A Spectacle That Inspires Anything But Confidence

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Yesterday Treasury Secretary Paulson, Federal Reserve President Ben Bernanke, and SEC Chairman Cox went before the Senate sub-committee to try and explain why such massive authority and access to capital is needed. For those in the financial services industry, they presented their argument very well. But according to Jeff Voudrie, President of Legacy Planning Group, LLC, it appeared to those outside that industry (which means almost all of America), to be "gobbly-gook" and it looks like the tax payer is once again coming to the rescue.

Yesterday Treasury Secretary Paulson, Federal Reserve President Ben Bernanke, and SEC Chairman Cox went before the Senate sub-committee to try and explain why such massive authority and access to capital is needed. For those in the financial services industry, they presented their argument very well. But according to Jeff Voudrie, President of Legacy Planning Group, LLC, it appeared to those outside that industry (which means almost all of America), to be "gobbly-gook" and it looks like the tax payer is once again coming to the rescue.

Mr. Voudrie goes on the say that "the questions of the Senators were comical and illustrated to me that they really don't understand the issue and the importance of getting it fixed. Granted, in a public hearing they are more interested in getting sound bites, but when Senator Dodd ended the meeting with the suggestion that there needs to be joint hearings with both the House and Senate the market took a dive. Is Congress really willing to do nothing or to take a measured step that will fail to have the needed impact?"

Posturing aside, Jeff believes that they will do something. Does he think the plan is great? "Do I like the power it gives the Treasury secretary? No. But it's the best solution that I've heard so far. These are difficult times indeed. The flow of money in our financial system is coming to a halt. And that's not good for America."

Jeff further explains, "think of it this way. The financial system of America (and the world) is the plumbing that allows our economies to function. Imagine if the plumbing in your house, your neighborhood, your city, your state, your nation and the world became 'backed-up'. Think of the disruption that it would have on our daily life. Think of the impact on business's ability to make and sell products, to expand and to keep paying their workers. It would be a situation, that if not corrected, could have devastating effects. In other words, it would STINK! (Sorry, I couldn't help myself.)"

This is an exaggerated illustration of what is occurring right now. Fannie and Freddie were called before Congress and grilled in 2006. In order to keep from being subject to closer and tighter regulation, they placated our leaders by saying that they would start buying mortgages from low income neighborhoods. That resulted in every Republican supporting tighter regulation and every Democrat rejecting it.

Previously, Fannie and Freddie only bought the highest-quality mortgages which meant there was very little risk in their loan portfolio. Mortgages for those with less than stellar credit records were strictly reviewed by the lenders and mortgage companies because they knew that they bore risk, whereas all the risk on high-quality mortgages got transferred to Fannie and Freddie. Suddenly that changed. Now the risk of low-quality mortgages could be transferred to Fannie and Freddie as well. It was off to the races---banks, real estate agents, appraisers, mortgage companies, syndicators, etc. all profiting from pushing through every mortgage possible.

When the economy started to slow down and interest rates started to rise, guess who couldn't make their mortgage payments? That monthly payment is what flowed through the plumbing and kept the process from collapsing. If Fannie and Freddie weren't getting that income each month then they can't buy more mortgages and the value of the mortgages they own dropped.

Fannie and Freddie didn't hang on to all of those mortgages. They grouped them up and sold them to investors. Somehow they got a AAA rating. So now all of these low-quality mortgages are owned by investment banks, pension funds, your local bank, 401k's, IRA's and banks and governments around the world.

Jeff explains it as follows, "A house with plumbing that doesn't work is worth considerably less than the same house where it works. It's the same with these mortgages. Their value plummeted."

Jeff also points out that there is an accounting rule that states that companies have to 'mark to market' their investments. "That means if you bought a house that is worth $300,000 and the market now says that house is worth $150,000 then you have to change the value of that house on your company balance sheet. That's a $150,000 loss! That's what occurred on the balance sheets of companies. That's what resulted in their share prices dropping 30% or more."

"The domino effect was started. A company's stock price is taken into account when they receive their credit rating. Just like everyone else, a company's credit rating determines how much interest they have to pay to get a loan. Suddenly, sterling companies couldn't get loans. If they can't get loans, they can't finance their businesses. They can't expand.

Anyway, the point of this press release is to help you understand, in general, what is going on. As Jeff explains, "The current plan is for the government to step in and provide a market for all of these bad loans. If the government offers to buy them it will allow these companies to exchange those loans for cash. Companies need cash. If those bad loans are no longer owned by the company then their credit rating will go up. They will be seen as more stable and it will be easier for them to get the money they need to operate.

When the government buys one of these loans, that money is not gone forever. It's an investment in an asset where the main problem is there aren't enough people willing to buy it, so the prices are artificially low. If I own a house that's dropped in value and no one wants to buy my house, I'm stuck. That's what's happening."

The home in the example above still has value. It's an asset. As the economy improves, as the fear and panic subsides, people are going to start buying homes. The government offering to buy these bad loans may also encourage hedge funds and other opportunists to step up and start buying them. It is designed to reduce the fear and to get normal buying as selling (even at a reduced price) happening again. As more buyers step into the market, the value of the home (these bad loans) is going to go up.

Jeff notes that the nightly news has been encouraging panic. Why? "The viewership of CNBC has risen dramatically. It's to NBC's benefit for Americans to be scared right now. It improves their ratings and allows them to charge more for advertising. Is this situation bad? Absolutely, but not as bad as they make it sound."

There was an isolated case where a money market fund invested in some bonds of Lehman. When Lehman went bankrupt, the share value of the money market fund dropped below $1. That kind of investing is not something that should occur in a money market fund. But yet, it caused a panic and everyone started selling their money market funds. Everyone started pulling money out of their banks and brokerage accounts. If allowed to continue, this would have caused the classic run on the bank. The situation was so bad that at one point, Treasury Bonds were selling with negative interest. That meant the buyers were paying the government to hold their money instead of the government paying the buyer to loan them money.

According to Jeff, "that's why the government has stepped in to end the exodus and restore confidence in money market accounts. That's why, in most cases, you shouldn't be concerned about the money in your money market account."

The bottom line is that this is a multi-faceted issue that cannot be easily explained in one sentence.

What does Jeff think will happen?

"I think that Congress will pass some sort of a bill this week. My concern is that it will be too limited and may not have the desired impact. It might be baby steps when we need to leap forward. That will result in a muted market reaction.

The Treasury currently has the ability to buy mortgages on the market and it will begin to do so. The Federal Reserve is also flooding the system with money to encourage banks to loan it out.

This will result in more inflation over the long term. This will mean our dollar will have less value."

What portfolio action is Mr. Voudrie taking in his client's accounts?

"I am remaining defensive. Most portfolios have very large cash positions. There are opportunities in these markets to pick up longer-term holdings that should do well over the next 12-24 months. I had exited the commodity/hard asset sector about a month ago. That sector seems to have bottomed and I anticipate moving some money back into it.

There continues to be opportunities to buy high-quality bonds at a discount, which results in a very attractive yield. For instance, there is a closed-end fund that invests in the government bonds of emerging markets. These receive the highest credit rating. Yet, because of the panic in the market, these bonds can be bought for 20-30% less than their current market value. That is an opportunity. As the panic subsides, we will see the share price of that fund go up--quickly.

History has shown that the best buying opportunities occur when fear is at its worst. I believe we are in one of those situations. Therefore, I anticipate cautiously moving more money into the markets as they decline. I believe there are attractive opportunities in financials, in the broad markets and in small companies."

Jeff continues, "regardless of what the evening news might lead you to believe, this is not the time to panic. It's a time to profit from everyone else's panic. That's what Warren Buffet does and is one of the main reasons he is considered the greatest investor alive. By the way, he bought $5 Billion of Goldman Sachs last night. If he's investing selectively, I want to be too."

"A local hotel was built about 10 years ago for $6 million. It was financed mainly with debt. After 2-3 years it went bankrupt. A disaster, but not for the group that bought it for $3 million. They are able to operate it profitably because they aren't saddled by all the debt. That is what is going to happen in our economy. The people that step in and buy the bargains are going to be the ones that profit." Jeff explains that this is his intention in the portfolios.

Jeff Voudrie, Certified Financial Plannerâ„¢, is the president and founder of Legacy Planning Group and Common Sense Advisors. He writes a weekly newspaper financial column and services money management clients nationwide. Jeff has been interviewed by the Wall Street Journal, CBS MarketWatch, The London Financial Times, The Christian Science Monitor, CFO.com and Financial Planning Magazine and has appeared on CNNfn as an expert.



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