AIG Announcements

In the wake of the announcements by AIG of a restructuring of its loans from the U.S., I did quite a bit of research to actually see if there are any negatives to the changes. From independent analysts and company spokesmen, I could find none.

According to an interview of Mr. Liddy I saw on CNBC on Monday, the restructuring allows AIG the ability to repay the loans over 5 years instead of 2 years, and it gives it much more flexibility in the pursuit of liquidating some assets (including the VALIC arm). There is no material change to the company or its issues, thus the changes are not anything a consumer would necessarily ever see.

Additionally, I did receive an e-mail from AIG on Monday morning with two press releases. I am posting the first regarding the restructuring of the loans. The second press release pertained to the earnings of AIG and is not necessarily relevant.

U.S. TREASURY, FEDERAL RESERVE AND AIG

ESTABLISH COMPREHENSIVE SOLUTION FOR AIG
Designed to Create Durable Capital Structure, Resolve Liquidity Issues From Credit Default Swaps and U.S. Securities Lending, Facilitate Orderly Asset Sales, and Enable Repayment of Loan Plus Interest

NEW YORK, November 10, 2008 - American International Group, Inc. (AIG) today announced agreements with the U.S. Treasury and the Federal Reserve to establish a durable capital structure for AIG, and facilities designed to resolve the liquidity issues AIG has experienced in its credit default swap portfolio and its U.S. securities lending program.

Edward M. Liddy, AIG Chairman and CEO, said these agreements are a dramatic step forward for AIG and all of its stakeholders: "Today's actions send a strong signal to our policyholders, business partners and counterparties that AIG is on the road to recovery. Our comprehensive plan addresses the liquidity issues that threatened AIG, and gives us the financial flexibility to complete our restructuring process successfully for the benefit of all of our constituencies."

Liddy continued, "The $85 billion emergency bridge loan was essential to prevent an AIG bankruptcy, which would have caused incalculable damage to AIG, our economy and the global financial system. Thanks to decisive action by Congress, Treasury and the Federal Reserve, there are now additional tools available to create a durable capital structure that will make possible an orderly disposition of certain of AIG's assets and a successful future for the company. Our goal is to repay taxpayers in full with interest, and emerge as a focused global insurer that will create meaningful value for taxpayers and other stakeholders."

The actions announced today include both ongoing financing facilities and one-time transactions designed to address AIG's liquidity issues. The ongoing financing facilities include:

• Preferred Equity Investment: The U.S. Treasury will purchase, through TARP, $40 billion of newly issued AIG perpetual preferred shares and warrants to purchase a number of shares of common stock of AIG equal to 2% of the issued and outstanding shares as of the purchase date. All of the proceeds will be used to pay down a portion of the Federal Reserve Bank of New York (FRBNY) credit facility. The perpetual preferred shares will carry a 10% coupon with cumulative dividends.
• Revised Credit Facility: The existing FRBNY credit facility will be revised to reflect, among other things, the following: (a) the total commitment following the issuance of the perpetual preferred shares will be $60 billion; (b) the interest rate will be reduced to LIBOR plus 3.0% per annum from the current rate of LIBOR plus 8.5% per annum; (c) the fee on undrawn commitments will be reduced to 0.75% from the current fee of 8.5%; and (d) the term of the loan will be extended from two to five years. The extension of the term of the loan will give AIG time to complete its planned asset sales in an orderly manner. Proceeds from these asset sales will be used to repay the credit facility. In connection with the amendment to the FRBNY credit facility, the equity interest that taxpayers will hold in AIG, coupled with the warrants described above, will total 79.9%.

The one-time transactions involve the creation of two financing entities capitalized with loans from AIG and the FRBNY. These entities will purchase assets related to AIG's U.S. securities lending program and Multi-Sector Collateralized Debt Obligations (CDOs) on which AIG has written credit default swap (CDS) contracts. The entities will collect cash flows from the assets and pay interest on the debt. FRBNY and AIG will share in any recoveries in the market prices of the assets.

• Resolution of U.S. Securities Lending Program: AIG will transfer residential mortgage-backed securities (RMBS) from its securities lending collateral portfolio to a newly-created financing entity that will be capitalized with $1 billion in subordinated funding from AIG, and senior funding from the FRBNY up to $22.5 billion. After both amounts have been repaid in full by the financing entity, the parties will participate in any further returns on RMBS. As a result of this transaction, AIG's remaining exposure to losses from its U.S. securities lending program will be limited to declines in market value prior to closing and its $1 billion of funding.
  
  This financing entity, together with other AIG funds, will eliminate the need for the U.S. securities lending liquidity facility established by AIG and FRBNY in October, which had $19.9 billion outstanding as of November 5th. Upon repayment to all participants, AIG will terminate its U.S. securities lending program.
• Reduction of Exposure to Multi-Sector Credit Default Swaps: AIG and FRBNY will create a second financing entity that will purchase up to approximately $70 billion of Multi-Sector CDO exposure on which AIG has written CDS contracts. Approximately 95% of the write-downs AIG Financial Products has taken to date in its CDS portfolio were related to Multi-Sector CDOs.
  
  In connection with this transaction, CDS contracts on purchased Multi-Sector CDOs will be terminated. AIG will provide up to $5 billion in subordinated funding and FRBNY will provide up to $30 billion in senior funding to the financing entity. As a result of this transaction, AIG's remaining exposure to losses on the Multi-Sector CDOs underlying the terminated CDS's will be limited to declines in market value prior to closing and its up to $5 billion funding to the financing entity. As with the securities lending program, FRBNY and AIG will share in any recoveries in the market prices of assets.
  
  AIG will continue to have exposure to CDS contracts on Multi-Sector CDOs that are not terminated. As AIG winds down its Financial Products division, it will also have exposure to other types of remaining CDS contracts, which have generated substantially smaller total collateral demands than the CDS contracts on Multi-Sector CDOs.

Taxpayers will benefit from the transactions with AIG as follows: fees, interest and repayment of the FRBNY loan in full, payment of a 10% coupon on the newly issued preferred shares, cash payments from the assets purchased by the two financing entities and potential asset appreciation in the underlying securities held by those entities. Taxpayers will own 77.9% of the equity of AIG and will hold warrants to purchase an additional 2% equity interest, and so will benefit from any future appreciation in AIG shares.

AIG will also continue to participate in the recent government program being utilized by many companies for the sale of commercial paper. The Commercial Paper Funding Facility (CPFF) has allowed AIG to reenter the commercial paper market. AIG is authorized to issue up to $20.9 billion to the CPFF and has currently issued approximately $15.3 billion as of November 5.

Mr. Liddy continued, "All of these steps, which would not have been possible in September, will benefit AIG, its stakeholders and the American taxpayers. This plan contributes to stabilizing the financial system and provides the opportunity for the public to realize gains on its AIG investment in the future. These measures will also put AIG on track to emerge as a nimble competitor with good long-term growth prospects."

"This innovative solution enhances AIG's liquidity position. At the same time, American taxpayers will be fairly compensated for funds lent to AIG, and they will capture the majority of any appreciation in the value of the securities involved in the program in the years ahead."

Liddy added, "Today's announcement would not have been possible without the vision and extraordinary hard work, dedication and cooperation of officials from the U.S. Treasury, the Federal Reserve Bank of New York, the Federal Reserve Board and the state insurance departments. On behalf of AIG, I would like to extend sincere thanks to all of those involved in crafting this mutually beneficial solution."

Source: AIG

A Response from My TRS Letter and Research on the Markets

I last posted to this blog on Sunday, October 19, and since that time I have been busy researching various items on the stock market, responding to e-mails from educators, and when possible... actually working.

A Response from My TRS Letter

On Monday, October 27, I received the following e-mail from State Senator Bill Heath, Chairman of the Senate Committee on Retirement:

Thank you for your correspondence concerning the proposal dealing with COLAs before the Board of Trustees of the Teachers Retirement System of Georgia (TRS). Time does not permit me to write an individualized response to each of you. I do understand this is an important issue to you. I hope this will help you understand what is taking place. This matter is not before the General Assembly and therefore I do not have a vote in this matter.

The Board of Trustees consists of ten trustees whose responsibilities include administration of the fund and to manage the fund so as to ensure the continued fiscal soundness for the current retirees as well as for the current and future members. To date the fund has been well managed and I commend the board for their actions. They have an increasingly challenging job as the make up of the members, their expectations and financial universe evolve. I trust the Board to continue to make wise decisions as they fulfill their responsibilities.

The Board consists of the ten trustees. The law requires a majority (six) to be active or retired members of TRS. One trustee is selected by the other nine and shall be a citizen of Georgia who is not a member of TRS but with experience in the investment of moneys. The other three trustees include the State Auditor, the director of the Office of Treasury and Fiscal Services and one trustee appointed by the Governor without restrictions.

At the September 24, 2008 meeting of the Board of Trustees, a proposal was made to consider changing the administrative rule that deals with the method by which the Board grants and funds the semi-annual cost-of-living adjustments (COLAs). The current policy, which was adopted in 1969, states that the Board will grant a 1.5% COLA on July 1st and January 1st provided there is an increase in the Consumer Price Index. The proposed amendment states that the Board will determine at its annual meeting each year the amount of COLA up to a maximum of 1.5% that may be granted for the following July 1st and January 1st.

It is possible that the Board will take up this proposal at its November 19, 2008 meeting if the Trustees feel they have had the necessary time to evaluate the proposal. If you would like to voice your concerns or ideas to the Board of Trustees before this is taken up you may do so by sending an email to Executive.Director@TRSGA.com.

I thank you for you interest in this matter. As Chairman of the Senate Committee on Retirement, I spend a great deal of time and energy working to ensure that the pensions of our employees are safe. It is the intent of the legislature to provide an environment that will allow the experts in finance and pension management to maximize the benefits available to those who have served our citizens so faithfully.

Well, at least I have received one response. Nothing much said, but it is a response.

Research on the Markets

I find it interesting that in the "dire" predicament the stock market is in that few people actually do any research on past markets, trends, and outcomes. This market is quite a bit different than many previous problems we have had before due to the issues of credit and globalization.

I read an article about Anna Schwartz who co-authored, with Milton Friedman, "A Monetary History of the United States" (1963). It's the definitive account of how misguided monetary policy turned the stock-market crash of 1929 into the Great Depression. She is obviously a brilliant woman that has looked throughout history, but many believe that she may be missing the globalization of the market.

She says the issue is confidence and not liquidity (The Great Depression was caused by liquidity). This is true, but she does not feel the U.S. Treasury and Federal Reserve are handling the confidence issue. I think history will eventually show that the Treasury and Federal Reserve are working to resolve every single issue both before and after something becomes an issue.

When liquidity was a problem... they injected it. When money market confidence was an issue... they guaranteed it. When we needed worldwide coordination... they orchestrated it.

I think looking 2, 3, 5, 10 years out, we will look back and be amazed from where we have been. The markets are powerful machines that are like a cruise ship to turn... they do not turn on a dime.

Finally, anyone that started to believe the U.S. was now not the center of the financial universe simply needs to see where everyone looked and returned to for guarantees and leadership. We may not all agree on politics or policies, but it cannot be said that the U.S. Treasury and Federal Reserve have not stepped in to help Americans and foreign companies and nations alike.

The trip ahead will be bumpy, but the end should be good for those along for the ride. Just remember - your TRS pension is guaranteed by law, and your 403(b) account is not used on any single day. It is a retirement fund.

As always, let me know if you have any questions.

Is It Time to Buy?

Frequently investors wonder if now is the time to buy. Most investors want to make sure that they buy when the market is going up. Interestingly though, most great investors think about 2, 5, and 10 years down the line.

In Friday's The New York Times, Warren Buffett, arguably one of the greatest investors in the history of the stock market, wrote an Op-Ed piece titled "Buy American. I Am." Below is the article for you to enjoy.

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

Warren E. Buffett is the chief executive of Berkshire Hathaway, a diversified holding company.

Source: The New York Times

What Now? 403(b) and Pension Comments

Last week I received numerous e-mails about 403(b) accounts and pensions. "How safe is my 403(b)?"; "Will it just go away?"; "If I take it all out what happens?"; "Is the TRS pension guaranteed?"

403(b) Safety

A 403(b) is much like any other type of retirement account - 401(k), IRA, Roth, SEP-IRA - when it comes to investing. Within most 403(b) accounts you have a fixed annuity option, a cash/money market option, and then various mutual funds that you can own.

• Fixed Annuity - This option allows you to put your money in a "fixed annuity" that generates a return somewhat along the lines of a CD. The exception here is that most fixed annuity investments only let you take 10-25% out of the investment at a time. This is usually not a good investment due to the constraints of taking the funds from the account - even when you are trying to get them out in retirement. While this does not lose money, it also generally only keeps up just above the rate of inflation.
• Cash/Money Market - This option allows you to park uninvested cash in a place that earns a rate of return that is along normal money market rates. It will not have the return that the Fixed Annuity has, but you can withdraw, reinvest, or hold it without fearing that you cannot touch it (unlike a Fixed Annuity). This is a good place to hold cash for future investments or distributions.
• Mutual Funds - This option is the one where you will buy shares of a "mutual fund" that owns usually 25-100 stocks. A mutual fund can make or lose money. It is an investment that can go up or down based on the underlying investments in the companies of the fund. Depending on the fund, you may invest in bonds, big, small, or even international companies. Some of the funds will correlate more with the Dow, S&P 500, or Nasdaq, etc. The custodian (AIG-VALIC, Fidelity, Lincoln National, etc.) is not to blame or get credit for the performance of the funds. The funds are run by fund managers that use your money to invest in companies.
  
  
  • For example - if you own the "Janus High Yield Fund," the fund is run by a manager from the Janus fund company that will use your money to invest in high yield bonds from various companies.

What I would like to stress here is that your 403(b) investments should depend on your age, risk tolerance, and goals. In coordination with your TRS pension, your 403(b) is a powerful tool when used correctly, and it can help you realize some of your dreams after you retire from education. There is a huge difference though between making sure you do not want to lose any money and making wise investments. Know your risk tolerance and expectations.

Also, rolling over your 403(b) to an IRA is fine (if you can), but taking all of your money from the 403(b) as a distribution creates a taxable event that can have huge tax implications. Do not take a distribution without first talking to an accountant or financial advisor. It could cost you 35-45% in taxes!

TRS Pension

There are many things to consider when you start thinking about your TRS pension benefits, but one of them is not if the fund will be there. As of June 2007, the pension fund was worth $53.3 billion, and it paid out about $2.2 billion with about $1.7 billion in contributions. Thus, only about $0.5 billion was taken from the fund in FY 2007.

The fund, as of June 2007, was "balanced" with about 62% in equities and 38% in cash and bonds. TRS has not yet released the June 2008 figures, but even with the declines in the stock market, the fund is viable and continues to be reevaluated every year by auditors and actuaries. In June 2009, the employee and employer rates of contribution will rise slightly due to past stock market performance. This increase is to insure the benefits that have been guaranteed to educators.

One important thing to remember is that the TRS benefit is guaranteed by Georgia law. It is not just a guideline but a law.

One additional item on your pension benefits - TRS is proposing a change to the Cost of Living Adjustment (COLA). It is absolutely imperative for all educators - current and retired - to write a letter to TRS asking them to NOT change the wording as the proposal requests. The wording that would change could and most likely would ultimately change your pension benefit. GAE and PAGE are both against this action, and I cannot imagine an educator that is for the change. My post, TRS Board of Trustees to Vote on Cost of Living Adjustment (COLA) Change, on the proposed change includes a my comments and a copy of the letter that I sent to Jeffrey Ezell, Executive Director of TRS, last week.

I hope your school year is going well, and please e-mail me if you have any questions.