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Caveat Emptor

By Larry Doyle on February 26, 2009 at 8:00 AM in Wall Street

buyer-beware The equity markets across all sectors have gotten off to a very rocky start for 2009 (down 15% on average). In the midst of that, a lot of institutions and individuals have fled to the safety of short term government funds, money market funds that now benefit from a government backstop, and other cash alternatives. On average, these investments pay Wall Street and fund managers perhaps anywhere from .1% to .3% of the assets being managed. Those fees will not make the managers rich anytime soon. How do they respond? Welcome to the world of “principal protected notes.”

These structured notes are marketed to track an underlying index (say the S&P 500) while guaranteeing no loss of principal. Wow. Sounds like a great product. Where do I sign? Well, hold on just a second. I am not stating that structured notes do not have some degree of merit, but one needs to be very cautious in fully understanding how these notes work before purchasing. Questions a potential investor should ask:

1. What is the fee structure? Meaning what is the annual charge in order to get the comfort of that guarantee? Do not be surprised if it is anywhere from 1.5% to perhaps as high as 3% of your assets charged on an annual basis. Why so high? For the manager to hedge the volatility in the book of underlying assets, he has the head start provided by your fee.

2. What is the base rate earned by your money? Meaning what will the manager pay you for holding your assets. If the manager has sold out of stocks or other assets of the underlying index, and has your assets parked in a cash vehicle, what do you earn? Check that rate versus what you can earn in a separately held cash account.

3. What is the time to maturity of the note? Any manager will want to lock up your money for as long a period as possible in order to collect the fees earned. The longer the maturity, the less flexibility you have to manage your finances.

4. Where is the credit risk involved in the product? It is critically important to understand this exposure. Is the product an obligation of an insurance company, a bank, a money manager? You can rest assured there will be no reasonable secondary market for these structured notes so you will be locked into this credit exposure.

These notes are not “bought” they are “sold” and they will be very aggressively marketed by the financial industry in the days, weeks, and months ahead. I hope your financial planners are looking out for you. Trying to help you naviagte the economic landscape.

The WSJ provides some excellent insights on how ‘Safe’ Products May Pose Risks for Investors.

Caveat Emptor!!

TheBigB

http://www.google.com/hostednews/ap/article/ALeqM5gHs5OM3gFG_DytQQZFbWfgPT08MAD96HGV600

When the President speaks, the market listens… and crumbles.

November 5, 2008 (Wednesday after Election Day): -486 (5.0%)

January 9, 2009 (one day after Obama speaks at George Mason University on “need” for $800 billion stimulus package): -143 (1.6%)

January 20, 2009 (Inauguration Day): -332 (4.0%)

February 10, 2009 (one day after Obama declares that without a stimulus, “an economy that is already in crisis will be faced with a catastrophe”): -382 (4.6%)

February 17, 2009 (market opens for the first time after Congress passes $787 billion stimulus on February 13; Obama signs bill into law, declaring, “The stimulus lets Americans claim destiny.”): -298 (3.8%)

February 19, 2009 (one day after Obama announces potential mortgage relief plan): -90 (1.2%)

February 25, 2009 (one day after Obama’s first speech to the full Congress): -80 (1.1%)
J.J. (The PUMA)

Hell, I could sell securities with the same guarantee. That doesn’t mean I could honor the guarantee if the market went south.

The only guarantee that means anything to me comes from the institution that can legally print dollars. And even they may pay me with one hand, and then take it away with the other hand through taxation.
boonies

I hear NO ONE defining just what will constitute the new “normal”, whenever things stabilize.WHAT are we expecting to happen? Definition ,please.

We have lived thru 20-some years of financial bubbles of one sort or another, which in the mind of many Americans IS what is “normal”…an inflated and unsustainable standard of living and consumption.

I would appreciate someone telling me what we are lokking for…a reinflation of the real estate bubble?

10% increases every year in home prices and so on?

No one seems to be defining this and if we dont know where we are headed HOW do we expect to know when we have done it?
lark

Today’s news will scare the pants of any guarantor.
Patience

How to invest safely is a huge dilemma today. I take with a grain of salt any advice I hear or read from someone in the business of selling or trading — those fees can be killing.

I know people who are only buying gold these days, expensive as it is. I find that to be rather risky as well for the long term. How can an investor commit long-term with so much uncertainty?

LD, how safe do you think simple savings accounts are these days? Is there any FDIC track record we can look to for assurance? I’m wondering if, say, one has a $250,000 savings account in a bank that tanks. How long would it take for the government to settle up? How does it play out? Are there fees involved, etc?
TeakwoodKite

“We have already identified 2 trillion dollars…”

I watched ‘em release “da budget”. Housing sales the worst in 40 years.

Lark, what news are you referring to?
lark

All of them. But mostly that the budget has a deficit that is exploding and that the government will seek to control the health care industry by imposing its way around. Both news should cause a lot of concerns. Whether it does or not is another thing.
Jackie

The wall street Journal on Ohbummer

http://online.wsj.com/article/SB123561551065378405.html?mod=rss_opinion_main
mountainaires

Really Bad News Today–So, the Market Rallies!

http://247wallst.com/2009/02/26/jobs-durables-so-bad-a-possible-inflection-point/

How does a $1.8 Trillion Deficit for the fiscal year sound to you?

Feb. 26 (Bloomberg) — President Barack Obama’s first budget request would provide as much as $750 billion in new aid to the financial industry, as well as overhaul the U.S. health-care system and launch a program to cut carbon-dioxide emissions.

The spending blueprint, being sent to Congress today, anticipates the government will run a deficit totaling $1.75 trillion in the year ending Sept. 30, equivalent to about 12 percent of the nation’s gross domestic product. Obama has promised to cut the shortfall — the biggest since World War II – - in half by the end of his first term.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aY8vuevw1NKs&refer=home#

http://eye-on-washington.blogspot.com/2009/02/treasurys-rescue-plan.html

http://www.calculatedriskblog.com/

http://www.ritholtz.com/blog/

Durable Goods Orders Way Down:

http://www.marketwatch.com/news/story/Demand-durable-goods-sinks-52/story.aspx?guid=%7B1EC9200E%2D6C12%2D49A8%2DB442%2DCEFD6287D665%7D

Unemployment Claims Way Up:

http://www.marketwatch.com/news/story/Initial-jobless-claims-rise-ongoing/story.aspx?guid=%7B498AF5D6%2D0F43%2D42CD%2D9883%2D25E605638967%7D

This is a “Stress Test?” [bwahahahahahaha]

Today, the Federal Reserve answered some questions on the bank “stress test”, which they say is being conducted, “to determine if the largest U.S. banking organizations have sufficient capital buffers to withstand the impact of an economic environment that is more challenging than is currently anticipated.”

Banks have been instructed to analyze potential firm‐wide losses, including in its loan and securities portfolios, as well as from any off‐balance sheet commitments and contingent liabilities/exposures, under two defined economic scenarios over a two year time horizon (2009, 2010). The capital assessment will cover two economic scenarios: a baseline scenario and a more adverse scenario:

Baseline scenario (average):

GDP: -2% (2009), +2.1% (2010)

Unemployment Rate: 8.4% (2009), 8.8% (2010)

House Prices -14% (2009), -4% (2010)

Adverse scenario:

GDP: -3.3% (2009), +0.5% (2010)

Unemployment Rate: 8.9% (2009), 10.3% (2010)

House prices: -22% (2009), -7% (2010)

http://www.streetinsider.com/Economic+Data/Feds+Bank+Stress+Test+Doesnt+Account+For+%22Black+Swan%22/4437298.html

A good example of the “black swan” effect:

“[B]ased on recent data from Housingtracker.net, which is a combined look at condo and single-family home statistics, Las Vegas’s median home values are currently down 40% YoY and 53% from April 2006 (April 2006 Median=$344,900; Today’s Median=$162,500).

Based on the data/trends above, combined with the significant uptick in Las Vegas’s unemployment situation and lack of available mortgage credit, I anticipate foreclosures and inventories to significantly increase and prices to fall another 30% by this time next year.

Stated differently: Today’s Median price is $162,500. After a 30% haircut from here, I expect to see a median of ~ $115K by March 2010 – very close to the $60 median price that I wrote about last year.

http://economicrot.blogspot.com/2009/02/las-vegas-housing-crash-continues.html
LD

Mountainaires….

You are all over this!!! Well done!!

I do think the government is indicating that they are going “all in” and that this may serve to put the equity markets into sideways price action for the time being but willdrive interest rates up sooner rather than later.
mountainaires

They may be calming the market, but they’re scaring the pants off of me, LD. Wow. Some of the perspectives I’ve read this morning, made me want to spew my coffee on my new keyboard.
Patience

Note that the POTUS claimed those earning under $250,000 won’t be taxed “one single dime” to pay for his lavish agenda.

Could it be he means not “one single dime”, but many many thousands of dimes? Lawyers tend to be literalist manipulators of language, after all.

The current administration and Congress are so pre-occupied with profligate political patronage in the guise of stimulus spending it’s no wonder the market tanks after nearly every new pronouncement.
LD

Inhale…exhale….inhale…exhale…

My sense is that we will all be blown away by the size of the commitments going forward.

Moral hazard …what’s that?
LD

Patience…I have no concerns that you will get your money althogh you may wait. The FDIC reserves have dropped precipitously.

Maybe I should increase my concerns a little but I’m not there yet.
lark

My sense is that something will give in terms of social order. Just saying.

I want my money in WalMart credits.
getfitnow

The Dow is down 88+.
lark

Why is it that (the left) politicians from both parties (even though Republicans imply the contrary) like this so much?

http://www.breitbart.com/article.php?id=CNG.2b04b3e135c9639d2bbf7a45f32c5bad.201&show_article=1
LD

not a bad day….getfit…in all seriousness, the market has little chance of doing decidedly better anytime soon…