Letter - September 2008





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The Fix Is In

Monday Lehman Brothers went under and Merrill Lynch sold itself to Bank of America. Tuesday AIG had to be rescued. Wednesday money market funds were said to be “breaking the buck”. Thursday Morgan Stanley looked in trouble and the market tumbled, some stocks falling 30% or more on rumor and innuendo. Friday the market rallied sharply. The weekend brought news that Goldman Sachs and Morgan Stanley will become regulated banks with access to the Fed window.

Every time we have put pen to paper in these past few days to communicate with clients and reassure them, events have made our missives old news within hours. Now the fires seem to have subsided enough to begin making sense of it all.

The fix is in. The Treasury/Fed will seek Congressional approval to create a Federal agency similar to the Resolution Trust Corporation formed in the 1980s to clean up the S&L debacle. American taxpayers will fund a $700 billion investment pool (about 5% of GDP) to buy distressed securities from financial institutions, pumping much needed liquidity into the financial system. In essence, Uncle Sam will become the investor of last resort.

The title of this piece suggests there may be a bit of a scam going on here. It could be argued that the true cost will be much higher and that responsible taxpayers like you and me will have to bail out irresponsible banks, mortgage brokers and home speculators. That may well be true. But we have no choice.

Fed Chairman Bernanke is a practical man. He has commented that, “In foxholes there are no atheists, in financial crises there are no ideologues.” A failure of the financial system would leave us impoverished indeed. And we may get some of the money back. Unlike much government spending, which is gone when spent, this scheme, if handled skillfully, could return to the Treasury much of the money invested up front.

While the fix may be in, for investors it is unlikely to be a quick fix. Problems for the economy remain. Unemployment is rising, housing foreclosures have yet to peak, consumer debt is high, corporate earnings are bound to come down, and oil, despite its recent decline, remains very high. We note that it took a year for the market to make its low after the creation of the Resolution Trust Corp in 1989. We don’t know how long it will take this time, but it could be a while.

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We realize that clients are anxious about their hard-earned savings and investments. For the last six months we have been slowly raising cash in client accounts to the highest level in many years. This

has helped cushion the declines. As of the end of August, managed client accounts in the aggregate fell 7.6% versus 11.6% for the S&P with dividends included.

Wall Street panics come and go, and many investors sell at just the wrong time. In the midst of all the media pandering to investor fears (our advice: don’t watch CNBC!) it is easy to forget that US authorities are coordinating vigorously with counterparts in other countries (where stock prices have dropped more sharply than here) to prevent the disorderly collapse of crucial financial institutions.

Until things settle down we will maintain above average cash balances in client accounts. We take comfort in knowing that your cash is in funds prudently managed by Federated Investors and that your assets are held at Pershing/Bank of New York Mellon, a good port in the storm.

However, we don’t believe long-term investors should be excessively cautious in the face of panic which often represents the final stage of a market decline. Bear markets offer exceptional opportunities. We note that in the midst of last week’s turmoil, Warren Buffet’s Berkshire Hathaway made a $5 billion acquisition of a distressed electric utility whose stock had collapsed. During these turbulent times, we will consider buying stocks that represent good value.

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The SEC requires us each year to offer to clients our Form ADV II, which discloses important information on how we manage client funds and run our business. You can find the form (technically a “replacement brochure”) in the “Disclosures” section on our website at www.prherzig.com. Let us know if you would like us to mail you a hardcopy. Also FINRA requires us to ask clients periodically to advise of any changes in address, financial circumstances, or financial objectives. Please let us know if we need to update any of your information.

Tom Herzig


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