Financial advice in turbulent times

Many of you know that in addition to working for a company that services institutional investors, I also stay up to date on the markets and am fascinated with economics and finance. I don't normally post financial advice because it ideally needs to be delivered in person so it is not misconstrued. Due to what is happening in the markets I felt it was necessary to post something very specific that will hopefully be helpful for you or your family, while at the same time will be simple and straight-forward.

Make no mistake about it. The U.S. economy and financial system is a wreck and will not be getting better anytime soon. In fact, it will get much worse before it gets better. Hundreds of banks, brokers, and insurance companies will fail in the next few years. I don't write this to scare anyone but to try to give advice on how to act based on how I have interpreted the Federal Reserve and the U.S. Treasury's responses to date.

The Fed and the Treasury have made 15 announcements on Sunday afternoons so far this year. There have been a slew of bailouts of firms like Bear Stearns, Fannie Mae, Freddie Mac, and tonight with insurance giant AIG. Capitalism in America is essentially gone and has given way to socialism for corporate America similar to the socialism at the personal level that has been emerging for years. Like most forms of socialism, only select people benefit. This became apparent over the weekend when the government let Lehman Brothers fail while saving AIG tonight. Lehman's bankruptcy was not anticipated by a marketplace that has been conditioned to believe that all Wall Street firms will be bailed out if they scream loud enough to the politicians they have lobbied for years. I was shocked that they let them fail, though I welcomed it as the right thing to do if you believe in capitalism. You might be thinking "Who cares?" but the events of the last two days tell me two things:

1. The government will only protect the biggest and most reckless firms (AIG, Fannie, Freddie) whose failures will lead to systematic troubles. The taxpayers will be on the hook for the billions of dollars of losses so Wall Street doesn't have to take them.

2. The government will let the smaller to medium tier firms (Lehman) go bankrupt so as to look tough and still have some ability to say they believe in free markets and capitalism though their actions prove they do not. In this scenario, the stock market will suffer some, but it will probably go down slow rather than crash. It also means if you have any dealings with these companies the government will NOT protect you. They are only interested in protecting Wall Street, not Main Street.

So what does this mean practically for you? Scenario 2 means if you have family or friends with annuities at small or medium tier firms they need to get them out if there are not huge penalties to withdraw. The government bailed out AIG tonight because up until a few months ago they were the biggest insurance company in the world and pose systematic risk to the stock market. They also are one of the biggest sellers of annuities in the world. Yesterday, unbelievably the New York attorney general allowed AIG to use monies that are by law segregated for holders of life insurance policies, annuities, etc... to use the segregated funds for general corporate purposes. The government bailout tonight will negate their need break this law, but smaller insurance companies and banks will be failing over the ensuing months who will not be so fortunate to get taxpayer funds. This means your annuities will be at risk as AIG annuities and Life insurance policies would have been prior to the bailout. I have never been a fan of annuities but now is a particularly bad time to have them. Since many older people put huge sums of money in them at retirement, you probably know people that have them. I know several people in our sphere of family and friends.

So where should you put your money if you have annuities? In a period like we are in now, not losing is winning. What that means practically is that you should have your money in short-term U.S. Treasury bills or a U.S. Treasury Money Market fund. Do not settle for a money market fund with corporate debt. You should only own U.S. Treasuries with maturities under a year. You can buy them at your bank or at http://www.treasurydirect.gov/ Treasuries are only yielding around 2% right now but remember, "not losing is winning."

Deposits at banks and CD's up to 100k are safe with FDIC insurance. FDIC will be insolvent after a couple more bank failures, but I am 99.9% confident that the Congress will pledge more taxpayer funds to make them liquid, especially in an election year. Though it is almost a foregone conclusion that FDIC will be bailed out, they will be stressed soon. Washington Mutual and Wachovia bank will likely fail in the next few weeks. They will wipe out the rest of the FDIC reserves so Congress will be forced to act soon. This is why I prefer T-Bill's, though I am confident that CD's will likely be fine.

The landscaped has changed massively in the last two weeks. Though we are supposedly capitalists in America here are two facts that are staggering to me....

1. As of two weeks ago, the biggest mortgage issuer in the U.S. is the U.S. Government. 8 out of 10 mortgages in the U.S. are now funded by Fannie Mae, Ginnie Mae, or Freddie Mac. Only 2 out of 10 mortgages are funded by private companies. That will be zero soon enough. No private company can compete with a government that has printing presses for bad loans.

2. As of tonight, the U.S. Government has become the biggest insurance company in the world and by default a leading player in the annuity market.

If that doesn't sound like capitalism to you then we are on the same page. The American people are growing weary of the socialism for the rich (as am I), and I am not a "soak the rich" class warfare person at all. I am, in fact, very conservative philosophically, but more libertarian fiscally. Going forward the Republican administration will try to look tough by letting small companies fail, while bailing out the big firms. This is what you should expect in the headlines going forward so if you know anyone with annuities they need to seriously consider whether they should keep them.

If you want un-varnished reporting of the events to help you stay ahead of the curve, here are two excellent financial blogs. These two guys have a great grasp on what is going on and what will continue to happen over the coming months.

Calculated Risk

Mish Shedlock