so it appears that insurance policyholders should be relatively undisturbed by this mess.  The piece continues:

AIG’s millions of insurance policyholders appear to be considerably less at risk. That’s because of how the company is structured and regulated. Its insurance policies are issued by separate subsidiaries of AIG, highly regulated units that have assets available to pay claims. In the U.S., those assets can’t be shifted out of the subsidiaries without regulatory approval, and insurance is also regulated strictly abroad.

…AIG’s cash squeeze is driven in large part by losses in a unit separate from its traditional insurance businesses. That financial-products unit, which has been a part of AIG for years, sold the credit-default swap contracts designed to protect investors against default in an array of assets, including subprime mortgages.

But as the housing market has crumbled, the value of those contracts has dropped sharply, driving $18 billion in losses over the past three quarters and forcing AIG to put up billions of dollars in collateral. AIG raised $20 billion earlier this year. But the ongoing demands are straining the holding company’s resources.

…As confidence in AIG declined recently, the amount of money it felt compelled to raise to calm its constituents continued to rise. Over the weekend, the figure was $40 billion. That climbed to $75 billion on Monday and, according to a person close to the company, rose further on Tuesday.

In other words, AIG was facing a liquidity crunch that it could not resolve.  And, the amount of capital needed was going up exponentially.  Given the lack of confidence in the company and the enormous sums involved, no banks were willing to step up and loan that kind of money.  So, AIG was facing insolvency and the Feds stepped in.

Barry Ritholtz at The Big Picture blog has a good summary on this deal.

For additional background on Wall Street’s travails, see (Bad News & Good News On Wall Street and Bill Gross Was Correct — Treasury To Take Over Fannie & Freddie).

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Kurt Brouwer September 15th, 2008

The action on Wall Street is wild and woolly today.  Actually, it’s been that way all year long it seems.  But, this is particularly crazy.  The major stock indexes have fallen sharply today.  This was preceded by declines on the European exchanges before our markets opened.  Today’s market action was triggered by some wild scrambling (see The Mother of all Mondays) over the weekend as Wall Street executives and U.S. Treasury representatives met to figure out what to do with several troubled and tottering financial services firms.

The problems at these firms could probably be resolved with time. Unfortunately, owing to the negative climate, time is in short supply. Compounding the problem is leverage — that is borrowed money. Many of these institutions are operating on very high leverage and that puts them under the gun.

The outcome of all the activity had some bad news and good news in it for investors along with some good news for U.S. taxpayers.

Lehman Files For Bankruptcy Protection

First, Lehman Brothers, a 14-year-old firm with a 158-year-old name filed for bankruptcy protection.  Most of the media is talking about how this old firm weathered multiple crises over the past 158 years and now has finally succumbed.  But, Lehman Brothers was bought by American Express in 1984 and only became an independent company again in 1994. The demise of a 14-year-old firm is not as good a story, but it does have the charm of being accurate.  For more on this, see this piece by our friend Allen Sloan at Fortune magazine.

One piece of news is that Lehman’s share price actually hit 19 cents today.  That’s good.  The shareholders were invested in a highly-leveraged company that made enormous bets in a wide variety of real estate related deals.  Those deals soured and the company’s shareholders paid the price.  That’s how it should work.  The market giveth and the market taketh away.

Bank of America Buys Merrill Lynch

Second, Merrill Lynch was snapped up for $50 billion by Bank of America.  The $50 billion figure is a bit fluid as the deal was originally announced as $44 billion. Nonetheless, that number represents a healthy premium from the recent price of its shares.  And, that’s pretty good news because in this extreme environment, Bank of America actually is offering a substantial premium for Merrill.

As an alum of Merrill, I have to say that this outcome is probably good for Merrill and its customers and, ultimately, should be pretty good for Bank of America. If you are keeping score, BA is going to come out of this mess as the holder of two diverse and yet dominant franchises — Countrywide Mortgage and Merrill Lynch (see Bank of America Snaps Up Countrywide).

Insurance Giant AIG Wants Bailout

Three, American International Group, an enormous insurance company, is also in deep trouble.  It is seeking a very large loan from the Feds after having turned down several buyout offers.  No telling how it will work out, but given the events of the past week, I suspect it will end in tears for its shareholders.

And, that’s the news — both good and bad — for investors.

The good news for taxpayers is that the Feds let Lehman Brothers go under.  As we saw earlier this year, the Treasury helped J.P. Morgan purchase Bear Stearns and it did so by backing a pretty big pool of Bear Stearns’ obligations (JP Morgan, Fed Move To Bail Out Bear Stearns).

Then, there was the takeover of Fannie Mae and Freddie Mac (Bill Gross Was Correct — Treasury To Take Over Fannie & Freddie).

Finally, the Feds decided they could not take over every troubled financial services firm so they told the assembled mass of Wall Street CEOs — who were lined up in their limos over the weekend — the bailout window is closed.  And, that is good for taxpayers.

After the government takeovers of Fannie and Freddie, we were getting perilously close to an absolutely untenable position in which Wall Street firms could make enormous bets and when those bets paid off, they made oodles of money.  But, when those bets lost huge amounts of money, Wall Street turned to the government for a bailout.  That’s not the way it is supposed to work and I’m happy the U.S. Treasury finally got the message.

Here is what happened over the weekend as told by Bloomberg [emphasis added]:

Lehman Files for Record Bankruptcy, Victim of Meltdown Firm Helped Create  (Bloomberg, September 15, 2008, Yalman Onaran and Christopher Scinta)

Lehman Brothers Holdings Inc., the fourth-largest U.S. investment bank, succumbed to the subprime mortgage crisis it helped create in the biggest bankruptcy filing in history.

…Lehman was forced into bankruptcy after Barclays Plc and Bank of America Corp. abandoned takeover talks yesterday and the company lost 94 percent of its market value this year. Chief Executive Officer Richard Fuld, who turned the New York-based firm into the biggest underwriter of mortgage-backed securities at the top of the U.S. real estate market, joins his counterparts at Bear Stearns Cos., Merrill Lynch & Co. and more than 10 banks that couldn’t survive this year’s credit crunch.

…Lehman shares plunged 95 percent at 11 a.m. in New York trading to 19 cents from their $3.65 close on Sept. 12.

…Since the collapse of the subprime home-loan market last year, the world’s biggest banks and brokerages have reported more than $510 billion of writedowns and credit losses on securities tied to mortgages. Lehman still had a $50 billion stockpile of the investment at the end of August. Falling housing prices and fear of a U.S. recession have eroded prices for the holdings.

Lehman’s leverage — the ratio of total assets to shareholders’ equity — was 31 last year when the mortgage market collapsed. That compares with 33 at Morgan Stanley and 32 at Merrill Lynch. Only Goldman Sachs had a lower ratio, at 22..

In other words, Lehman made a two-part bet.  First, it put many billions into risky real estate deals and real estate-related securities.  Second, it did so by using enormous leverage, which is illustrated by its ratio of assets to equity of 31.

Bank of America Will Buy Merrill for $50 Billion as Credit Crisis Broadens (Bloomberg, September 15, 2008, David Mildenberg and Bradley Keoun)

Bank of America Corp., the biggest U.S. consumer bank, agreed to acquire Merrill Lynch & Co. for about $50 billion as the credit crisis claimed another of America’s oldest financial companies.

Bank of America will pay $29 a share for New York-based Merrill in stock, 70 percent more than the Sept. 12 closing price, the company said in a statement today. Merrill, battered by $52.2 billion in losses and writedowns from subprime- mortgage-contaminated securities, has plunged more than 80 percent from its peak of $97.53 at the start of last year.

The takeover ends 94 years of independence for Merrill and gives Charlotte, North Carolina-based Bank of America a sales force with 16,690 brokers who manage $1.6 trillion for customers. Merrill, led by Chief Executive Officer John Thain, was in danger of becoming the next subprime casualty after Lehman Brothers Holdings Inc. filed for bankruptcy court protection earlier today.

…Merrill is the second bargain picked up this year by Bank of America Chief Executive Officer Kenneth Lewis tied to the collapse of the mortgage markets. The bank bought Countrywide Financial Corp. for $2.5 billion in stock last July to become the nation’s biggest home lender. As recently as Sept. 12, Bank of America was considering making a bid for New York-based Lehman…

AIG Slumps After Insurer Rejects Buyout Offers, Seeks $40 Billion Fed Loan  (Bloomberg, September 15, 2008, Hugh Son)

American International Group Inc., the largest U.S. insurer by assets, fell by almost half in New York trading as the company failed to present a plan to raise capital and stave off credit downgrades.

AIG, seeking to raise $20 billion in capital and sell $20 billion of assets, rejected investments from buyout firms KKR & Co., TPG Inc. and J.C. Flowers & Co., people familiar with the talks said. AIG instead sought $40 billion from the Federal Reserve, the New York Times reported, citing an unnamed person. Warren Buffett is said to be in talks with AIG as well, Insurance Insider reported today citing unidentified people.

“People are afraid of what they are not hearing from the company,” Robert Bolton, managing director at Mendon Capital Advisors Corp., said today in a Bloomberg Television interview. “The only thing people have to trade on right now are the rumors, and they are coming up with their own conclusions.”

So, what are we to make of all this.  First, I’ve been paying attention to Wall Street for over 30 years now and, quite frankly, Wall Street firms have always been over-leveraged and undercapitalized.  Many Wall Street firms failed in the late 1960s and early 1970s due to a variety of factors, primarily mismanagement and undercapitalization.  Then, we had the stock market crash in 1987 (see The Crash of 1987).  In fact, the last big Wall Street crisis we had, the collapse of Long-Term Capital Management in 1998, was also triggered by a highly-leveraged entity — in that case, a hedge fund.

Second, though it generates lots of scary headlines, this financial panic on Wall Street may not have that much impact on Main Street.  Back in October of 1987, when the stock market fell 22% in one day, there were widespread predictions of another depression.  Never happened though.  Though this crisis will certainly impact the stock and bond and mortgage markets — real estate too — it will blow over as have all the other ones.  Congress will call for hearings and proposals for increased regulations. Pundits will claim that over regulation or under regulation led to this outcome.  And, the country will survive.

As investors, the events of this year are a reminder that there are no sure things.  Real estate, stocks, corporate bonds, commodities and even government-backed bonds have all taken hits this year.  That is why as investors we need to be well-diversified. And, as downturns such as this one demonstrate, we have to be patient as well.

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Kurt Brouwer September 6th, 2008

Given the news of late, I suppose it had to end like this for the two government-backed mortgage behemoths.  The U.S. Treasury looks set to take over both companies and put them in some form of government control.  This Bloomberg piece spells it out [emphasis added]:

Paulson To Take Over and Restructure Fannie, Freddie (Bloomberg, September 6, 2008, Dawn Kopecki and Alison Vekshin)

Treasury Secretary Henry Paulson will use his authority to rescue Fannie Mae and Freddie Mac, likely placing the beleaguered mortgage-finance companies under government control as early as this weekend.

The Treasury plans to put Fannie and Freddie into a so-called conservatorship and pump capital into the companies, House Financial Services Committee Chairman Barney Frank said in an interview after being briefed by Paulson. The government would make periodic injections of funds by buying convertible preferred shares or warrants in the companies as needed, avoiding large up- front taxpayer costs, according to a person briefed on the plan.

“This is no bailout, particularly for the shareholders,” Frank said. The federal government “will be senior to all shareholders, preferred and common.”

It is quite ironic that these two mortgage giants have been laid low by the subprime lending mess and the collapse of the bubble in home real estate prices.  Both entities were created by the Federal government to help finance the purchase of homes by Americans and to help keep the mortgage market operating smoothly.

…Fannie was created by the government in 1938 and Freddie was chartered in 1970 mainly to boost the availability of home loans and provide market stability. The companies currently own or guarantee almost half of the $12 trillion in U.S. home loans.

…Pacific Investment Management Co., manager of the world’s biggest bond fund, and other large investors may put in their own money once the Treasury decides to inject government funds, Bill Gross, co-chief investment officer at Newport Beach, California- based Pimco, said yesterday in a Bloomberg Television interview.

“They have to open their wallet,” Gross said. About 61 percent of Gross’s holdings were mortgage-backed securities as of June 30, mostly debt guaranteed by Fannie, Freddie or government agency Ginnie Mae, according to data on Pimco’s Web site.

As we posted back in August, Bill Gross predicted the government would have to take over Fannie and Freddie:

Pimco’s Gross Says U.S. Will Rescue Fannie, Freddie (Bloomberg, August 6, 2008, Kathleen Hays and Shannon D. Harrington)

Bill Gross, who manages the world’s biggest bond fund, said the U.S. Treasury will probably be forced to buy as much as $30 billion of preferred shares in both Fannie Mae and Freddie Mac to help shore up their capital.

“By the end of the third quarter, the preferred stock in Fannie and Freddie will be issued, the Treasury will have bought it,” Gross, co-chief investment officer at Pacific Investment Management Co., said today in an interview on Bloomberg Television. “We’ll be on our way toward a joint Treasury-agency combination.”

Gross adds to a growing chorus of investors and analysts predicting U.S. Treasury Secretary Henry Paulson will need to use his newly won power to prop up Freddie and Fannie. Freddie posted a second-quarter loss that was three times wider than analysts estimated and said credit losses doubled in three months, heightening concerns it may not be able to weather the worst housing slump since the Great Depression.

Freddie Chief Executive Officer Richard Syron today told investors the company will wait for its stock to improve before starting its planned $5.5 billion capital raising. Freddie agreed in May to raise the capital but failed to complete a sale as its stock slumped as much as 80 percent.

“I have enormous respect for Bill Gross,” Syron, 64, said today in an interview with CNBC. “I think he’s an extraordinarily talented manager, particularly on the fixed income side. But based on the information I have now, I do not believe that the Treasury will end up having to inject money into Freddie Mac.”

…About 61 percent of the holdings of Gross’s Pimco Total Return Fund were mortgage-backed securities as of June 30, mostly debt guaranteed by Fannie, Freddie or U.S. agency Ginnie Mae, according to data on Pimco’s Web site…

Turns out that Gross was right on target and the head of Freddie Mac was wrong. The government will buy the preferred stock and will no doubt guarantee the existing debt. But, those who still own common stock in the two companies have already seen their holdings decline precipitously as seen below.  It is unclear what will be left for the common shareholders after the takeover and they may be left with little more than memories.

The Bloomberg piece on the government takeover of Fannie and Freddie continues:

Washington-based Fannie and Freddie dropped in after-hours trading yesterday. Fannie fell $2.25, or 32 percent, to $4.79 at 5:50 p.m. in New York Stock Exchange trading and Freddie slumped $1.40, or 27 percent, to $3.70. Fannie is down about 66 percent since the end of June as concerns about the companies’ capital grew. Freddie has fallen about 69 percent.

Fannie’s market capitalization is now $7.6 billion, down from $38.9 billion at the end of last year. Freddie’s has fallen to $3.3 billion, from $22 billion over the same period…

It has been fascinating to see Bill Gross operate in this arena.  His fund — Pimco Total Return — has been a big buyer of government-backed bonds lately.

See also PIMCO Buys $2.5 Billion In Mortgage-Backed Bonds and Bill Gross — Stop Falling Home Prices Now.

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Kurt Brouwer September 2nd, 2008

Here is a study on just who owns the bulk of the shares in Big Oil.  The study was done by Sonecon, an economic consulting firm run by a former adviser to President Clinton.

The Distribution of Ownership of U.S. Oil and Natural Gas Companies (Sonecon, September 2007, Robert J. Shapiro and Nam D. Pham)

…These data, along with previous analyses that we conducted, further suggest that ownership of oil and natural gas company shares is broadly middle-class.

42.7 percent are owned or held by mutual funds and other asset management companies that have mutual funds. Mutual funds manage accounts for 55 million U.S. households with a median income of $68,700, and the owners of mutual funds include 16 percent of households with incomes of $25,000 or less, as well as 83 percent of households with incomes of $100,000 or more.

Earlier analysis found that an estimated 27 percent of oil and natural gas company shares are held in private and public pension funds, and these funds manage assets, directly or indirectly, on behalf of 129 million pension-fund participants whose accounts have an average value of $62,280. For example, some 28 million public pension accounts in over 2,650 public employee pension funds represent the major retirement security for current and already-retired soldiers, teachers, police and fire personnel, social workers and office workers employed at every level of government. In 2004, these funds held approximately $64 billion in shares of U.S. oil and natural gas companies..

This chart shows the percentage breakdown of ownership in oil companies of all types:

Source: Sonecon

Peruse the numbers above.  I’m only focused on the first column in the chart — Oil & Gas Industry, which is the total ownership statistics of Big Oil as the media likes to call it. Based on the chart above, it’s pretty clear what group owns the biggest chunk of Big Oil — mutual funds.

But, who owns mutual funds? Mutual funds are owned by individual and institutional investors including retirement plans, endowments and charities.  The following chart spells out the number of American households that own mutual fund shares.

It’s from the Investment Company Institute (ICI) and its annual work, the Investment Company Fact Book.

Just as a point of reference.  There is a discrepancy in the numbers between the Sonecon study and the ICI Fact Book, which reports lower numbers for the number of households owning mutual fund shares.  I suspect the difference has to do with the definition of a household and other fairly arcane statistical matters, but I would go with the ICI number.

In any case, over 50 million households — that is 88 million people — hold shares in mutual funds.  Add in the holdings of Big Oil shares by public and private pension plans and you reach out to many more millions of Americans who are beneficiaries of public and private pension plans.

No doubt there are plenty of wealthy investors who own shares in oil companies directly or through mutual funds, but the point is still very clear.  Mutual funds are the investment of choice for Americans and mutual funds are the biggest owners of shares in Big Oil.

So, who owns Big Oil?  The answer is clear: we do.

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Kurt Brouwer August 19th, 2008

In this piece, Joe Mysak of Bloomberg eviscerates Wall Street firms for walking away from auction-rate securities that they sold to thousands of clients.  Auction-rate securities are generally long-term, tax-exempt securities issued by municipalities and other issuers.

However, the magic came from the fact that brokerage firms held weekly or monthly auctions on these securities at which point rates were reset and investors could cash out.  Unfortunately, when the going got tough with these auctions, the brokers and bankers got out of the auction business, leaving thousands of their clients holding the bag.

Bankers Get Ready To Kiss 200,000 Clients Goodbye (Bloomberg, August 19, 2008, Joe Mysak)

The real numbers to look at in the auction-rate securities settlements are the ones in thousands, not billions.

By the time this is finished, and we’re probably months away from that, it looks like securities firms will return money to more than 200,000 individual investors.

And prepare to kiss them goodbye.

The ultimate loser in the auction-rate market collapse is going to be the U.S. securities brokerage business.

It is hard to see how the dealers involved are going to retain the customers they treated so cavalierly in February, when they decided to stop supporting auctions and blew up the market.

…Did they, the top officers of the securities companies, really think their customers could be separated from their money for any length of time and not complain?

Now, I cannot read the minds of the CEOs of large brokerage firms and big banks.  However, if history is any guide, these folks thought the gravy train would keep on chugging.  I’m sure it never occurred to them that this lucrative business could blow up.  And, once it did blow up, they must have panicked.

…At the same time, of course, the big securities firms advertised almost endlessly, emphasizing trust and reputation, and how they could take care of you if you were their client. Those ads showed a world of ease and comfort.

…Now those illusions are shattered. The thousands of investors who will be reunited with their cash are now disabused of the notion that a brokerage account means they have arrived…

Actually, problems surfaced with auction-rate securities a few years back as this New York Times piece spells out:

…In 2006, the Securities and Exchange Commission reached a $13 million settlement with 15 investment banks, and the industry agreed to impose a voluntary code of conduct for the auction-rate market.

The S.E.C. investigation centered on how bidding was conducted for these securities. Critics complain that investment banks have the upper hand in bidding because they can bid after seeing what other investors have bid…

Unfortunately, the regulatory problems did not slow the business down and investors continued to pour in the assets under the assumption that these were really solid, short-term investments.  But, once problems arose, the firms that sold these investments backed off until state securities regulators pushed them to make a deal.  Bloomberg continues:

…And they all know that, no matter how the companies themselves spin it, none of them would see a single dollar if the states hadn’t forced the firms to cough up the cash, and in the most humiliating way possible — by pulling back the curtain and revealing what was going on backstage. It wasn’t a pretty sight.

It is passing strange that this disaster occurred not with stocks or bonds, but with something called auction-rate securities, that were touted — securities professionals hate the word, which connotes a gamble — as safe cash-equivalents.

Or, as Merrill Lynch & Co. put it in December 2007, “We remain convinced that auction market preferreds of closed-end funds are a conservatives’ conservative security with respect to credit risk.”

The real question in the months ahead is where the wistful victims of the Great Auction Securities Freeze of 2008 are going to take their money. If I were a betting man, I’d bet that you are going to see a lot of that money going home to local banks, if not under mattresses…

On this final point, I hope these investors get the message and leave Wall Street for Main Street.  As the co-founder of an independent, fee-only financial advisory firm, it may seem self-serving, but I really I hope many of these clients will turn — not to banks or brokers — but to fee-only advisers.

By way of background, fee-only financial advisers are generally registered with the SEC as investment advisers.  As such, they are considered to be fiduciaries and are required by law to act in the client’s best interest.

Hopefully, some of these investors will figure out that they should be getting investment advice from an independent source.

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