Friday Desk Clearing Time - 9/19/2008

To say that this has been an eventful week in the investment world would be an "understatement of immense proportions". So, just to close out a few things we discussed earlier in the week, consider the following major interventions by the government that have immensely boosted confidence in the financial markets:

• AIG Bailout - check


• Money Market Funds Bailout - check (indirect effect of Lehman's bankruptcy and the Fannie/Freddie bailout earlier)

I am happy to report that today's market rally has at least pared somewhat the market (paper) losses in my 401(k) account. With this as the backdrop, I turned to a page one article in Friday's Wall Street Journal, as reported by Jennifer Levitz, Ilan Bhat, and Nicholas Casey: "Wall Street's Ills Seep Into Everyday Lives." This article reports on how "common people" are coping with the turbulence in the financial markets:

Bradford Roth, the 56-year-old chairman of a Chicago law firm, had a clear strategy for dealing with Wall Street's gyrations when he stopped by a local Fidelity Investments branch Wednesday.

He'd make a deposit to his cash-management account, but he wasn't going to check the balance of his retirement account.

"The less you know," he said, "the better you feel. There's nothing wrong with working in your 80s."

Mr. Roth is clearly unsettled a bit.

"I've been talking to my banker and telling him to get all my money out of the market," said Pat Hurley, a 57-year-old electrical contractor from Phoenix. "I'm really worried -- I think the stock market is going to get worse and worse," he said.

Mr. Hurley has $440,000 in his retirement fund, a sizable chunk but not nearly the million dollars he was hoping for. "I finally got back to where I was in 2001 and n0w the stock market's diving again," he said.

This is the reality facing many boomers - a 57 year old with $440,000 in his retirement fund, not the million dollars he was hoping for...

Bob Conrad, a 59-year-old budget director at the U.S. District Court in Dallas, sees his chance for retirement next year slipping further away. After his nest egg lost 10% of its value, he moved his money a few months ago out of stocks. He thought he was set, but soaring food prices and seesawing energy prices already had him worried. And now, "this thing looks like it's going to get worse before it gets better," he said. "That's just my luck. Looks like I'll be working a while longer."

I am not a licensed financial advisor, but I can't help commenting on one thing here-What investment strategy is this 59-year old following, barely 1 year from his hoped-for retirement, that is causing him to lose 10% of his retirement account's value in a year?

I am going to steam ahead to near the bottom of the article where another boomer couple nearing retirement is quoted:

With their retirement savings building in a pension fund since 1983, Seattle residents Pat Williams and her husband, Jim, are now questioning their savings strategy. The retirement accounts, which are run by Smith Barney, a unit of Citigroup Inc., were worth a little more than $1 million until four months ago. Since then, Ms. Williams said the combined accounts have lost $170,000.

Now the stock-market plunge caused by the fall of Lehman Brothers and the sale of Merrill Lynch & Co. had their accounts losing an additional $40,000 a day for the past two days. So tomorrow, Ms. Williams said she and her husband are pulling out roughly 75% to 80% of the money invested in their retirement accounts and putting it in a money-market account while they figure out what to do next.

"We just don't have the staying power," said Ms. Williams, 58. "I can't watch anymore of our money go away."

Mrs. and Mr. Williams are rightly concerned about their investments. Once again, I can't help but comment on what kind of investment advice the Williamses are getting! At age 58 (Mrs. Williams age quoted above), they've lost 17% ($170,000 of $1 million)of their account in 4 months. Not stopping there, they've lost another 4% ($40,000 of $1 million) in the last couple of days. This implies a rough beta of 1.0 with the market taken as a whole.

Since this was the only example with good approximate numbers and ages given, I took the liberty of trying to figure out how they would have performed in an age-appropriate fully diversified portfolio such as a target-date mutual fund over the rough ranges of dates mentioned in the article. I am going to take Mrs. Williams age of 58 as a starting point and assume they will retire at age 65 in 7 years, i.e. the year 2015.

For no particular reason, I will pick the Fidelity Freedom 2015 Fund as their theoretical investment fund and see what happens next. Assume 4 months ago, from the date of the article (May 19, 2008), they had $1,000,000 worth of shares in this fund.

The NAV on 5/19/08 was $12.11/share, so lets say they had 82,576.383 shares for there $1 million. The closing NAV on Thursday, 9/18/2008, the day just before the publication date of the article was $10.74/share. Their account would have been worth 82,576.383 X 10.74 = $886,870.35. This represents a nominal non-annualized loss of 11.31%.

By way of comparison, if they had been invested 100% into the S&P 500 index (a popular benchmark) over the same time period, the real nominal return would have been -15.10%. So their $1 million portfolio would have lost $151,000 which is still less than the $170,000 quoted in the article. This implies a beta of more than 1.0 of their portfolio! (I invite any readers with more insight into investment strategies to help me make sense of this via comments.)

Again, stories of four baby boomers in their mid- to late-fifties terribly close to retirement age, is not a "statistically significant" sample to base any theories on, but they hold important lessons for anyone contemplating retirement over the next 5-10 years.

Last month I wrote similarly about a report in the Dallas Morning News in which I said: "However, these are cautionary tales at best - with coded messages for both retirement savers as well as policy makers. Social Security by itself is not enough, guaranteeing in some locales around the country barely a poverty-level monthly benefit payment, and a purely market-based defined contribution savings system that is too volatile to give savers peace of mind in their sunset years."

A Word on Vanguard Money Market Funds

In an encouraging sign after the news of the Reserve Primary Fund breaking the buck yesterday, Vanguard Funds came clean today on the state of their money market funds. Their release dated today on their website says:

The recent bankruptcy filing by Lehman Brothers Holdings Inc. and widespread turbulence in the financial markets have prompted a number of questions about the impact on Vanguard funds, including money market funds.

Vanguard is confident in the stability of its money market funds, all of which are managed with the objective of maintaining a stable net asset value of $1 a share. Vanguard continues to manage its money market funds very conservatively and with extreme prudence, focusing on high quality, short-term money market instruments.

All of the investments in our money market funds are closely examined by our Fixed Income Group's highly skilled and experienced credit analysts. Analysts assess the quality of each underlying issuer through in-depth credit analysis and do not rely on agency credit ratings.

Our largest money market fund is Vanguard Prime Money Market Fund, which currently holds more than half of its assets in U.S. Treasury and federal agency securities. In addition, Prime Money Market Fund has no exposure to money market instruments issued by securities dealers, including Lehman Brothers. It also has no exposure to securities of AIG, the insurance concern that is being supported by loans from the federal government.

Holdings of Vanguard Prime Money Market Fund (as of 8/31/2008)
U.S. Treasury: 36%
U.S. Agency: 17%
Certificates of deposit: 32%
High-quality commercial paper: 14%
Repurchase agreements: 1%

Old News Now - AIG taken over by Taxpayers

If you watched cable news or surfed the internet tonight, a version of this headline (from Bloomberg.com - By Hugh Son, Erik Holm and Craig Torres) was all over the place: "AIG Gets $85 Billion Fed Loan, Cedes Control to Avoid Collapse."

The official press release from AIG's website is as follows:

Sept. 16, 2008--The Board of Directors of American International Group, Inc. (NYSE:AIG) issued the following statement in response to today's announcement by the Federal Reserve Board that the Federal Reserve Bank of New York is providing a two-year, $85 billion secured revolving credit facility to AIG that will ensure the company can meet its liquidity needs:

"The AIG Board has approved this transaction based on its determination that this is the best alternative for all of AIG's constituencies, including policyholders, customers, creditors, counterparties, employees and shareholders. AIG is a solid company with over $1 trillion in assets and substantial equity, but it has been recently experiencing serious liquidity issues. We believe the loan, which is backed by profitable, well-capitalized operating subsidiaries with substantial value, will protect all AIG policyholders, address rating agency concerns and give AIG the time necessary to conduct asset sales on an orderly basis. We expect that the proceeds of these sales will be sufficient to repay the loan in full and enable AIG's businesses to continue as substantial participants in their respective markets. In return for providing this essential support, American taxpayers will receive a substantial majority ownership interest in AIG.

"We commend the Federal Reserve and the Treasury Department for taking this decisive action to address AIG's liquidity needs and broader financial market concerns. We thank them for their leadership during this critical time for the global financial markets. We also thank Governor Paterson, Commissioner Dinallo, Commissioner Ario, the other state Commissioners, and the Office of Thrift Supervision for their willingness to assist AIG.

"Policyholders of AIG companies around the world can rest assured that AIG's commitments will continue to be honored."

It should be noted that the remarks made in this press release may contain projections concerning financial information and statements concerning future economic performance and events, plans and objectives relating to management, operations, products and services, and assumptions underlying these projections and statements. It is possible that AIG's actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these projections and statements. Factors that could cause AIG's actual results to differ, possibly materially, from those in the specific projections and statements are discussed in Item 1A. Risk Factors of AIG's Annual Report on Form 10-K for the year ended December 31, 2007, and in Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations of AIG's Quarterly Report on Form 10-Q for the period ended June 30, 2008. AIG is not under any obligation (and expressly disclaims any such obligations) to update or alter its projections and other statements whether as a result of new information, future events or otherwise.

American International Group, Inc. (AIG), a world leader in insurance and financial services, is the leading international insurance organization with operations in more than 130 countries and jurisdictions. AIG companies serve commercial, institutional and individual customers through the most extensive worldwide property-casualty and life insurance networks of any insurer. In addition, AIG companies are leading providers of retirement services, financial services and asset management around the world. AIG's common stock is listed on the New York Stock Exchange, as well as the stock exchanges in Ireland and Tokyo.


CONTACT: American International Group, Inc.
Charlene Hamrah (Investment Community)
212-770-7074
or
Nicholas Ashooh (News Media)
212-770-3523

SOURCE: American International Group, Inc.

There are millions of 401(k) and 403(b) participants whose accounts are administered by AIG VALIC (collectively AIG Retirement Services). I am sure there are burning questions in their minds as to the safety of their accounts.

Participants in plans administered by AIG might be a little relieved to note that their accounts are safe. AIG had a press release tonight to help address some of these concerns. The text of the release is as follows:

NEW YORK--Sept. 16, 2008--American International Group, Inc. (AIG) today said that AIG's life insurance, general insurance and retirement services businesses, including its extensive Asian operations, continue to operate normally and remain adequately capitalized and fully capable of meeting their obligations to policyholders.

AIG continues to pursue alternatives to increase short-term liquidity in the parent company. Those plans do not include any effort to reduce the capital of any of its subsidiaries or to tap into Asian operations for liquidity.

The insurance policies written by AIG companies are direct obligations of its regulated subsidiary insurance companies around the world. These companies are well capitalized and meet or exceed local regulatory capital requirements. The companies continue to operate in the normal course to meet obligations to policyholders. In particular, AIG noted its long tradition of service in Asian markets, which are key to AIG's future growth. Founded in Shanghai in 1919, Asia is home to some of AIG's oldest and most valued clients.

The AIG companies are fully committed to maintaining required capital levels in all of its subsidiaries and to meeting the needs of their customers around the world.

American International Group, Inc. (AIG), a world leader in insurance and financial services, is the leading international insurance organization with operations in more than 130 countries and jurisdictions. AIG companies serve commercial, institutional and individual customers through the most extensive worldwide property-casualty and life insurance networks of any insurer. In addition, AIG companies are leading providers of retirement services, financial services and asset management around the world. AIG's common stock is listed on the New York Stock Exchange, as well as the stock exchanges in Ireland and Tokyo.

CONTACT:
American International Group, Inc.
News Media:
Nick Ashooh, 212-770-3523

Investment Community:
Charlene Hamrah, 212-770-7074

Reserve Funds - Primary Money Market Fund Valued at 97 cents on the Dollar

The Reserve Funds' Primary Fund has been revalued at an NAV of $0.97. (Hat tip = CalculatedRisk) The Reserve is considered a pioneer of Money Market funds. The Reserve (Reserve Management Company, Inc.) is also the parent company of Reserve Solutions, the company that recently pioneered the marketing of 401(k) debit card loans.

The press release from The Reserve:

September 16, 2008

The Board of Trustees of The Reserve Fund, after reviewing the unprecedented market events of the past several days and their impact on The Primary Fund, a series of The Reserve Fund and taking into account recommendations made by Reserve Management Company, Inc., the investment manager of The Primary Fund, approved the following actions with respect to The Primary Fund only:

The value of the debt securities issued by Lehman Brothers Holdings, Inc. (face value $785 million) and held by the Primary Fund has been valued at zero effective as of 4:00PM New York time today. As a result, the NAV of the Primary Fund, effective as of 4:00PM, is $0.97 per share. All redemption requests received prior to 3:00PM today will be redeemed at a net asset value of $1.00 per share.

Effective today and until further notice, the proceeds of redemptions from The Primary Fund will not be transmitted to the redeeming investor for a period of up to seven calendar days after the redemption. The seven-day redemption delay will not apply to debit card transactions, ACH transactions or checks written against the assets of the Primary Fund provided that any such transaction from an investor, individually or in the aggregate, does not exceed $10,000. The Primary Fund will continue to accept purchase orders.

Effective tomorrow, September 17, 2008, the NAV for the Primary Fund will be
calculated once a day at 5:00PM, New York time.

...Another Lehman casualty.

PIMCO, Vanguard Funds Hit By Lehman Bankruptcy

John Glover of Bloomberg News reports: "Pimco, Vanguard Are Biggest Lehman Bond Fund Losers."

Pimco Advisors LP, Vanguard Group Inc. and Franklin Advisers Inc. are among investment companies that may face losses of at least $86 billion stemming from the collapse of Lehman Brothers Holdings Inc., the biggest bankruptcy in history.

"Disaster for Public Confidence"

"The losses look set to be widespread, hurting the public through their mutual and pension funds,'' said Ciaran O'Hagan, a credit strategist at Societe Generale SA in Paris. ``It's clearly a disaster for public confidence.''

Pimco holds Lehman bonds in at least 12 of its funds, including the $134 billion Total Return Fund. Bill Gross, manager of the fund and co-chief investment officer of Pimco, was buying Lehman bonds as recently as June, Bloomberg data show.

...

While Gross may have lost on Lehman investments, he gained from those in Fannie Mae and Freddie Mac. His Total Return Fund made a $1.7 billion gain after the U.S. government seized control of the two mortgage-finance companies, Bloomberg data show. The fund's assets rose 1.3 percent to more than $134 billion on Sept. 8, according to Bloomberg. It has returned 4.19 percent this year, beating 98 percent of similar funds, Bloomberg data show.

Vanguard holds Lehman bonds among the $450 billion of fixed income it manages, spokesman John Woerth said. An outside spokeswoman for Pimco in London, who asked not to be named, said the company had no immediate comment, Lisa Gallegos, a spokeswoman for Franklin in San Mateo, California, wasn't immediately available.

AXA, Fidelity and Legg Mason have not been spared on the equity side either:

Axa SA, Europe's second-biggest insurer, and unnamed affiliates, own 7.25 percent of Lehman's equity, according to the filing. Clearbridge Advisers LLC, the asset manager that Baltimore-based Legg Mason Inc. acquired from Citigroup Inc. in 2005, held 6.33 percent, according to the filing. Boston-based FMR LLC, the parent of Fidelity, the world's largest mutual fund company, held 5.9 percent, the filing said.

Weekend DOL Blotter - 9/14/2008

"U.S. Labor Department obtains civil contempt order against trustees of California-based health benefit fund."

A federal district court in Atlanta has held two former trustees of the California-based International Union of Industrial and Independent Workers Benefit Fund (IUIIW) in civil contempt for failing to comply with a previous court order barring them from serving in a fiduciary capacity to plans governed by the Employee Retirement Income Security Act (ERISA).

Under the contempt order, Geoffrey Beltz and James Miller are barred from serving in a fiduciary capacity to any plans governed by ERISA; communicating with participants of the IUIIW fund; and marketing, selling and recruiting employers or employees for plans offering benefits under ERISA. Furthermore, to the extent that Beltz or Miller work for any employer, association or labor organization which sponsors an ERISA-covered employee benefit plan in the future, the contempt order requires them to notify the directors and officers of such organizations of the terms and requirements of the contempt order.

...

Under the 2004 court order, the fund’s trustees were required to pay $840,000 in restitution to the fund and to pay civil penalties to the federal government. The trustees were also barred from serving as plan fiduciaries.

The Labor Department alleged in the 2004 lawsuit that improper actions by Beltz, Miller and other trustees to a health fund sponsored by the International Union of Industrial and Independent Workers resulted in several million dollars in unpaid health claims. The fund, which purported to be a union-sponsored benefit plan, was marketed to employers and individuals in Texas, Georgia, Oklahoma, California and many other states. Several states, including Oklahoma and Georgia, ordered the fund’s operators to stop all insurance-related activities.

Beltz and Miller admitted they later violated the 2004 contempt order by directly or indirectly controlling an ERISA-covered health plan offered by the International Union of Industrial and Independent Workers Local 30, another purported labor organization. The contempt order was entered in federal district court in Atlanta.

International Union of Industrial and Independent Workers
Civil Action No. 1:04-CV-0934-BBM