Huge Risks Ignored by Wall Street

This weekend, I did something absolutely wonderful: I took Maya, my older daughter, fishing.

We didn’t rent a 30-footer and power out of Jupiter Inlet on some deep sea expedition. Heck, we didn’t even leave our neighborhood. Instead, we met up with two of our neighbors and their kids and headed up to one of our subdivision’s retention ponds.

Low key? Sure. But there’s nothing like watching an almost-four-year-old discover fishing for the first time.

She squealed “eeewww” as I dug out a worm and baited the hook. Her eyes lit up when the line finally jerked and jumped. But it wasn’t easy. It took an hour and 20 casts. A strong breeze kept blowing our line into the reeds. And we managed to lose our bait at least twice.

In the end, we caught more weeds than fish. And the fish that we did catch was an ugly one! A “walking catfish,” my neighbor said. To prove his point, he took the hook out, put that sucker on the ground, and let him wriggle his way back into the water.

Maya didn’t care about the results, of course. She loved the whole experience.

But the outing got me thinking about another group that’s fishing in muddy waters. And somehow I don’t think they’re going to come away as happy as my gang did …

Wall Street Crowd Ignoring
Choppy Waters . Baiting
Their Hooks with Your Money

Right now, far too many professional money managers – the people running mutual funds and pension plans – are completely ignoring the risks in stocks and bonds. They’re not seeing the reeds … testing the wind … or taking heed of the muddy shores. Instead, they’re just throwing your hard-earned money into the pond.

Their hope: That a bunch of big profits will just jump into their nets. In reality, here’s the kind of stuff they’re catching:

High-risk debt securities
Lenders loaded to the gills with shaky mortgage assets
High-yield bonds

If they were smart, they’d throw this stuff back in the water. Instead, they’re serving it up to you.

And it’s not just the money managers. Plenty of pundits and corporate managers are fishing the same holes. Every day, I’m amazed anew at the financial idiocy:

Commentators on CNBC are pounding the table on Countrywide Financial (CFC) for instance. Who are they kidding? This subprime lender has huge exposure to slumping California real estate and option adjustable-rate mortgages that might never be paid back.

A few months ago, Wachovia (WB) announced that it would acquire Golden West Financial (GDW). If you’re not familiar with Golden West, it’s a California-based lender whose business is practically all adjustable rate loans. This is possibly one of the worst banking industry bets of all time. Who in their right mind would load up on risky mortgage assets at the tail end of a massive real estate bubble?

More recently, Midwest bank National City (NCC) just announced a pair of Florida deals. It’s buying Fidelity Bankshares for $1 billion and Harbor Florida Bancshares for $1.1 billion.

Didn’t anyone up there in Ohio read the latest FDIC profile of our economy? Sure, it showed that job growth and overall economic activity has surged here in Florida. But this is mostly due to huge increases in construction. It also showed that Florida banks are extremely overloaded on loans to shaky businesses like subdivision developers and strip mall builders.

In short, I’m seeing a complete disregard for risk in the financial industry.

Don’t Count on the Fed
To Provide a Life Preserver

I guess all these people think the Federal Reserve won’t let them get caught in the reeds. They figure the Fed will deliver a textbook soft landing, avoiding both an inflationary surge and a domestic economic crunch. They’re counting on a repeat of 1995 – economic and investing nirvana.

I see three reasons why that’s not going to happen:

Energy prices continue to explode higher. Natural gas surged a whopping 29% in just the last two weeks. Crude oil pushed back up toward $75 a barrel and gasoline tested all-time highs.

The largest housing bubble in U.S. history continues to bust. Almost every day, another home builder reports plummeting orders and skyrocketing cancellations … another report shows record high home supply … and another region clocks in with year-over-year price declines.

The Fed has a hideous track record. Sure, the 1994 Fed tightening cycle led to a massive stock market rally in 1995 as the economy glided to a soft landing. But much more recently, the “experts” at the Fed helped engineer one of the greatest booms and busts in U.S. financial history – the Nasdaq mania and crash.

Former Fed Chairman Alan Greenspan warned us about “irrational exuberance” in the mid 1990s, then went silent as the Nasdaq doubled, and doubled again. By the time the Fed dropped the interest rate hammer, the bubble was so out of control, a crash was unavoidable and the economy slumped into recession.

Let’s not forget the late 1970s and early 1980s, either. That was another time when the Fed failed to act decisively enough to prevent an inflation explosion. Ultimately, Paul Volcker had to come in and drive short-term rates to 20% to get things under control.

If Wall Street’s counting on these guys to save the day, I have just one thing to say: Eeewww!

Take Steps to Protect Yourself

I’m not an unabashed bear. There are banks that will ride out this real estate downturn just fine. There are mortgage brokers and lenders who didn’t rip off their customers. There are fiscally conservative investors who wouldn’t dream of fishing in these markets without weighing the risks. And there are lots of borrowers who will not default on their loans.

But I can’t help thinking that this is going to get ugly for a lot of people. As far as I’m concerned, ignoring risks just doesn’t make sense – not in fishing, not in banking, not in investing.

That’s why you should consider taking these steps to protect yourself, your family, and your portfolio …

First, check up on a bank’s safety rating before showering it with your hard-earned money. (Check yours at www.WeissWatchdog.com.)

Second, avoid higher-risk debt, especially debt with longer maturities. The extra yields available still don’t reflect the true risk. Short-term Treasuries are a better choice right now.

Third, if you’re going to invest in bank stocks, make sure they don’t have excessive exposure to commercial real estate and residential mortgages.

Above all, stay safe.

Until next time,

Mike

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About MONEY AND MARKETS

MONEY AND MARKETS (MaM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Sean Brodrick, Larry Edelson, Michael Larson, Nilus Mattive, and Tony Sagami. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MaM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MaM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Regular contributors and staff include John Burke, Colleen Collins, Amber Dakar, Ekaterina Evseeva, Monica Lewman-Garcia, Wendy Montes de Oca, Jennifer Moran, Red Morgan, and Julie Trudeau.

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