NYB/S/Government Entitlements/Principal Protected Notes/Build America Bonds/Rand Paul-Reactionary Not Conservative//

I did not place any orders yesterday. I am hibernating. Yesterday was unusual in that the VIX fell 4.44% to close at 38.32 and the S & P 500 declined 1.29%. Still, the recent spikes in the VIX, discussed in this earlier post have made the LB more cautious than usual. RB could not resist saying that volatility is a friend that needs to be embraced by Mama's Boy. Besides, the RB added for good measure, that stinking VIX Asset Allocation model promulgated by the NERD is simply capturing a market experiencing post traumatic stress disorder with flashbacks to September 2008. The problems in Europe are nothing like the sovereign debt problems confronting the emerging long term secular bull market in 1982, as the Old Geezer started to reminisce about the good old days, when most of the Latin American countries actually defaulted on their debts. Latin American debt crisis

Wherever Europe may be headed, the market certainly needs less hyperbole from business and political leaders. Yesterday, I read excerpts from a speech by Jeff Immelt that Europe may be "teetering" on the edge of economic disaster: Reuters CNBC

The announcement by the ECB of its tepid purchases of government and corporate debt during the second week of its buying program was not reassuring to the market: NYT RBS is saying that the ECB needs to pick up the pace to prevent a "complete collapse in confidence" BusinessWeek The currency ETF for the Euro (FXE) fell $1.94 or 1.55% in trading yesterday.

1. Build America Bonds: Bill Gross recommended Build America Bonds (BABS) in this interview with CNBC, based on their yield being about 2% over treasuries. BABS are taxable municipal bonds. More information about these bonds can be found at the SIFMA site. Powershares has an ETF devoted primarily to Build America Bonds (BAB). The expense ratio is .35%, and this ETF had 193 holdings as of 5/24/2010: Build America Bond Portfolio | BAB A list of its holdings can be found at Holdings. A waiver brings the expense fee down to .28% until it is revoked. Looking through the list of holdings, most are rated A or better with a number of AA rated municipal bonds. Distributions are paid monthly.

SPDR has also recently launched a similar fund with the symbol BABS. The expense ratio is .35% and this ETF has 39 holdings: SPDR Nuveen Barclays Capital Build America Bond ETF

Both of these funds' holdings will be similar in credit quality to investment grade corporate bonds. The average yield to maturity would be long term for both funds, giving them a lot more interest rate risk than an intermediate term bond fund with an average maturity of 7 to 10 years.

I do not have a position but may buy one of these ETFs at some point.

2. Principal Protected Notes: I really do feel sorry for individuals who bought principal protected notes issued by Lehman. There is no doubt in my mind that many individuals did not fully understand what they were buying and were not fully informed about the risks inherent in these products. Unfortunately, many individuals rely on brokers to act in their best interests and are not inclined to make any meaningful effort to protect themselves.

If an investor takes the time to read a prospectus, or just the opening paragraph of one, it would be apparent that the Lehman principal protected note was in fact a senior obligation of Lehman Brothers, subject to the credit risk of the issuer. If Lehman failed, then the owner of the note would be an unsecured creditor in Lehman's bankruptcy. I would never expect to recover more than 20 cents on the dollar in that eventuality, and would not be surprised that the "principal protected note" would be worth only a few cents. I view that as nothing more or less than common sense that does not require much if any financial sophistication. It does require some effort to learn about the security before making the investment.

In her column in the NYT on Sunday, Gretchen Morgenson takes on the role of an advocate for those unfortunate individuals who bought Lehman notes. She mentions a couple who invested half of their savings in one at the urging of a UBS broker. This is just awful advice which was made worse by the timing of it, just a few months before Lehman's collapse. I am not questioning the facts as recounted by Ms. Morgenson. I find it easy to believe that the broker did not fully inform this couple about the risks and gave the couple extremely bad advice.

But, it is also clear the couple made no meaningful effort to assess the risk themselves, and I view that as negligent too. They claim the broker did not send them a prospectus. Okay, if they did not receive one, why did they not ask for a copy or just go online and find it? The couple claims that they did not understand the product or even know Lehman was the issuer. Okay, if that is true, the broker sounds like a cad, but why would anyone invest so much money in something that they do not fully understand or have no meaningful grasp of the product being purchased? This comes back to individual responsibility and an unwillingness among millions to accept any responsibility for their own actions or their failures to take even rudimentary precautions to protect themselves.

Morgenson quotes a lawyer for the aggrieved individuals, Jacob Zamansky, who says that these products are not capable of being understood by individuals. And, he adds for good measure that no investor would buy one if the risks were honestly disclosed. That is self-serving hogwash and garbage. Some of them are somewhat complex and do require a few minutes to grasp, but they are not that difficult to understand. These kind of instruments can play a role in a conservative investors portfolio, but I would not buy one that is not publicly traded. If I become concerned about credit risk, I at least want the option of bailing by selling the security just like I would a stock.

Recently, I have invested in several exchange traded notes, issued by Citigroup and Bank of America, that are similar to the ones described by Ms. Morgenson. I took the time to read each prospectus and to understand exactly what I was buying before investing $1000 in the first one. It is obvious after reading a few lines that these notes are senior obligations of the issuer which exposes me to credit risk. For the ones issued by Citigroup funding, I am principal protected at maturity provided Citigroup survives to pay me the $10 par value. I am not principle protected in the event Citigroup is seized by the FDIC or files for bankruptcy. In that eventuality, I am just screwed. This is not a difficult concept to grasp or for a broker to explain to a client.

When I initially decided to buy some exchange traded principal protected notes issued by Citigroup Funding, my first decision was to limit my exposure to a specific dollar amount given the credit risk connected to holding senior note obligations of Citigroup. Some investors could rationally conclude that they do not want any exposure based on their tolerance to risk and their personal situational risks. The credit risk is the same as buying a fixed coupon senior bond from the issuer. The difference is that the distributions are tied to the performance of an index for the principal protected notes. After making the decision on the dollar amount of risk, I proceeded to select a few to buy. On one, I have already received an annual interest payment of $180 on a $10 note, based on the percentage gain in a commodity index. MKN & MKZ

Some of the discussions on the Citigroup exchange traded notes that I have purchased this year can be found in these posts:

Bought 100 MKN at 9.85- Tied to Commodity Index

100 MKZ bought at 9.96 Bought 100 MKZ at 9.91 in the Roth IRA -Tied to Commodity Index (100 of the 200 shares have already been sold)

Bought 100 MYP at $10.12 -Tied to the S & P 500

Bought 100 MHC at 9.8 Tied to the S & P 500

Bought 100 MOU at $10.12 -Tied to the Russell 2000

Bought 100 MBC at 9.84 -Tied to the Russell 2000

MBC is ex dividend today for its 3% guarantee ($30 on 100 shares). ( referenced in today's WSJ.com under "initial")

Each of those notes have a $10 par value and mature in 2014. Distributions are paid annually at the greater of a guarantee or a percentage gain in an index, provided the index does not gain too much as explained in the foregoing linked posts in greater detail and in the relevant prospectuses. There is no excuse for anyone who buys these securities to refrain from reviewing the prospectus or refusing to take the time to understand exactly what they are buying. If they do not take the time, then they have no one to blame but themselves.

The similar products that were issued by Bank of America do not guarantee the return of the $10 par value below a certain level in the index, and are more risky in that respect. I am more comfortable with a BAC note than one from Citigroup, but there is obviously risk in owning notes from either of them. The BAC notes are discussed in these posts:

ITEM # 8 Discussing the Purchase of 100 LMZ at $10.06 in the Roth: Sold 50 COP at 56.63/Bought 50 BNCN at 9.99/ Sold 50 of the 150 of VNOD at 25.54/SOLD 50 PLP at 22.06/C/ OSKB/Bought 50 DKK AT 24.5

Bought 200 SFH at 10.18- Tied to S & P 500

Bought 100 SDA at $9.8/-Tied to S & P 500 and matures in 2015.

Bought 100 SJV at 9.67 -Tied to the S & P 500

I am not likely to invest in more than 100 shares of another BAC special investment product, since I own other types of BAC securities, including trust preferred issues and common stock. I will not exceed $10,000 in exposure to any firm after combining the purchase cost of all securities issues by it, including the common stock, preferred stock, junior bonds, and senior notes. In addition to over 200 shares of the common, I also own the following junior bonds: Buy of 50 MJH at $7.51; Bought 50 BACPRW at 22.62 in the ROTH; Bought 50 of the TC CPP at $24.2.

3. Rand Paul Is a Reactionary-Not A True Conservative: Rand Paul is not a conservative. His supporters are not true conservatives. I am glad to see him win the republican nomination for the Kentucky Senate race since some of the prevailing views of the Tea Party can be aired to a nationwide audience. Ultimately it is up to the people whether or not to accept his reactionary views.

Paul's beliefs have many similarities to the European anarchists, though I am sure that he would be offended by that comparison. He views government as the source of evil and wishes to eliminate virtually all activities of the federal government except for defense of our shores. When Rachel Maddow asked Paul whether he approved of the 1964 Civil Rights legislation (YouTube), Paul tried to obscure his core beliefs but they managed to shine through anyway: Coward If a white businessman wants to refuse to serve a black patron at a lunch counter, or to provide them lodging in a hotel, then Paul believes that is their right. The federal government has no role to play whatsoever in regulating anyone on anything. He views any such effort to be an infringement of the citizen's freedom, which means to him that individuals have a right to do whatever they please free from federal government interference. The states can regulate activity within their borders that are a proper exercise of police power in Paul's ideology but the federal government should be constitutionally prohibited from any similar type of regulation.

So, without a a state law, a meat packer could mix rat meat with the ground beef; BP would be free to pollute the waters of the gulf; there could be no Federal Reserve Bank; no Food & Drug Administration; No Environmental Protection Agency; and so on. In short, just to keep this brief, all of the laws passed by the Federal government that most people take for granted now as necessary to protect the public's health, safety and welfare should be repealed according to Mr. Paul and the Tea Party crowd. This philosophy is not new. It is the same platform previously known by the name "States' rights" reincarnated with a different white face than Strom Thurmond, Lestor Maddox or George Wallace. What is the Appropriate Political Label While those advocating the core belief of State's Rights wish to call themselves conservatives, they are in reality reactionaries, desiring to turn back the clock to the 19th Century in order to protect what they view as their freedoms: freedom to discriminate, freedom to pollute, freedom to have an unsafe workplace, freedom to sell unsafe drugs and food, freedom to sell harmful products, and generally the freedom to cause whatever harm so desired by them. It is not surprising that this movement has a found a home in the modern day GOP.

I discussed in two earlier posts the desire of these reactionaries to overturn the Supreme Court decision in Wilkard v. Filburn. Most people would not have any idea about the full scope of this controversy. Conservative or Delusional Reactionaries? the 10th Amendment & the Commerce Clause They view this decision as a primary source of where America went wrong. Why? The Supreme Court's interpretation of the Commerce Power in that case extended the federal government's regulatory power to private activity, and this was the jurisdictional source of all the subsequent legislation that the reactionary forces in America do not like. This would include the Civil Rights Act of 1964, environmental protection, minimum wage, occupational safety legislation, food and drug laws, and any other progressive legislation adopted in the past 100 years. It is why Glen Beck views the republican President Theodore Roosevelt with such hostility, since he advocated federal legislation regulating the safety of food and drugs. Item # 3 Conservative or Delusional Reactionaries?

Some of Paul's core beliefs are discussed in two recent Wall Street Journal articles: Republicans Are Peppered Over Paul's Remarks - WSJ.com Paul Remarks Have Deep Roots - WSJ.com His true colors are on display for all to read in a letter he wrote in 2002: Rand Paul POLITICO.com The core of his philosophy is considerably broader than opposition to federal civil rights legislation as applied to private citizens or to the ADA requirements for private business. A lot of the commentary misses the mark entirely on the true scope and implications of his beliefs.

It is also not surprising that Paul and the Tea Party crowd will forever fail to learn anything from history or the consequences of what happens in a society free from federal regulation. And, they will never understand how their core philosophy was the key contributing cause to the Great Depression in the 1930s and to the recent Near Depression. Instead, as shown in their recent successful effort to defeat the real conservative GOP Senator from Utah, Robert Bennett ( USATODAY.com), they are angry about the actions necessary to save the financial system from collapse largely caused by allowing people to do what they want in a vacuum of meaningful federal regulation. POLITICO Ignorance can be a form of bliss.

4. Unsustainable Government Entitlements: The sovereign debt woes of Greece, and to a lesser extent Spain and Portugal, are the first major warning shots that western governments have promised more than they will be able to deliver. There is not a bottomless pit of money that can be borrowed and spent on entitlements.

True conservatives and the tea party crowd share some common views on the direction of government spending.

The article on Sunday in the NYT discusses the growing gap between the liberal benefits promised by European governments and the ability of those governments to pay for them. The problem has just hit the weakest of the EU members first. And how do they plan to support these liberal retirement benefits when the ratio of active workers to retirees falls to 1.3 to 1 from 7 to 1 in the 1950s.

Greece is allegedly tightening its belt some by extending the retirement age of civil servants. When there are already more than 500,000 union members of the Greek civil service, out of a population of just 11 million, extending the retirement age is not exactly an attack on the root cause of too much government spending.

This article from Morningstar highlights the differences between European sovereign and corporate debt. There is at least one ETF that is devoted to worldwide corporate bonds: SPDR Barclays Capital International Corporate Bond ETF That ETF has some exposure to U.S. corporate bonds, at around 18.75% of the portfolio, followed by Germany at 16.15%, the U.K. at 12.51%, and France at 11.28%. Given the large percentage of foreign corporate bonds, this fund would have a considerable amount of currency risk for a U.S. investor. I would anticipate that the changes in the currency valuations to be far more significant than the modest dividends paid by this kind of ETF, so any purchase by me would primarily be a "bet" against the U.S. dollar, just like BWX and WIP, and consequently not something that I would want to own during a period of dollar strength as now. I will key off the US Dollar Index Future (DXY) as a key consideration in buying and selling these foreign bond ETFs. The Dollar Index & Foreign Government Bond ETFs WIP & BWX

5. New York Community Bank (owned-regional bank strategy): NYB was upgraded to outperform by BMO Capital Markets yesterday. The analyst, Peter Winter, believes that the dividend is secure and the bank will not likely be impacted by regulatory changes. He raised the price target to $20. My shares were bought in 4 fifty share lots with an average cost of around $11, with the position divided between the taxable and regular IRA account. NYB is the only stock owned in the regular IRA. Bought 50 NYB at $11.3 50 NYB at 10.9 50 NYB at $11 Added 50 NYB at $10.57

6. Sprint (own bonds): GS upgraded Sprint to buy and raised the price target to $6 from $3.5. Citigroup reiterated its buy rating. MarketWatch

Bought 50 PBIB at 13.27/Added 50 XKK at 8.98/ Bond CEFs

The preceding table is the latest update on the regional bank stock basket strategy. Needless to say, I took a hit since I lasted posted this table on May 14th: Bought 50 WAIN at 8.72/Added 50 ORHPRA at $25/Bought 50 BACPRW at 22.62 in the ROTH/BDF Acquisition of HSF

Since I characterize the current stock market as a long term secular bear market of unknown duration, I am mostly in an extremely active trading mode. Notwithstanding that overall thrust, I am following some long term strategies. The regional bank stock basket is one such strategy. To date, I have realized approximately $1275 in profits, but the intention is to hold most of the stocks in this basket for five to ten years. I recognize that this strategy has a number of downside risks, but I still view the potential upside as outweighing those risks. I expect to have several periods where several thousand dollars is clipped from my unrealized gains, and I had a couple of grand clipped just in the past week.

Instead of selling any of the securities in this basket, I added late Friday 50 shares to the existing position in Porter Bancorp.

The two other long term strategies involve keeping consumer staple stocks purchased in March 2009 for as long as the firms continue to raise the dividends. This includes purchases of CPB, KO, UN, SYY and HNZ. The only other long term strategy is to keep the investment grade bonds bought during the Near Depression period that have current yields in excess of 10%. There are a few caveats to even a long term strategy. I will not tolerate a major adverse development in the company that shakes my confidence in the firm's long term future.

There are a few other securities being held long term for reasons unique to them. Examples would include PFK, the CPI floater from Prudential, term bond CEFs, and a few stocks held under the dividend growth strategy.

1. Bought 50 PBIB at 13.27 on Friday (Regional Bank Stocks basket strategy)(see disclaimer): I have warmed up to Porter some after its 1st quarter's report. I decided to add to the position for two simple reasons. Porter Bancorp declared its regular quarterly dividend of 20 cents per share on Friday. At 80 cents per year, this gives me about a 6% yield at a total cost of $13.27. This is a permitted purchase under the existing restrictive trading rules since it is a reinvestment of the proceeds realized recently from the sell of EWBC and WIBC.

The second reason was an article in the a Louisville business journal summarizing part of the CEO's discussion at the recent shareholder's meeting. Maria Bouvette is reported to have said that she expects the "credit metrics" to improve during 2010. This last purchase is an average down from the 50 share purchase at $14.1: Item # 2 Bought 50 PBIB at 14.10.

2. Added 50 XKK at 8.98 Friday (See disclaimer): In March, I sold 300 of my 550 of XKK at $9.72: Sold 300 of the 550 of the TC XKK Par value is $10. XKK is a TC containing a senior Goodyear Tire bond, rated junk, that matures in 2028. The coupon on the TC is 8%, higher than the 7% coupon of the underlying bond. (compare FINRA information on the underlying bond and the prospectus for the TC at www.sec.gov)

This particular TC can be extremely volatile during days of extreme market distress. In March of 2009, I bought shares at $3.80: Buys of CPB LQD SYY XKK I was placing orders at around $5 in December 2008: Goodyear Tire TC xkk In a post from November 2008, I was discussing the yield on this one being over 27% at less than $3. Emerson Electric and the Goodyear Tire TC XKK That is just nuts. On May 6th, 2010, the day of the flash crash, it fell to $5. XKK: Historical Prices If I could have accessed by Fidelity account that day, I could have picked up those 50 shares at $7 and change. There can be some benefit to leaving a small GTC limit order well below the market to see if I can catch one of these meltdowns. XKK, for whatever reason, seems to be susceptible to the bottom falling out during times of market stress even if the underlying bond is holding up relatively well.

The yield at $5 total cost would be twice the coupon, or 16%. The yield at a total cost of $8.98 is about 8.9%. The yield on the underlying bond at last Friday's closing price of 85.125 ($7 divided by $85.125=8.22%).

3. Bond Closed End Funds: A reader commented on the widening discount to NAV of the bond CEF GDO over the past few weeks. In periods of extreme stock market turbulence and stress, it is normal for all CEFs to go down in price more than their respective declines in net asset values. During the last week, several investment grade bond CEFs experienced increases in their discounts even though their net asset values increased or held relatively steady. The increase in the discount was accomplished primarily by a decline in the share price, rather than a decline in net asset values. For me, I just look at this phenomenon as a potential buying opportunity, though admittedly it is aggravating when I already own a position.

Unlike the investment grade bond closed end funds, the bond ETFs held their values during the turmoil last week, since their market price is closely aligned with their net asset values. That alignment is not as precise as a mutual fund and can be off by up to 1% and sometimes more intraday. The bond ETFs are an alternative for those who do not care to experience the often irrational pricing prevalent in the closed end fund universe. The irrationality in the pricing of CEF runs the gamut. The most bizarre pricing is in a number of CEFs selling at substantial premiums to their NAV.

For investment grade corporate bond ETFs, there are two low cost alternatives. The iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD) has an expense ratio of .15% and about 429 investment grade corporate bonds. The other is the Vanguard Intermediate-Term Corporate Bond ETF (VCIT) that has a .15% expense ratio and around 400 investment grade corporate bonds. Those link web sites also provide information on the relationship of the market price to the net asset value. Those two ETFs are intermediate term. These ETFs have been averaging recently between 4 1/2 to 5% in yields.

Vanguard also has a long term investment grade corporate bond fund: Vanguard - Long-Term Corporate Bond ETF (VCLT). A complete listing of the low cost Vanguard bond ETFs can be found at Vanguard ETFs.

These kind of ETFs will generally be priced fairly close to their NAVs which is good and bad from my perspective compared to the bond CEFs. It is bad for two reasons. First, I juice my current yield by buying the bond CEF at a discount to NAV. And, I juice it more by buying at a 10% discount compared to a 5%, sort of like buying a bond at a discount in that respect. Second, I can make money by buying at a discount and selling when the discount narrows, an option unavailable with a bond ETF. I can still lose money, of course, for the same reasons that a bond ETF falls in value, with interest rate risk being the one most feared here at HQ. But, if the NAV increases and the discount narrows, I will make more with a comparable CEF. I just have to be patient and wait for that to happen. If the discount expands, I will consider buying more shares and/or changing my distribution option from cash to reinvestment.

For a term CEF like IGI and GDO, both of which will liquidate in 2024, I know that the discount to NAV will eventually be eliminated. I do not have that assurance with open term CEFs or bond ETFs. So, if the NAV is $20 at the time of liquidation, I will not have to worry about a discount continuing. I will receive my share of the liquidation proceeds after expenses. Assuming the managers for these two term CEFs do not trade too much, and hold the bonds to maturity, the fund will recover any value lost due to credit or interest rate risks impacting the value of the bonds now or in the future, as long as the issuer pays par value at maturity. And that is the key for IGI and GDO. If I see too much trading, I may liquidate my holdings. You certainly do not want to see a bond sold at a loss due to the current fears sweeping the markets now, when the issuer is likely to survive and pay par value at maturity.

Last week, I had one CEF investment grade bond fund actually hold its discount fairly steady and that was IGI. Another one IMF, which holds mostly inflation protected securities, held up pretty good too. I had two bond CEFs experience a large increase in their respective discounts, HSF and WIW, even though the net asset values held up well during the turmoil.

WIW invests in U.S. treasury TIPs which were steady in price last week. The discount however of this staid bond CEF increased by almost 4%. I had just sold 200 shares at 12.5 and tried to buy those shares back at 12 on Friday. Sold 50 of the 150 GJD at 18.59/SOLD 200 of 300 WIW at $12.5 & Bought 300 HSF at 5.76/ While a $100 or so profit on those 200 shares of WIW may not sound like much (Bought 300 of the CEF WIW at $11.94), I am not aiming high with these bond CEFs. I am also wary of them due to my concerns about interest rate risks. I am not a long term holder of the ones with no term dates which includes the recently acquired CEFs BDF, HSF, WIW, and IMF. I would be more tolerant of holding bond CEFs that invest in inflation protected securities during a rising rate environment than one that invests primarily in fixed coupon bonds irrespective of the quality. If I can pocket some dividends and come out even on the shares after moving in and out for the next 6 to 12 months, I will be satisfied with that result. The alternative is to use those funds to buy stocks or to keep the excess funds in money market or short term CDs, both earning far less than what I am paid by these bond CEFs. The bond CEFs do of course entail more risk, but I attempt to reduce the risk by trading them and eventually selling most of them when I become more concerned about interest rate risk which is the primary danger associated with owning investment grade bond funds.

In a linked post in the preceding paragraph, I mentioned buying HSF, another investment grade bond CEF, when its NAV was $6.26 and its discount to NAV was 5.43%. As of the close last Friday, after two weeks of a strong stock market downdraft, HSF had a NAV of 6.23 after paying out its dividend and the discount had increased to 12.04%: WSJ.com So, in effect, it held all of its value during the awful slide in stocks and paid a dividend too. Rationally speaking, you would think investors would buy this CEF during periods of stock market turmoil, but that is not what happened. The irrational occurred instead. I understand why many investors do not want any part of that kind of action. I am use to it, and the irrationality of the pricing dictates my investment strategy in this area.

4. SEC's Case Against Goldman: I have basically come to the conclusion that the only fraud manifested in the SEC's case against Goldman on the Abacus transaction has been committed by the SEC in bringing the case. I have discussed the glaring and obvious weaknesses in the SEC case in previous posts. ITEM # 3 GS; ITEM # 2 Goldman's Defense and Possible Penalties in the SEC Case A recent opinion piece in the WSJ highlights these weaknesses and emphasizes what can only be considered the real motive behind the suit: to assist the administration's effort to pass its financial "reform" package. The timing of the filing, along with the glaring weaknesses in the case, suggest no other explanation.

Bought 50 MSPRA at 15.7/Unfunded Pension & Disability at State & Local Governments/Added 50 KTX at 25/Yamada Interview

1. Pensions and Disability: While reading a front page story in the NYT about how police in Yonkers pad their pensions, I was reminded of an earlier series of stories in the NYT exposing the disability farce at the Long Island Railway, where almost 98% of retiring workers were awarded disability, and a large chunk of those payments were funded by Social Security. As you would expect, the union for the railroad workers defends the awards.

In today's story about police pensions, there was a focus on how certain police officers would start to work as flagman for Con Ed shortly before retiring in their 40s. While Con Ed paid those officers, their overtime would be tacked on to the base pay in determining their pension payments for the remainder of their lives, and I would assume the lives of their spouses. In many cases, this padding would result in their annual pensions exceeding their salaries at the time of retirement. Con Ed does not want to hire them, but is required to do it by the City.

This sort of thing is occurring at a time when numerous state and governments, in dire fiscal straits, are laying off teachers and other active personnel.

The NYT helpfully provides a list of those persons receiving the highest pensions in New York. I thought that it was odd that they were mostly teachers, with an annual pension hitting $316,245 at the top.

When you read stories from around the country discussing this type of issue, it is impossible to draw any distinction between the Greek government and our state, local and federal governments. Eventually, promising vast sums of borrowed money to a rapidly growing number of government workers will end in a financial disaster. The USATODAY recently ran a story about how the total number of federal employees making over a $100,000 per year grew by almost 400,000 during the last recession. Early retirement with a boatload of benefits for life is of course available to them.

Forbes ran an article earlier in the year about the growing unfunded pension liabilities of state and local governments. Forbes also provides an interactive map of unfunded pension liabilities by state. The PEW Foundation issued a report earlier in the year estimating that unfunded state retirement benefits currently exceed 1 trillion dollars. pewcenteronthestates.org/.pdf

2. Bought 50 of MSPRA at $15.7 on Friday (see Disclaimer): I mentioned in a recent post that I intended to buy back some of the equity preferred floating rate stocks with guarantees. Item # 4 Added 100 BDF in the Roth at 17.1/Bought $1500 CAD/Bought 100 SJV at 9.67/LTD With one notable exception (SCEDN), the exchange traded equity preferred floaters are issued by financial institutions. That fact, along with their many disadvantages, make them particularly volatile on the downside during periods of market stress. It was not long ago that I sold 100 shares of MSPRA at 21.43, having bought those shares in May 2009 at $12.88. Bought MSPRA

I do not want to take the time to discuss the basic characteristics of this type of security, and would just refer any new reader to this earlier post: Advantages and Disadvantages of Equity Preferred Floating Rate Securities. One of the advantages, the payment of qualified dividends, may go away after this year: Dividend Tax Rate in 2011?

MSPRA is an equity preferred stock (also called traditional preferred stock) issued by Morgan Stanley. There is a lot of headline risk associated with investment banks now, along with uncertainties in future government regulation of the financial services industry. Those factors are just adding to the downward pressure on the non-cumulative equity preferred stocks originating from financial institutions.

MSPRA is non-cumulative and perpetual, two undesirable characteristics in my opinion. It has priority over common stock and is junior of course to all bonds. In the event of a bankruptcy, I would be shocked if it had any value whatsoever.

On the bright side, the fall in price to $15.7 increased the value of both the guarantee of 4% and the float provision, when it becomes the applicable rate. The main advantage of this type of security is that it provides a measure of inflation and deflation protection in the same security. The deflation protection is the 4% guarantee on the $25 par value which is worth 6.37% at a total cost of $15.7. The inflation protection is in the LIBOR float provision. This security pays the greater of 4% or .7% above the 3 month LIBOR. When the central banks cease keeping short rates artificially low, and short rates start to reflect the inflation rate again, the short LIBOR rates will start to rise.

If inflation becomes a problem down the road, the LIBOR float will eventually replace the 4% guarantee, and this will start to occur when the 3 month LIBOR rate rises above 3.3% during the applicable computation period. Historically, a 3 month LIBOR of 5% is not unusual: LIBOR Rates History (Historical) At a 5% LIBOR at the relevant computation date for this security, the coupon rate for MSPRA would rise to 5.75% or a 9.076% yield at a total cost of $15.7. The percentage yield would be about 13.85% at a 8% 3 month LIBOR. So the LIBOR floats provides some protection against rising rates. If the price of MSPRA falls from $15.7, the value of the guarantee and the float to a new purchaser will rise compared to my purchase. I will add the other 50 shares if there is another point or two decline, assuming no new, material adverse news relating to MS.

This is a link to the prospectus: www.sec.gov The dividend stopper provision is typical (see page S-14). As long as MS pays a dividend on a junior security, meaning its common stock, it has to pay the preferred stock dividend with certain limited exceptions. Once MS eliminates the cash stock dividend, however, the owner of MSPRA could legally have their dividend eliminated which may or may not happen. Several companies eliminated their common dividends and continued to pay preferred stock dividends during the Near Depression period. I just characterize the elimination of a common stock dividend as placing the traditional preferred stock owner in an enhanced danger of losing their dividend.

While some preferred stocks have cumulative dividends, mostly REITs, MSPRA and most of the equity preferred floaters are non-cumulative, which means the dividend can be eliminated just like the common stock dividend with no obligation to pay it in the future. Once the firm starts paying the common dividend in this hypothetical situation, it has to resume paying the traditional non-cumulative dividend again too. To drive this point home, I will simply quote some language from the MSPRA prospectus:

"Dividends on the Series A Preferred Stock will  not be cumulative. If our Board of Directors (or                               a duly authorized committee of the Board) has not declared a dividend before the dividend payment                               date for any dividend period, we will have no  obligation to pay dividends accrued for such                               dividend period after the dividend payment date  for that dividend period, whether or not                               dividends on the Series A Preferred Stock are declared for any future dividend period."

The QuantumOnline.com site gives the credit rating as investment grade, with Moody's at Baa1 and S & P at BBB. I did not attempt to confirm that information.

3. Bought 50 of the TC KTX at its Par Value of $25 (See Disclaimer): This buy was primarily to diversify my bond portfolio further and to further increase the cash flow into the main taxable account for later reinvestment. KTX has a 8% coupon so that is close to my current yield. This trust certificate contains a Trust Preferred originating from Xerox Capital Trust I and guaranteed by XRX as provided in the prospectus. A TP is technically a preferred stock issued by a Delaware Trust (hence the name Trust Preferred) that represents a beneficial interest in the asset of the Trust. For KTX the underlying TP contains a junior bond issued by Xerox. This security has a somewhat daunting legal structure. KTX is a Trust Certificate representing a beneficial interest in the asset of a Grantor Trust, which is a Trust Preferred stock issued by Xerox Capital Trust, and the TP represents a beneficial interest in the asset of that trust which is a junior bond issue from Xerox. In effect KTX is a junior bond from Xerox.

The underlying bond and the TC mature on the same day, which is 2/1/2027. Interest payments are made semi-annually on 2/1 and 8/1. The last ex date was on 1/27/2010: CorTS Trust For Xerox Capital Trust I, KTX The underlying bond is rated investment grade by Moody's at Baa3 and junk by S & P. Fitch has it at BBB- according to Finra. This TC was trading at about the same current yield and YTM as the underlying bond, which also has a 8% coupon. So, today, there was no advantage to buying the TC except that I no trouble buying 50 shares of the TC when I saw the spread narrow and this kind of small order is far more difficult in the bond market which trades in $1000 increments. FINRA An order for 1 bond can be made but would be frequently ignored in my experience.

The underlying bond is a typical trust preferred which means deferral of the distribution is possible for up to five years, but the distributions are cumulative. Since Xerox is currently paying a common stock dividend, I do not have to worry now about a deferral. The stopper provision reads in part as follows: "During any such period (i.e. deferral period), Xerox Corporation will not be permitted to make a payment on its capital stock or any debt securities that rank equal to or junior to the Junior Subordinated Debentures".

This is a link to the prospectus: www.sec.gov The underlying security is callable now, but Xerox would have to pay a premium as set forth at page S-13.

I placed some other trades, including a purchase of a double short near the close that had declined about 5% or so in value today. I may discuss them in my next post over the weekend or in the Monday post.

4. Interview with Louis Yamada on CNBC Friday: She recommends to "wait and see". Enough technical damage has been done to the market that "we want to see whether a repair can take place". She talks about the market hitting higher highs and higher lows since March 2009. If the DJIA falls below the low in February of around 9800, then the market could fall further.