I'm shocked

I'm shocked to find myself in agreement with Eliot Spitzer, writing in Slate Magazine about the catastrophe facing state and local governments: pension obligations gone wild while tax revenues are cratering.

Key point:

In New York alone, where the state pension fund lost $44 billion, or about 28 percent of its value, during the last year, local government contributions to the pension fund are going to have to triple over the next six years to make up the shortfall. Local governments will have to supply an extra $5.5 billion per year. That tax burden alone—traditionally derived to a great extent from the property tax—could break the backs of many communities.

Thanks for the heads up, Eliot. Too bad you didn't address that problem when you had the chance.

The recession is over!

Reports Daniel Gross at Slate Magazine, reviewing the predictions of two firms that analyze business cycles. They acknowledge the rotten employment picture, but suggest that jobs will be coming back by the end of the year.

Pardon my skepticism. I'm blogging this now so as to be able to refer back to it in six months.

Wall Street, 1907

In 1907, ten years before Childe Hassam painted Brooke Astor's "Flags, Fifth Avenue," he produced this impression of the financial district – a view up Broad Street to Wall Street and Federal Hall. (Click on thumbnail for larger image.) Lots of people in the street in those days. Not surprising – the Curb Exchange didn't move indoors until the 1920s.

1907 was the year of the Panic, the crisis that led to J. P. Morgan taming the trust companies.

Tourist note: I found the painting on Teri Tyne's Walking off the Big Apple. Her strolling guide to New York City should appeal to tourists and new residents alike.

Elk, Wall Street Bankers and the Average Investor

Economists may learn more from Charles Darwin than Adam Smith from now on, writes Cornell's Robert H. Frank.

Frank points to the elk. Mutations have resulted in male elk with antlers spreading five feet or more. These weapons of broad destruction help in fights with other males for mates – but they place the elk in deadly peril the first time predators chase him into the woods. (Could that help explain why the Eastern Elk, portrayed here by Audubon, is now extinct?)

Frank doesn't quite single out Wall Street bankers and their financial engineers as similarly maladapted, but one gets the picture: The ability of many to make lots of money individually did not assure their collective survival.

Even average folks may be ill-adapted to the investment world, as demonstrated by Mark Hulbert. We've evolved enough to see the theoretical advantages of timing the market, but not enough to realize we can't actually do it.

Hulbert cites a Morningstar study of the giant Growth Fund of America. In the bear-ridden 12 months through May, an investor holding the fund would have lost 31.4 percent. But "the actual return for the average investor in the fund was worse: down 32.7 percent.… The reason for this bigger loss was that the average investor had more dollars invested in the fund when it was declining than when it was rising."

The gap of 1.3 percentage points echoes the findings of an earlier, broader study. From 1991 through 2004, the tendency of mutual-fund investors to buy high and sell low reduced their average returns by 1.6 percentage points a year.

As for the presumably sophisticated investors who put money in hedge funds, Hulbert points to a study showing that market timing costs them a bundle: "The dollar-weighted return of the average hedge fund is 4 percentage points a year below its time-weighted return."

Toxic Trading on Wall Street

It's a mean, mean financial world, where predators operate in microseconds; individual investors need all the help they can get.

So we learn via John Mauldin who calls attention to a white paper written by Themis Trading, called "Toxic Equity Trading Order Flow on Wall Street."

Basically, they outline why volume and volatility have jumped so much since 2007; and it's not due to the credit crisis. They estimate that 70% of the volume in today's markets is from high-frequency program trading. They outline how large brokers and funds can buy and sell a stock for the same price and still make 0.5 cents. Do that a million times a day and the money adds up. Or maybe do it 8 billion times.••• This is a game played out in microseconds.

The retail world doesn't get to play. This is a game only for big boys who can afford to pay for the "arms" needed to fight this war. But the rest of us pay for the game, as that half cent is like a tax on transactions, not to mention the increased daily volatility, which skews pricing.

"Filing Chapter Heaven"

In the WSJ Brett Arends uses the term "filing Chapter Heaven" to enliven a report on how the Great Recession may prompt retirees to buy annuities and die broke. Sounds like a win-win situation – stable income for the retirees, freedom from the worries that go with investing an inheritance for their kids.

One Way to Inherit a Dukedom

Kind Hearts and Coronets, a masterpiece of English film comedy, debuted sixty years ago this summer. It's the movie that asks the question, "How can a draper's assistant become the 10th Duke of Chalford?" Answer: by practicing the gentle art of murder on the seven members of the aristocratic D'Ascoyne family that stand in his way. The Telegraph salutes the occasion with a tribute to the film's writer and director, Robert Hamer.

Hamer drank himself to death, but what a legacy he left us: a movie in which young Alec Guinness portrayed not only the murderer but all seven of the murder victims as well.

The Emporer's New Securities

Last December we noted that a Connecticut bank had been drawn into the Madoff scandal. Now the holders of more than two dozen retirement accounts are suing Westport National Bank, which served as custodian of the $60 million in their accounts. Except, of course, there was no $60 million – everything was invested with Madoff.

Madoff's operation is still a puzzlement. Both fund-of-fund managers and direct investors seemed to think of it as a hedge fund. Yet hedge-fund investors own partnership interests or shares or something. Madoff investors owned nothing; they merely opened brokerage accounts with him.

The New York Times succinctly describes the problem of custodianship that resulted:

[Westport National's custodian] agreement … indicates that the bank would take custody of whatever investments Mr. Madoff made on the customers’ behalf. For example, the agreement specifically requires the bank to adequately document the customers’ ownership of investments made with the Madoff firm “and held by the bank as custodian.”

In fact, there was nothing for the bank to hold since Mr. Madoff never bought any securities for his investors, according to the bankruptcy trustee ….

You can read the entire custodian agreement here.

Another “Dis-Astor”

The Daily News reports Chaos in the Courthouse when Anthony Marshall, Brooke Astor's son, fell today when taking a bathroom break. One can't help feeling sorry for the elderly Marshall. As we've observed before, "The Case of the Astor Will" is woefully miscast.

And yet … Marshall's reported conduct toward his mother could appear mean and avaricious in the extreme. He sold one of her favorite paintings, Childe Hassam's "Flags, Fifth Avenue (1917)," allegedly telling her that she needed the money. A dealer paid $10 million. Marshall awarded himself a $2 million "commission."

Art dealers customarily pay no more than half the price they hope to get for a work. The dealer reportedly resold "Flags, Fifth Avenue" for over $20 million.

Nominee for most misleading headline in 2009

From Bank Investment Consultant:

Clients Prefer Proactive Advice to Beating the Market

We'd love to believe that's true, because that would take all the pressure off in delivering satisfactory investment services, wouldn't it? But a scan of the article suggests that the clients said something very different, they were not presented the choice the headline implies.

A survey sponsored by MetLife, one that looks like it might have been skewed to favor large insurance companies, revealed that 45% would choose a financial advisor who would provide products that protect them against market risks. Only 18% said that they wanted an advisor who could "recommend products that can generate greater returns, despite greater risk."

I'm pretty confident that if the survey simply asked, "Would you like to beat the market with your portfolio returns?" they'd get a 100% affirmative.

Just to calibrate the demographics of the respondents, 29% said that if they received a windfall of $50,000 the first thing that they'd do is pay down credit card debt (the number one answer). Only 5% said that their first move would be to buy a investment product.

Seniors! Beware of Financial Alchemists

The Alchemist, via Wikimedia Commons

"[C]reating investments that promise investors both gains and protections is essentially like trying to work alchemy in the financial markets," observes The Wall Street Journal.

Despite last year's setbacks, the alchemists are back in their laboratories, seeking to turn derivatives into gold and stocks into investments that always go up.

The Journal reports they hope to sell their inventions to seniors – retirement-age investors.

(Advice from this senior to his peers: "Be afraid. Be very afraid.")

Custodianship

When I was a lad, many prudent investors kept their stock certificates in safe deposit boxes and took pains to clip their own bearer-bond coupons. Only the truly monied treated themselves to the convenience of having a trust institution as custodian.

Despite marketing efforts like the 1964 Chase nest egg ad shown here, custodianship remained a dull subject for decades – until Mr. Madoff reminded people of how expensive a brokerage account can be.

How Banks Make Money These Days

"It's the fees, stupid," according to data from Marketwatch:

Late fees, loan-origination fees, over-the-limit and overdraft charges helped generate 53% of banking-industry income in 2008, according to R.K. Hammer, up from 35% of income in 1995.

Tax and Trust Planning, 1936

We will get around to a post on Earl MacNeill's two estate planning books – maybe next week. Meanwhile, look what turned up in a December, 1936 issue of the Cornell Alumni News:

BOOKS
By Cornellians

TO SAVE TAX COSTS
Adjustments to Minimize Taxes. By
Earl S. MacNeill '15. Trust Department,
The Continental Bank and Trust Company,
30 Broad Street, New York City.
This useful booklet illustrates various
plans for reducing the payment of taxes
by the establishment of trusts. With
hypothetical cases it indicates ways of
lessening the effect on an individual's income
of the new tax on corporate surpluses,
of using insurance as an automatic
offset to estate taxes, of setting up a life
insurance trust to avoid Federal and
State taxes which apply to life insurance
proceeds in excess of certain statutory
exemptions, of saving estate and gift
taxes by gifts anticipating increasing
values, of making savings by systematic
giving, and of ascertaining the ideal
ratio of gifts and testamentary estate
for maximum tax savings.
It includes also non-technical discussion
of such matters as gifts made in
contemplation of death, reservation of
control of trust property, reversion of
principal to the donor, establishment of
the right in another to terminate a trust,
the giving of trust income to dependents,
the valuation of large blocks of securities,
costs of trusts, and the necessity of employing
professional advice in setting up
trust plans. Appended are convenient
tables of gift taxes and Federal and state
estate and individual income taxes.
The author is assistant trust officer of
The Continental Bank and Trust Company
of New York. Stephen L. Vanderveer
'08, vice-president of the Bank,
writes that the booklet "is in great
demand."—A. M. P. Ί8

Continental was absorbed into Chemical Bank in 1947. Eventually Chemical merged with Chase and took the Chase name, which survives as the "brand" for the retail banking arm of JP Morgan Chase.

The Most-Hated Tax?

You know how most people (Messrs. Gates and Buffett excepted) feel about the death tax. Imagine how they feel about the other transfer tax – the one Uncle Sam expects you to pay while you are still above ground.

The subject of federal gift tax came up at Tony Marshall's trial yesterday. Brooke Astor, his mother, had signed a letter in August 2003 authorizing him to receive a $5 million gift from her. In the letter she also agreed to pay gift tax on the $5 million.

As The New York Times reports, the $5 million gift looked a lot smaller by the time it was reported on Mrs. Astor's gift tax return for 2003.

How the Rich Stay Rich

As every investor knows, the first rule for making money is not to lose money. Last year that was a tough rule to follow, especially for investors in mutual fund packages known as target date funds. Funds targeting a 2010 retirement date declined an average of 25%. Some lost 40%.

Investors with seven-figure portfolios were far more successful in limiting their losses, according to a survey done by Richard Day Research for Fidelity Investments:

High-net-worth individuals who manage their own investments limited their 2008 losses to an average of 18%, compared with a 38.5% drop in the S&P 500.

HNWI's who relied on financial advisers did even better, darn near breaking even. Their losses were limited to a mere 4%.

Wealth managers, you couldn't ask for a better illustration of the value of professional investment guidance!

Unless, perhaps, it's too good. An 18% loss sounds plausible for a reasonably conservative mix of stocks, bonds and cash last year. An average loss of only 4% is something else again.

When something sounds too good to be true . . .

Feel Sorry for Harvard and Yale?

The endowments of Harvard and Yale are expected to report declines of 25% to 30% for their fiscal years, which end today. Many a smaller endowment has done better, the WSJ reports, mainly because smaller endowments invest more in bonds and little or nothing in "alternative" investments.

Don't feel sorry for the Ivies. As of a year ago, Yale had achieved a 20-year average annual return of 15.9%. Say Yale's return for fiscal 2009 is -30%. That still gives the Elis an average return of 13.15% over 21 years. And that's one reason Yale's endowment is still so large.

Compare:

At a nice, conservative 6%, in 21 years $100 will grow to about $340.

At 13.15% , in 21 years $100 will grow to well over $1,300.

Prudent Men Shouldn't Try to Time the Market

A googling of "Earl S. MacNeill," (see below) revealed this July 1951 item from Time.

New York State last year passed the "prudent man" rule. It allows trustees to buy common stocks, up to 35% of the trust's value, which a prudent man might buy for his own investment. Last week Irving Trust Co. Vice President Earl S. MacNeill reported that of $350 to $400 million eligible for such purchases in New York, trustees had invested not much more than half in common stocks. Reason: trustees think that stock prices are too high, are waiting to buy when they drop.

Not even prudent, professional corporate fiduciaries can time the market, it seems, As the chart below shows, buying stocks in 1951 would have been a cool move. But the Great Depression had cast a long shadow over equities.

Revenge of the Defrauded Widow

U.S.Judge Danny Chin, who today sentenced Bernie Madoff to 150 years in prison, noted that he received no letters from Madoff's family or friends requesting leniency. But he got plenty of other letters:

Chin recounted one letter that strongly affected him. It told the story of a Madoff investor who had died of a heart attack. Madoff, presumably at the man's funeral, put his arm around the widow and said, "Your money is safe." The widow then gave Madoff more money, all of which is gone.

Long-Term Care Insurance

"Why is long-term care insurance like a yacht?

"Because if you have to ask the cost, you can't afford it."

Now that we have that over-used jibe out of the way, see Walecia Konrad's column in the NYT. Shoppers for LTC insurance (at least those as ignorant on the subject as I am) and their advisers should find it useful.

News From 1930

We've mentioned this blog before, but News From 1930 is such a cool way to gain investment perspective that I'll plug it again. Warren Buffet has recalled how fascinated he was to come across a trove of papers from 1929. This daily dose of items from the Wall Street Journals of 1930 has the same attraction.

See also Why this blog, which includes a reminder that the Great Crash of '29 was a piece of cake compared with what followed:

What's not as commonly known about 1929 is that the Great Crash was followed by a nice rally with the Dow almost hitting 300 again in April 1930, and, at the point where we begin this blog in June 1930, still hovering in the 270's - not that far off where it was at the start of 1929. The real damage was done in the following two years when, following a spectacular series of further declines and rallies, the Dow bottomed out at 42 - almost 90% off its peak.

For a broader look at The Crash and what led up to it, see Frederick Lewis Allen's Only Yesterday. UVa has kindly put this most readable book online. To go directly to the chapter on The Crash, click here.

And don't worry about reliving the 1930's. Allen tells us that we can be sure of one thing – decades do not repeat themselves. "The stream of time often doubles on its course, but always it makes for itself a new channel."

We're Not a Fashion Blog, But . . .

The preppy look is back, reports the NYT, thanks in part to the Japanese. (They loved the look enough to buy J. Press.)

To our regular readers, that's old news.

Seniors As Entrepreneurs

Business Week sees a surge in senior-run businesses. Here on the New England coast, anecdotal evidence supports that view. For those ending long-term business or professional careers, "retirement" often means the start of something new. Some seniors pursue a long-nurtured Great Business Idea. Others seek to turn a hobby into a source of retirement income. A significant number start business ventures in partnership with sons or daughters, hoping to give the younger generation a leg up.

Senior entrepreneurship is not a new trend. Far from it. Here's a mid-twentieth-century example from the annals of The Merrill Anderson Company:

Earl S. MacNeill, senior entrepreneur

in 1958 Earl S. MacNeill – estate attorney, trust executive, author – retired from a fine old trust institution in New York City. Presumably fearing that estate planning and writing wouldn't keep him occupied, he joined Merrill Anderson. He'd already moonlighted a bit for the company, contributing booklet copy and articles for the trust newsletter.

When the eponymous founder retired, Earl MacNeill became Merrill Andersons's principal stockholder. Under his leadership the company morphed from a small ad agency, mainly serving a handful of major clients, to the premier provider of newsletters, presentation materials and other marketing tools to hundreds of trust institutions nationwide. One of Mac's innovations, still going strong today, is Estate Planning Studies and Briefs.

• • •

Mac, as everyone called him, wasn't the sort of highly polished, expensively tailored estate attorney you read about these days. Genial and down to earth, he never lost his unpretentious, upstate New York manner.

Here's the jacket blurb for the first of his two books, published by Harpers in 1957, a year or so before he joined Merrill Anderson full time.

Earl S. MacNeill is Vice-President of the Irving Trust Company of New York. He is the author of numerous articles on tax and trust subjects. He has long been active in the Trust Division of the American Bankers Association, is a member of the Committee on Taxation of Income of Trusts and Estates of the American Bar Association, and is on the faculty of the Graduate School of Banking, Rutgers University.

Mac's books, and what they tell us about the evolution of estate planning, deserve a post of their own. Watch this blog.

That Shot Was Out?

Fascinating tid-bit from The New York Times for Wimbledon watchers: When line calls are disputed, "in" calls usually prove correct. "Out" calls are usually wrong.

Theoretically, line judges should be equally likely to call an out ball in as they are an “in” ball out. But when objects travel faster than humans’ eyes and brains can precisely track them — for example, Andy Roddick’s 150-mile-per-hour serves — they are left having to fill in the gaps in their perception. In doing so, they tend to overshoot the object’s actual location and think it traveled slightly farther than it truly did.

This error in perception must have some relevance to investors and investment management. What is it?

The State of State Death Taxes

Do you realize California might be $1 billion per year less broke if it still collected the "pickup" estate tax that most states used to levy? So claims a rant at the Daily Koz.

Before 2005, the federal estate tax offered a credit for state death taxes paid. What the states collected cost the heirs of deceased residents "nothing." If a state didn't take the money, the feds would.

Currently, some states states collect estate taxes anyway. CCH offers a state-by-state guide.

Revisiting the Depression

Do comparisons of the present troubles to the Great Depression help to divert investors, or do they make investors more … depressed? Comparisons are inescapable in any case. Here, two economists chart a series of definitely depressing comparisons between then and now. More diverting is News from 1930, a blog that summarizes highlights from The Wall Street Journal on the corresponding date in 1930.

New Yorker subscribers have a cheerier way to revisit the bad old days. A digital archive of every issue, which the magazine used to sell on CD-ROM, is now available online. Except for dowdy fashions and primitive electronics in the ads, New Yorker issues of the 1930 don't look much more dated than those of the 1950s. Aside from occasional jibes about worthless stock certificates, you'd hardly know the Great Depression was occurring.

Certainly this ad from a June 1930 issue manages to sound positive. The global investing pitch wouldn't seem out of place today.

A Case of Premeditated Probate?

Most-visited article relating to the trial of Brooke Astor's son, Anthony Marshall, according to Google: On Sample Tax Form, Mrs. Astor Died Early.

18,500 New Fiduciaries?

Could Smith Barney's 18,500 brokers (a.k.a. "financial advisors") suddenly turn into fiduciaries? The Wall Street Journal reports on the prospect:

Buried in President Obama's proposed regulatory overhaul is a change that could upend Wall Street: Brokers would be held to a higher "fiduciary" standard that would compel them to place their client's interests ahead of their own.

Wealth Advisers vs. the Wealthy

Robert Frank's post on how differently investors and their advisers evaluate adviser performance drew a number of comments, mostly serving to accentuate the gap in viewpoints. Maybe we should call it a standoff.

You're right, angry investor: "I paid … a lot of fees last year to lose 30% of my assets. Can someone explain to me why I should PAY someone to lose money, when I can lose that money for free?"

You're right, too, former wealth manager: "Clients want no risk and 20% returns. They want maximum liquidity and no fees.
They want everything except the truth that investments fluctuate."

“There's More to Managing . . . ”

Cambridge Trust, one of the few venerable New England financial institutions still around, clearly shares our belief that now's the time to step up advertising and marketing. All those investors shaken loose from their advisers by the bear market need new financial homes.

You've probably noticed Cambridge Trust ads on line. Among other marketing efforts, around Boston they're running radio spots. I do wonder about their tag line on the commercials:

"There's more to managing your wealth than just managing your assets."

Oh? Like managing your liabilities … especially if you've been Madoffed or otherwise ripped off?

O.K. I know what Cambridge Trust means: stuff like advanced estate planning and heirship camp for the kids. Do you think most listeners get it?

Nursery Rhyme for Bad Times

From the November 1929 issue of Trust Companies, the predecessor to Trusts and Estates:

The Mother Who Would Not Die

Irene Prusik died in 2003 at the age of 73. But with the help of her son, she collected Social Security and rent subsidies for another six years. See Brooklyn man impersonates dead mother.

Top “Wealth Manager Brands”

Courtesy of Bessemer Trust, here's the Luxury Institute's 2009 survey of top wealth manager brands.

"Brand." When that term stops being overused, the marketing of financial services to the well-endowed will be better off. Meanwhile, note that BofA's US Trust "brand" is fading but still ranks higher than BofA's Merrill Lynch "brand."

Two Financially Fallen Women

Were you too busy enjoying the weekend to check the Sunday papers? By design or coincidence, the Sunday New York Times offered detailed glimpses into the lives of two women once considered super rich.

See Checkmate at the Yellowstone Club for a visit with Edra Blixeth. She and her former husband founded the Yellowstone Club, where even Bill Gates and his family can ski in privacy. After Mr. Blixeth mortgaged the club to the hilt in hopes of financing new resorts, it went bankrupt.

The loneliest woman in New York describes the circumscribed circumstances in which Ruth Madoff, Bernie's wife, now lives. Does she share Bernie's guilt? Even her hairdressing salon doesn't know for sure, but it's not taking any chances.

Another Big Bank Fails, Virtually

You can't make this stuff up:

Uh-oh! Another big bank is the subject of a depositor run amid charges its chairman has run off with customers’ money. Thankfully, this scandal is taking place in Eve Online, a space-age virtual reality created by CCP, a games developer and Iceland’s coolest company. But these troubles in the ether may offer some valuable lessons for earthly banking and regulation.