Fed to consider new lending regulations to curb abuses

Fed to consider new lending regulations to curb abuses

In a letter to Senate Banking Committee chairman Christopher Dodd, Federal Reserve Chairman Ben Bernanke said the regulatory agency would consider new regulations to curtail abusive lending, but wanted to make sure to avoid issues with legitimate credit. "With respect to the recent problems in the subprime mortgage market, the Board plans to consider how it might further use its rulemaking authority ... to address particular lending practices," Bernanke wrote.

"We are mindful, however, that loan terms that may be harmful to some borrowers may provide benefits in other transactions."

Fed chief vows to review lending rulesBernanke says he'll consider rulemaking authority amid problems in the subprime mortgage market.

May 25 2007: 12:03 PM EDT WASHINGTON (Reuters) --
The Federal Reserve will consider whether new regulations could curtail lending practices that have contributed to a rise in mortgage delinquencies, Fed Chairman Ben Bernanke said in a letter released Friday.

"With respect to the recent problems in the subprime mortgage market, the Board plans to consider how it might further use its rulemaking authority ... to address particular lending practices," Bernanke said in a May 18 letter to Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat.

At the same time, the Fed will tread carefully to avoid choking off legitimate credit, Bernanke said.

"We are mindful, however, that loan terms that may be harmful to some borrowers may provide benefits in other transactions," he wrote.

"Accordingly, any rules should be tailored to avoid the unintended and undesirable consequences of limited credit availability in legitimate transactions," he said.
The Fed is due to hold a hearing June 14 on rules governing lending.

A slowdown in house price gains and rising interest rates have led to a jump in delinquencies and foreclosures in the United States, particularly among borrowers with weak credit who took out loans with adjustable rates.

The rise in delinquencies and the failure of numbers of lenders in the subprime mortgage sector, as the market for loans to borrowers considered greater credit risks is called, exposed loose lending practices.

Dodd, a presidential candidate, has criticized the Fed's oversight of subprime mortgage lenders. The Fed is required to write rules to protect borrowers from unfair or deceptive practices, he has said.
The Connecticut lawmaker urged the Fed to issue rules that would require lenders to fully evaluate a borrower's ability to repay and to restrict lending with little or no documentation of the borrower's income or ability to make payments.

"These protections, while not comprehensive, will stem some of the most abusive practices we see in the marketplace today," he said Friday in a statement.

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mortgage backed securities, subprime, real estate

What to Do With $2,500

What to Do With $2,500: Advice for Young Investors

After a few years in the workforce we may find ourselves with a little extra cash. Maybe it's a delightfully large tax refund or an apartment deposit you finally got back, but it's the first significant sum of money you've had that doesn't need to be spent paying back loans or furnishing an empty apartment. For the first time, you want to save or invest that money, instead of spoiling yourself with a spray-on-tan.

I spoke with five financial advisers about what a young investor should do with a small windfall: $2,500. I created a profile of a twentysomething novice investor who doesn't have debts and is diligently paying into a 401(k). Investor X doesn't necessarily want to lock up this money until retirement. He or she may want to buy a house, fund a year off or have something socked away in case of a car crash or other emergency.

After each planner made a recommendation, I asked for numbers on the performance of their picks from the beginning of 2002 until this May.

Set up a Roth IRA
Charles Buck, a financial planner in Woodbury, Minn., recommends that you set up a Roth IRA, as he did for his 27-year-old son. The nifty thing about the Roth is that we don't have to pay taxes when we finally withdraw the money after age 59 ½. We don't get a tax refund now on our contributions, but it's likely that we'll enter a higher tax bracket by retirement and will thus save the difference in taxes. In special cases, like when buying a home for the first time, all of the money in a Roth IRA can be tapped pre-retirement without penalties. We can also withdraw our contributions -- but not returns -- early without penalties. Keep in mind Roths are only for singles who make less than $110k or marrieds who make less than $160k.

Mr. Buck advises that the twentysomething investor's Roth IRA include shares in a diversified mutual fund targeted for retirement withdrawal in 2045. "Target-date funds are good for young people," he says: "Pick a fund, forget about it and it takes care of itself." Mr. Buck's fund pick is the T. Rowe Price Retirement 2045 Fund1. It charges a fee of 0.76%. T.Rowe Price has reported returns of 17.01% from the fund's inception on May 31, 2005 to April 30, 2007.

Put Something Aside First
Richard Rosso, a Charles Schwab financial planner in Houston, recommends setting your $2,500 aside in an emergency reserve for six months of living expenses. "Keep $1,000 in a CD that matures in 6 months, $1,000 in another that matures in 12 months, and put $500 in a savings account in case you need to change your tires or replace an air conditioner," he says. (For more info on CDs, see WSJ.com's savings center2 from Bankrate.com)

If you already have a reserve, Mr. Rosso says you should use the money for living expenses and increase your salary deferral to your 401(k) to benefit from employers' matching contributions.

"If all this is done," says Mr. Rosso, "I would contribute to the Roth IRA…invest in a way that's fully diversified." The mutual fund Mr. Rosso recommends is the Schwab Total Stock Market Index Fund, which contains a large amount of U.S. stocks and charges a fee of 0.53%. Schwab reports a five-year annualized return of 7.43% for the fund. Setting up a Roth or traditional IRA through the brokerage's Web site is free. The other large financial services firms I mention in this column also offer free Roth IRA enrollment.

ETFs, ETFs, ETFs
For the young person who is eager to learn about securities and actively manage his or her own portfolio, exchange-traded funds are an option. An ETF tracks an individual stock index such as the S&P 500 or a specific asset class such as real estate, currencies or gold. Unlike mutual funds, ETFs trade on a stock exchange or in an electronic market. Expenses tend to be lower, and ETFs that track a multitude of securities may not be as much of a gamble as an individual stock.
Kim Arthur, an investment adviser in San Francisco, doesn't invest on behalf of people with less than $1 million dollars, but if he were your mom's best friend he might tell you, over lunch, that you should build a diversified ETF portfolio and rebalance it every year. His firm, Main Management, only manages ETF portfolios. He likes their transparency, tax efficiency and low expenses. The goal: "10%-type returns with lower volatility than the stock market."

The blend Mr. Arthur recommends, and calls "all asset lite," contains five different ETFs weighted at different percentages. For stocks: 30% Vanguard Total Market and 30% State Street Developed and Emerging Market. For bonds: 20% iShares 3-7 year Treasury. For commodities and real estate: 10% PowerShares DB G10 Currency Harvest Fund and 10% State Street International REIT. "It's diversification at a low price," he says, "there are over 2,000 stocks in this blend." Though many of these ETFs didn't exist five years ago, Mr. Arthur calculates that based on their underlying indexes, an investment of $2,500 would have returned an annual average of 12.91% between 2002 and now.

The expenses of an ETF are twofold: Those charged by the fund -- an average of 0.29% for all of Mr. Arthur's recommendations -- and broker trading fees. At TradeKing.com5, for example, you will pay $4.95 per trade. Re-balancing your portfolio back to the original asset weightings every year will cost $25. Mr. Arthur says these ETFs have a lot of assets and thus won't suddenly shut down, as some ETFs with lower net assets have recently done. (Read more about ETFs here6.)

Be Aggressive
If you expect to sell your shares ten years from now to purchase a house or pay a smidgen of your graduate-school tuition, financial planner Kathy Hankard says you want to be pretty aggressive and should invest in a mutual fund that is comprised mostly of stocks, with some short-term bonds. "You don't want to risk not making enough money and inflation eroding the value," says Ms. Hankard, whose firm is based in Verona, Wis.

She suggests the Vanguard Star Fund, for its low fees: 0.35%. It is the only fund that Vanguard offers for investors with less than $3,000. Made up of 11 mutual funds, the "fund of funds" invests 62% in stocks, 25% in bonds, and 13% in short-term bonds. Vanguard's Fran Kinniry, a principal of investment counseling and research, says it's good for investors with a five-20 year horizon, and gives broad diversification. Vanguard lists the fund's annualized five-year return as 8.26%.

Take the Bond Route
One planner recommended bonds for young people who don't know how their financial needs will flesh out.

"So many things are going to change in your twenties that it's possible you're going to need some of this money," says Christine Fahlund, a senior financial planner at T. Rowe Price in Baltimore. When Ms. Fahlund's son inherited some money and stashed it away in a conservative money market account, she thought that was correct. "You don't want to be in stocks with this money, and you have a lot of issues on your mind right now." Ms. Fahlund remembers telling him, "you might use it next year." She recommends using $2,000 of your $2,500 on a mutual fund that's heavy in bonds, the T. Rowe Price Spectrum Income Fund (with fees of 0.70%), and putting the other $500 in a conservative money market fund, her company's Prime Reserve fund (0.60% fees).

T. Rowe reports a five-year annualized return of 8.16% for the Spectrum fund and 2.21% for the Prime Reserve fund.

When many of us get a bit of extra cash, we consult a list to choose between a new laptop or a trip to some hot place with scuba diving. Perhaps we shy away from saving or investing because we're intimidated. Don't be.

The risks of stocks are serious – you can lose your money -- and should be considered whenever a mutual fund is heavily weighted in stocks. Intermediate government bonds, a more conservative option, will yield negative returns extremely rarely, but they will not likely return more than 8% per year, according to charts going back to 1966 by Morningstar Inc. High-yield bonds, on the other hand, are loans to companies that might default and never return your cash -- but if they do, your return will be a percentage that's typically higher than that of government bonds. The Merrill Lynch High Yield Master II Index, a benchmark, has average five-year returns of 10.36%.

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investments, young investors, financial plan, savings, ETFs, mutual funds

Best Affordable Suburbs: Midwest U.S.

Best Affordable Suburbs: Midwest
Dreaming of idyllic and inexpensive suburban life? Head to the heartland
by Maya Roney

Think of Midwest suburbia, and you may picture squeaky-clean streets lined with identical single-family homes and friendly neighbors who bring over fresh-baked pies. You may imagine a place where you can let your children play outside and leave your door unlocked without a worry in the world.

Of course, this is an exaggeration—the Midwest has its fair share of economically depressed cities, and it's certainly not crime-free. We do know of a few places, however, that live up to the region's idyllic stereotype. And you'll be pleased to discover that in the Midwest, you don't always have to pay a premium price for the good life.

In part three of our four-part series on America's Best Affordable Suburbs by region—after the first installment on suburbs in the Northeast and the second on suburbs in the West—the places on our list of the Best Affordable Suburbs in the Midwest, compiled with Portland (Ore.)-based research group Sperling's BestPlaces, have the best combination of affordability and quality that we have seen in any U.S. region so far. Half of the suburbs on the list have a median home price below $239,800, and only five of the 25 have median home prices above $300,000. The average cost of living index among these suburbs falls just short of the average for the country (100), at 98.4.

In many other parts of the country, schools and safety suffer as affordability increases, but this doesn't seem to be the case in the Midwest. The secondary school test score indexes on our list range from 93.2 (Rochester, Minn.) to 210.5 (Columbia, Mo.), compared to each state's average of 100. The average violent crime index on the list is just 57, vs. the nation's average of 100—so you may be able to leave that door unlocked after all.

The Best in Chicagoland
To be sure, finding a high-quality, inexpensive suburb outside Chicago—the third most populous city in the U.S. and the Midwest's largest city by a long shot—is a tougher task than finding a place to live in some of the region's less-populated spots.

You could do far worse than Lake Zurich, Ill., a village of about 19,000 residents roughly a 40-minute drive northwest from the Windy City. "It's a great place to raise a family," says Sadie Winter, a realtor with Century 21 Premier Properties in neighboring Glenview, Ill. "It has a small-town feel."

The almost rural scenery, complete with lakefront beaches and parks, makes Lake Zurich a kind of oasis in an area that also houses the headquarters of such major companies as Boeing (BA), Motorola (MOT), McDonald's (MCD), and Sears (SHLD). Settled in the 1830s and incorporated in 1896, it remained a farming community before developing into a popular summer resort in the late 1920s. Housing development began in the 1950s, and in 2006 the village broke ground for a downtown redevelopment.

Lake Zurich's above-average school system (test score index: 111.5) and virtually nonexistent crime rate (violent crime index: 29) complement its aesthetic appeal. "When you have good schools for an affordable price, of course everybody flocks there," says Winter. And while the town's median home price of $659,900 is the highest on our list, there are plenty of fine homes at lower price points in the district. Winter says she and business partner Dana Cohen were recently showing brand-new, three-bedroom homes in Lake Zurich in the $400,000 range. In the town's Forest Lake neighborhood, similar-size homes are priced in the $300,000s, Winter adds. While these homes tend to be older, it's the same school district.

Wisconsin Wonder
Sitting just above Illinois and sharing the Western shore of Lake Michigan, the state of Wisconsin, known to many as the nation's leading cheese producer and the home of Miller beer, may now have another claim to fame—there are six Best Affordable Suburbs here, more than in any other Midwestern state.

The towns of DeForest, Wausau, Waukesha, Green Bay, and Sheboygan all make the top 25, but Appleton, Wis., stands out from the rest with a median home price of just $119,500, the lowest on our list. This small city (pop. 70,000) on the Fox River near Lake Winnebago is big on cleanliness and tough on crime—the violent crime index is 50. Appleton schools also stand out—the test score index is 110.3, vs. the state's average of 100.

It's an easy day trip to Milwaukee (89 miles), but you don't need to leave Appleton for jobs or entertainment. "It's still a small town, but we've got a lot of big-city conveniences," says Richard DeKleyn, a Coldwell Banker realtor and lifetime Appleton resident. Electronics manufacturing services company Plexus (PLXS) is based in nearby Neenah, and paper-product maker Kimberly-Clark (KMB) is a big employer. A touring production of the Broadway show The Lion King is currently playing in downtown Appleton's performing arts center, and this summer the city plans to throw a 150th anniversary bash.

But it's Appleton's truly affordable way of life that really reels in the out-of-state home buyers. "New York people especially like our prices," says DeKleyn, who recently sold a nearly new, three-bedroom ranch home for $189,900. "We even had some buyers from London a little while ago. They are so happy, they're going to pay cash."

BusinessWeek.com's slide show looks at the 25 Best Affordable Suburbs in the Midwest.

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real estate, affordable housing, suburban development, home builders, home ownership

Checking Out China Funds

Checking Out China Funds
Managers still see solid opportunities away from Shanghai's frenzy. Here are five savvy playsby David Bogoslaw

Alan Greenspan may have warned of a possible "dramatic contraction" in Chinese equities in a May 23 speech, but investors appear so far to be unfazed. Despite the bubble talk, many fund pros are still focused on opportunities in the Middle Kingdom.

When investors think of opportunities to make money in China, companies riding the wave of huge exports are typically the first to spring to mind. But fund managers have begun to pay attention to stocks whose fortunes are tied more to growth in the domestic market, as the sizzling Chinese economy creates a widening population of eager consumers.

With China's economy growing at around 11% a year, investors are looking for ways to grab a piece of the action. Although the current Year of the Pig may excite investors with visions of becoming fat, happy, and prosperous, a note of caution is in order: Investors should be wary of gorging themselves amid what appears to be a stock-market bubble to many economists (see BusinessWeek.com, 5/18/07, "China Tries to Turn Down the Heat").

Consider the relatively new Shanghai Stock Exchange, whose composite index has jumped 50% since the beginning of the year. Some fund managers are steering clear of the index, warning that its sharp and sudden gains reflect a torrential inflow of domestic money with nowhere else to go at the moment. That's bound to change as the government's Qualified Domestic Institutional Investor (QDII) plan, which would allow a greater portion of domestic funds to be invested in other markets, gains traction, albeit ever so slowly. The government quota on how much money can be invested outside the country is a paltry $15 billion to $17 billion, chump change compared with China's $2.6 trillion economy.

With an eye toward prudence, some portfolio managers who wish to play China are sticking to stocks that list in Hong Kong, where transparency and corporate governance are far better than on the mainland. While economic growth is expected to moderate in 2007 due to slowing U.S. export demand, the continued rise in property prices is likely to support local investor sentiment in the months ahead, according to a May research note from Aberdeen Asset Management.

Obviously, investing in China carries notable risks. Investors who want some exposure to one of the world's most dynamic economies may want to do some homework first. With that in mind, this week's Five for the Money looks at a few funds with sizable exposure to China that remain open to new investors.

1. Guinness Atkinson China & Hong Kong Fund (ICHKX)
This $172 million fund has been making money by focusing on companies staking a claim in the infrastructure boom. That includes energy companies with ADRs trading on U.S. exchanges such as CNOOC (CEO), PetroChina (PTR), and Yangzhou Coal, and industrials such as Angang Steel and Dongfang Electrical Machinery.

Dongfang is one of the two largest domestic manufacturers of electrical turbines, which are in great demand in "a country installing the equivalent of the U.K. national grid every year," says Edmund Harriss, who has co-managed the fund since 1998.

He prefers Dongfang to its competitor Harbin Power, which he faults for over-diversifying, and points to Dongfang's slimmer balance sheet; cleaner, more straightforward business focus; and superior returns on investment.

In the auto industry, Harriss has been a buyer of Denway Motors, which, through a joint venture with Honda Motor (HMC), makes the Honda Accord and Odyssey for the Chinese market. There has been a general upgrade in the car models available to Chinese consumers; they're now as good as anything being sold in the U.S. or Europe, he says.

Harriss advises investors interested in China to avoid getting caught up in the vaunted huge growth story and instead to drill down into particular market niches, with the aim of finding those companies that have genuinely been generating high growth, beating their competitors, and capturing higher margins. The fund has a 70% weight in Hong Kong-listed stocks, with the other 30% invested in Hong Kong-based companies doing business in other parts of Asia.

2. Oberweis China Opportunities Fund (OBCHX)
Managed by James Oberweis since its launch in October, 2005, the China Opportunities Fund is taking cues from the explosion in consumer buying power on the mainland. Looking beyond the 20 largest companies favored by most institutional investors, Oberweis is buying up shares of second-tier companies that have strong retail potential.

"This is a country where the biggest consuming class in the world is likely to develop over the next 20 years, and it's already happening," he says. That creates an opportunity for retailers to develop brands—and they stand to profit nicely by doing it sooner rather than later.

Li Ning (LNNGF), which makes athletic shoes, is an obvious choice, since domestic sports-apparel manufacturers are well-positioned to go up against international rivals like Nike (NKE) in catering to domestic Chinese demand with their lower prices. But an equally savvy way to play the surge in consuming power is the advertising market, Oberweis says.

He points to the focused approach Focus Media (FMCN) is taking, targeting affluent consumers by placing flat-panel display screens in the lobbies of large office buildings in China's biggest cities. With a 95% market share in this area, Focus Media nearly tripled its sales in 2006 from the prior year, with sales expected to nearly double this year. Focus Media is a Chinese-owned company based in Shanghai, but its shares trade only as ADRs on the NASDAQ exchange.

Oberweis is also leery of shares trading on the Shanghai Stock Exchange and says the bulk of his portfolio is in H shares of Chinese companies, or those listed on the Hong Kong Stock Exchange, which can be bought for half the cost of Shanghai-listed A shares. Once the government's QDII scheme takes hold and is expanded beyond the initial quota of $17 billion, he expects prices of H shares to rise and prices of A shares to drop, as investors take advantage of arbitrage opportunities between the two markets.

"We're not buying for the arbitrage opportunities. We're buying because we think they're good companies. And [buying H shares] is the cheapest way for us to invest in those companies," he says. Oberweis has $825 million in assets under management.

3. U.S. Global Investors China Region Opportunities Fund (USCOX)
For 2007, this $90 million fund is pushing the theme of "asset-injection" plays as an easy concept for investors to wrap their minds around. Romeo Dator, who has co-managed the fund for the past five years, is betting on Hong Kong-listed names that are buying assets at hefty discounts to market prices from their government-controlled parent companies on the mainland. "It's a way for the parent company to realize the benefits of getting these assets off their books, and the government getting out of the business of owning some of these companies," Dator says.

The bonus is that this is happening mainly to resource companies at a time when the massive infrastructure buildup in China has stoked demand for these products. The stock price of China's premier copper producer, Jiangxi Copper, is up at least 50% since it bought cheap copper mines from its parent earlier this year. And coal producers China Coal Energy and China Shenhua Energy should see comparable gains after their asset injections, Dator predicts.

The China Region Opportunities Fund also favors health-care suppliers such as Shandong Weigao, a manufacturer of female sanitary napkins and other health-care-related products. Dator says he believes these stocks will benefit from the emphasis the Chinese government has placed on health-care spending in its latest five-year economic plan.

The fund's turnover rate was 200% in 2006, the result of the managers' decision to prune their holdings and take profits following dramatic runups in stock prices across the board.

4. Eaton Vance Greater China Growth A Fund (EVCGX)
Portfolio manager Pamela Chan is also a great believer in the profit potential of branding. She likes high-end department stores such as Ports Design, Peace Mark, and Parksons that have come to dominate the market thanks to strong brand recognition.

With the infrastructure development in China showing no sign of abating, she's also a fan of building-materials manufacturers such as Anhui Conch and China National Building Materials. These companies are benefiting from ongoing consolidation within the cement industry, which has been aided by government policy stressing sustainable growth. That has driven out highly polluting kilns, which had been a source of excess supply and low pricing in recent years.
Chan thinks the property sector is another attractive bet amid rising income levels and the ability of developers to increase their land-banks, she wrote in an e-mail message.

5. Dreyfus Premier Greater China A Fund (DPCAX)
Don Martin, president of Mayflower Capital, a California-based financial adviser, recommends this fund, which invests in midcap growth stocks. With 20% of its portfolio allocated to consumer-discretionary names, 17% to industrials, and 15% to financial companies, he sees Dreyfus' China fund as a safer bet than some other options that are too heavily weighted in financials and more vulnerable should the volatile China market crash.

To avoid the potential for capital-gains taxes of around 30%, which would be triggered if portfolio managers started selling off shares of stocks, Martin advises new investors who haven't benefited from the stock gains to buy through a fee-only planner that can get the load fee waived on these funds.

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china, foreign investment, mutual funds

Homebuilders in a Hole

Homebuilders in a Hole

Battered by the bust, they're filing for Chapter 11 and begging hedge funds for help
by Dean Foust and Dawn Kopecki

When Kara Homes began building Horizons at Birch Hill, a community for active seniors, the plans were ambitious: 228 spacious residences that weren't typical cookie-cutter McMansions. But four years later, the project in Old Bridge, N.J., has been abandoned by Kara, which is now in Chapter 11. A dozen or so homes stand unfinished, the front doors swinging in the wind, and the half-built clubhouse bears a large "Unsafe for Human Occupancy" sign.

"It's not a great situation, but we're all hanging together," says Frank Ramson, one of the development's 70-odd homeowners. "What's killing us is the uncertainty of how long it might take another builder to step in."

Ramson isn't alone in his angst. The downturn in the housing market has caught the nation's homebuilders by surprise, leaving many overextended with costly land they can't develop and unfinished homes they can't sell. The financial strain is starting to show. From Arizona to Arkansas, dozens of small- and midsize builders have filed for bankruptcy over the past six months.

And in late April, credit analysts at Moody's Investors Service (MCO) warned that a number of large homebuilders could fall out of compliance with their debt agreements later this year, leaving them at risk of default unless lenders come to their rescue by agreeing to rework their loans. Some builders are so desperate, in fact, that they're even running into the arms of hedge funds to bail them out with fresh loans at high rates and onerous terms.

More Bankruptcies?
Wall Street certainly has its concerns about the industry. This year the price of credit default swaps—in effect, a tool for bondholders to hedge their risks—has risen sharply for several large builders, including Pulte Homes (PHM), Toll Brothers (TOL), and D.R. Horton (DHI). Toll Brothers Chief Financial Officer Joel Rassman says: "The people buying the swaps may think it's riskier, but the people actually buying our paper don't [because our spreads with Treasuries are shrinking]."

But for the industry as a whole, there may be even more problems waiting just below the surface since many builders entered into big land deals with partners, amassing billions in debt that doesn't show up on their balance sheets. "I think we're going to see a lot more [bankruptcy] filings in the next 6 to 12 months," says Tucson attorney Eric Slocum Sparks, who is representing one local builder, AmericaBuilt Construction, in Chapter 11. "I've got a couple of clients who want to see me next week, and I know these aren't social visits."

The extent of the industry's woes will depend on where housing heads from here. So far analysts and executives alike are unsure whether, or by how much, the slump will deepen. But the trends aren't pretty. The National Association of Realtors now predicts that new-home sales are likely to drop 18% this year, a bleaker scenario than the 9% decrease in the February forecast.

Daring Bets
Nonetheless, the current generation of builders entered this downturn with far better balance sheets than their brethren in the last housing bust during the late 1980s. And barring a total collapse in the market, lenders are also likely to offer a safety net, making concessions to keep the builders afloat in the near term. "I expect the lenders will be willing to work with them," says Fitch Ratings analyst Robert Rulla. "They'll want to maintain that relationship for when the turnaround comes."

Still, those lifelines can come at a big cost, namely higher interest rates, special loan modifications, and tough new stipulations that restrict everything from the builder's right to repurchase shares to its ability to take on new debt for future expansion.

For some, the white knights may be hedge funds. Consider the plight of Dominion Homes (DHOM), an Ohio-based builder that sold $257 million worth of homes last year. When Dominion fell close to default last August on $216 million in bank debt, hedge fund Silver Point Finance bought the loans and negotiated tough terms. Some $90 million of the refinancing came with an interest rate of 15%, vs. the 9.25% Dominion had been paying.

Silver Point also stipulated that it could receive a 15% stake in Dominion in the event of default. "The [fund was] willing to go where no other regulated institution would go," says Ronald F. Greenspan, an attorney and restructuring adviser for FTI Consulting (FCN). Dominion CFO William Cornely admits the new rates are high, but says it "affords us the opportunity to continue operations during the downturn and position us for the rebound."

Using Up Cash
If business doesn't stabilize, more builders could find themselves in the same hole in the ground as Dominion. Already, some analysts are concerned about the pace at which many builders have been burning through cash. Moody's credit analyst, Joseph A. Snider, notes that 11 of the 21 large builders whose debt his firm rates had negative cash flow in 2006 as many were stuck with higher-than-expected inventories of homes they couldn't sell.

Dallas-based Centex (CTX) took a $150 million charge after walking away from options for more than 37,000 lots nationwide and wrote down other land by roughly $300 million, triggering a 79% plunge in fiscal 2007 profits. "We still see uncertainty in many of our markets," Centex CEO Timothy Eller told analysts on Apr. 30, warning that the industry could be in the middle of a three-year correction.

More bloodletting may be ahead. Many large builders also took minority stakes in joint ventures, allowing them to stockpile land for future needs while keeping billions in debt off their balance sheets. Alisa Guyer Galperin, an analyst at the Center for Financial Research & Analysis, estimates that Lennar (LEN) is on the hook for up to $910 million of $5.6 billion in debt through partnerships not on its books.

Battles Ahead?
One fear is that if a partner runs into financial trouble, Lennar and other homebuilders could find themselves battling with lenders that demand they make good on the partnership's total outstanding debt. Florida builder Technical Olympic USA (TOA) is now embroiled in a lawsuit with one of its lenders, Deutsche Bank (DB), which claims the builder is in "multiple potential defaults" on $675 million in debt owed by joint venture partners that failed.

For its part, Lennar CFO Bruce Gross says the company has mitigated its risk by partnering with strong institutional investors like the pension fund CalPERS and has structured the deal to make sure it isn't liable for its partners. "Our joint ventures are very strategic and are designed to share the upside opportunity and downside risk with other investors," says Gross. For now, Wall Street is thinking only about the downside.

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real estate, mortgages, home builders, hedge fund returns, lending, real estate market downturn

Greenspan sends markets spinning

Greenspan's comments keep sending markets spinning

For 16 years as the Federal Reserve Board chief, Alan Greenspan issued only reserved comments about the financial industry, the economy and other weighty issues, writes David Callaway for MarketWatch. Now that he's no longer the Fed chairman, however, he seems to be constantly making comments that briefly send the markets into a tailspin, and he's been at it again this week.

Greenspan unavoidable for comment
Commentary: Free of Fed collar, former chief can't stop blabbing

By David Callaway, MarketWatchLast Update: 3:26 AM ET May 24, 2007
Anyone else grown tired yet of Alan Greenspan's Cassandra act?

The former Federal Reserve Board chief, for 16 years the epitome of economic discretion, offering only mumbled (and sometimes jumbled) assurances to weighty questions about market bubbles and global financial risk, is suddenly shouting from the rooftops.

It seems that a week can't go by without Greenspan issuing some dire warning about the markets or global economy, typically sending stocks into a brief tailspin until investors remember that he's not the Fed chief anymore. Unlike the mythical Cassandra, doomed to have nobody believe her predictions, people actually believe Greenspan.

Wednesday he was at it again, telling a conference in Madrid via teleconference that the China market is due for a "dramatic contraction."

As wire services reported the comments, what had been a nice gain for the Dow Jones Industrial Average, above 13,600, suddenly evaporated and turned into a 30-point loss. The Dow ($INDU) managed to recoup some of the losses by the end of the day, closing down 14.30 points at 13,525.65. See Market Snapshot.

Perhaps Fed Chief Ben Bernanke should give old Greenspan a call and let him know that while it's fine to go make a bundle on the chicken dinner-speech circuit after one's retirement, it's not a great idea to be going around using terms like recession and dramatic contraction to people who aren't used to hearing you say those words.

As a journalist over the past 20 years, I've heard Greenspan give many speeches. All were given in his trademark plodding style. Then I had the opportunity two years ago to hear him give a speech off the record. Suddenly he was Bill Maher, providing succinct thoughts and theories, laced with hilarious commentary. No wonder he is in such demand, now that he can speak freely. At this off-the-record speech, he warned about an impending housing crisis in the U.S., well before even the first hint of a slowdown had occurred. He also warned that the Chinese government would have to get more transparent with its financial machinations, something we're still waiting for. Let's face it, he knows what he's talking about.

So when Greenspan warns about China's stock market, it makes sense to listen. But then again, who isn't warning about China these days? Even Chinese experts are warning about China. See Todd Harrison's latest column.

That China is going to blow and blow big is a given. The question is how will that spread to the rest of the world's markets? Everyone seems pretty confident that it won't spread to the established markets, largely because Western investors have been locked out of investing in Shanghai's local market during the boom of the past year. Most economists don't even think a big fall in Chinese stocks will hurt the Chinese economy, as it speeds merrily along.

That's probably right. But while the raging bull market in China may not be tied to the rest of the world, the psychology behind it has definitely caught on. With markets in the U.S. at record highs and markets in Europe and elsewhere in Asia soaring as well, we're heading into the summer with a pretty confident feeling. Summer rally anyone?

When that type of collective mindset seeps in, and you've got people talking about the stock market going straight up for another year - or two -- it's a recipe for a surprise rout one day, or week, or month.

Greenspan hasn't warned us about that yet. But he's probably got at least two or three more speeches coming before the end of the month, so anything can happen.
The only thing we shouldn't be when a big rout does come one day is surprised.

wath the video

full article

Allan Greenspan, market commentatry, global equity markets

Investment advice for 20's & 30's crowd.

Younger generations get investment advice

People in their 20s and 30s have been left out of the financial-planning loop because they lack the one quality that makes them attractive to planners: wealth. The tide is changing, however, as more people in this demographic look to make investments including 401(k) plans and property acquisitions. The financial industry is answering by targeting more services for this young demographic.

Financial Planning for the Not-Yet-RichIndustry Targets More Services at Long-Ignored DemographicOf People in Their 20s and 30s; 'We're Behind the Eight Ball'By JEFF D. OPDYKE
Financial planners are beginning to pay closer attention to people in their 20s and 30s, a group that has long received the brushoff from the financial-services industry because of its lack of wealth.

Many people in this age group, launching careers and starting families, are looking for a wide range of financial advice. Among other things, they need help investing in their first 401(k) plans, saving for a house, understanding insurance needs and managing debt and budgets.
And lately, they're finding a financial industry increasingly willing to help. Though the bulk of the industry's efforts remain focused on the baby boomers and retirees with the fattest wallets, planning firms and some brokerage houses are beginning to provide services aimed squarely at a younger demographic. These clients are younger than the relatively established middle-age set traditionally targeted by the firms. But a growing number of planners recognize the possibilities of taking on clients who they suspect will work or inherit their way into larger wealth in coming years.

Marta and Jake Kagan -- she's 35 and a marketing manager, he's 32 and a physician still in residency -- knew they needed help when they began a hunt last year for their first house. The Boston couple has student loans to pay off, two children to provide for and live in a place "where we can't buy a starter home for under $500,000," says Ms. Kagan. "We feel like we're behind the eight ball relative to where our parents were."

Four months ago, they hired Stacy Francis, a 32-year-old New York planner, largely because "I want someone closer to my age, closer to our realities," Ms. Kagan says. Ms. Francis, a fee-only planner, provided the Kagans a year-by-year plan. "It's a conservative, clear view that looks at our future more broadly so that we can see how to get from point A to point B. We've decided to wait before we look for a house."

For the most part, people like the Kagans are largely underserved by the financial industry. Research by the Financial Planning Association, an umbrella group for planners, shows that just 11% of the industry's client base is under the age of 40, though that same research also indicates that people approaching 40 are the most eager for financial advice.

Jennifer Cray, a planner in Menlo Park, Calif., says demand from younger clients is so great that she now turns away potential business because she's already loaded with people in this age group. Ms. Francis has begun hosting seminars for younger clients, who now account for half of her business. And in Dallas, Kalita Blessing, a planner with Quest Capital Management, says a quarter of her business is now young people because "so many parents are gifting financial plans to their kids." Those parents recognize that their offspring often have large debts from school loans, likely won't have pensions to rely on, and could face a sharply altered Social Security system at retirement.

Tom and Donna Dietrick, a Mount Lebanon, Pa., couple, went looking for a planner last year to help wade through the abundance of investment and savings options that boomers never had when they were younger -- everything from online savings accounts to Roth IRAs and 529 college savings plans. Mr. Dietrick, a 38-year-old worker at US Airways Group Inc., says he and his wife "got to a point where we said we've got to find someone who can help us prioritize because there are so many options and philosophies on what's best to do."

The Dietricks hired Pittsburgh planner Bob Nusbaum, with whom they spent five or six hours over several sessions. Mr. Nusbaum rearranged their portfolio and helped them begin looking toward retirement, their life-insurance needs and their kids' education. "We don't have an enormous amount to invest, and we just want to know it's doing its best," Mr. Dietrick says. The planner "even looked at our budget and told us we're not spending enough on leisure."

The best time for young people to consider hiring a financial professional "is when you land your first real job," says Barbara Roper, director of investor protection for the Consumer Federation of America. "At that point, you have a variety of financial issues to consider, such as your 401(k) plan and your benefits," and a financial plan will set you on an appropriate course, she says.
For savers with modest assets, Ms. Roper says, a fee-only planner is generally the best match. These planners only sell their time, at a cost of between $100 and roughly $250 an hour, depending on where they're based geographically. Because they don't pitch products tied to a particular company, "it minimizes the potential conflicts," she says.

To find local planners, consumers should ask friends, family and colleagues if they can recommend someone they trust. Several Web sites, including the National Association of Personal Financial Advisors (napfa.org), the Financial Planning Association (fpanet.org) and the Garrett Planning Network (garrettplanningnetwork.com), which emphasizes planners who charge by the hour, offer locator services to help find planners in your area. Planners with a CFP designation, for certified financial planner, have passed a comprehensive exam that typically requires multiple years of study.

Jennifer Billock, a 36-year-old San Francisco grad-school student, says she and her husband, Jim, have worked with several different professionals -- from big brokerage firms to various financial planners -- and "all we ever got were computerized asset allocations that cost $400 to $1,500," she says. "We don't have much money, so it seemed irrelevant."

The couple then went looking for a financial pro "who is objective, and would do more than just portfolio planning," Ms. Billock says. After a three-month search they found Ms. Cray in Menlo Park, a fee-only planner who charges $240 an hour, or a retainer of between $290 and $490 a month for unlimited access.

"She went through all this insurance stuff I never thought of, and helped with our cash-flow analysis. When we were setting up a 529 plan for our daughter, she told us the firm's expert was just finishing new research and to wait a bit for the analysis. So she's not giving us canned answers."

Some young people want a hand on their money. Tim Leidig, a 28-year-old applications analyst in York, Pa., says he seeks advice from Mr. Nusbaum, the Pittsburgh planner, on everything from where to invest his 401(k) plan to whether he should pay off his student loans quickly or use that money for other financial needs. But then Mr. Leidig tracks down specific investment options and makes his own decisions.

"I feel like I'm getting totally independent advice," Mr. Leidig says. "And I remain in charge of my assets."

Some savers want not just planning, but money-management services, as well. That adds extra charges, either through commissions or an annual fee based on a percentage of the assets under management, usually up to 1% or 1.5%. If you're a buy-and-hold type of investor, paying commissions for money-management services can make the most sense, because these can work out to be less than continually paying an annual management fee when your portfolio doesn't change.

Lifesyle and Life Events Financial Planning Stages (diagram)

Write to Jeff D. Opdyke at jeff.opdyke@wsj.com
Full article

investment advice, financial planning, lifestyle, life events, savings

N.J. pension fund explores massive infrastructure investment

N.J. pension fund explores massive infrastructure investment

US pension fund explores $2bn infrastructure investmentStephanie BaumNew Jersey is exploring whether to make infrastructure investments as a hedge against inflation to boost its $81.2bn (€60.4bn) pension fund.

Strategic Investment Solutions, a California-based consultancy, advised New Jersey's investment council to put up to $2bn in infrastructure assets.

Mark Perkiss, a treasury spokesman, said New Jersey has not yet made a decision on specific infrastructure investments, but the pension fund is likely to put the money into private equity funds and could include global infrastructure assets such as toll roads and airports.

New Jersey currently owns 32 million shares valued at $190m in private equity infrastructure firms Cintra and Macquarie Infrastructure Group. These companies own a 75-year lease for Indiana’s toll road which they purchased last year for $3.8bn. They also own a 99-year lease for the Chicago Skyway, an eight mile toll road valued at $1.8bn.

New Jersey Governor Jon Corzine has repeatedly urged state representatives to explore leasing or selling the state’s own infrastructure assets such as the Atlantic City Expressway and the state lottery to reduce its debt burden.

Earlier this year an actuarial assessment revealed a $26bn shortfall in the pension fund.Separately, Pennsylvania is considering a recommendation from Morgan Stanley to lease the state’s toll road. Morgan Stanley's analysis estimated the Pennsylvania Turnpike lease could be worth up to $3.6bn for a 30-year lease and up to $20bn for a 99-year lease.

Full article

urban development, private equity, infrastructure, investment

Are Hedge Funds Worth It?

Hedge fund managers sitting pretty

Annual lists of high-paid hedge fund managers show astronomical gains ($1.7 billion at the top of the list -- for just one man), but is it worth it to use a hedge fund manager? Typical hedge funds come with a 2% management fee no matter how they perform, and they include a big cut on profits that exceed certain amounts. Even low-performance hedge funds can mean big profits for managers.

Worth a Lot, but Are Hedge Funds Worth It?
By DAVID LEONHARDT

When Institutional Investor’s Alpha magazine released its annual list of the highest paid hedge fund managers last month, it allowed the rest of us to play an entertaining little parlor game: what could you buy if you made as much money as those guys?

James Simons, a 69-year-old mathematician who was at the top of the list, earned $1.7 billion, which equaled the amount of money that the federal government spent last year running its vast network of national parks. Down at No. 3 on the list, Edward S. Lampert of Greenwich, Conn., the investor who owns a large chunk of Sears, made $1.3 billion, which, if you forget about taxes, would have allowed him to buy the entire economic output of Sierra Leone. We’re talking about real money here.

Today, Alpha magazine will release another big list, and this one offers a chance to answer another, arguably more important, question: Are these billionaire hedge fund managers really worth it? The reason hedge funds are a license to print money is their fee structure. A typical fund charges a 2 percent management fee, which means that it keeps 2 cents of every dollar that it manages, regardless of performance. Mutual funds, on average, charge about 1 percent. On top of the management fee, hedge funds also take a big cut — usually at least 20 percent — of any profits that exceed a predetermined benchmark.

So in a good year, a fund’s managers bring in stunning amounts of money, and in a bad year, they still do very well. Some quick math shows why: 2 percent of a $5 billion portfolio, which was roughly the cutoff for making Alpha’s list of the 100 largest funds, equals $100 million. A fund’s managers get to take that fee every single year.

Last year was actually a pretty tough year for the industry. Because hedge funds tend to make a lot of countercyclical bets — thus the name — they can often turn a profit even when the stock market falls. When it’s rising broadly, though, many struggle to keep up. Last year, the Standard & Poor’s 500-stock index jumped 14 percent, while the average hedge fund returned less than 13 percent, after investment fees, according to Hedge Fund Research in Chicago.

But the men — and they are all men — who appear on Alpha’s list of top earners don’t manage average hedge funds. They manage the biggest funds in the world, the ones that are winning the Darwinian competition for capital, and many of them aren’t having any trouble beating the market. One of the funds at Mr. Simons’s firm, Renaissance Technologies, delivered a net return of 21 percent last year. The other returned 44 percent after fees. And Mr. Simons, who relies on a fantastically complex set of algorithms, doesn’t charge “2 and 20” — as the typical industry fees are called. He charges “5 and 44” — a 5 percent management fee and 44 percent of profits — yet he has still been doing very well by his investors for almost two decades.

I realize that a lot of people find 9- and 10-figure incomes to be inherently excessive. Or even immoral. From a strictly economic point of view, however, they are also perfectly rational. You cannot find anyone else who is providing the same returns as the best hedge fund managers at a lower price. If you don’t like it, you don’t have to give them your money.

(Even if you do like it, they probably won’t take your money. In exchange for being lightly regulated, hedge funds are open only to wealthy investors and big institutions.)

Thanks to their incredible performance, the biggest funds have grown far bigger in recent years. The 100 largest firms in the world managed $1 trillion at the end of last year, or 69 percent of all the assets in hedge funds, according to Alpha. At the end of 2003, the top 100 had less than $500 billion, or only 54 percent of total hedge fund investments.

“The best performance is coming from the largest funds,” said Christy Wood, who oversees equities investments for the California Public Employees’ Retirement System, which, like a lot of pension funds, is moving more money into hedge funds.

But there is an irony to this influx of money. It all but guarantees that hedge fund pay over the next few years won’t be as closely tied to performance as it has been. The hundreds of millions of dollars that have flowed into hedge funds have made it all the harder for fund managers to find truly undervalued investments. The world is awash in capital.

All that capital, of course, also translates into ever-greater management fees, regardless of a fund’s performance. The flagship hedge fund at Goldman Sachs lost 6 percent last year, but it still brought in a nice stream of fees. Bridgewater Associates, which is based in Greenwich, has earned a net return of less than 4 percent in each of the last two years. Yet its founder, Raymond T. Dalio, made $350 million in 2006.

“When we have a bad year, we’re essentially flat,” Parag Shah, a Bridgewater executive, told me. “And when we have a good year, we have a great year.”

Goldman and Bridgewater may well bounce back, but the combination of extraordinary pay and ordinary performance is going to occur more and more in the coming years. Outside of the highfliers on the Alpha list, it’s already the norm. Since 2000, the average hedge fund hasn’t done any better, after fees, than the market as a whole, according to research by David A. Hsieh, a finance professor at Duke. Still, even mediocre managers, after a lucky year or two, are able to attract gobs of capital and charge “2 and 20.”

So are today’s hedge fund managers really worth it? Sure, but only if they deliver the sort of performance that Mr. Simons has, and very few will in the years ahead. More to the point, it’s extremely difficult to know who the stars will be.

In all sorts of walks of life, people tend to think that the past is a better predictor of the future than it really is. That’s why journeyman baseball players — a Yankees pitcher named Carl Pavano comes to mind — are able to sign huge contracts based on a single good season. It’s also why so many investors chase returns.

The genius of the world’s hedge fund managers isn’t only in how they invest their money. It also lies in having set up an industry that takes advantage of a timeless human trait.

E-mail: Leonhardt@nytimes.com
Full article


hedge funds, portfolio managers, hedge fund returns, alpha, beta

Subprime Mortgages - The Glory Days Are Over

Mortgage market unstable?

Surprise was the key word Monday at the Mortgage Bankers Association's National Secondary Market Conference & Expo in New York, as many were shocked at the quick collapse of the subprime-mortgage market. The quick market sell-off has led to the demise of many lenders in the industry, and many loans are no longer even possible for clients.

Speed of subprime bust surprises lenders
Many mortgage lenders expected a subprime meltdown, but not one that came so fast and strong.
By Les Christie, CNNMoney.com staff writerMay 23 2007: 8:18 AM EDT

The subprime mortgage meltdown has been a shock to industry insiders, but now they say it's hitting harder and faster than expected - even to those who predicted the crisis in the first place.That was the message Monday from a panel of leading industry executives on the state of the mortgage lending industry at the Mortgage Bankers Association's National Secondary Market Conference & Expo in New York.

Michael Marriott, a panelist and managing director for Credit Suisse, said, "Last October, I predicted the subprime market would collapse and many issuers would go out of business. But the violence and speed of the market sell-off surprised people."

David Lowman, a panelist and chief executive of JPMorgan Chase & Co.'s global mortgage business, said, "35 percent of what once could be done, can no longer be done," referring to mortgage loan products that have effectively been taken off the shelves.

And speaking separately from his Atlanta office, Duane LeGate, president of House Buyer Network, a specialist in short sales and foreclosure prevention, said one of the real estate agents he works with had six deals blow up within four days because, "The loan originator told him, 'We're not offering [these products] anymore.'"

According to LeGate, this kind of thing just started to happen in the past month or so.Allen Hardester, director of business development for mortgage broker Guaranteed Rate, said many once-common subprime loans products are now almost impossible to find.

Mortgage lenders get creative "Anything that smacks of no-income and no-documentation is history," he said. "Anything above 85 percent to 90 percent loan-to-value, anything non-owner occupied, anything ludicrous as to value - like someone stepping up from a $1,000 a month payment to a $6,000 a month - is history."

Lenders are also scrutinizing applications much more carefully, and many don't like what they find. Lowman said he had recently looked at a low-documention application for a UPS driver who earned a quarter of a million dollars last year - or so the application stated. Fictional claims, often involving outside income, are far from unusual.

"If you took into account every person with a lawn care service on the side, there wouldn't be a blade of grass left in the United States," he said.

Investors who buy and sell bonds backed by the mortgage payments of ordinary homeowners have seen bad loans rise and have told lenders and brokers they will no longer buy whole classes of securitized mortgages, which can quickly pull the plug on a prospective home buyer.

Lauren Pephens, managing principal of financial services advisory firm, Pephens & Co., called it the "push-down effect" at a session on loss mitigation at the MBA conference. She said that some buyers have gone to close the deal only to be told that their financing had fallen apart.
All the fudging, the lax underwriting, the push for loans that went on during the housing boom were facilitated by the rapid rise of home prices. Outsized increases in home equity in many U.S. housing markets covered a multitude of sins and encouraged lenders to extend loans to poor risk borrowers.

If an owner couldn't afford to pay the monthly mortgage bill when her hybrid adjustable rate mortgage reset at a much higher interest rate, well, that was just fine. Latest home prices Her home had gone up in value from $200,000 to $300,000 in the interim, and she could tap that extra $100,000 in home equity to pay her bills. If worse came to worse, she could sell her house at a big profit and pay off the entire bill. But when homes became unaffordable for too many buyers starting in 2006, "The people who were driving up prices couldn't drive them up further," said Hardester.

The speculators, the flippers and rehabbers fled. Houses went on the market and just sat. Inventories lengthened, home builders started pulling back and foreclosures climbed.A drop is seen before recoverySo far the turnaround on prices has not been huge - unless you compare it with what immediately came before. In 2006 the median U.S. home price rose 13.6 percent, and in 2005 it climbed 8.8 percent, according to the National Association of Realtors. Now the industry group has forecast a drop in home prices this year.

MBA's chief economist, Doug Duncan, who was at the conference, predicted his own housing-price decline of 2.7 percent for 2007. Factoring in inflation of about 2 percent, the decline in real dollars is between 4 percent and 5 percent.

Duncan had said a recovery would begin mid-year but he's revised that forecast, delaying his predicted rebound until the fourth quarter of 2007.

Despite their surprise at the speed and depth of the subprime meltdown, Marriott, Lowman and their fellow panelists expected a quicker recovery than Duncan.

The group, which also included Patti Cook, an executive vice president with Freddie Mac, and Thomas Lund, an executive vice president with Fannie Mae, cited a strong economy, low unemployment and favorable demographic growth for their optimistic stance that recovery will come soon.

The recovery will "play out quicker than in the past," according to Lowman, "because [the fall] happened faster than in the past."

Full article

subprime, mortgages, mortgage backed securities,

Tax Breaks for Municipal Bonds

Supreme Court to hear state-bond arguments

The U.S. Supreme Court has agreed to take on a case that will determine the legality of states' continuing to exempt interest on their own bonds from residents' taxable income, while taxing the interest on bonds issued by other states. The ruling is expected to impact the municipal bond markets, which SIFMA estimates would affect 50,000 municipal-bond issuers throughout the nation.

Supreme Court to Address State Tax Breaks for Bonds
By LINDA GREENHOUSE
WASHINGTON, May 21 — In a case with the potential to rattle, if not reshape, the market for state and municipal bonds, the Supreme Court agreed on Monday to decide whether states can continue to exempt interest on their own bonds from their residents’ taxable income, while taxing the interest on bonds issued by other states.

The preferential tax treatment for in-state bonds is longstanding and very common, offered by nearly all the states that have an income tax. State and local governments issued more than $350 billion worth of bonds a year from 2002 to 2006.

The practice was, in fact, largely taken for granted until it was declared “facially unconstitutional” in January 2006 by the Kentucky Court of Appeals. That state court, ruling in a case brought by a Kentucky couple, George and Catherine Davis, who own bonds issued by other states, said the preferential tax treatment erected a barrier against interstate commerce in violation of the Constitution’s commerce clause.

In the only previous decision on the subject, an Ohio state appeals court upheld that state’s preferential treatment of bond interest, in a 1994 decision that the Supreme Court declined to review. The fact that two state courts now disagree on such a fundamental question probably led the justices to conclude that the issue required their attention.

The National Association of State Treasurers, without taking a bottom-line position, urged the justices to accept Kentucky’s appeal. “Only this court can resolve the uncertainty,” the state treasurers said, adding: “Regardless of the merits of the question presented, the federal Constitution should apply uniformly to all 50 states.”

The tax-exempt status of state and municipal bonds permits issuers to borrow money at a lower interest rate because investors are willing to accept lower returns in exchange for not having to pay taxes on the interest they receive. The tax-exempt feature is very appealing to investors, as reflected in the popularity of mutual funds that offer baskets of a single state’s public debt.
Kentucky filed its Supreme Court appeal, Department of Revenue of Kentucky v. Davis, No. 06-666, in November. Rather than act immediately, the justices held the case while they were considering how to decide another case about the permissibility of state preferences under the commerce clause.

On April 30, the court decided that case, United Haulers Association v. Oneida-Herkimer Solid Waste Management Authority, No. 05-1345. By 6 to 3, the court rejected a commerce clause challenge to a program in two upstate New York counties that required private haulers to deliver all solid waste to a single publicly owned landfill. It did not violate the commerce clause for the government to prefer itself over private-sector competitors, Chief Justice John G. Roberts Jr. wrote for the majority.

Ordinarily, once the court has decided a case, it sends back to the lower court any related case that it has been holding, so that the lower court can reconsider its ruling in light of the new Supreme Court decision. But in this instance, the justices evidently concluded that the solid-waste decision did not shed much light on what the commerce clause might have to say about preferential taxation of bond interest.

In recent years, the court has been fairly aggressive about reining in state policies that could be described as protectionist. Two years ago, for example, the justices invoked the commerce clause to overturn laws in New York and Michigan that gave preferential treatment to in-state wineries.

But the court is hardly of one mind, either on basic principles or their application. Two justices, Clarence Thomas and Antonin Scalia, do not accept the premise that the commerce clause, which in the constitutional structure is a grant of authority to Congress, imposes any limitation on activity by the states. On the other hand, the newest justice, Samuel A. Alito Jr., dissented last month from the solid-waste decision, writing that “the public-private distinction drawn by the court is both illusory and without precedent.”

In the latest case, Kentucky is raising an argument based on state sovereignty, objecting that the state court’s analysis of the commerce clause “commandeers Kentucky’s tax laws to subsidize other states’ public debt if it wishes to exempt its own debt from taxation.” In fact, the Kentucky Court of Appeals did not dictate a remedy for the constitutional violation it found. If the decision is upheld, the state will have the choice of exempting every state’s bond interest, or none.

The case will be argued in the fall, with a decision unlikely before next spring. That means that the municipal bond market could be unsettled for months, said Alan D. Viard, a resident scholar at the American Enterprise Institute and a former Federal Reserve Bank of Dallas economist.In another action on Monday, the court dismissed a class-action antitrust suit against three former regional Bell companies that control nearly all the country’s local telephone service. Voting 7 to 2, the court held in an opinion by Justice David H. Souter that the complaint failed to contain evidence of an illegal agreement to restrain trade sufficient to impose on the defendants the burden of undergoing pretrial discovery. The dissenters were Justices John Paul Stevens and Ruth Bader Ginsburg.

The case, Bell Atlantic Corporation v. Twombly, No. 05-1126, had been closely watched for continued signs of the court’s growing skepticism about complaints, in securities and antitrust litigation, that contain little more than bare accusations of wrongdoing. The plaintiffs in this case “have not nudged their claims across the line from conceivable to plausible,” Justice Souter said.

Full article

municipal bond market, municipal securities, munis

New Census Data Proves Changing Demographics: People of Color Top 100M

New Census Data Proves Changing Demographics: People of Color Top 100M

People of color will be the majority in this country by 2050, if not sooner, the Census Bureau predicts. The nation got closer to that milestone yesterday when the Census Bureau announced that there now are more than 100 million people of color in this country, with Latinos and Asians growing the most rapidly.
(more )

Market trends and stocks to watch [May 2005]

FYI

 

Here are some trends and stocks to watch.

 

1) Downtown Brooklyn Real Estate

Now is the time to "double-down or leave the table".  There are agressive development plans in place for Downtown Brooklyn and Ft. Greene. Construction has started on the Sheraton Hotel on Duffield St. (between Fulton Mall and Wiloughby). Most local condo developers are 1yr behind schedule due to a weak real estate market in 2006. Prices to high end, luxury condos will continue to appreciate.  The only value play left is to lock-in a contract at the market price, then negotiate more amenities and high-end fixtures and appliances.  Try to get a balcony/terrace, on-site parking, private storage room, roof deck and a view of Manhattan skyline. Those features will be most valuable in the long-term.

 

2) Inflation is here. Invest in food and water.

Now is the time to build a significant position in the food/agriculture sectors. Think of the food markets as the energy market for humans.  Demand for meats, finished food products and basic grains is escalating very rapidly. Part of this is growing demand from Asia and new alternative enrgy uses for key grains like corn. Also note that available farmland in the US is stagnant (even reducing). There are also concerns about the low number of bees, which is critical to agriculture. All these issue point to higher food prioces in the next 8-12 months.  If you're not sure about this check out the price of lemons. It has tripled in the last six months. To capitalize, you can invest in agricutural sector funds, stocks in food companies (like ADM or WTR), or futures on specific agriculture commodities (corn, wheat, beef, pork, sugar). 

 

3) The longshot of new technology

Check out this firm MLER. Moller International Inc. has exclusive technology in developing personal flying machines and specialized unmanned aircraft. Their vehicles use ETHANOL. They have great potential as an alternative energy play, but also in the growing market for personal transportation. Their stock is closely held and has increased 50% this week. You can still buy for less than $1.

 

Congrats to Denton. He's been following this company [MLER] for a few months. It's tripled since he first started following the stock.

 

These three trends will make money in the next 6-12 months.

 

Victor

vsmith@taxprosonline.com