December 2009

December 31, 2009 10:45 a.m.
Happy New Year, and Some Important Items You Might Have Missed

I wish all my readers a Happy New Year. We have great plans for Retirement Watch, and the markets and economy promise to provide another interesting year. There also will be changes in the income tax, estate tax, and a range of health care programs. Other changes also are likely to spring up. It is going to be a busy year, and we’ll be on top of things. But first, let’s look at some news items from the holiday period, many of which have not received the attention they should.

The Treasury Department had some big news it wanted to keep quiet, so it released the item on Christmas eve. In 2010 and for the following couple of years the Treasury will provide unlimited support for any losses incurred at Fannie Mae and Freddie Mac. You’ll recall the government already invested billions in these companies when they were on the brink of failure in 2008. Since then, they and Ginnie Mae essentially have been the only mortgage lenders in the country. Recently, reports surfaced that more losses are in store at these companies. The Treasury made clear taxpayers will pay whatever is necessary to keep this prop under the housing market for at least three years. The assistance also is structured in a way that avoids having to ask Congress to approve it.

The Treasury essentially is taking over the Federal Reserve’s recent role. The Fed has been purchasing mortgages, allowing banks to get the failed loans off their books and boost their balance sheets. The Fed wants to scale back this operation for a variety of reasons but everyone knows doing so would cause problems for the economy. So, through a sleight of hand Fannie and Freddie will buy the mortgages, Treasury will issue debt and funnel the proceeds to Fannie and Freddie, and the Fed will buy whatever Treasury debt the market won’t. This allows the Fed to say the economy no longer is on life support, because it no longer is making its extraordinary intervention in the mortgage market.

Deceptions and nuances in health care reform continue to seep out and surprise people. Beneficiaries of Medicare’s Part D Prescription Drug program have one big gripe: the doughnut hole or coverage gap. After drug spending exceeds a certain amount, the beneficiary must pay all drug costs until a second level is reached. The levels change each year with drug price inflation. The health reform bill that recently cleared the Senate purports to eliminate the doughnut hole. But read this article that explains how the law proposes to do that. Not many seniors will agree it is an improvement.

We’ve said for years that for many retirees immediate annuities can provide a lot of financial security. Yet, few seniors buy them. There are some good reasons, such as that you don’t want to lock in today’s very low interest rates. There also are some not-so-good reasons. Forbes magazine put together a good online slide show explaining eight reasons why retirees don’t buy annuities.

The article explaining reasons for the great financial crisis continue to be published. The Washington Post has an excellent long piece delving into the Federal Reserve’s decisions about regulating banks and the mortgage markets during the 2000s. Clearly, the Fed’s staff misunderstood what was happening in housing and its potential effects. One things to keep in mind as you read this piece is how bad the Fed’s forecasts were. Remember that whenever the market reacts positive to a good forecast from the Fed.

Congress failed to take important action on taxes before the end of 2009. The estate tax will expire on Jan. 1, 2010. The estate of anyone who dies after that will not owe estate taxes, regardless of how valuable the estate is. Of course, Congress plans to reinstitute the tax sometime in 2010 (the House and Senate cannot agree on terms). But when? And will it try to make the tax retroactive to the estates of those who die between Jan. 1 and when the new law is enacted? It will be a fun year for lawyers and lobbyists. We’ve told you in the past how to put flexible terms in your will so it doesn’t have to be rewritten with each change in the tax law.

Congress also failed to extend about 50 tax breaks that expired at the end of 2009 but almost always are extended each year. Again, these probably will be extended sometime in 2010, but we don’t know when or under what terms.

In a week in late December companies issued more high-yield (junk) bonds  than they had in 18 months. There are two ways to look at that. It could be a sign that credit markets have mended and things are returning to normal. But take a look at the terms in many of the new issues. They are the same reckless terms investors agreed to near the peak of the credit bubble. It looks like smart companies are refinancing their debt on easy terms while they can. I’m still staying away from junk bonds for now.

Finally, let’s close the year with a cautionary tale about headline watching and trend following. In late 2009, Floyd Norris asked 10 investors which stock they would buy if they could buy only one and hold it for 10 years. The results were dismal. Most picked technology stocks, which were the hot thing at the time, and many believed they would be rising indefinitely. That turned out to be the peak for technology stocks and the Nasdaq. Look forward, not backward, when choosing investments.

Happy New Year.

December 18, 2009 10:00 a.m.
Treasury Bond Bubble to Burst?

Bill Gross, manager of PIMCO Total Return Bond fund, raised the fund’s cash to its highest level since Lehman Brothers filed for bankruptcy in Sept. 2008. Gross believes treasury bonds are overvalued (interest rates are too low) relative to the future inflation he expects. Their yields are higher than they were in the fall of 2008, when investors were fleeing to safety. In the January 2010 issue of Retirement Watch, now posted on the web site, we recommend selling Vanguard Short-Term Federal Bond. We also recommend selling TCW Total Return Bond.

The state of the financial system in the second half of 2008 was worse than many people realize. I’ve heard stories from different money managers who were watching the markets deteriorate up close. In last weekend’s Wall Street Journal Warren Buffett described how scared he was about the fate of the global financial system. He became optimistic too soon, investing in Goldman Sachs and GE in October. He received stock warrants in those deals that still are below their exercise prices. (Subscription might be required.)

Since the financial crisis accelerated, a series of exposes in various publications revealed how slipshod and even fraudulent many mortgage lending operations were. The latest is from Gretchen Morgenstern of the New York Times who discusses the details of a court battle between two giant banks. The big banks apparently trusted to the point of neglect the actions of much smaller banks and mortgage brokers, buying loans made by these entities without doing much homework.

One emerging estate planning issue we’ve brought up a time or two is the fate of your online activities. What will happen to your e-mail and other password-protected online activities? Time magazine offers some ideas in this posting. There is much more to consider, but this is a starting point.

You may remember a few accounting changes announced by regulators and accounting standard setters late in 2008 and early in 2009. The current “health” of banks could be largely attributable to these changes, allowing banks to avoid writing down loans despite rising default rates. The 2009 market rally even lets them write up the values of loans previously written down, though the likelihood of full repayment appears to be declining. On the other hand, new rules are requiring banks to put on their books some loans they previously were allowed to keep off the books. The result could be diminished solvency at many banks. Read some details here.

Meanwhile, the commercial real estate situation continues to deteriorate. Most recently, Morgan Stanley decided simply to turn over five San Francisco office buildings to their lenders. The values of the buildings are well below the debt against them. Morgan Stanley was not going to put in more equity and in the current market knew it wasn’t worth trying to refinance the buildings. The lenders now own them and will have to acknowledge losses on the money lent to buy the buildings.

Periodically we discuss the data from the Federal Reserve’s quarterly Flow of Funds report. The report accesses the debt and net worth of American households and businesses, among other things. The latest report shows the stock rally has increased the value of assets owned. Net worth also has increased as debt is reduced by a combination of saving and defaults. But debt levels still are not at sustainable levels, so there is more leveraging to come. Read a good summary here.

December 9, 2009 04:45 p.m.
Big Change at TCW Total Return Bond

Jeffrey Gundlach is out as manager of the TCW Total Return Bond fund. You know this has been a mainstay and top-performer of our portfolios for some time. You can read some details about the ouster here and here. But the story is one of corporate politics and egos.

The new managers are talented, but Gundlach and his strategy are unique. There is no indication that the new managers have anything near his level of expertise in mortgages, plus key members of Gundlach’s team are leaving with him. I expect Gundlach’s services will be available at another firm soon.

I don’t think new management will change the strategy or portfolio soon. They have said they won’t. The big risk is investors leave the fund and other Gundlach managed funds in a rush. Many of the mortgages purchased by Gundlach are thinly-traded. If the funds have to sell a lot of them quickly to raise cash for redemptions, their prices could fall dramatically. Already there are reports that a number of investors are asking for redemptions, and Bloomberg reports TCW is planning to sell $450 million of bonds.

I’m watching closely, but for now I don’t recommend rushing out of the fund. Before leaving Gundlach said it is set to earn double-digit returns for the next few years. He recently is reported to have said he won’t sell his shares in the closed-end fund TCW Strategic Income (ticker: TSI), because the portfolio is well-positioned. His deparature, by the way, created an opportunity in TSI. Many brokers recommended the fund to clients and issued sell orders as soon as Gundlach left. The price dropped sharply in one day and now is attractive.

I’ll have more details in the next issue of Retirement Watch, which will be posted on the web site next week.

You know that we have doubts about the recent stock market rally and the sustainable of economic growth. There is a good summary of some reasons to doubt the rally in the New York Times.

In the meantime, the debate over commercial real estate continues. This report from Bloomberg states that defaults on commercial real estate mortgages are at a record and likely to climb.

Allan Sloan does good, detailed reporting that digs into the numbers behind deals, corporate tax strategies, and the like. In 2007 he did an article pulling apart one of the complicated home mortgage toxic securities and concluded its AAA rating was insane. Recently, he followed up by showing what has happened to the mortgages within that security the last few years. The picture isn’t pretty, and one has to ask how such securities received AAA ratings and why major investors bought them.

Those expecting a swift rebound, or even a near-term rebound, in residential housing should be prepared to wait. This report explains why the rebound that many forecast to occur in late 2009 is delayed until at least some time in 2010. The market recovery so far seems to be based mostly on the first homebuyer’s tax credit.

The financial crisis created a cottage industry in conspiracy theories. This article reviews a number of them and presents what the writer believes are the facts. I don’t agree with everything in the article, but it is a good review of the theories and the arguments on both sides of them.

December 4, 2009 05:00 p.m.
What’s Moving the Markets and more…

The last couple of weeks in the markets have been interesting, especially today. The employment report was much better than expected, and the headline unemployment rate declined a bit. Initially stocks soared on the news, and then they quickly declined and began to show a loss. Finally, they rallied for a modest gain for the day. The pattern is stocks dip a bit when there is negative news, such as the Dubai World debt default, and then rise on good news or even no news.

Perhaps the puzzle is best explained by this article arguing that individual investors still are not buying stocks. The main movers of the markets in this rally have been hedge funds. In fact hedge funds have their highest equity exposure since the end of 2007. The lesson, this article asserts, is stocks have higher gains ahead because the smart professional money is in stocks while individual investors are not. Another way to look at it is that short-term investors are riding the stock rally as long as it lasts, while longer-term investors still are worried about risk.

You still have time to reduce your taxes for the year. A few of the widely-applicable ideas are in this article. They include energy tax credit and the usual ideas for taking investment losses and the like.

We’re not the only investors who are skeptical of the stock market rally and anticipating a less-than-robust economic recovery. Bill Gross, the bond king at PIMCO, has been talking about the “new normal” and says investors should anticipate lower returns in the years ahead than they earned in the past. Gross says here investors should anticipate returns perhaps half of what they are used to.

You are better informed than most Americans about long-term care if you’ve been following our coverage on the topic in Retirement Watch. The latest survey on the issue indicates most Americans have no idea how to pay for long-term care. They think government programs or regular health insurance will pay for any long-term care they need. They will be very disappointed if they should need LTC.

Many people have argued the debt crisis is not over, and the next big shoe to drop is commercial real estate debt. Here’s an argument by some very big players in commercial real estate that it is not in as bad shape as is widely believed. There also are argument that commercial mortgages are more likely to be extended or refinanced in some way instead of lenders simply allowing them to default.

Many of you are familiar with the famous Value Line Investment Survey, its mutual fund spinoff, and its mutual funds. The entire operation has been in decline for some time, since its founder died and left the firm to the next generation. Here’s a very good history of the company and what went wrong.

One piece of bad news that temporarily upset the stock markets this week was an analyst’s report that the insurance subsidiaries of AIG do not have enough reserves to pay their claims. We’ve been told all along that the only problem with AIG was in the holding company that insured debt. The story didn’t have legs this week, but it’s worth watching.

There’s no shortage of stories demonstrating why estate planning is about more than tax reduction and is critical to avoiding problems. This report shows how a very wealthy man, an heir to the Hearst fortune, apparently was hoodwinked out of millions of dollars by his wife while he still was alive. He also put the company at risk. Among the lessons in this story is you need to establish a financial power of attorney early, and you need to give careful thought to who should hold the power. Read this article if you don’t believe me.