Wednesday, March 26, 2008

Motley Fool Stock Advisor newsletter

I was just reading the ad and blurb for the Motley Fool Stock Advisor newsletter and it seemed rather interesting. Of course, the main interest is in whether investing in their top picks is a wise idea. Hard to say, but it does look intriguing.

Now, the question is whether investments today in Netgear (NTGR) and Copart (CPRT), the two top picks in the newsletter blurb, are doubles or even four-baggers or better over the next couple of years.

-- Jack Krupansky

What is SIPC and what does it protect?

SIPC or Securities Investor Protection Corporation is effectively an insurance company that assures that your securities at your broker will be replaced should your broker declare bankruptcy or if your broker steals any of your securities. Basically, your broker (brokerage firm) pays an insurance premium to SIPC to guarantee you will get back any securities that you have entrusted to your broker.

SIPC is not like FDIC in the sense that it does not guarantee the dollar value of your securities should they decline. SIPC only covers the number of shares or units of securities. SIPC will in effect only guarantee that you get your securities back.

SIPC covers up to $500,000 of securities and up to $100,000 in cash. Note that money market funds are considered securities.

A lot of brokers automatically purchase supplemental coverage from an insurance company (not SIPC) to cover any losses over $500,000 and over $100,000 in cash. Coverage will vary, so you will have to check with your broker for their specific coverage. At least one of my brokers has purchased unlimited coverage for both securities and cash, even though I am well under the SIPC limits.

To summarize, SIPC does not protect you from stock market losses or bankruptcy of companies whose securities you have purchased, but it does protect you against bankruptcy of your broker or theft by your broker.

-- Jack Krupansky

Are money market funds really any safer than ultra-short bond funds?

Some reporters are simply dense and will never get it no matter how many times you tell time. Other reporters know that they are saying something misleading but do it anyway just to attract more curious and anxious readers. There was a story on MarketWatch by John Spence and Greg Morcroft entitled "Are money market funds next? - Outflows at ultra-short bond funds show credit pain is spreading", which was clearly trying to artificially raise the anxiety level of readers and investors by posing a hypothetical which is more than a little bit far-fetched. To answer their headline question, No, money market funds are not "next"! Or to answer my own headline question, Yes, money market funds are MUCH safer than ultra-short bond funds. The two are not even comparable.

Much as with auction rate securities, a lot of people were misled into believing that ultra-short bond funds were a "good investment" that was... "as good as cash" and "as good as a money market fund" only that they would pay a higher yield than money market funds. Alas, the promises were not completely true.

Just as with auction rate securities, ultra-short bond funds are still "bond funds" and subject to the investment volatility of any bond fund. Bond funds do not just produce income. They also put you principal at risk for an investment gain or loss. Although the value of your principal in a bond fund can rise, that is not guaranteed and the value of your principal in a bond fund can decline.

Money market funds have an entirely different financial structure, investing only in very short term commercial paper, repurchase agreements, CDs, and other very short-term debt, with an average duration of well under 90 days. Another key difference is that money flows in and out of money market funds at very high rates, so that their financial structure needs to be capable of handle very large short-term outflows. The fact is, many people use them as checking accounts, so that shows you the kind of money flows that money market fund managers have to deal with. Money market funds also tend to be much larger and hence able to handle larger inflows and outflows. There are plenty of other differences, some of which are mandated for money market funds by the SEC. Granted, money market funds are still not as absolutely safe as bank deposits and do not have FDIC protection, but they are still quite safe and nowhere near as risky as other forms of mutual funds such as ultra-short bond funds.

To their credit, the reporters do mention that "The Schwab fund, and others like it, are not technically money funds", but then they go right ahead and confuse the two anyway, telling us "but they are similar enough that major problems with them have left some investors to wonder if anything other than cash is safe at this point." I am sorry, but this is classic yellow journalism, seeking to incite fear and anxiety unnecessarily, when all the reporters needed to do was a little homework and check with some financial experts to verify that money market funds are not like ultra-short bond funds in any way that should be a source of fear or anxiety.

These two reporters should be ashamed of themselves. I know that they can do better. Enough of this kind of yellow journalism.

Just to recap, Yes, your money market funds really are MUCH safer than ultra-short bond funds.

-- Jack Krupansky

Monday, March 24, 2008

Update on self-employed 401(k) retirement plan

I blogged on Saturday about the possibility of setting up a self-employed retirement plan but wasn't sure about whether I could do a post-tax Roth plan. I pinged Fidelity and they responded today that they did not offer a Roth option for self-employed 401(k) accounts but that you could do it through a third party:

Fidelity's Self-Employed 401(k) does not allow for Roth contributions. However, you can use Fidelity as the investment vehicle for a Roth 401(k) plan provided by a third party. We recommend the following two companies that provide this service:

PenServ 903-455-5500
NPIN 800-443-6746 [National Pension & Insurance Network, Inc.]

These firms would provide you with the Roth 401(k) plan document, plan administration, and assist with tax reporting and filings. These companies are not financial institutions, but rather third party administrators. You would be directed back to Fidelity to open an account to hold your investments. We call this type of account a "Non-Prototype" which simply means you are using a prototype plan document provided by the third party. You can download an application by using the link below:

I have not pursued this any further or contacted those two firms, but either way, it does look promising.

Here is another thought I had: make pre-tax contributions in years when your income and tax bracket are higher, and then convert to a Roth account in any "off" years when your income and tax bracket are much lower.

I have been enamored by no-tax Roth accounts, but in truth a Roth account may only be beneficial when your tax rate in retirement is higher than your current tax rate. That may happen for some people, but I actually expect that my income level and hence my tax rate will be significantly lower than my current income and tax rate. Something to think about 

-- Jack Krupansky

Advice for auction rate securities holders

I personally am not holding any auction rate securities (ARS), but the interest in them caused me to poke around a little. Although the short-term news is still rather gloomy, all is not lost.

If you are worried that your money in auction rate securities is "gone", simply relax, because you money is not gone. Sure, you cannot get at it right now, but that is a liquidity problem (short-term) and not a solvency problem (long-term.) You do not need to lie awake at night feeling like this is The Great Depression and your bank failed. It is not like that at all. So, relax, take a deep breath, and tell yourself that it is okay to sleep at night.

To repeat, your money in auction rate securities is absolutely safe (solvency) even if you cannot get at it right now (liquidity.)

That said, if you have money in auction rate secutities (or auction rate preferred shares or ARPS or auction rate preferreds or ARP) you will be in one of the following situations:

  1. You do not need the money today, but you are still worried about it. Do not worry at all. Period. Sure, you can tell your broker to get you out ASAP, but otherwise do not worry, at all. Period. Besides, you may in fact be earning a much higher rate of return due to the penalties borrowers pay when auctions fail. In other words, you may be paid to wait.
  2. You need the money today (or real soon) and all your broker can say to you is that the auctions continue to fail. You have two choices: 1) forego or defer that expense, or 2) borrow the money elsewhere. Do whatever makes your life work better for you. You may be terribly offended that your broker screwed you, but... get over it. Put simply, do not cut off your own nose to spite your broker's face. Get over it. Get on with your own life. But, be sure to keep clear records of all of the discussions with your broker and any real losses or actual costs incurred with coping with the lack of availability of your own money. No guarantees, but there are likely to be legal mechanisms for you to recoup some of the actual losses or additional costs that you incurred. But even if not, I repeat, do not screw up your own life just to get back at your broker. If it costs you an extra thousand dollars to borrow money until the auctions start succeeding again, frankly, consider yourself lucky, and move on.
  3. You need the money to pay taxes to the IRS. Relax. No problem. Call them directly ASAP and explain the situation. Worst case, set up an installment plan. Even if you do not have any cash to do an installment plan, relax, talk to the IRS directly, and trust me, they are willing to work with you. Sure, there may be penalties and interest, but some of that can be waived depending on your situation and assuming that you are upfront and communicate with them clearly and early. Again, keep records of all conversations and all costs, interest, and penalties, since there may be legal mechanisms to recoup at least some of them. And if you have never had to deal with the IRS before on an issue like this, trust me, they are not the big bad wolf that they are made out to be. They really will work with you. Yes, they really want their money, but that actually makes them fairly flexible. No free lunch, but not a disaster either.
  4. You need the money relatively soon, but not necessarily today or this week. Relax. Auctions are starting to succeed again, albeit in a spotty manner, if only because borrowers are refunding their debt to avoid the penalties that they pay when auctions fails. Tell your broker to get you out of ARS ASAP, but otherwise... relax. And, enjoy the higher rate of return you are earning. If the timing is getting too close for comfort, at least get a handle on the details of a loan or margin load from your broker, just in case.
  5. Some banks, brokers, or funds are actually taking the time and energy and their own money to restructure their auction rate securities to restore liquidity or at least partial liquidity. Maybe your broker or fund has not done so yet, but relax since there is some non-zero probability that this might happen in the coming days or weeks.
  6. You need the money now and it is too much to borrow elsewhere. You have two choices: 1) borrow from your broker or 2) take the hit from foregoing the large expenditure. The best you can do here is clearly document all conversations, all costs, all losses, all damages, and get ready for legal action to try to recoup those losses. OTOH, if your actual losses losses are no more than a few thosand dollars, you might be better off simply eating the losses and getting on with your life rather than spend the coming months and years being gragged along by the lingering legal proceedings.
  7. You need the money in a few months. Relax and hang in there. There may or may not be a resolution within the next month or two, but worrying about it will not gelp in any way. Besides, you will likely be getting a higher rate of return due to the penalties that borrowers pay for auctions that fail. As long as you have instructed your broker to get you out ASAP, sit tight and wait it out.

So, to be clear, you do have options. It is simply not true that holders of auction rate securities are totally screwed and without any options. Yes, there is a lot of anxiety and there is a lot of anger, but do not let any of that impact your own thought and decisionmaking processes.

Sure, you can also write and email and call all related parties and regulators and officials as well as both the financial media and general media. That never hurts and may help in this case.

As far as legal action, be very careful and very cautious and very skeptical. Even if legal action succeeds, it may take longer than it takes for auctions to start succeeding again and you may lose more of your money to the cut that the attorneys will take. Also, be clear to distinguish legal action to get access to your money and legal action to recoup losses, costs, and damages that you incurred as a result of not having access to your money. The former could be quite risky. The latter may be more attractive.

If you are trying to decide between legal action and borrowing from your broker, go for the latter and later you can try to convince your broker to cover the loan expense, particularly if you are a good solid client.

So, in short, relax, and give yourself permission to sleep well tonight.

 -- Jack Krupansky

Saturday, March 22, 2008

Self-employed retirement plan

Now that I am out on my own again, I need to set up some sort of retirement plan. I already have several Roth Rollover IRA accounts that I could make IRA contributions to, but I would like to get a formal plan set up to contribute more than $5,000 or $6,000 this year. Without going overboard, I could simply set up a SEP-IRA or a Self-employed 401(k) plan. The latter allows me to contribute more, but also requires annual paperwork filing.

If I understand the rules properly, if my compensation was $60,000 (working part-time), with a SEP-IRA I could contribute up to 25% or $15,000, but with a self-employed 401(k) I could contribute that same 25% plus another $15,500 plus another $5,000 catch-up contribution since I am over 50 or a total of $35,500.

Ah... I now read that your only have to file the annual IRS Form 5500 for a self-employed 401(k) after your plan assets exceed $250,000. Excellent.

And, I think I can still make a $5,000 or $6,000 IRA contribution as well. Have to check on that though.

One lingering question is whether either plan can be Roth, or whether it is all pre-tax money and I would be deferring income taxes.

 -- Jack Krupansky

Finished my tax prep

Vaguely in the back of my mind I knew that I needed to work on my tax prep real soon, but today was finally the day when I woke up and actually felt motivated to get it done. It only took me the morning and I got a couple of other things done as well. I actually do not do my taxes myself, but prepare a set a spreadsheets as an "organizer" plus a Word document with a list of notes for the remaining information about my situation. I then email those files off to my accountant and the result is a completed tax return ready for me to sign and mail.

I emailed my files at 12:37 p.m. today (Saturday), followed by a follow-up email to confirm that the main email and all of the attachments were received. With anti-virus software these days, you simply cannot assume that attachments always get through unmangled. I was only partially surprised when I got a reply email from my accountant only 15 minutes later. I can only imagine how busy it is at this time of year, only a little more than three weeks from April 15.

I am expecting to get a significant refund (since I did not claim any deductions), but I will have any refund applied to my estimated taxes (since I am now self-employed again) which are due on April 15.

 -- Jack Krupansky

Friday, March 21, 2008

Hedge fund crisis?

Although you frequently see "hedge funds" mentioned in many articles about the waves of crises overwhelming Wall Street over the past seven months, you rarely see any deeper explanation of the role that hedge funds have had in the various crises. In theory, hedge funds are ideally suited for exploiting crises because of their ability to arbitrage virtually any kind of pricing gap within or between markets. And all of these tend to be short-term trades.

Unfortunately, what happens is that once a hedge fund identifies an opportunity, other funds as well as the in-house proprietary trading desks at all of the financial firms begin to mimic that same "trade", squeezing the potential value of the trade down to zero or even negative. That is what markets do, so there is no problem there.

Two problems occur.

First, because the window of profitability for any trade may be small, funds leverage with borrowed money or options or futures, pushing their risk up towards the sky.

Second, they start chasing after lower-profit trades, possibly with even greater leverage.

But eventually even low-profit short-term trades become scarce, causing traders to lengthen their time horizon for a "trade" so that it may look more like a speculative position (months) or even an investment (years.) Hedge funds do not normally make long-term investments, but sometimes their trades go bad and turn a short-term "sure thing" into an investment-like position that they cannot dump either without a large loss or maybe even at all.

When leveraged hedge funds get into trouble, their brokers or "primes" (e.g., prime brokerages such as Bear Stearns) issue margin calls. Those margin calls can be quite painful for the hedge fund, but sometimes, as we have seen lately, even the securities held by the broker cannot be redily sold to satisfy the margin call, leaving the broker on the hook. That does happen on occasion, and in fact happens all of the time even in good markets, but it rarely happens simultaneously for a significant fraction of the broker's clients. And that is the problem we are experiencing might now on Wall Street, where hedge funds are falling like flies and unable to meet margin calls and repay loans, causing their brokers ("primes") to suffer as well.

The end result of all of this will be the purging of a significant number of hedge funds. There were too many of them chasing too few of the same trades and using ever-greater leveraging to exploit ever-narrower profits on fewer trades.

Lately commodities have been the last great refuge for hedge funds, but now it appears that even many of those profitable commodities positions will have to be sold off to satisfy margin calls.

Hedge funds are an important part of the financial ecosystem, but sometimes the do get carried away with their own over-inflated self-importance and think that somehow they are immune to the laws of supply and demand. Now, they are being forced to pay the piper.

I do wish that the media would do more in-depth coverage of the extent to which hedge funds were fueling the speculative exceses in both the mortgage and commodities markets and the extent to which hedge funds were in fact the primary cause of the current bout of crises fouling Wall Street and causing harm to consumers.

I would also like to see investigation into the extent to which banks which are supposed to have the interests of consumers at heart may have been fueling profits by catering to the excesses of hedge funds. And, the extent to which the banks themselves were engaging in the same risky  trades as hedge funds via their in-house proprietary trading desks.

In general, profits from hedge funds benefit primarily the wealthy (and pension funds as well), but it is especially shameful when the excesses of hedge funds (pushing commodities prices higher and literally destroying the mortgage and housing markets) are harming average consumers on Main Street. The media and Congress and state regulators should try to do a much better job of probing the roles of hedge funds and hedge fund-like activities and protecting the interests of consumers.

A strong and healthy consumer has to be considered the financial bedrock of our economy.

-- Jack Krupansky

Weakness in commodities

There was an article in Bloomberg by Pham-Duy Nguyen entitled "Commodities Drop, Rally in Dollar, Stocks Vindicate Bernanke" which chronicles some of the damage incurred by commodities markets this part week, referring to "The biggest commodity collapse in at least five decades" and telling us that:

Investors who had poured money into gold, oil and corn, seeking a hedge against inflation and a weak dollar, sold commodities to raise cash or buy stocks. The Reuters/Jefferies CRB Index of 19 commodities tumbled 8.3 percent this week, the most since at least 1956, after touching a record on Feb. 29.

"Bernanke took care of the commodity bubble," said Ron Goodis, the retail trading director at Equidex Brokerage Group Inc. in Closter, New Jersey. "Commodities are coming back to earth. The stock market looks OK, and Bernanke is starting to look a little better."

And that:

Gold had its biggest weekly loss since August 1990 after reaching a record $1,033.90 an ounce on March 17. Oil plunged almost $10 over three days, after rallying to $111.80 a barrel, the highest ever. Corn dropped more than 9 percent for the week, the most since July.

Now, to be clear, none of this necessarily precludes a rebound and a sprint to even higher price levels, but it might help a little to deter some of "The Stupid Money" from diving in headfirst as if the commodities markets had only one direction.

I would give the commodities markets another month, if not two or three, before making any confident pronouncements about their medium-term trend.

Disclosure: My total commodities holdings consist of 1/10th ounce each of gold and platinum, purchased about 10 years ago. I did own oil via Geodyne limited partnerships, but they have been liquidating over the past year, so I may be completely out of oil by now since the final payment is scheduled for April.

-- Jack Krupansky

Jobless claims in no man's land

Weekly unemployment insurance initial claims are frequently used as an indicator of the health of the economy, but right now they are in no man's land, signaling neither growth nor outright recession. Usually, 400,000 is the threshold rule of thumb level indicating outright recession. This week initial claims came in at 378,000 and the more-reliable four-week moving average came in at 365,250. In all honesty, these numbers are not that bad at all, being well short of the 400,000 threshold. Yes, they are a bit elevated (from 318,000 and 324,000 a year ago), but still not a serious threat to that 400,000 threshold. Sure, numbers such as these can sometimes "hint" that maybe a recession is around the corner, but they do not indicate that a recession is here right now. That is not a guarantee that we won't have a recession or even that we are not in a recession right now, but these numbers do say that you will have to look elsewhere for evidence of a recession.

All that these numbers tell us for now is that the economy is sluggish.

 -- Jack Krupansky

Thursday, March 20, 2008

ECRI Weekly Leading Index indicator falls sharply and is now unambiguously recessionary

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell sharply (-1.00% vs. -0.29% last week) while the six-month smoothed growth rate was unchanged (at -10.4 last week), and is well below the flat line, suggesting that the economy will be struggling in the months ahead.

ECRI does in fact say that "With the WLI having dropped more than 13 points in the last nine months, it is exhibiting a pronounced, pervasive and persistent decline that is unambiguously recessionary." They did not actually say that the U.S. is in recession per se, but they are indicating that the trend of the data is clearly in a contractionary mode typical of recession. Whether we actually have a recession will depend on how the economy performs in the coming months.

The bottom line is that the ECRI WLI remains "flashing red." Alas, even the ECRI WLI is not a guaranteed, fool-proof economic indicator, especially when the data is mixed.

I will raise my personal assessment of the chance of recession from 60% to 70% based on the magnitude of the negative level of the WLI smoothed growth index, the ECRI assessment, and the fact that although the data remains mixed, it is strongly biased towards weakness. I am also refraining from going higher that 70% because there simply has not been enough time for all of the positive stimulus in the pipeline to have had an effect on the real economy. The economy still has a very modest chance of avoiding an outright recession, but only if the data starts to improve within the next four to six weeks.

I am still at least somewhat optimistic that the U.S. economy will escape a full-blown recession, but I do have to recognize what the data itself is signalling to me. Incidentally, the Intrade Prediction Market has the probability of a U.S. recession in 2008 at 70.1%, not that different from my own assessment.

-- Jack Krupansky

Have commodities finally hit the wall?

I have been (incorrectly) forecasting that the commodities bubble was going to burst "any day now" for about three years now, causing me to miss out on a huge potential gain. Sigh. But, now, maybe commodities really are bumping into "the wall" and primed for a big fall. Commodities, especially gold, had been viewed as a safe haven relative to U.S. stocks, but yesterday gold actually fell sharply even as U.S. stock prices fell. That was unusual. Of course, a single day does not establish a change of trend. Still, it does give one pause. Then today I read an article in The New York Times by Diana Henriques entitled "Commodities: Latest Boom, Plentiful Risk" that tells us:

But this market, despite its glitter, offers risks of its own, including some dangerous weaknesses that are impairing the ability of regulators to police fraud and protect investors. Commodities are also vulnerable to the same worries affecting the rest of Wall Street, where on Wednesday the Dow Jones industrial average plunged almost 300 points, erasing more than two-thirds of Tuesday's steep gains.

Moreover, the biggest speculators and lenders in the commodities markets are some of the same giant hedge funds, commercial banks and brokerage houses that are caught in the stormy weather of the equity, housing and credit markets.

As in those markets, an evaporation of credit could force some large investors -- especially hedge funds speculating with lots of borrowed money -- to sell off their holdings, creating price swings that could affect a host of marketplace prices and wipe out small investors in just a few moments of trading.

"Right now is a very scary time" for commodity market regulators, said Michael Riess, a director of the International Precious Metals Institute, a consultant to commodities investors for more than 30 years. "It's not a question of overregulating or underregulating. It's a question of just being swamped by volume, volatility and a dramatic shift toward speculative interests."

That last phrase is key: "a dramatic shift toward speculative interests." The huge run-up in commodities prices is not about fundamentals or demand in India and China, but simply the fact that speculators have targeted commodities for their latest speculation, much as in the past dot-com stocks and home real estate were target by speculators. And we know how those movies ended.

The article closes with this cautionary characterization:

But some with experience in the commodities market remain nervous about the new money pouring in so quickly.

Commodity trading firms that have survived for any length of time have excellent risk-management skills, said Jeffrey M. Christian, managing director of the CPM Group, a research firm spun off from Goldman Sachs in 1986. Mr. Christian said he was less certain how the newcomers would deal with risk.

"You have the stupid money coming into the market now," he said last week. "And I think the smart money is beginning to get a little frightened about what the stupid money will do."

Yes, by all means watch out for where "the stupid money" is flowing.

Look for some undervalued markets to go after, not the markets that have been hot for many months if not years.

That said, I am still unable to predict with certainty that this time commodities really have hit the wall.

I think some of it may depend on whether the U.S. economy weakens a lot further. If so, commodities will fall like a rock. But if the U.S. economy continues to at least barely hang in there, hovering at the edge of recession, commodities speculators will likely continue to hover as well. In truth, I believe in the "hovering" economy more than a steep recession. Maybe in fact commodities will be our best indicator about the health of the U.S. economy.

One final thing I would say is that the U.S. economy always was, is now, and always will be much less like a well-oiled machine but much more like the old-fashioned Wild West. A boom here, a bust there, but always something interesting going on somewhere. Sometimes it is boom almost everywhere, but that is the exception rather than the norm. Only the media ever makes it seem as if the economy is booming (or busting) everywhere.

 -- Jack Krupansky

Wednesday, March 19, 2008

Fannie Mae and Freddie Mac unshackled

With all of the turmoil over mortgage debt, it has been a complete shame that the two entities in the world best suited for lending a hand, Fannie Mae and Freddie Mac, have been virtually sidelined from helping out. They were originally sidelined because Wall Street wanted the mortgage market to itself, but we all know how that movie ended. Even after Wall Street "screwed the pooch", they still continued to lobby against Fannie and Freddie being allowed to step in and help clean up the mess. Thankfully, a sequence of steps has been taken over the past few months that is finally going to unshackle Fannie and Freddie and let them reclaim and reconstitute the mortgage market. The latest step is discussed in a Reuters article by Patrick Rucker entitled "Fannie, Freddie cleared to pump $200 billion into market". It may still be a while before Fannie and Freddie start to gain traction again, but this is still an important milestone.

And if somebody tries to tell you that Fannie or Freddie debt is "risky", tell them to guess again. Fannie and Freddie are absolute saints compared to even the best that Wall Street has to offer.

-- Jack Krupansky

Labels: , , , ,

Tuesday, March 18, 2008

Skimpy T-bill yields

I still have a little money in 4-week T-bills which rolled over today. The weekly auction produced an investment rate (roughly annualized simple yield) of a mere 0.527%. That is in fact an annualized yield. Wow, that in a full order of magnitude below what I got over a year ago (5.27%.)

3-month T-bills fetched a yield of 1.12%.

6-month T-bills fetched a yield of 1.34%.

Very skimpy.

I would move my money back to a money market fund, but it is only a small amount and it does give me an excuse to keep up on the treasuries market.

-- Jack Krupansky

Federal Reserve surprises the markets with less than full percentage point cut

I was mildly surprised that the Federal Reserve FOMC only cut interest rates by 0.75% rather than by a full percentage point, but only mildly. Two FOMC members voted against the move, stating that they would have preferred an even smaller cut. The bottom line is that the Fed made a reasonable move. People can always debate whether the Fed erred a little too high or too low, but we should be content as long as they are in the right ballpark.

I did notice that the odds of the full point cut had declined to a little less than 100% this morning, probably due to the Producer Price Index report which showed rather strong inflationary pressures building.

 -- Jack Krupansky

Will the Federal Reserve cut rates from a full percentage point?

Who would have imagined it even a few weeks ago, the very real prospect that the Federal Reserve FOMC will decide to cut the Fed's target rate by a full percentage point on Tuesday? Well, it certainly does look like a slam dunk. Futures prices indicate a 100% chance of a full percentage point cut in the Fed target rate.

The truth is that the real economy, the "main street" economy, does not need such a low interest rate, but Wall Street with its garbage mortgage mess to clean up really does need low interest rates to "profit" its way back to solvency.

For the past seven months the Fed has been patiently feeding Wall Street liquidity, but the Bear Stearns meltdown and related problems at Citibank, Merrill Lynch, et al, are really issues of solvency, with assets on their books whose market value is quite questionable. Personally, I think a lot of these assets are going to be quite fine over the next few years, but right now with questionable practices at the ratings agencies and questions about counter-party risk and leveraging, a lot of assets are being unreasonably discounted due to firms raising cash even if the values of those assets will pop back up in a few months to a year.

Meanwhile low interest rates are needed to keep Wall Street propped up.

Maybe another big investment bank will fail, but probably not. There may be some smaller investment banks and hedge funds that fail, especially those who have been leveraging up on commodities to try to recoup losses on mortgage securities.

In any case, I would be surprised if the Fed does not deliver the full percentage-point cut on Tuesday, albeit with a disclaimer that it will rapidly hike rates as soon as Wall Street looks like it is back on its feet.

 -- Jack Krupansky

Monday, March 17, 2008

Congratulations to the New York Fed for protecting the financial system

With the successful acquisition of Bear Stearns by JPMorgan Chase, the Federal Reserve Bank of New York once again soundly showed its mettle and simply blew away its critics, every single one of them. The "bailout" on Friday -- which was really by JPMorgan with the NY Fed really only lending "assistance" was only an intermediate measure intended to buy time for the "main show" which occurred on the weekend with the acquisition of Bear Stearns by JPMorgan Chase with the Fed agreeing to loan money on Bear Stearns assets.

Now, some lingering critics will contend that the Fed should have bailed out Bear Stearns much earlier or even last Summer or maybe even let them fail through bankruptcy, but the NY Fed did precisely the right thing and refused to get into the so-called "moral hazard" of propping up weak players, and did in fact step in at precisely the right time to protect the health of the overall financial system.

The way they did it, the remaining, healthy value of Bear Stearns business and assets will survive with JPMorgan Chase. Alas, Bear Stearns shareholders not only took a haircut but had their heads handed to them, but the NY Fed did the right thing by refusing to outright bail out a failing financial institution. The Fed let this once mighty investment bank fail, but was standing right there to make sure that on Monday Wall Street could open to "business as usual."

This was a remarkable achievement for the NY Fed and the Fed overall.

And the really good news is that a year or two from now when all of the dust has settled this whole "bailout" will not have cost U.S. taxpayers a single dime and they will probably even have made money on the deal. The NY Fed did not give any money to JPMorgan, but is loaning them money for which they charge interest.

Way to go NY Fed!

 -- Jack Krupansky

Sunday, March 16, 2008

Overdue comeuppance for Bear Stearns

It took over nine years, but Bear Stearns finally got its comeuppance for refusing to lend a hand in the bailout of LTCM back in 1998. The Federal Reserve Bank of New York had helped to "orchestrate" the bailout of LTCM and had been able to convince the other major players that they stood to lose a lot more than the amount of money they needed to invest to bail out LTCM. Bear Stearns was the lone hold out. Some memories never die and this was probably one of them.

I won't go so far as to suggest that other Wall Street players orchestrated the undermining of Bear Stearns as a form a payback for their lack of action back in 1998, but it certainly is possible. It is likely that some of those old players at least turned a blind eye to the deterioration of Bear Stearn's financial condition and even smiled inwardly as they watched the decline and opted to refrain from offering any assistance when they could have actually helped in some manner.

You can read JPMorgan's press release about their takeover of the remains of Bear Stearns.

JP may be paying only $2 per share, but that is because they will be taking on vast boatloads of liabilities even as they also get significant remaining assets of value. The Federal Reserve Bank of New York is in fact helping out and loaning JP money based on remaining Bear Stearns financial assets of value. JP will then gradually unwind those old Bear Stearns liabilities by writing off the garbage (hard-core subprime debt) and repackaging and reselling any quality debt securities. The interesting effect will be that writing off a lot of "bad" subprime debt will effectively let a lot of holders of underwater mortgages off the hook. This could be a really good deal for a lot of people in the months ahead.

Personally, I never had any business with Bear Stearns, but that was mostly since they never catered to "main street" individual investors such as myself.

To me, Bear Stearns (as well as Goldman Sachs) represented the epitome of the "bad" side of Wall Street which was always more enthusiastic at profiting from us individual investors than helping us profit.

So, I say, Bear Stearns... good riddance.

The Bear Stearns web site has this message:


Gee, I wonder why?! The site goes on to tell us that:

In light of entering into an agreement to merge with JPMorgan Chase, The Bear Stearns Companies Inc. (NYSE: BSC) will not be announcing its first quarter 2008 financial results on Monday, March 17, 2008, as previously scheduled.

Almost as if they were writing an obituary (which they should), the announcement ends by telling us:

Bear Stearns

Founded in 1923, The Bear Stearns Companies Inc. (NYSE: BSC) is a leading financial services firm serving governments, corporations, institutions and individuals worldwide. The Company's core business lines include institutional equities, fixed income, investment banking, global clearing services, asset management, and private client services. Headquartered in New York City, the Company has approximately 14,000 employees worldwide. For additional information about Bear Stearns, please visit the firm's website at

All of this said, I was never a big fan of Chase or JPMorgan Chase either, or of any big banks, but at least they have retail operations and at least some sense of needing to cater to "main street" individual investors.

For now, most of my financial transactions occur through Fidelity Investments.

 -- Jack Krupansky

OPEC is right - there is no shortage of oil

I am no fan of OPEC or any cartel, but they are precisely right when they refuse to increase production and insist that there is plenty of oil available in the market. They are ABSOLUTELY correct in their assessment of the supply of crude oil. Sure, global demand for oil is growing, but certainly not at a pace even a fraction of the pace of recent price rises. In fact, the inventory level of crude oil here in the U.S. is quite healthy. As of Wednesday, the weekly U.S. DOE EIA inventory report says that we have 311.6 MILLION barrels of crude oil sitting in storage tanks waiting for someone to use it. Granted, that is 2.8% below the level a year ago, but is still "in the middle of the average range for this time of year." There is simply no shortage of crude oil. Let me say that again: There is simply no shortage of crude oil.

So, why is the price of oil so high? One word: speculation.

Of course, we have always had speculation. So, what is different this time? One phrase: taking delivery. In the past, speculators simply bought futures contracts, held them for days or weeks or months and then sold them at a profit and "rolled" into a new batch of futures contracts. Because they were buying and selling fairly frequently their net impact on the price level was fairly modest, a mere "tax." But now, hedge funds and proprietary trading desks within financial institutions, among other speculators, are actually taking delivery of oil and other commodities. Now, they do not actually have the physical product delivered to their offices, but simply begin paying for storage of oil in a storage tank or gold in a vault or grain in a storage bin or whatever the appropriate storage may happen to be. The point is that since they are no longer selling the futures contracts there is no opportunity for the upwards price impetus when they purchased the futures contract to cancel out with a sale.

In short, there is plenty of oil sitting in storage that could be sold, but hedge funds and financial institutions and other speculators are intentionally keeping product off the market. Even so, OPEC, et al are still pumping more than enough oil to keep the maket fully supplied, but the ongoing one-way trading of oil futures contracts keeps the NYMEX futures market price of oil artificially higher, much higher than actual demand by true users of oil (refiners, chemical companies, transportation companies.)

To put it another way, OPEC is in fact selling a huge amount of oil, but the one-way nature of futures markets is attaching a price to each barrel of oil or other unit of commodity that is completely out of line with the actual supply and demand for actual use of the commidity.

Not all speculators are engaging in taking delivery, but enough of it is going on to keep this pyramid scheme going. Technically what the big speculators are doing is cornering the market. That can work for a while and even for quite a while, but is a very dangerous game to play. If they do not get out before the full speculative demand is met, they will get stuck with losses so massive that they effectively cannot sell their holdings at any price. That is why OPEC is reluctant to increase supply further, because it will only fuel the speculative bubble and cause even greater risk that the market price for oil will completely collapse once speculators realize that "the bubble has burst."

To be clear, OPEC is doing precisely the right thing: Pumping just enough oil to meet real demand by real users of crude oil.

Another factor influencing supply is that the inventory in the U.S. Strategic Petroleum Reserve (SPR) has been rising lately, by 100,000 barrels of oil in the latest week. My suspicion is that the oil companies are pumping oil into the reserve to make room in commercial storage tanks for storage of oil for speculators who have taken delivery.

The bottom line is that "total stocks" of oil and oil products is 0.8% above a year ago and "in the upper half of the average range for this time of year." To say it again: There is no shortage of oil. As far as gasoline, the inventory is 11.2% above a year and and "above the upper limit of the average range." There is no shortage of gasoline.

What I find truly appalling is that not even any of the Democratic presidential candidates are focusing any attention of the massive tsunami of commodities speculation that is continuing to wash over the pocketbooks of middle-class consumers. Let me be clear, the problem is not "big oil companies" or "big bad OPEC", but primarily the self-serving "investment" practices of hedge funds, financial institutions, and other speculators, both large and small. There seems to be very little comprehension among politions of the massive, pervasive, and socially-ruinous qualities of this speculation. Or, when they do know, they have too many deep-pocket contributors who have grown dependent on that speculation.

Finally, it could very well be that profits from this tsunami of commodities speculation might very well be all that keeps Wall Street from complete collapse. That alone may be keeping the regulators at bay, the hope that maybe Wall Street can "profit" its way out of its current financial mess.

To close, I am once again forced to admit that: OPEC is right - there is no shortage of oil and that the causes of high oil prices have to be found elsewhere - namely Wall Street.

-- Jack Krupansky

Friday, March 14, 2008

ECRI Weekly Leading Index indicator falls modestly and still suggests high risk of recession

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) fell modestly (-0.24% vs. +0.81% last week) but the six-month smoothed growth rate rose slightly (to -10.4 from -10.5 last week), and is well below the flat line, suggesting that the economy will be struggling in the months ahead.

The bottom line is that the ECRI WLI remains "flashing red." Alas, even the ECRI WLI is not a guaranteed, fool-proof economic indicator, especially when the data is mixed.

I will keep my personal assessment of the chance of recession at 60% based on the magnitude of the negative level of the WLI smoothed growth index and the mixed nature of the data. The economy still has a fair chance of avoiding an outright recession, but only if we can repeat the improvement we have seen over the past six weeks.

No comment from ECRI this week, but the numbers haven't changed much since last week when they said that, "While WLI growth has stabilized a bit in the last two weeks, it remains in recession territory."

To be clear, there is no certainty as to whether we are currently in a recession. It will take another four months to confirm, if we are in fact in a recession.

Give the economy another month or so to see if the the weakness starts to "snowball." Without "snowballing" we will simply have a slowdown and not a true recession.

Right now, the WLI is higher than its level of six weeks ago and the smoothed growth rate is higher than three weeks ago. That is clear short-term improvement, but does not necessarily indicate a durable improvement for the medium-term.

-- Jack Krupansky

Tuesday, March 11, 2008

A recession seems almost certain

A am no fan of the media's "objectivity" when it comes to economic analysis, the state of the economy, or the economic outlook, especially in a presidential election year when media biases become even stronger. I was reading an article in The New York Times by Michael de la Merced entitled "Buyout Industry Staggers Under Weight of Debt", which is an interesting article in its own right about the LBO industry, when the phrase "a recession seems almost certain" popped out at me. That seems to be a common theme these days, with people either absolutely convinced that we are already in a recession or that a recession is absolutely going to commence any day now. The operative word in that phrase is not "certain" or even "almost certain", but "seems." People are chattering mightily about something with such great conviction, but at the end of the day, their cherished view is based on the necessity of this weasel word "seems." Seems is the ultimate weasel word.

My retort is simply, why bother? If people are that convinced, let them speak with unqualified conviction. And if weasel words such as "seems almost certain" are so necessary, why not just hold off judgment until there is greater clarity. What is the rush? A rush to false certainty and qualified pseudo-certainty? Guess what... that is what got us into Iraq.

I cannot strictly disagree with the assertion that "a recession seems almost certain", since so many people seem to believe it. Of course, belief is not a synonym for truth.

The only true certainty that we have right now is that the economy is sluggish and that the banking system has some problems. Beyond that, I am not sure that we need to worry about the technicalities of what actually constitutes a recession or not.

If all we have is a pseudo fact, something that seems true, what good is that to any of us? Maybe the answer is simply that it helps to sell newspapers.

-- Jack Krupansky

Harry Newton on Auction Rate Securities (ARS)

Harry Newton has excellent coverage of the Auction Rate Securities (ARS) disaster on his web site,, including background, news, resources, and names of real live people to contact about problems people are having with these securities which were improperly marketed as being "just as good (and liquid) as cash."

Many if not most auction rate securities are sold in the form of closed-end funds. Some are referred to as Auction Rate Preferred Securities (ARPS). Some are referred to as Auction Preferred Securities (APS.)

The news is starting to get a little more optimistic, but there is still quite a long way to go before this mess is cleaned up.

Alas, we are unable to count on any assistance on this front from former anti-Wall Street crusader and now (at least for the moment) New York Governor Eliot Spitzer. It would appear that he is... ummm... "indisposed"... at the moment. Spitzer's lone contribution to making the outlook for ARS look sunnier was to instigate a scandal even more negative than what was going on with ARS. If anybody believed that nothing could be more negative than the disaster on the ARS front, Spitzer clearly proved them wrong! Good luck, Eliot in your future endeavors!

Be sure to check out Harry Newton's In Search of the Perfect Investment web site for daily doses of information on all manner of topics related to investment, speculation, trading, finance, economics, and technology and life in general.

-- Jack Krupansky

States, cities, and public agencies begin liquidating auction rate securitiy bonds

Although holder of auction rate securities have been suffering from a virtually complete freeze of liquidity in recent weeks, a thaw may be coming soon. Some of the details can be found in an article from Bloomberg by William Selway entitled "California Dumps Auction Debt; States Push on Ratings" which points out that since failed auctions cause the borrowers (states, cities, and public agencies) to pay high penalty rates, and the borrowers cannot accept that burden for long, the result is that the borrowers are selling new non-auction-rate bonds to pay off the auction-rate bonds. Granted, the amounts are still a small fraction of the total auction rate market, but it is finally a good, solid, positive sign of progress. No idea how long it could take to completely replace the total auction-rate market, but the progress we are starting to see could quickly snowball, and possibly complete within a few months.

Another part of the article is about how most municipal bonds never really needed insurance to begin with. If the debt were rated with the same criteria as corporations, virtually all of it would be rated AAA. A significant portion of the auction-rate securities selloff was due to concerns about municipal debt if the insurers of that debt were to be unable to cover the debt if it defaulted. Of course, we can now see that this concern was always a complete red herring since the vast bulk of the municipal debt should have been rated AAA and not needed insurance since day one.

-- Jack Krupansky

Sunday, March 09, 2008

Mortgage rates settling back down

The latest weekly mortgage survey published by Freddie Mac shows that mortgage rates settled down again, more than reversing a big rise the previous week. The 30-year fixed-rate mortgage (FRM) averaged 6.03 percent with an average 0.5 point for the week ending March 6, 2008, down from last week when it averaged 6.24 percent. Last year at this time, the 30-year FRM averaged 6.14 percent. The 15-year FRM this week averaged 5.47 percent with an average 0.5 point, down from last week when it averaged 5.72 percent. A year ago at this time, the 15-year FRM averaged 5.86 percent.

-- Jack Krupansky

Saturday, March 08, 2008

Fearmongering about the economy by the media

The media is at it again, trying to spin and distort economic news to present it in as negative a manner as possible for their own commercial advantage. The monthly employment report on Friday showed a decline of 63,000 jobs which is a very modest decline. And, in fact, the overall unemployment rate declined. Nonetheless, an article in The New York Times by Edmund Andrews entitled "Sharp Drop in Jobs Adds to Grim Economic Picture" gives a very distorted view of the employment report. A decline of 63,000 is not a "sharp drop", not even close. A sharp decline would be a loss of 300,000 jobs or more.

The lead paragraph is a typical peiece of fearmongering:

The worst fears of consumers, investors and Washington officials were confirmed on Friday, as deepening paralysis on Wall Street collided with stark new evidence of falling employment and a likely recession.

"Worst fears"? Hardly. "Deepening paralysis"? Hardly. "Stark new evidence"? Hardly.

The article goes on to say "In a report that was far worse than most analysts had expected, the Labor Department estimated that the nation lost 63,000 jobs in February." Okay, sure, the number was larger than the analyst estimate, but if the number is still a relatively small number, how could it possibly be "far worse"? This is nothing less than blatant fearmongering.

Then The Times tells us that "Though monthly payroll data are notoriously volatile and subject to revision, the jobs report was so bleak that many of the few remaining optimists on Wall Street threw in the towel and conceded that the United States was already in a recession." What was bleak was the media coverage, not the report itself!! Here is what the actual report said in its lead paragraph:

Nonfarm payroll employment edged down in February (-63,000), and the unemployment rate was essentially unchanged at 4.8 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today.  Employment fell in manufacturing, construction, and retail trade.  Job growth continued in health care and in food services.  Average hourly earnings rose by 5 cents, or 0.3 percent, over the month.

The official characterization of "edged down" is correct. What is highly improper is the Times characterization as a "Sharp Drop."

Most of that paragraph is actually either benign, bland, or even positive. People already knew that construction and manufacturing were losing jobs, so there was no big new news there. In fact, if there was any real news, it was that the report did not confirm the prognosis of a "deepening recession." If  we were to start seeing losses above half a million over two or three months, that would be a "harbinger" of recession, but we simply are not even close to seeing such numbers at this stage.

I could go on, but frankly the overall thrust of the article doesn't warrant that much more of my attention.

To hear The Times tell it, a recession is already underway ("Many firms had already concluded that a recession was under way. Within minutes of the new report on employment, many in the dwindling pool of optimists changed their positions.") But, I would simply note that the pragmatic Intrade Prediction Market indicates a 68.5% probability of U.S. recession in 2008. Yes, that means that people are betting that a recession is fairly likely, but if the U.S. economy were as clearly in recession as The Times insists, that number would be way up at 95% or above. Clearly, there are a lot of people (31.5%) who do not find the evidence as convincing as The Times tries to sell us.

I wish The Times would get back to objectively reporting the facts.

-- Jack Krupansky

Disappointment on the employment front, but still not recessionary

Although we had a second consecutive monthly decline in nonfarm payroll employment, both declines were too small to be considered any more than "flat." Yes, they were disappointing, but they still are not deep enough and wide enough to be clear indicators of recession. In fact, the unemployment rate actually declined, which is not what you expect to see in a "deepening recession." Sure, part of the dip was due to people leaving the workforce, but the simple fact is that in a recession the unemployment rate rises due to significant layoffs and we simply are not yet seeing significant layoffs.

The second piece of good news in the employment report was that average hourly earning rose 0.3% over the month, which is quite respectable. Average weekly earnings increased by about the same rate, also quite respectable, especially for a so-called "recession."

The other good news this week was that the weekly unemployment initial claims declined and the four-week moving average of initial claims declined as well. If we really were in a recession or a "deepening recession" we would not be seeing this kind of moderation.

In short, as disappointing as the employment report was, the news was not anywhere near as bad as so much of the commentary and hand-wringing suggested.

Sure, maybe we will still have a recession, but the data this week says that we are not there yet.

-- Jack Krupansky

Friday, March 07, 2008

ECRI Weekly Leading Index indicator rises moderately sharply but still suggests high risk of recession

The Weekly Leading Index (WLI) from the Economic Cycle Research Institute (ECRI) rose moderately sharply (+0.87% vs. +0.06% last week) and the six-month smoothed growth rate rose slightly (to -10.5 from -10.6 last week), but is well below the flat line, suggesting that the economy will be struggling in the months ahead.

The bottom line is that the ECRI WLI remains "flashing red." Alas, even the ECRI WLI is not a guaranteed, fool-proof economic indicator, especially when the data is mixed.

I will keep my personal assessment of the chance of recession at 60% based on the magnitude of the negative level of the WLI smoothed growth index and the mixed nature of the data. The economy still has a fair chance of avoiding an outright recession, but only if we can repeat the improvement we have seen over the fast five weeks.

According to ECRI, "While WLI growth has stabilized a bit in the last two weeks, it remains in recession territory."

To be clear, there is no certainty as to whether we are currently in a recession. It will take another four months to confirm, if we are in fact in a recession.

Give the economy another month or so to see if the the weakness starts to "snowball." Without "snowballing" we will simply have a slowdown and not a true recession.

Right now, the WLI is higher than its level of five weeks ago and the smoothed growth rate is higher than two weeks ago.

-- Jack Krupansky

Thursday, March 06, 2008

Commercial paper bounces back for a second consecutive week

For a second consecutive week the latest weekly Federal Reserve report on Commercial Paper showed a sharp bounce-back in the amount of commercial paper outstanding. This was after three consecutive weeks of declines.

Financial commercial paper is coming back strongly.

Commercial paper is a key component of the credit market and is evidence that the credit market is not as "dead" as so many people insist.

One reason for strength in commercial paper is that money market funds thrive on it and due to its very short-term maturity it has a very low interest rate. And, its short-term maturity guarantees liquidity.

Another factor driving the commercial paper market is likely the tremendous turmoil in the auction rate secutities (ARS) market where rich people had previously been stashing their cash. Money market funds and actual commercial paper are now a much more attractive haven for parking of cash.

-- Jack Krupansky

Tuesday, March 04, 2008

Finally paid off IRS back taxes in full!

I finally bit the bullet and used a sizeable chunk of the cash in my rainy-day contingency fund to pay off my IRS back taxes in full. All the way to zero. For the first time since 2002 I do not owe the IRS any money. In fact, I am likely to get a sizeable refund in April. Last year I had a big refund, but it went towards the back taxes.

As a curious coincidence, the same week I am paying off the IRS, I am once again self-employed and liable for estimated taxes, which is what got me in trouble back in 2002. This time I have a solid plan for estimated tax payments. I have pre-calculated the taxes on my self-employment income and will be paying that money to the IRS either on a monthly basis or keeping it in a separate account (earning interest) for quarterly payments. No more co-mingling of "tax money" or expecting to pay taxes at the due date out of current income.

Now, it is time to start getting my data together for my accountant to prepare my 2007 tax return.

Also, since I am working part-time, I will be well under the limit for making IRA contributions, so I want to plan on making at least some conttribution to my retirement plans.

-- Jack Krupansky

Monday, March 03, 2008

ISM manufacturing report does NOT indicate that the U.S. economy is in recession

Although the latest ISM Manufacturing Report on Business out this morning does indicate a contraction in the manufacturing sector, it does NOT indicate that the overall U.S. economy is contracting or in recession. An ISM manufacturing index reading below 50.0 indicates contraction in the manufacturing secor, but the ISM manufacturing index needs to fall to 41.1 or below before a contraction of the overall economy is indicated. As per the ISM Manufacturing release today:

A PMI in excess of 41.1 percent, over a period of time, generally indicates an expansion of the overall economy. Therefore, the PMI indicates the overall economy is growing and the manufacturing sector is contracting at this time. Ore stated, "The past relationship between the PMI and the overall economy indicates that the average PMI for January and February (49.5 percent) corresponds to a 2.6 percent increase in real gross domestic product (GDP). In addition, if the PMI for February (48.3 percent) is annualized, it corresponds to a 2.3 percent increase in real GDP annually."

Read that last sentence again: "if the PMI for February (48.3 percent) is annualized, it corresponds to a 2.3 percent increase in real GDP annually."

Alas, the historic "relationship" between the manufacturing and non-manufacturing sectors is no longer fixed and reliable in terms of predicting the dynamics of the other sectors. In fact, last month we saw a contraction of the services sector. What this means is that any weakness in the services sector is not caused by weakness in the manufacturing sector.

In short, the ISM Manufacturing report simply tells us that the economy is weak, but not whether or not the overall U.S. economy is in recession.

-- Jack Krupansky

Saturday, March 01, 2008

Warren Buffett's annual letter to Berkshire-Hathaway shareholders

Warren Buffet released his annual letter to Berkshire-Hathaway shareholders for 2008 yesterday. I have only glanced at it, but as expected it has more than its fair share of insight into finance, investing, the economy, and economic policy.

Classic Warren Buffett humor (related to the insurance business of all things):

The best anecdote I've heard during the current presidential campaign came from Mitt Romney, who asked his wife, Ann, "When we were young, did you ever in your wildest dreams think I might be president?" To which she replied, "Honey, you weren't in my wildest dreams."

Or his view of commercial aviation:

The worst sort of business is one that grows rapidly, requires significant capital to engender the growth, and then earns little or no money. Think airlines. Here a durable competitive advantage has proven elusive ever since the days of the Wright Brothers. Indeed, if a farsighted capitalist had been present at Kitty Hawk, he would have done his successors a huge favor by shooting Orville down.

One thing to keep in mind about B-H as a business is that, as Warren says in his letter, "we will need large and sensible acquisitions to get the growth in operating earnings we wish." Although B-H has some amount of organic business growth, and reinvests some amount of its cashflow within the company, its operations simply do not throw off sufficient increase in business value to fuel robust earnings growth for all of B-H. And since B-H does not pay a dividend and earning a high yield on liquid assets is difficult, B-H needs to exchange a lot of its cash for business value outside of the company. I suspect that in 2008 he will do a fair amount of cherrypicking and acquire the remains of a number of financial firms.

-- Jack Krupansky

Considering IRS Form 656 - Offer in Compromise (OIC) to payoff taxes

I called the IRS this week to see if there was any way that they would offer me an incentive to pay off my back taxes sooner rather than later. They basically gave me three answers: 1) "Well, no, not really", 2) "You avoid interest by paying sooner", and 3) "We can send the application package for Form 656, Offer in Compromise (OIC), but the distribution center has it on backorder." Oh well. I was hoping that they might knock off some of the interest while I was on the phone.

It turns out there is a whole sub-industry of lawyers and accountants and scam artists to help people develop credible "offers" for Form 656. Sure, you can submit the form yourself, but any mistakes and it gets stamped "not processable" and you are out your $150 non-refundable application fee. If your offer is too skimpy, it gets rejected and you don't get a second offer other than the IRS counter-offer. And if your offer is too high, you are effectively leaving money on the table. In addition to paying that fee with the application (and every time you resubmit it), you also have to submit payment of 20% of the balance due. The key is that you need to convince the IRS that they will be unlikely to recover more money than your offer, even if they attach your assets.

The application must lay out your financial situation in enough detail that the IRS can evaluate your future likelihood of payment. Income, assets, debt, support obligations, everything.

I am still considering this route, but I am leaning away from it. Given my present financial situation, I find it hard to believe that the IRS would be worried about me not paying the entire balance due. Currently I am on an installment plan and haven't missed a payment.

Also, my balance is not so huge that I really need "relief" that badly. Also, I am personally morally offended by people who try to get out of paying their financial obligations if they really can afford it. I went through personal bankruptcy in 2005, but I really was in trouble. How quickly things change.

I am simply debating whether to call the IRS up to get the current balance and then simply pay it all off immediately. I may do that simply to close the book on this chapter of my financial history and to avoid any hassle or effort going forward. My immediate motivation is to remove my installment plan payment from my monthly budget so that I can reliably live on a lower level of income from part-time work.

An alternative is to simply put the cash for the tax balance into a side account and then continue to make installment plan payments on a regular basis from that side account. Finanically that costs me more due to accrued interest being more than interest I can earn in a money market fund, but it has the advantage that I continue to maintain a pile of cash that may come in handy if any unexpected expenses or opportunities arise in the next couple of years.

-- Jack Krupansky