Generational Dynamics: Forecasting America's Destiny Generational
 Forecasting America's Destiny ... and the World's


Generational Dynamics Web Log for 3-Mar-08
Your money market funds may be frozen without you knowing it

Web Log - March, 2008

Your money market funds may be frozen without you knowing it

Many people don't know that they've invested in auction-rate securities.

According to a report on CNBC on Monday morning, many people have invested in auction-rate securities (ARSs) without even realizing it.

In my new analysis article, "Cities and towns need to start helping themselves," I describe how the abusive use of ARSs has been one of the factors in the continuing collapse of the municipal bond market. (Read this article if you're interested in how you can help your city or town avoid the worst.)

In "Wealthy investors in auction rate securities can't get their money out," I described how wealthy sophisticated investors in these ARSs are now unable to get their money out in order to pay their tax bills and other obligations.

But now it turns out that ordinary investors in money market funds may have their money frozen -- and they may not even know it, since nobody's telling them anything until they try to make a withdrawal.

This is according to James Stewart, SmartMoney's editor at large, being interviewed on CNBC on Monday morning. Stewart was shocked to discover last week that his own money, in a Merrill Lynch fund, is now frozen. Here's what he said (my transcription):

"These were sold as a money market equivalent. ... They were sold as ready cash -- something that was always liquid - you could get your money out very easily.

James Stewart, SmartMoney's editor at large <font face=Arial size=-2>(Source: CNBC)</font>
James Stewart, SmartMoney's editor at large (Source: CNBC)

In return you got a low interest rate, but it was better than pure cash.

And so I woke up the other day reading about these so-called failed auctions, and discovered that these [securities] had hit my portfolio -- and in fact they are completely illiquid -- I can't get the cash out, and neither can anybody else. ...

This is a $330 billion market -- and I think that there are a lot of people out there who have these things, sitting in their account, who probably don't even realize that they're frozen.

These things come in a variety of packages. ... Mine is a tax-free version - I think many of them are - the funds [selling the auction-rate securities] had bought tax-free municipal bonds [which are tax-free in the sense that the investor doesn't have to pay income tax on the interest earned].

Then, to determine the interest rate, they would [run an auction] every week. Essentially they would re-sell shares in the portfolio every week, so you got no real interest rate exposure. There was no interest rate risk, because the interest rate was being reset every week.

Now, for the issuers it was great because you paid a short-term tax-free rate and then you got a long-term bond out of it, so it was the best of both worlds for everyone involved.

But putting aside the technicalities, to me here, what's so appalling is that they were sold to people as a money market fund. This is not like reaching for super-high yield, or taking on known risk. They were sold by all the big firms as a money-market equivalent and now, when they auctions have gone bad ... suddenly they're failing because there's trouble in the municipal [bond] market. [These big firms] won't step up to the plate and honor this commitment. They will not make these funds available. The big firms are offering their clients margin loans to the amount [that they're owed.] In other words, ... it's like they're asking you to pay interest to get your own money.

[[And so, what's happening is that the big firms, like Merrill Lynch, won't give you your money, but they're willing to loan you an equivalent amount, and you'll have to pay interest on those loans. - JX]]

Now, I think this is outrageous. This goes to the integrity of Wall Street. How can you trust any of these firms again when they say, OK, buy this, for this reason, it's very liquid, when they have fundamentally betrayed you in a situation like this.

[[I have to laugh at this. These investment banks have been lying to us for months, perhaps years, selling CDOs and other faulty securities long after it was already obvious that the securities were faulty. And the ratings agencies gave them AAA debt ratings, and the bond insurers gave them AAA level bond insurance. All of these people have been lying for a long period of time, and nobody believes anything they say any more, and now Stewart is suddenly outraged because these liars have betrayed HIM. What did he expect? - JX]]

[On having written books about being betrayed.] I have. But I've written about rogues, I've written about criminals, some of them highly respected, very wealthy, unexpected, but nonetheless individual wrong-doers. These are the biggest blue-chip gold names on Wall Street who are refusing to honor these commitments to their clients, and I think it's really a very serious issue of trust.

Merrill Lynch happens to be where I have my account, and they sold me these securities -- but I don't really want to single out Merrill Lynch because everybody [has been doing it]."

There's another laugh here. What he doesn't understand, is that this is a generational issue. It isn't just the big investment firms that did this. It was the Generation-Xers in those firms, translating their hatred and contempt for Boomers into massive fraud. And their Boomer managers were just as bad, letting the Xers commit this fraud, because both Xers and Boomers made tons of money.

For those of you web site readers who can't believe a generational explanation like this, you tell me, how is it possible that this kind of fraud occurred in almost every financial institution -- banks, ratings agencies, insurers? What other possible explanation is there, except a generational explanation?

Incidentally, much to my own surprise, fourth quarter corporate earnings estimates have continued to fall sharply. I thought that they had leveled off around -21%, and that we'd be done with fourth quarter estimates. But I was shocked to read the following summary from Friday from CNBC Earnings Central:

"As of Friday, February 29th:

486 companies in the S&P 500 have reported earnings for Q4, 63.37% have beaten estimates, 11.11% were in-line, and 25.51% have missed. (Data provided by Reuters Estimates)

The blended earnings growth rate for the S&P 500 in fourth-quarter 2007, combining actual numbers for companies that have reported, and estimates for companies yet to report, fell to -25.2%.

At the start of the quarter, the growth rate for Q4 was 11.5%. (Data provided by Thomson Financial)"

We can now update the table of the changes in fourth-quarter earnings estimates since the beginning of the fourth quarter, as follows:

  Date    4Q Earnings estimate as of that date
  ------- ------------------------------------
  Oct  1:             +11.5%
  Dec  7:              -1.3%
  Dec 14:              -3.8%
  Dec 31:              -6.1%
  Jan  4:              -9.5%
  Jan 11:             -11.3%
  Jan 18:             -19.0%
  Jan 25:             -20.5%
  Feb  1:             -20.7%
  Feb  8:             -20.2%
  Feb 15:             -21.1%
  Feb 22:             -21.0%
  Feb 29:             -25.2%

And so, the 4Q earnings estimates have taken another substantial fall in just the last week, which was totally unexpected, even by me.

Now my astute web site readers may have the following question forming in their minds: "Hey, it's almost the end of the first quarter, and you're still talking about fourth quarter estimates. Where's the table for 1Q corporate earnings estimates?"

Well damn, you took the words right out of my mouth. And the answer is, I can't find any first quarter estimates. (If any web site reader knows where I can find them, please let me know.)

Here's what I think is going on. Recall the following table, that I posted about a month ago:

  Period  Earnings growth estimate (Thomson Financial)
  ------- --------------------------------------------
  Q1 2008       2.6%
  Q2 2008       3.5%
  Q3 2008      20.0%
  Q4 2008      50.0%

These figures are from Thomson Financial, the same group that provides the Q4 estimates above. When I posted this last table, I described it as "absurd" and a "fantasy."

Well, my guess is that in the last month, even the high-priced financial geniuses at Thomson Financial realized that this table is a fantasy. Obviously they've been made total fools of in the 4Q figures, where they didn't just make one wrong estimate, but where EVERY estimate since October has turned out to be ridiculous.

So my guess is that they've stopped issuing official 1Q estimates, until they see how bad 4Q ends up, which we may not know even yet.

As I've said before, if you think of the world economy as a big bloated mansion, then a piece of that mansion is falling off into the ravine every day. Before long the entire mansion will collapse into the ravine.

Well, the freezing up of the ARSs, and the consequent collapse of the muncipal bond market and the freezing of many so-called "liquid" money market funds is another few rooms and gables of the mansion sliding off into the ravine.

I've estimated that the probability of a major financial crisis (generational stock market panic and crash) in any given week from now on is about 3%. The probability of a crisis some time in the next 52 weeks is 75%, according to this estimate. (3-Mar-08) Permanent Link
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