We've apparently learned nothing from the residential mortgage disaster, since we're about to repeat the identical mistake in the auto industry.

Obama's Car Puzzle

by Holman W. Jenkins, Jr.

Wall Street Journal

You have in GM's Volt a perfect car of the Age of Obama — or at least the Honeymoon of Obama, before the reality principle kicks in.

Even as GM teeters toward bankruptcy and wheedles for billions in public aid, its forthcoming plug-in hybrid continues to absorb a big chunk of the company's product development budget. This is a car that, by GM's own admission, won't make money. It's a car that can't possibly provide a buyer with value commensurate with the resources and labor needed to build it. It's a car that will be unsalable without multiple handouts from government.

AP

The first subsidy has already been written into law, with a $7,500 tax handout for every buyer. Another subsidy is in the works, in the form of a mileage rating of 100 mpg — allowing GM to make and sell that many more low-mileage SUVs under the cockamamie "fleet average" mileage rules.

Even so, the Volt will still lose money for GM, which expects to price the car at up to $40,000.

We're talking about a headache of a car that will have to be recharged for six hours to give 40 miles of gasoline-free driving. What if you park on the street or in a public garage? Tough luck. The Volt also will have a small gas engine onboard to recharge the battery for trips of more than 40 miles. Don't believe press blather that it will get 50 mpg in this mode. Submarines and locomotives have operated on the same principle for a century. If it were so efficient in cars, they'd clog the roads by now. (That GM allows the 50 mpg myth to persist in the press, and even abets it, only testifies to the company's desperation.)

Hardly mentioned is the fact that gasoline goes bad after a few months. If the Volt is used as intended, for daily trips of 40 miles or less, the car's tank will have to be drained periodically and the gas disposed of.

The media have been terrible in explaining how the homegrown car companies landed in their present fix, when other U.S. manufacturers (Boeing, GE, Caterpillar) manage to survive and thrive in global competition. Critics beat up Detroit for building SUVs and pickups (which earn profits) and scrimping on fuel-sippers (which don't). They call for management's head (fine — but irrelevant).

These pre-mortems miss the point. Critics might more justifiably flay the Big Three for failing long ago to seek a showdown with the UAW to break its labor monopoly. In truth, though, politicians have repeatedly intervened to prevent the crisis that would finally settle matters.

The Carter administration rushed in with loan guarantees to keep Chrysler out of bankruptcy. The Reagan administration imposed quotas on Japanese imports to prop up GM. Both parties colluded in the fuel-economy loophole that allowed the passenger "truck" boom that kept Detroit's head above water during the '90s.

Barack Obama and Nancy Pelosi now want to bail out Detroit once more, while mandating that the Big Three build "green" cars. If consumers really wanted green cars, no mandate would be necessary. Washington here is just marching Detroit deeper into an unsustainable business model, requiring ever more interventions in the future.

The Detroit Three will not bounce back until they're free to buy labor in a competitive marketplace as their rivals do. In the meantime, private money, even in bankruptcy, almost certainly will not be available to refloat GM and colleagues. Nationalization, with or without a Chapter 11 filing, is probably inevitable — but still won't make them competitive.

History seldom affords such perfect analogies: In 1968, the Penn Central merger (a proxy for GM-Chrysler) was touted as a fix for a sagging rail business. In two years, the company was in bankruptcy. When a judge couldn't find new lenders, Washington absorbed them into government-owned Conrail, but the death spiral continued. Finally, Congress passed the deregulatory Staggers Act, which overnight gave the rail industry back its future. Conrail was triumphantly reprivatized in 1987.

We're about to replay this ordeal with the auto industry. Let's at least give ourselves a chance to be successful on the first try.

The simplest step forward would be to get rid of the "two fleet rule," devised by Congress's fuel-mileage managers to keep Detroit making small econoboxes in high-cost UAW factories. Dumping the rule would force the UAW to compete directly inside each company for jobs against cheaper workers abroad.

Even better would be to dump CAFE altogether. If Congress really thinks consumers must be encouraged to use less gas, replace it with an intellectually honest gas tax. Mr. Obama promised to transcend the old stalemates — let him begin with the 30-year-old fraud that our fuel-economy rules represent.

He ran a brilliant campaign, but his programmatic prescriptions amounted to handwaving designed to capture the presidency rather than tell voters what really to expect. This may have been a virtue in campaigning but it becomes a handicap in governing. The public now has no idea what to expect — except miracles, reconciling all opposites, turning all hard choices into gauzy win-wins. Thanks to Detroit, his honeymoon is about to end before it begins.

  I had planned to write a piece on the limits of diversification, at a time when the underpinnings of almost every asset class is based on the twenty-five year bull market in interest rates.  However, the following article from The Economist is well-presented.

All bets are off

Oct 30th 2008
From The Economist print edition

Spreading the risk has spread the losses

Illustration by S. Kambayashi

THERE is such a thing as a free lunch. That, at least, is what pension funds have been told in recent years. Diversify into new asset classes and your portfolio can improve the trade-off between risk and return because you will be making uncorrelated bets.

Boy, did pension funds diversify. They bought emerging-market equities, corporate bonds, commodities and property, while giving money to hedge funds and private-equity managers with their complex strategies and high fees.

The idea was to “be like Yale”, the university endowment fund run by David Swensen, a celebrated investor, which started to diversify into hedge funds and private equity in the 1980s. Compared with other institutional investors over the past 20 years, Yale had very little exposure to conventional equities. It also produced remarkably strong returns.

But those who thought Yale had found the key to success have been disappointed. Every one of those diversified bets has turned sour this year. In retrospect, it looks like the strategy had two problems. The first was that all risky assets were boosted by the same factors: low interest rates and healthy global growth. That encouraged investors to use leverage, or borrowed money, to enhance returns. The result was what Jeremy Grantham of GMO, a fund-management group, describes as “the first truly global bubble”. As confidence has unravelled, investors have been forced to sell all those asset classes simultaneously, driving down prices across the board.

The second, and related, problem is that some of the asset classes were quite small. Initially, this illiquidity was attractive since it seemed to offer more alluring returns. And as more investors became involved, their liquidity duly improved. But they still suffer from the “rowing boat” factor. When everyone tries to exit the asset class at once, the vessel capsizes.

Furthermore, some of these asset classes were always likely to be driven by the same factors as stockmarkets. Private-equity funds, for example, give investors exposure to the same kinds of risks as quoted companies, only with added leverage.

So was the whole idea of diversification a write-off from the start? The strategy’s defenders say no. They argue that pension funds (and other institutional investors) had made too big a bet on equities in the 1990s. When the bet went wrong with the bursting of the dotcom bubble, funds went into deficit.

They accept that, in a crisis, correlations head towards one; in other words, all asset classes (except government bonds) tend to fall together. But the diversifiers have three counter-arguments. The first is that any correlation less than one is still worth having. Hedge funds may have performed badly this year but their losses have been far lower than those of equity markets.

Second, there is a difference between short-term correlations and long-term ones. If you take a five- or ten-year view, it still looks as if property, commodities and the rest offer some diversification benefits. They did so during the equity bear market of 2000-02, for example.

Third, consultants like Colin Robertson of Hewitt Associates argue that diversification does work when it is applied in a sophisticated way. There is no point in diversifying if the investment does not offer a genuinely different source of return (much of private equity falls into this category) or if the asset is already overvalued.

Yet even allowing for this, diversification has surely not offered the benefits most pension funds expected. Indeed, it may have had perverse results. In the old days, with equities trading at below-average valuations, funds would now be on a buying spree. They could afford to ignore the short-term risks because of the long-term nature of their liabilities. Pension funds thus acted as an automatic stabiliser for the market.

This time round, that does not seem to be happening. One reason may be accounting changes which make pension-fund managers more focused on the short term. Another, however, may be the strategic drive to diversification. The Wall Street Journal has reported that CalPERS, America’s largest public-pension fund, has been selling shares to meet commitments to put more money into private-equity firms.

The final problem with diversification has been the cost. Investing in quoted shares via an index fund is very cheap—a fraction of a percentage point. But diversified asset classes cost more to trade and involve higher management fees, expenses that eat into pension-fund returns.

So perhaps diversification has been a free lunch after all. Not for the pension funds, but for the fund managers.

In light of the recent stock market turmoil, investors are turning to bonds as a safe haven.  Financial planners, playing to the fear, recommend that an individual's bond allocation should approximate their age; i.e a forty year old should have about 40% of their assets in bonds.

This is interesting, because most money managers consider long treasuries to be the last remaining bubble.  Interest rates have fallen so low in anticipation of a recession, that any hint of inflation, or the market's demand for higher yields in the face of default risk, will send rates skyward.  Not everyone understands that as interest rates rise, bond prices fall.  And not everyone knows that the Federal Reserve has no control over long rates.  On the contrary; recent central bank policy will eventually guarantee vastly higher long rates.  So unless you are prepared to hold your bond to maturity (and honestly, who plans to hold a 4% bond for thirty years?), the probability of loss is virtually assured.

 The little homilies like "bonds for safety", "buy and hold", etc., were developed over the past twenty five years.  If such tactics were used during the inflation-ridden seventies, a period in which we seem to be repeating, you would have been crushed.

The current issue of Forbes reports that the stock of Horsehead Holding Company, a zinc producer in Pennsylvania, is currently selling at less than net working capital.  Pretty cheap.

At a time when everyone is worried about their retirements accounts, I thought the following article might offer some perspective.

Teachers in West Virginia offer a valuable lesson for what not to do
By JENNIFER LEVITZ

Wall Street Journal
August 4, 2008

Seventeen years ago, West Virginia school employees joined millions of workers nationwide in a shift from a pension plan that guaranteed a monthly check, to a retirement-savings plan that would make the teachers, bus drivers, custodians and other staff responsible for their own investment accounts.

"It was horrible," says Judy Hale, president of the WestVirginia Federation of Teachers union. Most felt poorly informed, and they invested too conservatively, putting the largest sums of money into a fixed-rate annuity, a safe but low-yielding option that typically is inadequate for building a nest egg.

As employees began to retire, most balances were pitifully small. So on July 1, after a vote authorized by the state legislature, 14,871 school employees, or 78%, switched to the old-fashioned pension plan.

After the vote, teachers were "jumping up and down and crying in the halls," Ms. Hale says.

The school employees put their mistakes behind them, but their experience stands as a cautionary tale for employers and employees across the country. As large numbers of workers are starting to retire with 401(k) or 401(k)-like plans to support them, what happened in West Virginia is a window into exactly how things can fall apart for workers, and it serves as a wake-up call for figuring out how to avoid having plans go as badly off track as this one did.

Many workers with retirement accounts have built nest eggs far bigger than they ever imagined possible. But unknowledgeable ones often are far short of comfortable retirements — and they don't have the option the West Virginia teachers did of appealing to state legislators to get them out of their investing mistakes. On top of all this is the havoc that the current bear market may be wreaking on older workers' accounts if they are too aggressively invested in stocks.

Around the country, a few big employers have ditched retirement-savings plans and returned to traditional pensions. The pace of big companies abandoning pension plans appears to be slowing as well.In 2007, 54 of the 100 largest U.S. employers offered an old-fashioned pension plan to new workers, down from 58 in 2006, according to Watson Wyatt Worldwide, a management-consulting firm in Arlington, Va. That 7% decline compares with a 14% drop as recently as 2005.

But there is little question that retirement-savings plans,which have proliferated since the 1980s, are here to stay. Only 21% of full-time employees had an old-fashioned pension plan in 2007, down from 54% in 2004, according to Transamerica Center for Retirement Studies, a nonprofit corporation funded by Aegon NV's Transamerica Life Insurance Co.

"A 401(k) gets employees to the right place if they're using it right," says Pam Hess, director of retirement research at Hewitt Associates a Lincolnshire, Ill., consulting firm, adding: "We still have work to do."Improvements ushered in by the 2006 Pension Protection Act are still being put into place by many employers, such as automatically enrolling new workers and providing investment advice. More employers also are offering account-management services, annual rebalancing of accounts to keep investments in line with designated asset-allocation targets andtarget-date funds that adjust their holdings from an aggressive to a conservative mix as workers age.

Challenges clearly remain: At the end of 2007, the median 401(k) account balance for people age 60 and above was $34,420, according to Hewitt, meaning half of the group had balances even lower. To be sure,some retirees have other savings, including money rolled into individual retirement accounts from 401(k)s at prior employers.

But studies are starting to document that traditional pension plans, which typically are overseen by professional money managers, outperform programs in which workers control an investment account, like401(k)s. Between 1995 and 2006, "defined benefit" pension plans, so-named because they give retirees a specified monthly benefit, outperformed defined-contribution plans, in which the employer makes a specified contribution to the worker's account, by about one percentage point a year, for a cumulative dollar difference of nearly 14%, according to a June report by Watson Wyatt.

A Church's Change

The United Methodist Church last year moved its 36,000 clergy and lay employees back to a traditional pension, realizing that "with ministers, really their talents are in creative areas, and often not in investment areas," says Ron Gebhardtsbauer, an actuary in University Park, Pa., and a former trustee with the church's pension board. Barbara Boigegrain, general secretary of the church's Evanston,Ill.-based pension board, adds that the church didn't believe it was fair that its employees "were at the whim of the markets." Those who retired in the bull market of 1999, for instance, generally had a better nest egg than those who retired as a three-year bear market ended in 2002. "We care desperately that they have an adequate income in retirement — and income that they cannot outlive," she says.

Beginning in the early 1970s, school employees in West Virginia were enrolled in an old-fashioned plan, with benefits calculated by a formula that took into account compensation and years of service. But after the pension plan faced funding shortfalls, it was closed to new enrollments as of June 30, 1991. The defined-contribution plan was set up to take care of new hires, and existing employees were given theoption of sticking with the old plan or transferring into the new one.

Under the defined-contribution plan, the state contributes 7.5% of each employee's annual eligible gross pay, according to the Web site of the state's retirement board. Employees have flexibility in terms of their contributions: While the state requires those in the pension plan to contribute 6% of pay into the state fund, those in the savings plan can contribute as little as 4.5% — a selling point to those who want greater take-home pay.

Of course, a smaller contribution has the effect of holding down the account balance. As for the state's 7.5% contribution, it is more generous than in the average private-sector 401(k), where the most common fixed match is 50 cents per dollar of an employee's contribution up to the first 6%, according to the Profit Sharing/401k Council of America, a nonprofit organization in Chicago. In contrast, to fund the defined benefit plan for the teachers, the state of West Virginia aims to contribute 15% of annual gross pay for people hired before July 2005 and 7.5% for those hired after. In general, a typical payout in the West Virginia pension plan is an amount equal to 2% of an employee's peak salary multiplied by years of service.

Sales at Lunch

The West Virginia plan initially offered stock and bond mutual funds, a money-market fund, and an annuity, in this case from Variable Annuity Life Insurance Co., or Valic, a unit of American International Group Inc. In addition to the Valic annuity, current offerings include funds from Capital Group Cos.' American Funds unit, Federated Investors Inc., Fidelity Investments and Franklin Resources Inc.

From the start, most employees favored the annuity. Some say they were swayed by Valic's sales force, which included former educators and school employees who went into the schools during the workday to talk about the option. "These people came during your lunch or during your planning period basically to sell the program," says Debra Elmore, a third-grade teacher in Ansted, W.Va.

Ms. Elmore acknowledges knowing little about investing. "Oh, Lord no," she says. "I had no idea." She set up her account so that 85% of her contributions would go into the fixed-rate annuity. "I just thought,'Well, these are safe. Let's stay there.' "

AIG spokesman John Pluhowski says the insurance company hires former school employees to sell its products to schools "because the education market is important to us; educators know the needs and concerns of educators." He says the representatives were "not authorized or directed to give investment advice; they were only authorized to sell a fixed-annuity contract."

Anne Lambright, executive director of the state's retirement board, says that the board offered "some general education" about investing to employees, but that "not everyone took advantage of it." She acknowledges that advice was limited and that much of the information employees received was probably from the companies selling the products. "I'm not sure how much information they got in terms of
comparison between products or stocks and bonds," she says.

At one point, about two-thirds of all assets in the plan were invested in the fixed-rate annuity, according to the board's annual reports. For the first two years, the annuity offered an annual return of 8.5%, but then it dropped to 4.5%, according to a state official. Mr. Pluhowski says the 4.5% is the guaranteed minimum return, while the higher percentage was based on then-market conditions.

By 2005, complaints from employees and the union about low balances in the defined-contribution plan had mounted. State officials closed the plan to new participants and reopened the pension plan to new hires. The following year, school employees voted on whether to end the defined-contribution plan, but a state court later deemed the vote unconstitutional because those satisfied with the plan would have been forced to return to the old-fashioned pension plan. This spring's election was couched differently:  Workers voluntarily could elect to transfer their account into the old pension plan, provided that at least65% of current employees wanted the transfers to be permitted.

The threshold easily was cleared — in part because as of April 30 the average account balance in the defined-contribution plan was $41,478, and of the 1,767 employees over the age of 60, only 105 had balances of more than $100,000. "Our members were going to run out of money five or six years into retirement," says Ms. Hale of the teachers union.

Some retirement experts say another problem that surfaces in 401(k) plans is the "red-truck syndrome":  Plan participants use some of their nest egg at retirement to buy something they always dreamed of having. Teresa Ghilarducci, an economist at the New School for Social Research in New York, says many workers take their 401(k) in a lump sum and have difficulty making it last. She says the West Virginia case "shows the nation what is wrong with everyone's 401(k)," including a lack of investment knowledge and fiscal discipline.

State Investigation

Meanwhile, West Virginia's state auditor and attorney general have announced that they are looking into whether Valic made misrepresentations to induce employees to invest in its annuity, with the attorney general appointing four prominent state lawyers as special assistant attorneys general to help with the investigation. Also, Valic and AIG are co-defendants in a civil lawsuit seeking class-action status in county court in Moundsville, W.Va. The lead plaintiff, a teacher, accuses Valic of fraud, alleging the company misled employees to get them to invest in a "commission-driven" product.

AIG denies wrongdoing. Mr. Pluhowski declined to specifically discuss the lawsuit or the current state investigation, but says, "We are confident we met the obligations we were contracted to provide." Hedeclined to say how much employees were paid for sales of the annuities, but says that "no plan contributions were used to pay commissions." West Virginia's insurance commissioner investigated Valic's sales practices in 2002 and cleared the company, saying it had found no misrepresentations by Valic agents.

Teachers returning to the pension plan will receive reduced benefits to reflect that they've contributed less than other state workers over the years. But they will have the option to make catch-up contributionsto "buy back" the full benefits.

Ms. Elmore, 46, says she realized her disappointment in the defined-contribution plan when she received a letter from the state's retirement board in April projecting that, at age 60, she would have a big-enough nest egg to provide her with $1,571 per month for her life. By contrast, the letter projected, if she voted to go back to the defined-benefit plan, she would receive a projected monthly payment between $2,656 and as much as $3,050."I jumped on it," she says. "I was just worried."–

As of today's close, 80% of stocks in the Russell 3,000 are down year to date, and a whopping 17% are down more than 50%.

The only two places to hide in recent weeks have been US Treasuries and the US Dollar.

Source:  Bespoke Investment Group

Please don't do this

Who can blame an investor for taking to the bottle?

Andy Pick, a 49-year-old stay-at-home father in Atlanta, recently bypassed the stock market for liquid assets — $120,000 in champagnes. He bought 400 bottles, mostly 1996 vintage, that he says he plans to "sit on" for 10 or 15 years and then sell at a profit.

"It sure beats looking at a Merrill Lynch monthly statement," he says, adding, "The worst thing that could happen is that I drink all of it."

Given the gyrations in the financial markets, some investors are abandoning stocks and bonds and seeking refuge in unusual alternatives — parking spaces, for instance, and condos in Peru. Sales of exotic livestock are up. The U.S. Mint has seen a gold-coin rush.

Associated Press

Peggy Parks invested in alpacas, which she believes have a better outlook than most mutual funds.

Investors have long turned to hard assets in market downturns, the idea being that if you invest in something real, it won't disappear, even if its value declines. But analysts say this downturn is different in that real estate, the most traditional safe haven, is also sinking. Between July 2006 and July this year, home prices dropped 19.5%, according to the S&P/Case-Shiller 20-city composite home price index.

After the market dropped in January, Steve Borter, the 56-year-old president of a heating-and-air-conditioning company, did invest in real estate, but not the usual sort. He became landlord of a single parking space in Chicago. He bought a 12-by-20-foot spot in the Field Harbor Parking Garage for $29,000 and rents it out. "The stock market is indicative of a lot of uncertainty. With a parking space, at least you end up with something," he says.

Peggy Parks, a 49-year-old auditor in Johnstown, Pa., turned to an unusual farm animal. "I've lost a fortune in stocks, and my 401(k) is falling through the floor. I feel comfortable in alpacas," she says. She invested $56,000 in a small herd that she believes has a better outlook than most mutual funds because of the animals' breeding potential.

The national Alpaca Registry Inc., in Lincoln, Neb., says registrations are on pace to rise 7% this year and currently stand at 140,297. Ms. Parks says a female of "medium quality" can fetch $10,000 and that prices have been rising, supporting her hopes that she'll see a profit on her alpaca portfolio in five years.

Tangible Assets

Financial firms are reporting that a growing number of retirees are rolling their money out of ordinary individual retirement accounts — commonly stocks, bonds and mutual funds — and into self-directed IRAs, where almost anything goes. "We've had people invest in a cypress farm in Costa Rica, and a condo in Croatia," says Tom Anderson, president of Pensco Inc., a San Francisco firm that has $3.3 billion in self-directed IRAs under custody. He says 20% more assets flowed in over the past three months than in the same period a year ago.

The New Gold Rush

Pat Roque/Associated Press

See images from fortune seekers and spenders world-wide.

In Centennial, Colo., Tim Boykin, 56, a retired engineer, says he pulled his entire nest egg of nearly $1 million out of stock and bond funds in August and put it into a self-directed IRA. He invested some of the money in his niece's company — which is building condos in Lima, Peru. While analysts warn that real-estate investments in emerging markets are risky, Mr. Boykin says he has done his research and remains confident: "I can see pictures of the land. I can see steel. I can see people working. When I put my money in a fund, I see a big list of things that don't sound good."

Ruff Times

Not everyone thinks alternative investments are a great idea. The Alabama Securities Commission over the weekend issued an "investor alert" urging caution. People are "panicking," says securities director Joseph Borg. He worries that investors who yank their money out of the stock market are prey for con artists hawking things like phantom oil wells.

Mr. Borg, past president of the North American Securities Administrators Association, adds that in past market downturns he saw people turn to chinchillas, worm farms and super-breeds of rabbits. Emus, too, were big. "Eventually, people got tired of them and just let them go," he says. "To this day, you'll be in West Texas and a big emu running wild will just come up next to your car."

Hard-asset gurus like Howard Ruff, a best-selling author who rose to fame in the inflationary 1970s, are convinced their moment has come again. "This is a big, big time, a very big time — and this is just the beginning," says Mr. Ruff. He has been advising people to buy bags of pre-1965 U.S dimes and quarters, which are 90% silver and in limited supply.

Gold coins also are in great demand. Last week, the mint suspended sales of American Buffalo 24-karat gold coins because it can't keep up with soaring sales. Last month, a record 14,000 bidders — 17% more than the previous high — turned out for a coin-and-currency auction in Long Beach, Calif., that generated $35 million in sales.

Bob Sale

Bob Sale, a Blue Bunny brand ice-cream distributor in Colorado Springs, Colo., says he purchased American Eagle gold coins last week after his 401(k) retirement account tanked. "Holding them in your hand is like no other feeling," he says.

Mark Craddock, manager of Comic Book World, in Florence, Ky., says stock-market investors also are turning to superheroes. "There's kind of a buying frenzy" in vintage comic books, he says.

The "Silver Age Comic Book Pricing Index" of 32 frequently traded '60s comics, was up 14.2% in the 18 months ending in July, while the Standard & Poor's 500 stock index was down 11% in the same period. Mark Haspel, president of Certified Guaranty Co. in Sarasota, Fla., which grades comic books, often for investors, says it's on track to handle 200,000 books this year, up from 150,000 in 2007.

"Spiderman is going to be here in 20 years — he's not going away," Mr. Haspel says.

"The trouble with the world is that the stupid are cocksure and the intelligent are full of doubt."

— Bertrand Russell

• I once met a man in his 60's, a mechanic by trade, who netted $3 million on the sale of his Harley dealership.  He dismissed any investment discussion with, "I have an account at Fidelity."  I have no idea what he thinks he meant.
• A friend recently invested several million dollars in long-term bonds on the advice of a Schwab advisor (which is akin to asking the girl at the Dairy Queen take-out window).  He had no idea that bond prices fluctuate like stock prices, and that long-term bonds are among the worst investments in an inflationary environment.
• A couple asked for a meeting to discuss tax strategies.  The wife had just received an inheritance, and the couple was taking a course on currency futures.  They wanted to discuss the tax problem they were about to have on all their profits.  It's impossible to know what to say after such a statement.

There are interesting tendencies when someone comes into a little bit (not a lot) of money:

1) The master becomes the servant. There is enough to self-indulge, but not quite enough to quell the fear that it's not quite enough.  A fascinating conflict develops between the desire to become lord of the manor, and an obsession to watch every penny.

2) New money will engage an accountant, a lawyer, a landscaper, a tennis pro, and every other kind of assistance, but by god, nobody touches the money (actually, a tennis pro once lectured me about real estate.  If I, in turn, lectured him about tennis, he would have thought me mad). Professional, educated men are the worst. The need to be clever with money is invariably a hard-wired guy thing, regardless of background, aptitude or education.

3)  George Soros talks about the profound influence of the philosopher Karl Popper, which can be described as the chronic habit of asking oneself  "what did I miss?  Why am I wrong?"  Professional money asks questions. It listens. It examines ideas under objective scrutiny.

New money proclaims.  It argues.  It never listens, never asks - not really.  The question is merely a pretense to give lecture.  Or a solicitation to repeatedly hear the answer they want to hear.  New money makes profound investment decisions with insufficient scrutiny.  And it is not wrong, even when it is dead wrong.

4) Managing money is hard.  It is a blood sport.  A good hedge fund manager is worth every penny.  But an essential skill is to assuage the vanity of the well-read, jargon-dropping client who nonetheless has no idea what they are doing.  Everyone was a dot.com expert before they became a real estate expert.  Everyone has a diversified, rebalanced portfolio until the damn asset classes all fall in unison.  Everyone knows to invest in index funds, but still lose their fingers diving for the falling knife.

I once had an investment banking client in the late 1980's who was among the richest real estate developers in the Bay area.  He was unburdened by reflection, compounded by an acute listening problem.  By 1995, he was renting a two-bedroom apartment.  That leaves an impression.

Perhaps Gordon Gecko said it best:  a fool and his money are lucky to get together in the first place.

If politicians raised a healing hand and commanded the winds of Hurricane Ike away from the Galveston shores, we would… well, obviously re-elect them, because now we accept nothing less in every financial storm.

George Soros is famous for making a billion dollars by shorting the British pound.  What he really did was bet against the Bank of England's attempt to prop up a collapsing currency.  It fact, it is one of his speculative axioms to always bet against such central bank arrogance.

In the clear recognition that the American public has no tolerance for any economic inconvenience, the Federal Reserve attempted to prop up the stock market by dropping the Federal Funds rate to 1%.  While this had no effect on dot.com stock valuations, the resulting credit and real asset bubble was, until the last few years, vigorously denied.  This "non-bubble" was applauded by every politician as the ultimate free lunch:  Wall Street ingenuity providing the "little guy" with the highest percentage of home ownership.  Fannie and Freddie (the most highly regulated companies in the world) dropped their underwriting standards to become the nucleous of the bubble, in spite of Moody's repeated warnings that reserves were wholly inadequate.  Alan Greenspan not only denying there was a bubble, but actually encouraged variable rate mortgages.

Many friend and acquaintances, often at the recommendation of their financial advisor, poured everything into real estate, included retirement accounts, because real estate never goes down - maybe just stays flat for a few years.  I have middle-class friends with $8,000-9,000 per month mortgages.  When I tried to talk them out of it, they mocked me.  And the Bush administration once wanted to permit the individual the pseudo-responsibility to invest their own Social Security earnings.

Now, of course, someone must hang.  The hypocrisy is breathtaking.  Wall Street chieftains at the center of the storm, with their personal net worth on the line, did not fully comprehend the market dynamics, and yet our presidential saviors, speaking with a certainty and moral indignation that underscores their utter naivete, are either a community leader who would be unemployable if not running for the presidency, or a man living off his wife's trust fund, and not sure how many homes he has.  Holy mother of god.  News pundits complain that the little guy was never warned, although when David Einhorn, a hedge fund manager, sounded the Lehman alarm six months ago, the SEC investigated him.

It is impossible to watch current events and not conclude that we've become a nation of silly people.  Tell me I'm special.  Tell me I'm pretty.  Give me a warm glass of milk and a bedtime story.  One with a happy ending.

The Wall Street Journal ran a recent article on a new variation of target-date and life-cycle mutual funds (which automatically adjusts the stock and bond allocation as a targeted retirement date approaches). The new "target payout" and "managed payout" funds adjust the stock and bond mix to provide a steady, above-market rate of return to the investor.  It has the perfect appeal for retiring baby boomers who wish to replicate the income of a steady paycheck, but do not have a large enough nest egg from which to generate sufficient income from the meager yields currently offered on bonds or fixed annuities.

Sounds terrific.  Does it work?  No.

It is standard financial planning gibberish to create a portfolio compiled from historically-derived investment returns and volatility.  And in spite of the disclaimers, the typical lay client has the distinct understanding that these investments are appropriately conservative, and will provide a lifetime of security.

Unfortunately, the only assured investment returns are from fixed income investments held until maturity.  Stock and bond investment returns cannot be managed, or adjusted like the temperature on a thermostat.  The returns are not guaranteed, and in a bear market, the portfolio (and all future income) can be devastated.  Frankly, the entire approach is disingenuous, since the portfolio is constructed to address a target nominal yield, rather than the yield necessary to maintain purchasing power (which is the only reason to take investment risk in the first place).  So even if the target yield is achieved over time, the client may still run out of money if inflation requires a much higher investment rate of return.

Individuals are by no means the only investors vulnerable to the siren song of high yield with low risk.  The sub-prime mortgage crisis was fueled in part by institutional investors with the same perspective.  Endowments and pension plans must plan for an eventual payout, and implicit in the calculations is some estimation of minimum and aggregate rate of return.  During the low return years, when even the highest fixed income rates were insufficient, the sub-prime and collateralized debt obligation packages offered an unbeatable combination of high yield and low statistical risk.  The institutional investment demand enabled the creation of all those now-worthless debt products.

Even today, it is standard practice among institutional investors and their consultants to evaluate money managers and hedge funds on their ability to deliver high compounded returns with low volatility, as if risk and return are utterly unrelated.  They are not.