Sunday Musings: Swallowing Money Market Losses

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I have repeatedly warned that some of the biggest investors in toxic Subprime mortgages are money market funds, especially those boasting above average returns. Let’s be clear about this. Any investment, even a money market fund, which offers an above average return, has to also take an above average risk.

Some firms will avoid passing on the losses to the investors for obvious reasons, such as creating a bad reputation, which will be bad for their business. The latest on this topic was the admission by Wells Fargo, that it had incurred a loss of $39 million from money funds:

Wells Fargo & Co, the fifth-largest U.S. bank, said on Friday it has recorded a $39 million loss tied to some complex debt that has lost value and which is held by its money market mutual funds.

In its annual report filed with the U.S. Securities and Exchange Commission, Wells Fargo said the loss relates to a capital support agreement for up to $130 million related to one structured investment vehicle held by some money funds that invest in non-government securities.

The San Francisco-based bank said it entered the agreement about a month ago to preserve the “triple-A” investment ratings for some of the funds. Wells Fargo said the $39 million liability reflects the guarantee it provided. The bank said it has about $106 billion of assets in money market mutual funds.

A Wells Fargo spokeswoman had no immediate comment.

Sure, why would they comment, it’s obvious they invested in some of the Subprime slime and, to keep investors happy, they chose to dip into their own pockets. Who else has similar troubles?

Wells Fargo joins several other companies with mutual fund operations to bail out or support money funds stuck with debt that became illiquid or quickly lost value, including Bank of America Corp, Janus Capital Group Inc Legg Mason Inc and Wachovia Corp.

Structured investment vehicles are off-balance-sheet entities that raise funding by issuing short-term debt and longer-term capital, and invest proceeds in such things as bank debt and asset-backed securities. Many have lost value as investors shunned complex debt and halted short-term funding, resulting in losses from forced asset sales.

Money funds are designed to maintain a constant $1 per share net asset value, and not lose investor principal. While fund sponsors need not make up investment losses, many do so to avoid investor redemptions and a loss of reputation.

As I said before, there are still way too many uncounted skeletons in unknown closets. If you have any money in high yielding money market funds, get out or change your selection to U.S. treasury only, if you can. When things really hit the fan, some companies may have no choice but to crack the buck and leave you holding the short end of the stick.

The Perfect Storm

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I read this excerpt from the Economist (sorry no link available), which said:

The size of the banks’ bets is rising rapidly the world over. This is because potential returns have fallen as fast as markets have risen, so banks have had to bet more in order to continue generating huge profits.

The present situation “is not dissimilar” to the one that preceded the collapse of LTCM … banks are walking themselves to the edge of the cliff. This is because—as all past financial crises have shown—the risk management models they use woefully underestimate the savage effects of big shocks, when everybody is trying to wriggle out of their positions at the same time … By regulatory fiat, when banks’ positions sour they must either stump up more capital or reduce their exposures.

Invariably, when markets are panicking, they do the latter. Since everyone else is heading for the exits at the same time, these become more than a little crowded, moving prices against those trying to get out, and requiring still more unwinding of positions. It has happened many times before with more or less calamitous consequences … It could well happen again.

There are a number of potential flashpoints: a rout in the dollar, say, or a huge spike in the oil price, or a big emerging market getting in trouble again. If it does happen, the chain reaction could be particularly devastating this time.

This article is right on with its observations and could have been written a few months ago. Actually, it was published exactly 4 years ago, in February 2004. Talk about somebody reading the handwriting on the wall…

No Load Fund/ETF Tracker updated through 2/28/2008

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My latest No Load Fund/ETF Tracker has been posted at:

http://www.successful-investment.com/newsletter-archive.php

A sharp correction to the downside turned a positive week into a negative one.

Our Trend Tracking Index (TTI) for domestic funds/ETFs remains now +0.02% above its long-term trend line (red), which means we are in borderline territory.



The international index dropped to -7.74% below its own trend line, keeping us in a sell mode for that arena as well.



For more details, and the latest market commentary, as well as the updated No load Fund/ETF StatSheet, please see the above link.

More Easing Ahead

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I saw this picture sometime ago at Minyanville and thought it was hilarious given the current market environment.

Fed chief Bernanke made it fairly clear yesterday that interest rates would move lower given that “the economic situation has become distinctly less favorable,” and “the risks to this outlook remain to the downside.”

This was an obvious sign for the dollar to head further south, which boded well for our gold and Swiss Francs positions. The markets ended almost unchanged as a morning rally could not be sustained.

Our Trend Tracking Indexes (TTIs) barely moved from yesterday, and we continue to abstain from any investment in the domestic market.

A New Bull Market?

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With yesterday’s higher close, our Trend Tracking Indexes (TTIs) are now situated in respect to their long-term trend lines as follows:

Domestic TTI: +0.62%
International TTI: -4.77%

As you can see, yesterday’s market activity pushed the domestic TTI slightly above its trend line. Since our Sell on 1/18/08, we’ve had this very same scenario on several occasions as prices bounced slightly above and below this divider between bull and bear territory.

To avoid another head fake, or whip-saw, I will not re-invest in the domestic market until I see continuous upward momentum and some staying power above the line. The markets have been rallying in the face of questionable economic news (high PPI) and may have very well priced in a far worse scenario than we’re currently seeing. Be that as it may, I am willing to give up some potential profit in order to increase my odds by having this domestic market demonstrate some staying power first before I put new money on the table.

However, in the meantime, there are several other bull markets going on in a variety of sector funds. Please refer to my latest StatSheet for details. We have increased our exposure in some of those areas that are supported by strong momentum figures.

Good Bank—Bad Bank

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Yesterday’s rally clearly was a follow through from Friday as Wall Street embraced S & P’s affirmation of the AAA rating of bond insurer MBIA—at least for the time being. The main concern has been that any downgrade would force banks and other financial institutions to write off billions of dollars in assets. That means that motivation is high to come up with any plan, now matter how ridiculous it may seem, to postpone the inevitable.

Minyanville’s Peter had this to say to help you understand the issue at hand:

A hurricane comes through your town and levels your house. A few weeks later, you receive a letter from your insurance company telling you that unless you buy some of its stock, it won’t be able to pay your insurance claim. What do you do?

As far fetched as this question may feel, this is, in principle, what’s behind the bailout of the monoline insurance companies. Unless their biggest CDS counterparties step up with more capital, the insurance companies won’t be able to make good on their CDS and the banks will be forced to take write-downs.

How this all plays out remains to be seen, but I would suggest that until additional capital comes into the financial services system from organizations other than other financial services companies, I am afraid that all that is happening is the further leveraging of an already leveraged and highly interdependent financial system.

Now there are those who suggest that creating a “good bank/bad bank” out of the insurance companies will create the opportunity for the incremental outside capital that I suggest is so much in need. And in general I would agree. Adding capital to the “good” municipal business would put that business on more solid footing. But what about the “bad” CDO business?

A review of history suggests that there was really no such thing as a good bank/bad bank strategy – only a good bank/dead bank strategy. For one to live, the other had to die. And to be clear, looking back in time, no matter how the good and bad eggs were unscrambled, the banks’ equity holders (and some holding company lenders) ultimately lost it all.

So until losses are taken, I continue to believe there is a day of reckoning to come for the monoline insurance companies. And, more sadly, I sense the same day of reckoning for those multinational banks who are stepping up to help. For rather than spreading risk beyond the financial system, it appears that every bailout effort seeks to concentrate it more and more onto the balance sheets of world’s largest banks.

And, while I truly wish it weren’t the case, because of the financial system’s interdependence, we continue to postpone the inevitable.

On a more lighthearted note, I got a kick out of a posting at Calculated Risk, which qualifies as the joke of the day. It’s called “Rob now, HOPE later” and is in reference to many home owners getting fed up with their ARM mortgages:

A robber in a ski mask blamed the bank for what he was about to do, The Associated Press reported Feb. 22.

“You took my house, now I’m going to take your money!” the assailant hollered. Talk about a reverse mortgage!

The FBI plans to review the bank’s foreclosure records for clues.

The suspect is presumed to be ARM’ed and dangerous.