Friday, July 31, 2009

Were You Ever a Super Hero?

When you were a kid did you have a super hero? Well I did and my superhero was Superman. I could pin on a bath towel and it magically turned into a red superman cape. It did not matter to me that the towel was white I was still superman. By the way, what super hero did you want to be when you were little? Can you remember?

I liked Superman because he stood for truth, justice and the American way. I’m not sure that I knew then what those three things stood for, but I know I have a better understanding about them today. I recently came across one of those items that caused me to be concerned about the concept of truth.

Some of you may recall the problems experienced by the Reserve Fund last fall. This first money market fund had to close for redemptions because it's directors said that a $785 million position in Lehman commercial paper was worthless due to the bankruptcy filing of Lehman the day before.

People who had money in the fund were told that there would be no redemptions and you could not get your money out. The problems experienced by Reserve Fund and other money market funds caused the government to insure through FDIC, money market mutual funds. That protection was extended to September 2009 when it will, unless extended, expire and the FDIC insurance on about $4 trillion in money fund assets will revert back to the way things used to be.

As a routine I check the Reserve Fund web site, to see what is happening in the Primary Fund. Below is a copy of the Floating Rate Note section of that fund. I have highlighted in bold the Lehman Brothers positions for you to see. This is important; the directors of the fund could not value these positions and could not find a discernible market for this commercial paper.

As you can see below they are showing the value of these positions at full value, what they paid for the position. So, when you look at this report you are led to believe that these positions in Lehman have not lost any value and when they sell them, because the fund is in liquidation, you’ll get all your money back.

Floating Rate Note ASB FINANCE LTD. 08/25/2009 1.0712 500,000,000 9.36%
BARCLAYS BANK PLC 09/16/2009 1.0744 200,000,000 3.75%
DEUTSCHE BANK AG NY 10/21/2009 0.8388 208,000,000 3.89%
GENERAL ELEC CAP CORP 09/24/2009 0.3550 200,000,000 3.75%
HSBC USA INC 10/15/2009 0.9250 275,000,000 5.15%

LEHMAN BROS HLDGS INC 03/20/2009 0.0000 250,000,000 4.68%

LEHMAN BRTHRS HLDG INC 10/29/2008 3.7100 185,000,000 3.46%

LEHMAN BRTHRS HLDG INC 10/27/2008 3.2900 200,000,000 3.75%

LEHMAN BRTHRS HLDG INC 10/10/2008 3.0000 150,000,000 2.81%

LLOYDS TSB GROUP PLC 08/07/2009 1.2862 183,000,000 3.43%
NATIONAL AUSTRALIA BK LTD 10/06/2009 0.8594 60,000,000 1.12%
NORDEA BK EXTENDIBLE SHORT 09/24/2009 1.4494 114,000,000 2.13%
ROYAL BK SCOTLAND PLC 10/09/2009 1.0294 390,000,000 7.30%
Total Floating Rate Note 2,915,000,000 54.59%

If in fact the Lehman positions prove to be worthless, then the funds shareholders would take a loss of $785 million. Let's assume that everything else is redeemed at par and the fund takes the loss of the $785 million in the Lehman position then the net asset value goes from $.97 to $.73. The net result is the possibility in a money market fund to loose 27% on your money.

What has me in my superhero costume is that the fund can get away with showing to the public that the Lehman positions are carried at par when in fact they maybe totally worthless. As one new contact I made on my most recent trip to Sanibel said to me, “Don’t tell me they are carrying them at par.”

I have a new super power. It is called Transparency. As a super hero I want to bring to investors the need for more transparency in all types of investments. This new power will not allow me to leap tall buildings in a single bound, but it can, if people use it, thwart wrong doers like Bernie Madoff and protect investors. As investors if you do not understand an investment then don’t buy it. If it seems risky it probably is. Don’t buy it. If it sounds too good to be true then it probably is. Do not buy it. My X-ray tells me to look at the returns in the 10-year Treasury market as the benchmark for risk. If the yield on the 10-year is 3.75% and somebody is talking about 10% then think real hard, use your X-ray vision to make a good decision.

Dan Perkins

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