BizAnalyst Network: 12/01/2007

Friday, December 21, 2007

Pros and Cons of Self-Directed 401Ks & IRAs

Pros and Cons of Self-Directed 401Ks & IRAs

By: Financial Planning Association

An increasing number of 401(k) and other types of qualified retirement plans are giving plan participants the option of opening a self-directed brokerage account within the plan. While this option offers participants a much broader universe of investment options, it is not without its risks, caution many financial planners and other investment experts.

Traditionally, employer-sponsored retirement plans have offered participants a varied but limited menu of mutual funds, ranging from a handful to 20 or more, and perhaps access to company stock. But some participants began pushing for more choices, especially with the explosion of online trading and the long bull market, so more employers have begun offering the option of self-directed brokerage accounts. The participant opens up an account with a brokerage firm of their choosing through the plan, which offers up a much wider universe of investment selections, sometimes including individual stocks and bonds.

Despite the market skid since the spring of 2000, the push for self-directed accounts continues to grow. In a survey earlier this year by Hewitt Associates, nearly 20 percent of employers offer self-directed accounts, another 5 percent will be offering them soon and another 30 percent are considering adding them.

How exactly do self-directed accounts work, and are they a good idea for both employer and employees? To begin with, self-directed accounts aren't usually as wide open as you might think. Most impose some limits on the participants. For example, participants might be able to invest only a portion of their retirement plan assets -- say 20 percent or a maximum monthly dollar amount -- in the self-directed option. The plan may limit investments to mutual funds. Others may allow individual stocks and bonds, but not municipal bonds, commodities, derivatives or buying on margin.

The main advantage of self-directed accounts is the increase in investment options, especially beneficial if the current plan offers a poor menu of mutual funds or the funds are performing poorly. Self-directing participants can then find better-performing funds or buy individual securities.

But this new flexibility comes with some risks and expenses, warn financial planners. First, is added investment responsibility on the part of the participant. Choosing from a large number of funds can be overwhelming, or the investor may end up buying only an individual stock or two that dramatically boosts the portfolio's level of risk.

It's also more tempting to trade frequently through such accounts, reacting to the ups and downs of the market.

Research shows that most workers using a plan's mutual fund menu tend to trade very little. That's why planners often say only more sophisticated investors willing to do their homework, including a careful review of their overall investment portfolio, should consider a self-directed option. In fact, according to the Profit Sharing/401(k) Council of America, less than five percent of employees take advantage of the self-directed option when it's made available.

Furthermore, self-directed accounts add to participants' cost. There typically is an administrative fee and there are transaction fees, though online trading may help keep these down. Usually these fees must be paid for by the participant.

Employers have mixed feelings about offering such plans. On the one hand, self-directed accounts help employers keep down the number of mutual funds they might otherwise be pressured to offer. More mutual funds mean more expenses and administrative headaches. Self-directed accounts are especially appealing to higher-paid executives, and by offering them, employers improve their ability to recruit and retain those executives.

On the other hand, surveys show that many employers refuse to offer self-directed brokerage accounts because they are concerned that employees will make poor investment choices -- and possibly sue the employer as a result. (Numerous studies have shown that plan participants already make poor investment choices with the limited fund menus.) How liable an employer may be with self-directed options is open to debate, but at a minimum, agree many experts, employers have to be very forceful in educating their employees about the risks.

Thursday, December 20, 2007

Bond Insurers Cut to Junk; Await more CDO Write Downs

Bond Insurer Cut to Junk; Negative Outlook for 4 More

By VIKAS BAJAJ

Citing deepening problems in the mortgage market, Standard & Poor's cut the rating of one troubled bond insurer on Wednesday and assigned a negative outlook to four other companies that guarantee debts linked to home loans.

The announcement shook an already unsettled credit market, signaling that investment banks and others that had thought they were protected from rising foreclosures might not be immune from all losses. Investors bid up Treasury debt, a refuge in troubled markets, and sold shares in bond guarantors and some investment banks.

In another indication that credit markets remained unhinged, the Federal Reserve said that its auction of $20 billion in short-term loans to the banking system drew 93 bids, seeking more than three times the amount available. Banks have become increasingly reluctant to lend to each other in the last few weeks, prompting the Fed to use new methods to lend directly to the banks.

The biggest impact of the S.& P. announcement was felt by investors who had bought protection from the ACA Financial Guaranty Corporation, whose rating was cut to CCC, a subinvestment grade, from an A rating. Merrill Lynch, the Canadian Imperial Bank of Commerce and several other investment banks could be forced to acknowledge billions of dollars in losses on securities that they insured through ACA.

S.& P. affirmed AAA ratings for MBIA, Ambac, XL Capital and Financial Guaranty Insurance, but assigned a negative outlook to them. And it left unchanged the ratings of five other bond insurers.

Later in the day, ACA said it had reached an agreement with its clients that would put off until Jan. 18 a requirement that the company post about $1.7 billion in collateral to cover future losses if its rating fell below A.

It said it would use the next month to come up with a more lasting solution to its financial problems, which could include raising new capital. It could also renegotiate the terms of its insurance contracts for a longer period.

The temporary agreement is a result of negotiations involving several banks that bought insurance from ACA, like Merrill and C.I.B.C. The talks have also involved Bear Stearns, whose merchant banking affiliate owns 29 percent of ACA.

It is unclear how much money ACA would have to raise and where it might turn for such an infusion. An S.& P. analysis indicated that ACA's portfolio of insurance contracts, also known as credit default swaps, could show losses of $2.2 billion above the $650 million it is capable of handling.

ACA has insured about $26 billion in mortgage-related collateralized debt obligations, some of them considered at high risk of loss as more homeowners fall behind on payments and end up in foreclosure. ACA typically makes up interest and principal payments to investors like Merrill Lynch if losses in C.D.O.'s they hold rise above certain thresholds set in the terms of their contracts. (ACA said Wednesday that the AAA-rated C.D.O.'s it had insured continue to carry the top rating.)

A spokeswoman for Merrill declined to discuss its exposure to ACA, but some analysts have said that it may have to write down as much as $3 billion if ACA fails. Shares in Merrill declined 78 cents on Wednesday, to $54.73.

C.I.B.C. has been the only bank to publicly acknowledge its exposure. In a statement released before the temporary arrangement was announced, the Canadian bank said there was a "reasonably high probability" that it would have to write down mortgage securities it had insured with ACA, suggesting that the charge could total up to $2 billion. C.I.B.C. fell $1.83 in New York, to $70.60, its lowest close in more than a year.

Shares of ACA Capital Holdings, the insurer's parent company, which has been delisted by the New York Stock Exchange, were trading at 65 cents on over-the-counter markets; they had been as high as $1 early Wednesday after The New York Times reported that investment banks were discussing aid for the company.

The S.& P. move left credit market investors with little comfort about the safety of mortgage securities, particularly those linked to home loans made to people with blemished, or subprime, credit. Many investors are counting on bond insurance to protect them from losses, and others have used credit protection contracts to bet that the housing market will weaken further.

Ratings firms like S.& P., Moody's Investors Service and Fitch Ratings find themselves in a tough position, with some investors demanding quick action while the guarantors are asking for more patience. Downgrades would make it impossible for insurers like MBIA and Financial Guaranty to write new contracts, which would undermine their already tenuous financial position.

Derrick Wulf, a portfolio manager at Dwight Asset Management in Burlington, Vt., said investors were trying to price bonds assuming that the insurance on them was worthless. "Given the fact that so much depends on what the ratings agencies ultimately decide, which can be very difficult for investors to forecast," he said, "there isn't a heck of a lot of trading."

In a conference call, officials at Standard & Poor's said that unlike ACA, most bond guarantors do not face an imminent crisis, because they pay claims only when bonds are in default and monthly payments have stopped, and even then in small monthly increments.

Still, the firm's analysis showed that some guarantors like MBIA and Financial Guaranty face losses far larger than the capital they have on their books.

In a related move, S.& P. also downgraded hundreds of municipal and corporate bonds that had been insured by ACA, because they no longer carried the protection of an A-rated insurer. As of September, ACA insured $7 billion in municipal and $43 billion in corporate debt.

U.S. Economy: Leading Indicators Down

U.S. Economy: Leading Indicators Dropped in November (Update1)

By Bob Willis

Dec. 20 (Bloomberg) --

The U.S. economy is at greater risk of faltering next year, according to an index of leading indicators, and a gauge of manufacturing in the Philadelphia region fell the most since the last recession.

The Conference Board's leading-indicator measure dropped 0.4 percent, more than forecast, to the lowest level in more than two years, the New York-based research group said today. The Philadelphia Federal Reserve said its factory index declined to minus 5.7, the weakest reading since December 2006.

The deepest housing slump in 16 years is likely to worsen as foreclosures mount and banks restrict lending, economists said. Declining property values, rising energy costs and a softening labor market may also hurt consumer spending, which accounts for more than two-thirds of gross domestic product.

``It's certainly pointing to a slowdown,'' said Roger Kubarych, chief U.S. economist at Unicredit Global Research in New York. ``The fourth quarter is going to be much weaker than what we've been seeing.''

A separate report from the Labor Department showed the number of Americans filing for jobless benefits rose a greater- than-anticipated 12,000 to 346,000 last week. The Commerce Department said the economy expanded 4.9 percent last quarter, unchanged from the previous estimate published last month.

Economists' Forecasts

Economists forecast the Conference Board's index would decline 0.3 percent following a 0.5 percent drop the prior month, according to the median of estimates in a Bloomberg News survey. The measure, which signals the likely performance of the economy over the next three to six months, dropped to 136.3, the lowest since September 2005.

The drop in the Philadelphia Fed's gauge coincided with gains in some of the survey's other indexes. The headline reading is based on a separate question, not always reflecting underlying trends. Measures of orders and sales rose, while inventories and employment fell, the report showed.

FedEx Corp., the second-largest U.S. package-delivery company, today said quarterly profit fell as fuel costs rose and demand for freight shipments slowed. The Memphis, Tennessee- based company said its third-quarter earnings would be lower than a year earlier and cut its capital-spending forecast.

``We see challenging near-term economic trends,'' Chief Executive Officer Fred Smith said in the statement.

Rite Aid Corp., the third-largest U.S. drugstore chain, posted a wider quarterly loss than analysts estimated and reduced its full-year forecasts for the second time in three months today. Sales of non-pharmacy goods such as snacks and health and beauty products fell 0.4 percent.

Sales Forecast

The National Retail Federation in Washington has forecast holiday sales this year will show the smallest gain since 2002.

The leading index is down at an annual pace of 2.3 percent over the last six months, short of the approximate 4 percent to 4.5 percent drop that Conference Board economists say signals recession.

``I still think we have a good chance of avoiding recession although we are in store for a couple of quarters of slower growth,'' said Michael Moran, chief economist at Daiwa Securities America Inc. in New York.

Former Treasury Secretary Lawrence Summers said yesterday it's ``quite likely'' a contraction will develop next year, while former Federal Reserve Chairman Allan Greenspan has given it about even odds.

Slower Growth

The economy is projected to grow at a 1 percent annual rate this quarter and at a 1.5 percent pace in the first three months of 2008, according to a Bloomberg News survey taken earlier this month. The last recession was in 2001, when the economy grew 0.8 percent.

The slowdown is all the more pronounced because of the surge in growth last quarter. The world's largest economy grew at a 4.9 percent annual pace from July through September, the most in four years, the Commerce Department's final estimate showed today.

Declines in stock prices, the money supply, consumer sentiment and an increase in firings pushed the leading index down, the Conference Board said. Gains in the factory workweek, orders for capital equipment and slower supplier deliveries limited the drop.

The Standard and Poor's 500 Index fell 5 percent on average in November to 1463.39 from the prior month, as mounting defaults on subprime mortgages forced banks to write off losses, leading to spreading declines in financial markets.

An average 336,400 workers a week filed first-time claims for jobless benefits in November, up from 327,500 a month earlier.

Consumer Headwinds

The softening job market combined with declining home values and rising fuel costs may contribute to a slackening in spending during the holidays.

``It looks as though consumer spending is going to slow considerably from the third quarter,'' said Paul Kasriel, chief economist at the Northern Trust Company in Chicago. ``I really do think the odds are better than 50 percent that we will have a recession.''

Seven of the 10 components of the leading economic indicators index are known before the report: initial jobless claims, consumer expectations, building permits, supplier deliveries, the yield curve, stock prices and factory hours.

The Conference Board estimates money supply adjusted for inflation, new orders for consumer goods and orders for non- defense capital goods.

The Conference Board's index of coincident indicators, a gauge of current economic activity, rose 0.2 percent in November after falling 0.1 percent in October. The index tracks payrolls, incomes, sales and production. Combined with gross domestic product, these are the figures tracked by the National Bureau of Economic Research to determine when recessions start and end.

The gauge of lagging indicators also increased 0.2 percent after rising 0.3 percent in October. The index measures business lending, length of unemployment, service prices and ratios of labor costs, inventories and consumer credit.

full article

Friday, December 07, 2007

Credit Crunch: Bush's Bad Mortgage Medicine

Credit Crunch: Bush's Bad Mortgage Medicine

The Bush Administration's plan to rescue the housing market and keep the economy from slipping into recession took flak yesterday for freezing interest rate hikes for a mere fraction of subprime, adjustable-rate borrowers. But there's a bigger risk: It could deepen and lengthen the credit crisis.

According to analysis by Barclays Capital, the "freezer-teaser" plan applies to just 240,000 subprime loans. The Mortgage Bankers Association reports the number of subprime adjustable rate mortgages at 2.9 million.

It also won't help the 16% of subprime borrowers who are already delinquent or in default, and it won't help millions of other homeowners who either will be deemed able to pay the higher rates when they adjust, starting in January, or who have the unhappy circumstance of having a house worth less than their mortgage or a loan that has already reset to the higher rates.

President Bush, along with Treasury Secretary Henry Paulson and Housing and Urban Development Secretary Alphonso Jackson, outlined other proposals Thursday that are meant to help the 2 million borrowers facing sharply rising rates on their adjustable-rate mortgages beginning next month. The plan includes refinancing some of the borrowers into private, fixed-rate mortgages, or putting them into Federal Housing Administration loans.

The loan modification, or rate freeze, would apply to a limited subset of subprime borrowers who meet a series of criteria, not least of which is that they must have paid their loans on time. Also, the freeze applies to loans taken between January 2005 and July 2007, excluding other adjustable loans that have already reset to higher rates.

The expected backlash to the plan started immediately after the Administration announced it. Housing advocates said it leaves millions of struggling borrowers at risk of foreclosure. Others decried it as a shameful bailout of irresponsible lenders and borrowers.

"President Bush's plan may make good politics, but it is terrible economics," said Edward Ketz, an accounting professor at Penn State University. "It punishes those who have acted prudently and rewards bad decisions by homeowners who bought what they could not afford. It gives incentives for future homebuyers to act rashly, because they may believe Washington will rescue them from error and greed."

Perhaps more significantly, Ketz and others warn the plan could further choke off the credit markets and result in higher mortgage rates in the long run.

Declining values in mortgage securities have plagued banks and investors since the summer, with banks writing off some $70 billion in mortgage and credit securities in the last three months. Modifying the terms of the underlying mortgages for some of these securities will mean payments even lower than the amounts investors had counted on when they bought the mortgage pools in the first place.

Mortgage servicers either originate their own loans or buy loan-servicing rights to them. The loans are sold to banks, which then chop them up and repackage them in securities, complete with ratings and tranches to appeal to different types of investors. These investors buy the securities expecting certain performance characteristics, including payment flows from the borrowers of the underlying loans.

If an investor can't count on the terms of a mortgage security at the time he buys it, he has less incentive to continue investing in them in the future. That would reduce demand for mortgage paper, in addition to embedding a risk premium in the rate for those investors still willing to take the gamble.

Investor demand for mortgage-backed securities--and banks' eagerness to buy loans, package and sell them to this hungry crowd--helped create the incredible run-up in the mortgage market over the last three years. Paulson's plan does not protect the investors of these securities--increasingly, as it turns out, public pensions and other public funds.

In a report Thursday, Standard & Poor's said freezing rates without assuring against further defaults "would have a negative impact on the ratings of certain U.S. first-lien subprime" mortgage securities. "Declining investor participation means reduced capital and liquidity, which may affect homeownership and borrowing opportunities," the company said.

In other words, this plan could make the whole situation worse, not better.

Secretary Paulson has been eager to show he is trying to alleviate the crisis, though many say he and the rest of the Administration have been slow to make a move. Mortgage payment delinquencies hit a 20-year high in the third quarter, according to the Mortgage Bankers Association, as borrowers were unable to refinance or sell their homes to get out of a credit pinch. The percentage of loans with payments more than 30 days late, including prime mortgages, rose to 5.59%, its highest level since 1986.

"Politicians want to look like they are doing something while not doing something," says Joseph Mason, a professor at Drexel University who studies banking regulation and capital markets. "This plan fits that perfectly."

What it also does is pass the problem on to the next president, who will be elected next fall, well before the freeze on those mortgages lifts--and possibly before the markets turn around. Despite a strong showing in many financial stocks Thursday after the plan was announced, analysts forecast slower growth for banks as they come to terms with rising credit costs and a slowdown in their bond divisions.

University of Maryland business professor Peter Morici puts is this way: "The Treasury seems obsessed with what investment bankers do best in a pinch--short-term workouts that punt difficulties into the high grass."

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