Need to rejuvenate the middle class and paths up into it

Maybe the biggest silver lining of the subprime mortgage mess and the end of the housing boom will be that people will wake up and realize that the "middle class" that we knew and loved in the 1950's and 1960's and 1970's is now virtually non-existent. Sure, there are plenty of househoulds with incomes in the $50,000 to $200,000 range, but try finding one that isn't struggling in some significant financial way and actually feels financially "secure." And try to find one that doesn't know of someone who hasn't "fallen" precipitously from their former financial security into deep financial insecurity. It is one thing to chatter about the rich getting richer and the poor getting poorer, but the really important issue is whether there is a broad and deep enough middle class to keep our political, social, and economic system afloat, on an even keel, and thriving. It won't do much good to help the poor if they don't have a secure middle class future to strive for. The middle class is now truly an endangered species in need of saving.

Try finding someone who doesn't know somebody who had a "secure", high-paying job and has fallen financially and now considers themselves lucky to have something even at half or less of their former pay.

Try finding someone who doesn't know of someone who has completely lost their sense of financial security due to corporate "downsizing."

Try finding someone who doesn't know of a household that is only able to stay financially afloat because both spouses had decent incomes and could cover (barely) when they lost one of those incomes.

Try finding someone who doesn't know of multiple households that are only able to support a middle class lifestyle if two members of the houshold work full time.

Try finding someone who isn't worried about rising health care costs and the pace at which employers are shifting health care costs onto the shoulders of employees.

Try finding someone who doesn't know of somebody who has had to stifle higher education plans due to outrageously high college and graduate school costs.

There is something wrong with this picture. Seriously wrong.

It is one thing to encourage people to strive to better themselves and to work harder to move up in the world, but it is an entirely different matter when people have worked really hard in school and their jobs but are finding it increasingly difficult to simply tread water, let alone get ahead.

The status of middle class has classically been driven less by level of raw income, but by a sense of security and a sense that pathways upwards were readily available. Today, even households with income levels of $200,000 or higher will tend to find themselves obsessing over the lack of security of their jobs and the difficulty of both making ends meet and moving up in the world.

Personally, I am doing "okay" right now, but I have had significant financial and employment difficulties in recent years, so I can relate to some of these problems, and if even I feel susceptible to some of these issues, I can only imagine how difficult things must be for so many others who are less fortunate than me.

I like to think of myself as being at the 50% level in all things, meaning that 50% are doing better than me and 50% are doing worse. And if even I am unable to feel that I have a "secure" position in the middle class of America, that says that a lot of people are much worse off. Actually, I'm in the top 25% and maybe even the top 20% based on househould income, so if even I feel significantly less than "secure", the thought that 75% or even 80% of households are struggling and suffering from higher levels of financial anxiety than me is quite breathtaking. Oh, and housholds with $200,000 in income who are still strugling and suffering from financial anxiety are in the top 5%, so we are talking about 95% of American households feeling that they have been deprived of the bright middle class future that they had been promised when they were young.

And, things only seem to be trending to get worse.

There is no quick and easy magic solution that I know about, but we do need to get started thinking about how to rejuvenate the middle class, coupled with robust pathways from poverty and near-poverty into a newly-healthy middle class.

On the bright side, I actually do believe that there are a number of relatively quick fixes that could relieve a lost of middle class anxiety and pain and enhance the stability of our political, social, and economic system at the same time. Summoning the political will to make such changes is another matter. In any case, there is a lot to think about here.

-- Jack Krupansky

$500 budget for a new Notebook computer

It will probably be another six to eighteen months before I feel compelled to buy a new notebook computer, but I am trying to decide whether $500 is actually a credible budget. I have seen plenty of machines advertised at $599 teaser rates, but now I am starting to see a few machines at $499 and even $449.

Sure, these are really basic, bare bones machines, running only Vista Home Basic, but they are probably plenty powerful enough for what I do these days. My current machine, a very decent mid-range Toshiba Satelite, is over two years old, so it won't be too much longer before even low-end machines can outperform it. I suspect that by Spring or next June the crossover point will have been reached.

Sure, I could afford to splurge and buy a machine for $699 or even $999, but there is something incredibly appealing about getting a semi-decent machine for under $500. I don't need anything fancy these days for home use since I am no longer self-employed and all of my work computing is done at work.

I should probably go ahead and pencil in a $500 budget for a new notebook PC next June.

-- Jack Krupansky

Rolling my 4-week T-bills this week

My automatic reinvestment plan with TreasuryDirect will be reinvesting my maturing 4-week T-bills this week. What interest rate I will get is anybody's guess. After seeing 13-week T-bills fetch only a mere 2.92% at the weekly auction last week, I actually considered pulling the plug on my automatic reinvestment plan. Fortunately, the 4-week T-bill auction last week gave a much better yield of 4.85%, so I don't feel so bad taking my chances this week. Besides, I got a 5.16% yield four weeks ago, so I can afford a somewhat lower yield this month and still come out fairly well compared to most money market funds. My guess is that I will get at least 4.95% since the "panic" over the "credit crunch" has now substantially subsided.

Note that T-bills are guaranteed by the full faith and credit of the U.S. govermernment. Although you can get a somewhat better yield with some money market funds and CDs, T-bills are a very good choice for people parking more than $100,000 (but less than $5 million) who otherwise would have only their first $100,000 of bank deposits protected by FDIC.

-- Jack Krupansky

How big an impact are ARM resets going to have on the economy and financial markets?

Although there is no question that there are a significant number of ARM mortgages that are going to have interest rate "resets" over the coming months and next couple of years, there is no clear view on what the net impact on the overall economy and financial markets will be.

Bankrate.com has an article entitled Survivor's guide to ARM resets. I am not offering any recommendation on that article, but it is one point of view on "The ARM Reset Mess."

Nobody knows with clarity how many ARM resets will result in defaults, how many will result in foreclosures, how many personal bankruptcies will result, or what the net hit to consuming spending might be. I'm sure it will be relatively ugly, but I am also sure that it won't be anywhere near as disastrous as a number of commentators are asserting.

As painful as bankruptcy can be, it is actually quite liberating to finally get your onerous debts discharged and start over fresh. Suddenly you actually have money in your pocket (assuming you had a decent income to begin with) that was being sucked into that giant mortgage payment. I do not want to make light of bankruptcy, but I do know from personal experience that there really is a silver lining in that dark cloud.

As far as defaults, not all of them will lead to foreclosure. Workouts will be effective in some portion of the defaults.

As far as foreclosures, I think it will all depend on the actual numbers that play out. If the numbers turn out to be relatively low, the mortgage lenders or MBS bondholders will simply suck it up and take a modest to moderate haircut. No disaster there. The market values of housing related debt securities have already priced in a very heavy haircut, probably far greater than what may transpire.

If the number of pending defaults or foreclosures turns out to be huge, a bailout of some form will clearly be the order of the day. We have a election coming up in 2008, so even the Republicans will willingly go along with "providing aid to distraught homeowners" in such a scenario since to do otherwise would be suicidal in the election. The bright side of all of this is that it won't take a massive amount of money to bail out homeowners, but simply a piece of paper from Congress and or state legislatures that would either dramatically cap or defer the amount of the interest rate reset. Yes, the lenders holding those ARM mortgages or MBS bondholders would take a modest to moderate "haircut", but their alternative would be to have to deal with all of those foreclosures and the resulting hit to their capital and their income.

There are plenty of middle-ground alternatives. Countrywide Financial, which services the mortgages it originated, will be under a lot of pressure, especially due to some of its shadier practices, and in my opinion will be likely to voluntarily (and with the agreement of the MBS bondholders) agree to dramatically alter the terms of the ARM resets simply to protect their own financial situation. It will be a simple financial calculation, the net cost of dealing with a foreclosure versus the reduction of income from foregoing much if not all of the ARM reset.

As far as the hit to consumer spending for people who are able to eat the cost of their ARM resets, it is difficult to project. As I said, if the overall ARM reset impact is really huge, a bailout will dramatically mute its economic impact. I also suspect, once again with the 2008 election looming, that there will be a fair amount of government aid to homeowners who have difficulty coping with a big jump in their monthly payment. And even that aid will likely be limited since the big gain comes from simply capping or deferring the ARM reset amount.

Also, we do know now that one of the bigger scandals of the past couple of years was consumers who were pushed into expensive subprime mortgages or even ARM mortgages despite the fact that they had the documented income and cash reserves to qualify for more economical fixed or FHA mortgages. I suspect there will be a combination of class action law suites and government intervention to help get quite a few of these homeowners converted over to the more economical mortgages that they really do qualify for.

I certainly do not want to be too sanguine about the impact of ARM resets, but we do need to be cognizant that there really are any number of different scenarios that could play out. You can't simply look at the maximal worst case number of defaults and using simple arithmetic to definitively forecast how it will all play out.

Yes, I believe there will be a significant amount of pain, but I also strongly suspect that there will be far more irrational anxiety than actual pain.

The overall hit to the economy from the housing mess will probably continue to be in the 1% range. Maybe it will dip to 0.75% and maybe it might rise as high as 1.5% over the next year to year and a half. So, we are mostly talking about a continuation of the current hit and not a huge new additive hit. And certainly nothing indicative of a recession.

One last factor to keep in mind is that the total amount of money flowing in the economy does not decline simply because less is flowing into housing, but rather it simply flows elsewhere in the economy. Commercial construction is still quite strong and many businesses in the service sector are still quite strong. We may not be able to directly discern where the money flows have moved to in the short-term, but money does not simply vanish, especially when the Federal Reserve is showing that growth of the monetary base (M2) has been 3.5% (annualized) over the past three months, 5.5% over the past six months, and 6.1% over the past year. There really is plenty of money floating around seeking a home.

-- Jack Krupansky

VIX suggests that the market crisis is over

The CBOE Implied Market Volatility Index (VIX) strongly suggests that the recent financial "crisis" is over.

The VIX "fear gauge" stayed under 20 in the pre-crisis period through July 25, 2007.

It spiked above 20 (intra-day peak of 23.36) and closed at 20.74 on July 26, 2007, marking the beginning of the market "crisis".

It bounced around in a range, no higher than 26.40 (early crisis) until August 9, 2007 when it hit an intra-day peak of 26.90 and closed at 26.48. This marked the beginning of the "crisis" itself.

The actual peak of the crisis was on Thursday, August 16, 2007 when VIX spiked as high as 37.50 intraday and closed at 30.83. In addition to being the peak, the decline marked the end of the "crisis."

The Fed cut the discount rate the next day (Friday, August 17, 2007), but VIX did not show the "crisis" as clearly subsiding until the following Monday when VIX closed at 26.33 after opening up at 29.87.

VIX fell moderately on each of the following four trading days, closing Friday, August 24, 2007 at 20.72.

Technically, people are still worried that the "crisis" will surge back, but given the steep fall-off over seven trading days and the itchy trigger finger of the Fed, VIX strongly suggests that the "crisis" is behind us.

Sure, I'd like to see VIX below 20 for a couple of weeks to completely confirm the end of the "crisis", but that is all a matter of people seeing some follow-through on the financial markets.

I call the current "crisis" a mini-crisis because it it so much less severe than what we saw back in 1998. On October 8, 1998, VIX spiked up to 49.53, but we didn't even get close to 40 this time. You could argue that the Fed nipped the crisis in the bud better this time, but no matter how you slice it, we simply have not seen the levels of raw "fear" that were associated with past market crises. So, I have to chalk this one up as being a mere "mini-crisis."

But whatever you want to call it, it is now most likely behind us.

Note: The current VIX ("new VIX") is different that the old VIX that was in use back in 1998 and during other crises. It is believed that the hostorical data has been properly adjusted to reflect new VIX, but I am at least somewhat skeptical. Old VIX was based on S&P 100 index futures, but in September 2003 it was changed to be based on S&P 500 index futures. The overall concept is still the same, but trying to judge the level of a crisis or panic using a different index may not be a 100% reliable approach. The bottom line is that we will need to see two or three full-blown crises, not a mini-crisis such as this one, before we can better calibrate new VIX for the new financial markets.

I have a web page with some information on VIX.

-- Jack Krupansky

Is the sky really falling? Sequel No. 2

Although the housing market and issues related to subprime credit and subprime mortgage-backed securities could well continue to be challenges in the coming months, the "contagion" affecting the rest of the financial markets really is mostly behind us. Sure, we will continue to see an occasional pothole or speed bump that will cause the gloomsters to remind us of their core belief that the sky is falling, but the overall economy and stock market will continue to plug along, neither booming nor busting.

Some weeks will be good and some weeks will be bad, but the overall trend really is likely to be incrementally upwards.

For the next six months each and every financial or economic pothole will be treated by the cynics as if it were a sign that the economy and stock market were rolling over and heading downwards into a deep recession. My advice is that every time we do hit one of these potholes, simply calm down and wait two or three weeks and see how things really look once the dust has settled.

-- Jack Krupansky

Cheap home mortgages continue to be readily available for normal people

Despite all the talk of a credit crunch, people with good credit and a documented income can still get reasonable size mortgages (under $417,000) at quite cheap rates. The latest weekly mortgage survey from Freddie Mac shows the average rate offered for 30-year fixed-rate home mortgage is 6.52% (down from 6.62% last week) and the average for the 15-year fixed-rate home mortgage is 6.18% (down from 6.30% last week.) These are truly great rates. Sure, people with lousy credit or without documented income or money for a deposit are on shaky ground, but that's the way it should be anyway. Jumbo mortgages for expensive homes (above $417,000) are a little more problematic, but still available depending on local conditions.

So much for being able to depend on the media for information about finance and the economy. 

-- Jack Krupansky

Euro continues to bounce around within its trading range

The euro recovered a bit this past week, but continues to remain trapped in its $1.33 to $1.38 trading range. September futures for the euro closed at $1.3682 on Friday, 1.94 cents above the prior Friday close of 1.3488, but still below the close of $1.3716 two Fridays ago.

There are plenty of traders and speculators who would like to see the euro break $1.40, but whether there is really a net demand for the euro at these levels remains to be seen. I would give the euro bulls and dollar bears a couple of more weeks to see if the euro really wants to stay up at or above $1.37 and $1.38 before concluding that the euro is likely to weaken for the rest of the year.

Euro futures out at December 2008 were only at $1.3753 on Friday (compared to $1.3559 the previous Friday, but still below the $1.3795 level of two Fridays ago), so there isn't exactly a lot of "slam dunk" enthusiasm for betting on a $1.40 euro, so far.

For now, the euro remains in relatively uncharted territory. It is now mostly a question of the level of speculative money flows. With some people still misguidedly believing that Fed rate cuts are still likely in the Fall, the flows could be net-euro for some time to come. On the other hand, just a few good economic reports, persistently high energy prices, strong talk from the Fed about fighting inflation, and a hint of a Fed rate hike in the Fall, could quickly sap the staying power of all but the most diehard of over-extended speculators.

I wouldn't be surprised if speculators managed to keep the euro up in the $1.33 to $1.38 range as long as there is any superficially bad news or even mere anxiety to focus on, but it is just as likely that they will trade it back down under $1.30 as soon as they begin to deeply grasp the truth that the Fed is very unlikely to cut rates over the coming year.

In short, the dollar is not "plunging." [And I will continue to repeat this line until The New York Times admits that they were wrong for claiming that the dollar is "plunging."] It is certainly fun to chatter about how expensive things are for tourists in Europe, but there are other factors that are more significant as far as keeping prices high in Europe than the minor impact of foreign exchange rates.

-- Jack Krupansky

Fed still likely to stay on track with target rate at 5.25% for the rest of 2007 and probably well into 2008

Despite all of the "turmoil" in the financial markets and a credit crunch is some credit markets, the Fed will likely continue on its current path (including sporadic liquidity injections into the banking system) and stay on track to keep the fed funds target rate paused at 5.25% for the rest of the year and probably well into 2008.

Usually, in normal times, the fed funds futures market is a good indicator of what the Fed will do over the next month or two, but we are not in normal times right now and currently there is such a dramatic dislocation between what a lot of people fear or hope for on the one hand and what the calmer Fed is actually likely to do. So, I do report the fed funds futures here, but for now I do so with the caveat that they are completely out of whack. Yes, they do reflect what people hope and fear, but they are not predicting likely Fed activity.

In a lot of cases they are either speculative bets seeking to make a quick buck if the Fed does happen to cut rates, or actually legitimate hedges by holders of fixed income assets who are really buying insurance in case the Fed does happen to cut rates, but do not necessarily represent a core belief that the Fed really will cuts rates.

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• This week through the end of August: 100% chance of a cut and 4% chance of a second cut -- cut is very likely
• September before the September 18, 2007 meeting: 100% chance of a cut and 22% chance of a second cut
• September 18, 2007: 100% chance of a cut and 42% chance of a second cut -- flip a coin, but leaning away from second cut
• October 30/31, 2007: 100% chance of a cut and 88% chance of a second cut  -- second cut is likely 
• December 11, 2007: 100% chance of a second cut and 26% chance of a third cut -- third cut is unlikely
• January 2008: 100% chance of two cuts and 60% chance of a third cut -- flip a coin, but leaning towards a third cut
• March 2008:  100% chance of two cuts and 74% chance of a third cut -- third cut is likely
• May 2008: 100% chance of two cuts and 88% chance of a third cut
• June 2008: 100% chance of two cuts and 84% chance of a third cut
• August 2008: 100% chance of two cuts and 56% chance of a third cut -- flip a coin, but leaning towards a third cut

So, the futures are telling us that a cut is a "slam dunk" before the September meeting, but I would urge caution in depending on that number since: a) the Fed has given no indication that it is leaning towards such a cut, and b) bets placed in the "heat" of a crisis are frequently unwound in the weeks following the crisis. In just the past week alone the fed funds futures market has "unwound" a fourth rate cut in 2008 and unwound a thrid rate cut by the end of this year.

Note: Studies have shown that the fed funds futures market only has a high degree of forecast reliability about 30 to 45 days out (high out to 30 days, only modest reliability out to 60), so those probabilities beyond September are shaky at best and could easily change very dramatically.

What we saw these past three weeks was a simple knee-jerk reaction to a very real, but brief crisis. Wait a few weeks and the picture will change again.

And to repeat one thing that bears repeating: the economy is much stronger than many people on Wall Street are claiming it is. We actually had a few decent economic reports this past week, which made a lot of people on Wall Street look like fools. Most of the guys on Wall Street are certainly not fools, but they have certainly been trying to play the rest of America for fools.

-- Jack Krupansky

PayPal money market fund yield remains at 5.04% as of 8/25/2007

Despite the chatter about the so-called "credit crunch" and "subprime crisis" and the potential risk of even money market funds, money market funds are still an extremely safe place to park cash.

Here are some recent money market mutual fund yields as of Saturday, August 25, 2007:

• iMoneyNet average taxable money market fund 7-day yield fell from 4.76% to 4.54%
• GMAC Bank Money Market account rate remains at 5.16% or APY of 5.30% (only $500 minimum for that rate)  -- Note: This is an FDIC-insured bank deposit account, not a money market fund 
• Vanguard Prime Money Market Fund (VMMXX) 7-day yield fell from 5.11% to 5.09%
• Vanguard Federal Money Market Fund (VMFXX) 7-day yield fell from 5.03% to 4.99%
• AARP Money Market Fund 7-day yield fell from 5.07% to 5.04%
• TIAA-CREF Money Market (TIRXX) 7-day yield rose from 5.03% to 5.05%
• PayPal Money Market Fund 7-day yield remains at 5.04%
• ShareBuilder money market fund (BDMXX) 7-day yield rose from 4.47% to 4.63%
• Fidelity Money Market Fund (SPRXX) 7-day yield fell from 5.07% to 5.05% ($25,000 minimum)
• Fidelity Cash Reserves money market fund (FDRXX) 7-day yield fell from 5.05% to 5.03%
• Fidelity Prime Reserves money market fund (FPRXX) 7-day yield fell from 4.51% to 4.50%
• Fidelity Municipal Money Market fund (FTEXX) 7-day yield rose from 3.26% to 3.42% or tax equivalent yield of 5.26% (up from 5.02%) for the 35% marginal tax bracket and 4.75% (up from 4.53%) for the 28% marginal tax bracket -- this may be the best rate that most of us can get for "core cash" in a checking-style account
• Fidelity Tax-Free Money Market fund (FMOXX) 7-day yield rose from 3.22% to 3.36% or tax equivalent yield of 5.17% (up from 4.95%) for the 35% marginal tax bracket and 4.67% (up from 4.47%) for the 28% marginal tax bracket
• 4-week (1-month) T-bill investment rate rose from 4.65% to 4.85%
• 13-week (3-month) T-bill investment rate fell from 4.76% to 2.92%
• 26-week (6-month) T-bill investment rate fell from 4.91% to 4.10%
• Treasury I Bond composite earnings rate (semiannual compounded annually) for new I Bonds is 3.74% (down from 4.52%), with a fixed rate of 1.30% (down from 1.40%) and a semiannual inflation rate of 1.21% (down from 1.55%) -- updated May 1, 2007, next semiannual update on November 1, 2007
• NetBank 6-month CD APY remains at 5.40%
• NetBank 1-year CD APY rose from 5.35% to 5.40%
• Bankrate.com highest 6-month CD APY rose from 5.50% to 5.55% (Countrywide Bank, $10,000 minimum)
• Bankrate.com highest 12-month CD APY is at 5.65% (Countrywide Bank, $10,000 minimum)

Note: APY yield is worth somewhat less than the same 7-day yield. See my discussion and table for Comparing 7-day yield and APY.

When I look at the sharp decline in the iMoneyNet average rate and the sharp decline in the 13-week T-bill rate, I can't help but wonder whether some money market fund managers got spooked and put more of their maturing commercial paper holdings into "safe" T-bills. Who knows.

Update: Still no confirmation on the apparent shortfall of the PayPal dividend for July.

Right now, Fidelity Cash Reserves (FDRXX) is my preferred parking place for the bulk of my cash. I do appreciate the higher yield I have been getting these past few weeks, which is probably due to higher yields on commercial paper.

DISCLAIMER: I am not an investment adviser, so my opinions and the data presented here should not be considered as advice for where to invest your money. You should examine this and other available data before deciding how to invest your money. And, seriously, past returns should not be construed as a guarantee or even an "indication" of future returns.

-- Jack Krupansky

ECRI Weekly Leading Index indicator down sharply but continues to point to a relatively healthy economy in the months ahead

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell sharply (-1.37% vs. -0.14% last week) and the six-month smoothed growth rate fell sharply (from +4.1% to +2.6%), but remains modestly above the flat line, suggesting that the economy continues to have some amount of steam, neither booming nor busting.

A WLI growth rate of zero (0.0) would indicate an economy that is likely to run at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to forecast a relatively stable "Goldilocks" economy. We're actually doing somewhat better than that now.

If I were looking at this one indicator alone, I would say that the Fed is succeeding at its goal of moderating the economy to a sustainable growth rate.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner, but presently indicates "clear weather" for the next few months, even if the interval is occasionally punctuated with financial market "gyrations."

-- Jack Krupansky

Fed still on track

I'll have more to say on the weekend, but halfway through the week it is fairly clear that the Fed is doing a great job of preventing the mini-crisis of two weeks ago from mushrooming into a full-blown crisis (ala 1998.) Sure, the kiddies on Wall Street are still demanding a fed funds target rate cut (which they are not going to get any time soon), but it should surprise no one that the greed on Wall Street knows no bounds.

One thing to keep in mind is that August is usually a very slow time for the Wall Street, so you have to take some of these "credit markets have siezed up" comments with a grain of salt. Yes, there was a Wall Street-led "run on the banks" which caused the mini-crisis over bank liquidity, which the Fed has deftly outmanuveured, but a fair amount of business is still happening.

Wall Street essentially shot themselves in both feet by talking up this story that the credit markets were "totally siezed up", ignoring the fact that if their silly story was true then it would mean that the bankers on Wall Street would not be collecting any transaction fees at all. As we all know, there is no honor among thieves, so even as the leaders of the "siezing" held ranks (and continued to clamor for a fed funds target rate cut), more sensible and pragmatic bankers (yes, there are actually some of those, even on Wall Street) quitely continued to cut deals.

The media continues to eat up this "markets are siezed" story even though the mini-crisis is now mostly behind us.

I just saw a story about Bank of America investing $2 billion in Countrywide Financial. So much for this story that credit markets are "totally siezed up." Sure, the old subprime mortgage securitization credit market that Wall Street created and loved so much is kaput (maybe, for now), but good riddance anyway. Let's try to get back to focusing on "normal" credit.

Sure, it could be a while before everything gets completely back to "normal" (whatever that really is), but we are now on a clear march out of the woods. The sleazebags on Wall Street gave it their best shot and they did manage to create a mini-crisis that drew the Fed into action, but that was it, that was their best game, and now it is over. Meanwhile, the economy is doing "okay", just as it has for the past year, neither booming nor busting. Maybe that's the biggest problem for the boys down on Wall Street: they only really know how to play boom or bust, so a mere "okay" (GDP between 2.25% and 3.00%) is not something they know how to do, let alone something they enjoy or would willingly settle for.

-- Jack Krupansky

Is the sky really falling? Sequel No. 1

Despite the "crisis" of the past three weeks, I continue to contend that the financial sky really is not falling. Yes, the Fed has had to inject significant liquidity into the banking system due to some significantly irrational behavior by a number of "players" on Wall Street. Yes, there was a temporary crunch in the commercial paper market. Yes, the stock market has declined in sympathy to difficulties in some credit markets. Yes, people with bad credit now have trouble getting mortgages. Yes, people trying to buy expensive homes (mortgage over $417,000) are finding it expensive to indulge their financial fantasies. Yes, people do have to get used to saving up a down payment to buy a home. Yes, the whole subprime mortgage market is in the process of being "rationalized." Yes, there will be more ARM resets and foreclosures over the coming year, but so much of this has been priced several times over into mortgage debt. Yes, to all of this and a lot more, but a resounding No to the idea that all of this constitutes a major financial crisis (ala 1987 or 1998), and a resounding No to the idea that this "crisis" is sending the economy down into a recession.

Expect the Fed to maintain its vigilence to the ongoing misbehavior of various players in the financial markets and to continue to inject liquidity into the banking system, as needed. This process won't instantly restore Wall Street's confidence in the banking system overnight, but each day that passes adds incrementally to longer-term confidence.

Then Fed is standing by and ready to give the banking system as munch money as it needs to stay on an even keel, but that in no way suggests that the Fed is likely to cut the fed funds target rate any time soon. We would have to see some convincing evidence of substantial economic deterioration, which we are not, before the Fed would actually cut the fed funds target rate. Yes, it could actually happen, but it is still very unlikely.

The Fed really is a lot more capable of dealing with "challenging market conditions" than many so-called  "professionals" on Wall Street give it credit for. Do not bet against the Fed. A number of unscrupulous players on Wall Street may have managed to outmanuver the Fed and engineer this "crisis", but they made a big mistake by managing to awaken this slumbering giant. The Fed is very capable and very vigilent, but even they cannot guard against every  single financial "pothole" that may arise (or be engineered by the profiteers on Wall Street.) But now that the Fed is solidly on the case, watch for some significant moderation of the shenanighans on Wall Street.

There are plenty of unscrupulous players on Wall Street who will continue to try their best to take down more hedge funds, try to take down some major banks, and even try to take down the Fed itself. Their hubris knows no bounds. But, sooner or later they will have reached a bit too far and find themselves to be the next and final victims of this "play."

The other major factor in this crazy "crisis" is that old saying "When the tiger is away, the monkeys rule the jungle", meaning that with a lot of the heavy-hitters off enjoying their summer vacations, you have a lot of second and third-tier players "messing around." Wall Street is never truly dead in the Summer, but the pace does slow down dramatically and usually many operations are simply on auto-pilot. But, of course, auto-pilot cannot handle very many curve balls, so a situation which might have been handled rather easily in the Fall, completely overtaxed the third-string players manning the trading desks and those playing caretaker for absentee executives.

Is it a good time to jump back into the stock market? Hard to say. I'll make an effort to avoid trying to time the market. You'll need to figure that out for yourself. The best advice I can give you is to focus on fundamentals and look for companies with solid earnings growth potential selling for a discount.

The stock market may or may not be poised for a decisive rebound. Worst case, give it another two weeks.

-- Jack Krupansky

Is my money safe in my money market fund during this credit crisis?

Lots of people keep a lot of cash in money market funds, presuming that they are as safe as bank accounts, but in fact money in such funds does not have the same kind of FDIC protection, even if the funds are offered by a bank. Nonetheless, the short answer to the safety question is that there isn't even close to a remote chance that any of us is going to have problems with our money market funds during the current "credit crisis."

First, to clarify some terms, the FDIC insurance offered by most banks covers only deposit accounts, which include checking, savings, NOW, money market deposit accounts, and CDs.

Any stocks or bonds or mutual funds or other "investment products" offered by a bank are not covered by FDIC insurance.

It is extremely important to understand that money market funds are not covered by FDIC insurance. Yes, money market accounts (properly called money market deposit accounts) are covered by FDIC insurance, but money market funds (properly called money market mutual funds) are not covered by FDIC insurance since they are an investment product and not bank deposit.

Even if the bank advertises a money market fund, that does not automatically give it FDIC insurance protection.

Also keep in mind that in general FDIC protection covers only the first $100,000 (in deposits) you have in a bank (as an individual), although up to $250,000 (in deposits, not stocks or bonds or mutual funds) is protected in many retirement accounts kept at banks.

A lot of people are very loose with some of these terms, so check and double-check to make sure that you are dealing with a money market account or a money market deposit account that is covered by FDIC insurance, if that is what you seek. Yes, a money market fund or money market mutual fund will tend to offer a significantly higher yield, but it also offers somewhat less absolute protection.

Now we shift to money market funds or money market mutual funds.

Although there is nominally no explicit guarantee comparable to FDIC insurance, money market funds are generally implicitly protected in a number of ways.

First, given that money market funds have a relatively high money flow rate in terms of people frequently adding and removing money from the fund, the managers of these money market mutual funds are forced to invest primarily in very liquid short-term assets, such as T-bills, bank CDs, commercial paper, repurchase agreements, etc., that tend to mature and get rolled over on a very frequent short-term basis. In general, a money market fund won't be holding an asset that matures in more than a year or maybe thirteen months at the outside.

Second, given the short-term nature of money market fund investments, in general the fund holds them to maturity and gets the full cash value, as opposed to a longer-term fund where there may be a significant "turnover" that exposes the fund to market fluctuations in the market-perceived "value" of assets. Fidelity Cash Reserves indicates that its turnover rate is 0.0%. This means that the full cash value of a money market fund with NAV of $1.00 can be withdrawn within no more than one year to thirteen months. Funds tend to keep the bulk of their assets with durations of less than 90 days to handle wild swings of money flows into and out of the fund.

Third, there is a general "promise" by the money market mutual fund industry not to "break the buck." In general the value of a money market mutual fund "share" is exactly $1.00 and higher earnings on investments within the fund results in higher yields and lower earnings within the fund result in lower yields with exactly zero change in the NAV. The manager of the fund keeps a chunk of the earnings, which is why so many investment companies offer money market funds. The "promise" is twofold: 1) to manage the fund so that the Net Asset Value (NAV) of the fund is exactly $1.00, and 2) if for some reason the NAV dropped below $1.00, the manager (the investment company) would make up the shortfall since failure to do so would cause significant reputation harm to the investment company managing the fund.

Most of my cash is currently in Fidelity Cash Reserves (FDRXX.) I'm personally not worried about its safety, but I'll walk through it as an example since I have all of the information at hand. Fidelity has the following "risk" statement for this fund:

An investment in the fund is not a deposit of a bank and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the fund. The rate of income will vary from day to day, generally reflecting changes in short-term interest rates. Entities located in foreign countries can be affected by adverse political, regulatory, market, or economic developments in those countries. Changes in government regulation and interest rates and economic downturns can have a significant negative effect on issuers in the financial services sector. A decline in the credit quality of an issuer or the provider of credit support or a maturity-shortening structure for a security can cause the price of a money market security to decrease.

That doesn't provide much in the way of enlightenment, other than to confirm that the fund "seeks to preserve the value of your investment at $1.00 per share" and to give Fidelity an out by declaring that "it is possible to lose money by investing in the fund." Obviously that doesn't sound like a very strong promise, but as I said, it is more of an implicit promise. Sure, the company lawyers might insist that the company is not on the hook, but the industry-wide "don't break the buck" "promise" and the reputation risk of breaking that promise is a very strong incentive for Fidelity to keep the NAV at exactly $1.00 come proverbial hell or high water.

In terms of the rest of that risk statement, we need to examine what assets are actually in the fund's portfolio and to what extent these credit risks and other risks might be very real or de minimis. And to the immediate concern, people want to know if they have any exposure to subprime mortgage-banked securities and other "toxic" securities which might "blow up" and which are causing the denizens of Wall Street so much difficulty lately.

According to the latest (May 31, 2007) semi-annual report for Fidelity Cash Reserves, the asset allocation is was follows:

• Bank CDs, BAs, TDs, and Notes: 57.5%
• CDs: 20.9%
• Bank Notes: 0.1%
• Master Notes: 4.1%
• Medium-Term Notes: 31.1%
• Short-Term Notes: 1.3%
• Repurchase Agreements: 26.0%
• Commercial Paper: 15.3%
• Government Securities: 0.5%
• Other Investments: 1.7%
• Asset-Backed Securities: 1.7%

(Note: I believe that "BA" is Bankers Acceptance and "TD" is Trust Deed, but I saw neither in the actual portfolio listing.)

(Note: Those number add up to 101.0%, as is stated in the semi-annual report, suggesting that there is some kind of 1.0% reserve in the fund. I have no further details on that issue.)

In terms of maturity, Fidelity Cash Reserves was as follows:

• 0-30 days: 67.7%
• 31-90 days: 19.0%
• 91-180 days: 5.0%
• 181-397 days: 8.3%

So, 86.7% of the NAV $1.00 asset value could be paid out in no more than 90 days with absolutely zero risk of having to take a "hair cut" due to short-term market mispricing of any assets. That is reasonably liquid.

The Asset-Backed Securities category raises a flag, but is a rather small slice of the total pie. A second flag is raised when I read that two of the ABSs are CDOs (Collateralized Debt Obligations.) You see CDOs in the news a lot lately, and almost never with a good connotation. The good news is that all of the listed ABSs would have matured back in June or early July. On the one hand I don't like to see ABS/CDO in a money market fund, but the exposure is minimal and maybe not even an issue due to the fact that money market funds tend to depend on maturing of the asset rather than having a tradable market.

As I look through the portfolio details, I do see that the fund has repurchase agreements with Countrywide Financial, who is also in the news a lot lately and rarely with positive connotations, but once again these are rather small holdings and would have matured back in June.

I see that the fund held a small position in CDs from BNP Paribas that mature by October 2, 2007, but that doesn't particularly alarm me. They also hold about 1.7% position in Medium-Term Notes from BNP Paribas, and a small position of Medium-Term Notes in Countrywide Bank.

I see that the fund held about 1.5% of assets in Master Notes from Countrywide Commercial Re Finance, Inc., but they would have paid off back at the beginning of June. Still, it does raise a flag that such a conservative fund would be "gambling" on such a shaky company. I don't like it, but I don't think there is a real risk here.

Repurchase Agreements are usually very safe since they are very short term and do not depend on trading on a market, but it still raises a flag when I read that a number of them are "Collateralized by Mortgage Loan Obligations." The risk with such collateral in a short-term repurchase agreement lies mostly with the owner who has to worry about refinancing when the repurchase agreement matures and pays back the fund. So, no real problem here.

This analysis is as of the end of May, so it may have changed significantly, but my suspicion is that the fund probably has roughly the same composition today. Of course your own mutual fund may have significant different holdings, but I suspect that Fidelity is fairly representative of the types of assets held in most money market funds.

That's it. Yes, I see some stuff in this fund that I don't like, but nothing that actually alarms me, either now, or for the near or longer-term future.

Actually, the good news is that due to the so-called "credit crunch", companies are being forced to pay higher rates on a lot of these repurchase agreements and notes, which could result in higher yields for money market mutual funds. I have in fact seen the yields on a number of money market funds rise in the past week.

Granted, there will always be some extreme "perfect storms" which could give grief to holders of money market mutual funds, but we aren't even close to the conditions needed for such a storm. At this time, I can do nothing other than give a solid clean bill of health for money market mutual funds. That doesn't mean that there might not be some bad apples out there somewhere, but I can state with great confidence that Fidelity Cash Reserves looks rock solid.

-- Jack Krupansky

What is the risk with getting a 1-year CD from Countrywide Bank?

If you look at the list of top interest rates for 1-year CDs at BankRate.com, you will see that the #1 top rate of 5.65% APY (5.49% simple, $10,000 minimum, Internet rate) is paid by Countrywide Bank, FSB. That sounds like a great deal. But... we all know that Countrywide Financial, the parent of the bank, is in a very precarious situation as one of the casualties of the ongoing subprime mortgage debacle, with some analysts even suggesting that bankruptcy is a very real prospect. So, does that mean you should stay away from this bank's tempting CD deal? Maybe not.

First, let me be clear that I do not at this time have a firm position as to whether investing in this CD is either a good or bad idea. I simply wish to call attention to both the upside and the downside.

On the upside:

1. Top interest rate.
2. FDIC guarantee.
3. Rate is locked in for a full year, even if short-term interest rates fall if the Fed cuts interest rates as is widely expected (but not by me.)
4. Full year of guaranteed return.

On the downside:

1. Nagging doubt as to whether difficulties at the ailing parent could "infect" even the FDIC-protected investment.
2. A Fed rate hike is a very real possibility once we get through the current "crisis" within a few months, making 5.65% only an average rate rather than an outstanding rate.
3. What does the FDIC protect? Your principal and your accrued interest for sure, but are you guaranteed to get interest after the bank "goes under" as well? Unknown. Are you guaranteed to get the full, locked-in yield? Unknown. Are you guaranteed to get your cash in liquid form in exactly one year? Unknown. There doesn't appear to be any downside risk to your principal and accrued interest, but I suspect that this is about the extent of the protection. I'm making a note to check into this stuff some more, eventually.
4. FDIC protection is only up to $100,000 for an individual at a single bank, but (bank deposits in) many retirements will be covered up to $250,000 per individual, per bank.

I myself am tempted by this opportunity, but since I am in the camp that says that the Fed could be raising rates within a few months, plus the uncertainty of how the FDIC protection actually pays out, I have to pause. Still, I am tempted.

-- Jack Krupansky

What is the Federal Reserve Discount Window?

Most people have never even heard of the Federal Reserve's "Discount Window", but on Friday it was on center stage when the FOMC cut the interest rate used for loans from the Federal Reserve Banks to banks that are made through the discount window.

There is actually an entire Fed web site dedicated to the discount window. For a little background:

When the Federal Reserve System was established in 1913, lending reserve funds through the Discount Window was intended as the principal instrument of central banking operations. Although the Window was long ago superseded by open market operations as the most important tool of monetary policy, it still plays a complementary role. The Discount Window functions as a safety valve in relieving pressures in reserve markets; extensions of credit can help relieve liquidity strains in a depository institution and in the banking system as a whole. The Window also helps ensure the basic stability of the payment system more generally by supplying liquidity during times of systemic stress.

Loans from the Fed through the discount window require collateral, which can include Treasuries, but also mortgages and even mortage-backed securities:

As always, Discount Window loans must be secured by collateral acceptable to the lending Reserve Bank.

Note: Each of the twelve regional Federal Reserve Banks does the actual lending.

The common forms of collateral include, but are not limited to:

• Obligations of the United States Treasury
• Obligations of U.S. government agencies and government sponsored enterprises [Fannie Mae, Freddie Mac, et al]
• Obligations of states or political subdivisions of the U.S.
• Collateralized mortgage obligations
• Asset-backed securities
• Corporate bonds
• Money market instruments
• Residential real estate loans
• Commercial, industrial, or agricultural loans
• Commercial real estate loans
• Consumer loans

There are a number of different categories of credit offered by the Discount Window:

The primary credit program is the principal safety valve for ensuring adequate liquidity in the banking system and a backup source of short-term funds for generally sound depository institutions. Most depository institutions qualify for primary credit. Secondary credit is available to meet backup funding needs of depository institutions that do not qualify for primary credit. Seasonal credit is available to depository institutions that can demonstrate a clear pattern of recurring intra-yearly swings in funding needs.

There is in fact a fourth type of credit available through the Discount Window, Emergency Credit:

In unusual and exigent circumstances, the Board of Governors may authorize a Reserve Bank to provide emergency credit to individuals, partnerships, and corporations that are not depository institutions. Reserve Banks currently do not establish an interest rate for emergency credit, but Regulation A specifies that such a rate would be above the highest rate in effect for advances to depository institutions. Such lending may occur only when, in the judgment of the Reserve Bank, credit is not available from other sources and failure to provide credit would adversely affect the economy. When not secured by U.S. government or agency securities, loans of this type would require the affirmative vote of at least five members of the Board of Governors of the Federal Reserve System. (If fewer than five but at least two Board members are available, the available members may approve an extension of emergency credit by unanimous vote, subject to the conditions set forth in section 11(r)(2) of the Federal Reserve Act.) Emergency credit loans have not been made since the mid-1930s.

-- Jack Krupansky

Fed still likely to stay on track with target rate at 5.25% for the rest of 2007 and probably well into 2008

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

Despite all of the "turmoil" in the financial markets and a credit crunch is some credit markets, the Fed will likely continue on its current path and stay on track to keep the fed funds target rate paused at 5.25% for the rest of the year and probably well into 2008.

Yes, the Fed did cut their "discount" rate and did issue a special inter-meeting FOMC statement that said that the FOMC is "monitoring the situation and is prepared to act as needed to mitigate the adverse effects on the economy arising from the disruptions in financial markets", but that is still quite a distance from actually cutting the fed funds target rate.

Yes, the Fed is poised and prepared the pull the trigger on one or more rate cuts should the economy need them, but the Fed also told us on Friday that "recent data suggest that the economy has continued to expand at a moderate pace", strongly suggesting that the Fed does not believe that any fed funds target rate cuts will be needed in the near future.

The key takeaway from the FOMC statement on Friday is that the Fed is telling everybody "We actually do have our finger on the trigger and we really are vigilant on the state of the economy, so we really are prepared to cut rates if the economy needs it, so chill."

The Fed cut only the "discount rate" on Friday. This is the interest rate that the Fed charges financial institutions to directly borrow money from the Fed. Usually, only banks in serious distress utilize the "discount window", but the current situation is such that even finanicial institutions in only modest distress might conceivably utilize the discount window.

The financial duress of the past few weeks has not been due to a lack of money in the real economy, but primarily a lack of "liquidity" in the the banking system due to the fact that a lot of banks have gotten involved in holding mortgage-based securities since they were so popular and profitable. The result was a temporary spike in interest rates driven by banking liquidity rather than a spike in real demand. By pumping liquidity into the banking system, the Fed enables normal demand to be met on more normal terms. In short, it wasn't necessary to try to lower normal rates, but simply to supply sufficient banking liquidity to enable banks to lend at normal rates.

Another key takeaway is that to date, the Fed has only been adding liquidity to the banking system and has not taken any action to stimulate the economy. I know, many of the denizens of Wall Street are howling about how the mortgage mess is going to throw the economy into a recession, but it just ain't so. Just this past Wednesday, the Fed itself issued the Industrial Production and Capacity Utilization report for the month of July and it showed a monthly production rise of 0.3% and a slight rise of 0.1% in capacity utilization. This is not an economy headed into recession. Sure, the Fed will be vigilent in the weeks and months ahead, but people are whining about a situation that simply hasn't been transpiring.

Plenty of so-called "professionals" on Wall Street are clamoring for rate cuts and the fed funds futures market does indicate that people are betting on a cut within the next month and three cuts by the end of this year, but it is never wise to depend too heavily on "forecasts" made by people in the "heat" of a crisis.

Normally, the Fed funds futures prices are a reliable indicator of what the Fed will do over the next 45 days or so, but we are not in a normal market right now, so I think there is a huge "fear factor" overlaying normal demand for fed funds futures. Yes, a lot of people are "betting" on a number of Fed rate cuts and soon, but I do think it is reasonable to discount much if not all of this frenzied speculative "betting." In short, I'll give you the numbers, but I urge you to deliberate carefully before paying too much attention to them.

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• Over the next two weeks: 88% chance of a cut -- cut is very likely
• September before the September 18, 2007 meeting: 100% chance of a cut and 26% chance of a second cut
• September 18, 2007: 100% chance of a cut and 60% chance of a second cut -- flip a coin, but leaning towards a second cut
• October 30/31, 2007: 100% chance of a second cut and 46% chance of a third cut  -- flip a coin, but leaning towards no third cut
• December 11, 2007: 100% chance of a third cut -- third cut is very likely
• January 2008: 100% chance of three cuts and 40% chance of a fourth cut
• March 2008: 100% chance of three cuts and 68% chance of a fourth cut -- flip a coin, but leaning towards a fourth cut
• May 2008: 100% chance of three cuts and 92% chance of a fourth cut -- fourth cut is likely
• June 2008: 100% chance of three cuts and 88% chance of a fourth cut
• August 2008: 100% chance of three cuts and 88% chance of a fourth cut

So, the futures are telling us that a cut is a "slam dunk" before the September meeting, but I would urge caution in depending on that number since: a) the Fed has given no indication that it is leaning towards such a cut, and b) bets placed in the "heat" of a crisis are frequently unwound in the weeks following the crisis.

Note: Studies have shown that the fed funds futures market only has a high degree of forecast reliability about 30 to 45 days out (high out to 30 days, only modest reliability out to 60), so those probabilities beyond September are shaky at best and could easily change very dramatically.

What we saw these past two weeks was a simple knee-jerk reaction to a very real, but brief crisis. Wait a few weeks and the picture will change again.

-- Jack Krupansky

Despite the Credit Crunch, cheap home mortgages are still readily available for normal people

Despite all the talk of a credit crunch, people with good credit and a decent income can still get cheap mortgages (under $417,000.) The latest weekly mortgage survey from Freddie Mac shows the average rate offered for 30-year fixed-rate home mortgage is 6.62% (up from 6.59% last week) and the average for the 15-year fixed-rate home mortgage is 6.30% (down from 6.25% last week.) These are truly great rates. Sure, people with lousy credit and without a decent documented income or money for a deposit are on shaky ground, but that's the way it should be anyway. Jumbo mortgages for expensive homes (above $417,000) are a little more problematic, but still available depending on local conditions.

-- Jack Krupansky

Is the Fed no longer worried about inflation?

Some commentators are strongly suggesting that the Fed has abandoned its concern about inflation. Sorry, but it simply isn't true. The Fed is still very concerned about inflation and their decisions over the next few months will deeply reflect that ongoing concern.

The source of this misunderstanding by some commentators is simply the fact that the special inter-meeting FOMC statement on the current "crisis" did not include any mention of inflation. That is reading way to much into one statement. The FOMC used the words "the Federal Open Market Committee judges that the downside risks to growth have increased appreciably", but there is no rational reading of those words that would require concluding that the language excludes other considerations.

The special statement was focused on financial market conditions, tighter credit conditions, and the vague "increased uncertainty", and how these factors "have the potential to restrain economic growth going forward." Be very careful not to presume that "potential" means the same as "likely."

The FOMC says that the committee "judges that the downside risks to growth have increased appreciably", not in any way indicating that this is the only risk.

Simply put, given the importance that the Fed has given to "vigilence" on the inflation front, one would expect that they would make a serious note if they believed that they had finally tamed inflation. By now, we should all know that inflation is implicitly a concern of the Fed even if it isn't mentioned in every utterance.

It is important to note that the Fed did say "recent data suggest that the economy has continued to expand at a moderate pace", indicating that the Fed does not see any immediate certainty of of the kind of economic downturn that a number of commentators are strongly suggesting.

Granted, the statement is somewhat ambiguous, but ambiguity is not a valid rationale for making strong statements about the Fed abandoning anything.

The proper stance to take is to accept that we simply need to get a few more speeches from Fed officials before we can conclude firmly that the Fed considers inflation to be "solved."

In short, the Fed is still taking a tough stand on fighting inflation.

-- Jack Krupansky

Euro reverts to bouncing around deep within its trading range - dollar strengthens

For all of the turmoil in the mortgage securities markets and the minor financial crisis it caused these past two weeks and even despite the heightened expectation that the Fed would be cutting interest rates multiple times over the coming year, the dollar strengthened against the euro. Even with market expectations of a Fed rate cut no later than next month and a discount rate cut already in hand, the euro still wasn't able to convincingly break out of the $1.37 to $1.38 upper end of its $1.33 to $1.38 trading range, and in fact slumped back into the middle of the range. The euro is no longer poised as if it might break out, but could still recover over the next few weeks. September futures for the euro closed at $1.3488 on Friday, 2.28 cents below the prior Friday close of $1.3716.

There are plenty of traders and speculators who would like to see the euro break $1.40, but whether there is really a net demand for the euro at these levels remains to be seen. I would give the euro bulls and dollar bears a couple of more weeks to see if the euro really wants to stay up at or above $1.37 and $1.38 before concluding that the euro is likely to weaken for the rest of the year.

Euro futures out at December 2008 were only at $1.3559 on Friday (compared to $1.3795 the previous Friday), so there isn't exactly a lot of "slam dunk" enthusiasm for betting on a $1.40 euro, so far.

For now, the euro remains in relatively uncharted territory. It is now mostly a question of the level of speculative money flows. With some people still misguidedly believing that Fed rate cuts are still likely in the Fall, the flows could be net-euro for some time to come. On the other hand, just a few good economic reports, persistently high energy prices, strong talk from the Fed about fighting inflation, and a hint of a Fed rate hike in the Fall, could quickly sap the staying power of all but the most diehard of over-extended speculators.

I wouldn't be surprised if speculators managed to keep the euro up in the $1.33 to $1.38 range as long as there is any superficially bad news or even mere anxiety to focus on, but it is just as likely that they will trade it back down under $1.30 as soon as they begin to deeply grasp the truth that the Fed is very unlikely to cut rates over the coming year.

In short, the dollar is not "plunging." [And I will continue to repeat this line until The New York Times admits that they were wrong for claiming that the dollar is "plunging."] It is certainly fun to chatter about how expensive things are for tourists in Europe, but there are other factors that are more significant as far as keeping prices high in Europe than the minor impact of foreign exchange rates.

-- Jack Krupansky

Fidelity and Peter Lynch on "Market Fluctuations"

Blah, blah, Blah, everybody has an "expert" opinion on recent "turmoil" in the financial markets. Fidelity has a nice article that quotes some of the saner experts, including Peter Lynch, who says:

If the Dow and the overall market fall 5 to 10%, and you feel compelled to sell, don't invest in the stock market. These drops are normal. They happen every 12 to 15 months and you need to have the stomach to ride them out.

If you worry about what the market will do in the next 6 to 12 months, you are not investing. You are gambling. Some of my best stocks paid off handsomely in three years, some in five. In every case, earnings made the difference.

So focus on earnings more than fluctuations. Corporate earnings drive the stock market. Yes, other influences impact stock prices, especially over a short period: the influx of money, even tragic or shocking events, can have an effect, but ultimately earnings decide.

And from William O'Neil, founder and publisher, Investor's Business Daily (IBD):

The public gets most of its information about world politics and the economy, critical to investor psychology, from our national press. Most of the press, however, is woefully ignorant or perhaps biased about how our economy, business, and the stock market work.
...
My advice to investors: Check charts and fundamentals to see how leading stocks hold up each week. Think contrary when the press tells you how bad things are. Conditions are frequently better than you think.

And if you are unable or unwilling to follow the advice of these two top investment experts (true experts), you won't have anybody to blame but yourself for any anxiety you may be suffering from due to recent market "turmoil."

-- Jack Krupansky

PayPal money market fund yield rises to 5.04% as of 8/18/2007

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

Here are some recent money market mutual fund yields as of Saturday, August 18, 2007:

• iMoneyNet average taxable money market fund 7-day yield rose from 4.73% to 4.76%
• GMAC Bank Money Market account rate remains at 5.16% or APY of 5.30% (only $500 minimum)  -- Note: This is an FDIC-insured bank account
• Vanguard Prime Money Market Fund (VMMXX) 7-day yield remains at 5.11%
• Vanguard Federal Money Market Fund (VMFXX) 7-day yield fell from 5.08% to 5.03%
• AARP Money Market Fund 7-day yield remains at 5.07%
• TIAA-CREF Money Market (TIRXX) 7-day yield rose from 5.02% to 5.03%
• PayPal Money Market Fund 7-day yield rose from 5.03% to 5.04%
• ShareBuilder money market fund (BDMXX) 7-day yield fell from 4.49% to 4.47%
• Fidelity Money Market Fund (SPRXX) 7-day yield rose from 5.04% to 5.07% ($25,000 minimum)
• Fidelity Cash Reserves money market fund (FDRXX) 7-day yield rose from 5.02% to 5.05%
• Fidelity Prime Reserves money market fund (FPRXX) 7-day yield rose from 4.48% to 4.51%
• Fidelity Municipal Money Market fund (FTEXX) 7-day yield rose from 3.22% to 3.26% or tax equivalent yield of 5.02% (up from 4.95%) for the 35% marginal tax bracket and 4.53% (up from 4.47%) for the 28% marginal tax bracket -- this may be the best rate that most of us can get for "core cash" in a checking-style account
• Fidelity Tax-Free Money Market fund (FMOXX) 7-day yield rose from 3.17% to 3.22% or tax equivalent yield of 4.95% (up from 4.88%) for the 35% marginal tax bracket and 4.47% (up from 4.40%) for the 28% marginal tax bracket
• 4-week (1-month) T-bill investment rate fell from 5.08% to 4.65%
• 13-week (3-month) T-bill investment rate fell from 4.91% to 4.76%
• 26-week (6-month) T-bill investment rate fell from 4.93% to 4.91%
• Treasury I Bond composite earnings rate (semiannual compounded annually) for new I Bonds is 3.74% (down from 4.52%), with a fixed rate of 1.30% (down from 1.40%) and a semiannual inflation rate of 1.21% (down from 1.55%) -- updated May 1, 2007, next semiannual update on November 1, 2007
• NetBank 6-month CD APY rose from 5.25% to 5.40%
• NetBank 1-year CD APY rose from 5.20% to 5.35%
• Bankrate.com highest 6-month CD APY rose from 5.43% to 5.50%
• Bankrate.com highest 12-month CD APY is at 5.65%

Note: APY yield is worth somewhat less than the same 7-day yield. See my discussion and table for Comparing 7-day yield and APY.

Update: Although I do believe that I have solved the mystery of the apparent shortfall of the PayPal dividend for July, I still have not gotten confirmation from PayPal customer service. I have gotten back two more responses, each was relatively standard, vague language that doesn't even begin to cut to the heart of the problem. As I say, I think I understand what may have happened and I'll simply keep an eye open when the August dividend gets paid in two weeks. I'm keeping my cash there intact, but not adding more until I can get a credible response from PayPal customer service.

Right now, Fidelity Cash Reserves (FDRXX) is my preferred parking place for the bulk of my cash. Actually I'm not that far away from being able to achieve the minimum for the Fidelity Money Market Fund (SPRXX) which usually has a slightly higher yield. It is a single click (well, maybe it is five or six clicks, but no more than a minute) away from my main Fidelity count which I use as my checking account. The convenience and fairly decent return are worth more than the hassle of using other, more offbeat or less accessible funds. The Vanguard and AARP funds look attractive, and the GMAC bank money market is tempting but I'm unsure about the association with GM/GMAC and whether the rate might be more of a teaser.

DISCLAIMER: I am not an investment adviser, so my opinions and the data presented here should not be considered as advice for where to invest your money. You should examine this and other available data before deciding how to invest your money. And, seriously, past returns should not be construed as a guarantee or even an "indication" of future returns.

-- Jack Krupansky

ECRI Weekly Leading Index indicator down slightly and continues to point to a relatively healthy economy in the months ahead

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell slightly (-0.10% vs. -0.30% last week) and the six-month smoothed growth rate fell moderately sharply (from +5.2% to +4.2%), but remains moderately above the flat line, suggesting that the economy continues to have a fair amount of steam, neither booming nor busting.

A WLI growth rate of zero (0.0) would indicate an economy that is likely to run at a steady growth rate, neither accelerating nor decelerating. A WLI fluctuating in a range from +1.5% to -1.5% would seem to forecast a relatively stable "Goldilocks" economy. We're actually doing somewhat better than that now.

If I were looking at this one indicator alone, I would say that the Fed is succeeding at its goal of moderating the economy to a sustainable growth rate.

I will offer the caveat that the Weekly Leading Index and its smoothed growth rate do not tell us how strong the economy will be six or nine months from now, but do tell us whether whether weakness or strength is more likely a few months from now. It works best to tell us whether a "gathering storm" might be lurking just around the corner, but presently indicates "clear weather" for the next few months, even if the interval is occasionally punctuated with financial market "gyrations."

-- Jack Krupansky

Fed repurchase agreements for high-quality mortgage-backed securities

There were numerous mentions in the press on Friday about the Fed engaging in repurchase agreements for mortgage-backed securities (MBS) from "dealers", but the details were scant. Not all mortgage-backed securities are of equal quality, so I have been anxious to know what the Fed was actually "buying" (for three days before the dealers would be obligated to buy them back) and from whom.

First, I believe that the term "dealers" refers to "designated Primary Dealers", which is a set of 21 banks and financial institutions which the Fed regularly works with for carrying out open market operations. According to the Federal Reserve Bank of New York web site:

The primary dealer system has been developed for the purpose of selecting trading counterparties for the Federal Reserve in its execution of market operations to carry out U.S. monetary policy.

Note: BNP Paribas is one of the 21 primary dealers.

Normally most Fed open market operations involve Treasury securities, but sometimes also the securities of government sponsored enterprises (GSE) such as Fannie Mae and Freddie Mac.

The first question that popped  into my head was whether the Fed repos involved MBS issued by the GSEs or MBS and CDOs issued by Wall Street firms. If the latter, then the question was whether the Fed action involved primarily the higher-quality tranches of MBS which are not subprime, or the the much lower-quality subprime MBS and CDO securities.

Initially, the most detail I could find was in the Financial Times:

It told dealers it would re-enter the market as often as necessary, and -- in a highly unusual move -- accepted high-quality mortgage-backed securities as collateral for the entire $38bn of funds.

I'm glad to hear that the Fed focused on "high-quality" MBS rather than bail out firms holding risky subprime mortgage securities. Alas, this still doesn't tell us whether the Fed repoed GSE MBS (super-high quality) or Wall Street MBS (less-clear quality.)

But, the real point is that the Fed was taking on the short-term risk of the markets irrationally undervaluing high-quality, low-risk MBS debt simply because it was "smeared" with the bad reputation of subprime MBS.

A repo is typically only for a few days, but the Fed can simply roll them over indefinitely, as long as the liquidity crisis persists. The liquidity crisis may in fact be nearly completely behind us, or we may experience a few aftershocks.

This article in Reuters seems to indicate that the Fed did in fact stick with GSE MBS:

As guarantee for repayment, banks could have also offered as collateral U.S. Treasuries or corporate agency debt of thegovernment-chartered housing finance companies Fannie Mae and Freddie Mac.

But they nixed those options, offering just mortgage-backed securities issued by Freddie Mac, Fannie Mae and government-owned Ginnie Mae.

That article also notes that:

Dealers did not submit Treasuries and agency debt in any of the three repo operations because they wanted to retain their best performing securities, analysts said. The Fed, which has the option to exclude certain collateral, opened the repos for all three security types for "operational simplicity."

"My impression is that there are some liquidity issues in (agency MBS) and that there's plenty of that collateral hanging around," said Ward McCarthy, a founder of financial research firm Stone & McCarthy Research Associates.

Note thate the GSEs ("agencies") issue both normal debt (borrowing money for their own needs) and MBS debt. This seems to affirm the idea that the Fed repos were for GSE MBS and not any of the Wall Street subprime MBS or CDOs, but the issue remains unclear.

Also note that the Fed statement on Friday says:

As always, the discount window is available as a source of funding.

In addition to inter-bank lending, which the Fed facilitates by managing the fed funds target rate, the Fed also has the capacity to directly loan money to banks via the "discount window." Normally banks never go near the discount window since it is a source of last resort and is considered by most players on Wall Street as an act of desperation. Nonetheless, it is a source of funds should a bank find itself in a genuine liquidity crisis.

However this all plays out, rest assured that the Fed is on the case.

-- Jack Krupansky

Update on PayPal Money Market Fund: Mystery solved?

I have recently blogged about an apparent discrepency between the 7-day yield that is claimed for the PayPal Money Market Fund and the actual dividend I received for the month of July. I had contacted PayPal and gotten a standard "read the prospectus" reply and I responded by requesting that they escalate the issue to address my concerns in detail. I did some more digging and looking at my precise account history and I think I may have solved the mystery of the dividend discrepancy.

First, I discovered that even though I had made a deposit at the end of June, it was not credited to my account until July 5, 2007. The funds were debited from my Fidelity account on July 2, 2007, so PayPal had a couple of days of free float, but I think most of us are used to that kind of practice by now. Alas, even when I re-cranked the numbers I still came up with a dividend shortfall.

Next, I noticed that the date of the dividend payment was July 31, 2007, which I had assumed meant that the dividend was calculated for the full month, or at least through the day before. After all, the prospectus says that "The Fund declares a dividend on every Business Day. Dividends are credited to shareholder accounts monthly." Alas, one less day of interest was not even close to making up for the shortfall.

Special note: My account "history" shows the dividend being credited on August 2, 2007, while the money market "activity log" shows a "Accrual Income Div Reinvestment" on July 31, 2007. Again, a couple more days of free float for the fund or for PayPal.

Next, I challenged my assumption that the period over which dividends accrue was even necessarily the day or two before the date they were credited . The annoying thing is that the dividend payment does not disclose the precise daily period that it covered, leaving us to guess.

So, I guessed that maybe the dividend is paid 5 to 7 days after it is accrued. Yes, it is annoying that the fund might enjoy the few days of free float, but that is not so unusual.

If I assumed that the accrual period started six days before the start of July and did last for 31 days and that the 7-day yield averaged between 5.02% and 5.03%, say 5.025%, presto, I calculate an expected dividend within a quarter of a penny of what I received.

If true, one implication is that the dividend payment for a given month does not accrue compounded interest for the full coming month. According to my calculation, my June dividend only received 25 days of interest in my July dividend.

I have no confidence that my assumptions are actually correct, but I am confident that they are plausible, and they do in fact account for all of the shortfall.

I'll await direct confirmation from PayPal and recommend to them that they disclose the period over which the dividend accrued as well as the average daily balance, but for now I feel comfident that despite the uncertainty of the details, PayPal is in fact paying a dividend at the advertised rate, at least if you leave the full balance unchanged for more than a month.

Pending confirmation, I consider the mystery solved.

-- Jack Krupansky

Dry powder to cope with the mortgage mess

With all the talk about "mortgage woes" and even talk that even the Fed can't do anything about it, it is truly amazing that so many people just completely ignore the fact that we have a mechanism in place for fairly rapidly cleaning up the mortgage mess, Fannie Mae and Freddie Mac. These so-called government-sponsored enterprises routinely buy and securitize home mortgages. But Wall Street, Republicans, and various other groups with vested interests actually object to even giving Fannie and Freddie a shot at cleaning up the mess.

The basic problem is that Fannie and Freddie had a great business buying and securitizing home mortgages and Wall Street wanted a piece of the action. Wall Street managed to buy enough political support to effectively "shackle" Fannie and Freddie so that a big slice of the pie would be dedicated to Wall Street. Unfortunately, Wall Street got the business, bit off way more than they could chew or swallow, and presto you have the current mortgage mess.

Fannie and Freddie are still in business and still buying and securitizing home mortages with no real problem (other than lingering internal accounting issues that they are gradually working through.) Fannie recently asked their oversight regulator for permission to exceed their regulatory limit and buy $72 billion in mortgages for its own portfolio. You would think that such a helpful offer would be welcomed, especially in the middle of a crisis, but the politicians controlled by these Wall Street interests strenuously objected for no particiularly good reason.

You can read about the latest episode of the Fannie/Freddie saga in an article in The New York Times by Eric Dash entitled "Fannie Mae's Offer to Help Ease Credit Squeeze Is Rejected, as Critics Complain of Opportunism."

In any case, Fannie and Freddie are still standing by, ready and able and willing to clean up a big part (if not most of) of the current mortgage mess. All that is necessary is for a bunch of politicians to simply snap their fingers, make a phone call, unshackle Fannie and Freddie, and stand back and watch the big dogs run. It probably wouldn't take more than a couple of weeks for these big dogs to chase the kiddies on Wall Street back into their tree forts where they belong.

-- Jack Krupansky

Despite mortgage woes, Fed still on track to keep target rate at 5.25% for the rest of 2007 and probably well into 2008

[Gentle reminder: I may suspend this weekly post in the near future, but I haven't decided for sure yet.]

Despite the minor financial crisis that markets went through last week, the economy really is in quite decent shape, so the Fed really does remain on track to keep the fed funds target rate paused at 5.25% for the rest of the year and probably well into 2008.

Sure, plenty of so-called "professionals" on Wall Street are clamoring for rate cuts and the fed funds futures market does indicate that people are betting on a cut within the next two months and three cuts within a year, but it is never wise to depend too heavily on "forecasts" made by people in the "heat" of a crisis.

As of Friday, Fed funds futures contracts indicate the following probabilities for changes in the Fed funds target rate at upcoming FOMC meetings:

• Between now and the September 18, 2007 meeting: 60% chance of a cut -- flip a coin, but leaning towards cut
• September 18, 2007: 98% chance of a cut -- cut is virtually a "slam dunk"
• October 30/31, 2007: 100% chance of a cut and 38% chance of a second cut
• December 11, 2007: 100% chance of a cut and 86% chance of a second cut -- second cut is likely
• January 2008: 100% chance of two cuts and 34% chance of a third cut
• March 2008: 100% chance of two cuts and 62% chance of a third cut -- flip a coin, but leaning towards third cut
• May 2008: 100% chance of two cuts and 88% chance of a third cut -- third cut is likely
• June 2008: 100% chance of three cuts and 2% chance of a fourth cut

So, the futures are telling us that a cut is a virtual "slam dunk" for the September meeting, but I would urge caution in depending on that number since: a) the Fed has given no indication that it is leaning towards such a cut, and b) bets placed in the "heat" of a crisis are frequently unwound in the weeks following the crisis.

Note: Studies have shown that the fed funds futures market only has a high degree of forecast reliability about 30 to 45 days out (high out to 30 days, only modest reliability out to 60), so those probabilities beyond September are shaky at best and could easily change very dramatically.

What we saw last week was a simple knee-jerk reaction to a very real, but brief crisis. Wait a few weeks and the picture will change again.

-- Jack Krupansky

Despite the Credit Crunch, cheap home mortgages are still readily available for normal people

Despite all the talk of a credit crunch, people with good credit and a decent income can still get cheap mortgages. The latest weekly mortgage survey from Freddie Mac shows the average rate offered for 30-year fixed-rate home mortgage is 6.59% (down from 6.68% last week) and the average for the 15-year fixed-rate home mortgage is 6.25% (down from 6.32% last week.) These are truly great rates. Sure, people with lousy credit and without a decent documented income or money for a deposit are on shaky ground, but that's the way it should be anyway.

-- Jack Krupansky

Stock market in the summer

With all of the press coverage of the turmoil in the financial markets, nobody is pointing out the obvious: it is August, the middle of the Summer, when most sane people are at least mentally if not physically off on vacation, at the beach, out on the golf course, lying around the pool, or anywhere but focused on the financial markets. Sure, there are many people still toiling away in the markets, but even they are not at the top of their investment game.

There is an old saying which describes any social environment, including the financial markets:

When the tiger is away, the monkeys rule the jungle.

Clearly, the "tigers" have hung out a "Gone Fishing" sign for the Summer and the "monkeys" are fully in "control."

Nothing good ever comes from having the monkeys in charge. Sure, they can in fact run the markets up and down and quite dramatically to boot, but ultimately not in anything resembling an orderly manner.

Not to worry, within a month the tigers will be back in town, tanned and rested, and then the monkeys will go back to hiding in the trees, where they belong.

As far as I can tell, the economy is still in reasonably decent shape, so there is good reason to believe that quality stocks will bounce back in short order. Whether the "monkeys" will engineer a market recover or whether we have to wait for the tigers, either way the current weakness is unlikely to persist for very long.

I don't advocate trying to time the market, but prices do look a lot more reasonable than in early July, so "buying the dip" is not an unreasonable temptation. My biweekly Roth 401k stock purchase will occur on Wednesday and my monthly ShareBuilder stock purchase plan will buy on Tuesday. I'm going to be a net buyer of stocks for at least another five years, so every dip is a good deal for me. I personally won't mind if the market goes lower.

-- Jack Krupansky