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ADV Part 2

 

 

 

Investor Resources Inc, Investment Advisory Service, Port Orchard, WA

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2012Jan30 We have seen the enemy

"Yep, son, we have met the enemy and he is us." ~ Pogo

 

Real Estate:

 

Freddie Mac, a taxpayer-owned mortgage company, is supposed to make homeownership easier. One thing that makes owning a home more affordable is getting a cheaper mortgage.

 

But Freddie Mac has invested billions of dollars betting that U.S. homeowners won't be able to refinance their mortgages at today's lower rates, according to an investigation by NPR and ProPublica, an independent, nonprofit newsroom.

 

These investments, while legal, raise concerns about a conflict of interest within Freddie Mac.

 

"We were actually shocked they did this," says Scott Simon, who heads the mortgage-backed securities team at the giant bond trading and investment firm called PIMCO. "It seemed so out of line with their mission, out of line with what Congress wanted them to do."

 

This hypothetical example may help explain what happens:

 

1) Freddie Mac takes, say, $1 billion worth of home loans and packages them. With the help of a Wall Street banker, it can then slice off parts of the bundle to create different investment securities, some riskier than others. The slices could be set up so that, say, $900 million worth are relatively safe investments, based upon homeowners paying the principal on their mortgages.

 

2) But the one remaining slice, worth $100 million, is the riskiest part. Freddie retains that slice, known as an "inverse floater," which receives all of the interest payments from the entire $1 billion worth of mortgages.

 

3) That riskiest investment pays out a lucrative stream of interest payments. But Freddie's slice also has all the so-called "pre-payment risk" associated with that $1 billion worth of loans. So if lots of people "pre-pay" their old loans and refinance into new, cheaper ones, then Freddie Mac starts to lose money. If people can't refinance, then Freddie wins because it continues to receive that flow of older, higher interest payments.

 

In his State of the Union address, President Obama pushed for legislation to allow "every responsible homeowner the chance to save about $3,000 a year on their mortgage" by refinancing without what he called "red tape" or a "runaround from the banks." It will be interesting to see if we get any such legislation. As we have said many times before, the real estate market has more downside to go.

 

Demographics:

We knew that there wasn't much population growth in Japan, but the extent to which the population is expected to shrink is stunning. The National Institute of Population and Social Security Research predicts the Japanese population will shrink by two thirds (!) by 2110. About a third of the population will disappear by just 2060. The group also forecasts an increase in life expectancy from 86.39 years to 90.93 years. If demographics is destiny, and a high dependency ratio spells doom for the economy, well then... yeah, this is trouble.

 

Broker or Advisor:

It may not be a household word, but the battle over your broker's "fiduciary" role has moved in a new direction  -- away, some say, from a lot of clients' best interests.

 

A major push by consumer advocates to hold stockbrokers to the same client-comes-first standard of care required of investment advisers -- the so-called fiduciary standard -- seemed close to success only a year ago. That was after a study by the Securities and Exchange Commission had called for the new rules, despite brokers arguing that dispensing advice was only a part of their business model and they shouldn't be held to the same standard as advisers in all situations.

 

Here's what CEO Dick Averitt had to say about his firm's (Raymond James) current business mix at a recent conference (via Financial Advisor):

 

Averitt speculated that the migration of reps to the RIA space could turn out to be a long-lasting megatrend.. He recalled that 25 years ago Raymond James' independent contractor business was a small part of the firm's total revenues.

 

"Now it's our biggest business," Averitt said. Today, "we're wondering if it won't be the RIA business." If that turns out to prove prescient, Averitt noted Raymond James will have to make adjustments to maintain their profitability.

 

There's a reason FINRA wants very badly to become the regulator for the Registered Investment Adviser channel.  It has a lot to do with the fact that the shepherd, upon seeing the exodus of a great portion of his flock, is best advised to follow after it rather than to take a knee and hope the remnant doesn't amble away as well.

 

Ten years ago,the Wall Street wirehouse brokerage firm seemed unassailable - part of the very firmament underpinning the entire investment industry from coast to coast.  Now there are questions about whether the model itself can remain viable once the firms stop paying advisors to stay.