It seems these days you can’t trust anyone anymore. One of the foundations of finance is trust, so if we can’t trust our business associates and relationships, we are in deep trouble. Am I exaggerating? Here are a few examples to illustrate why it has become so difficult, if not outright impossible, to trust anyone these days.
For months, the chairman of GE continued to insist the company was sound and would not cut its dividend. Last week, they cut their dividend. Is Mr. Immelt a liar or a con man?
The rating agencies, those companies that specialize in keeping us informed about who is, financially speaking, exceptionally strong, very strong, strong, somewhat strong, weak, very weak and in default, don’t seem to know what they are doing either. For example, they have continuously rated GE as AAA. This is a distinction given to only 7 companies in the entire USA. Yet GE’s stock has dropped about 80% in the last few months and 26% in the past four days. The market is sensing that GE is weak, yet it is still rated AAA by the agencies. Who do you trust, the rating agencies or the market?
The other day a client of mine emailed me with a deal that sounded too good to be true and asked for my advice. This was the scoop: Investors were selling Bank of America bonds with a two year maturity and yielding 14%. Let me put this in a different way. Bof A was trying to borrow money for 2 years and was willing to pay 14% for it. And you know what? I told my client not to do it. Imagine me, refusing to lend money to my own banker. How crazy is this?
How about insurance companies? Can we trust them? They sell insurance which is supposed to be safety. How safe are they? Let’s look at one of their favorite products these days: variable annuities. Brokers, financial planners, advisors, etc. love to sell this investment because they get a big up-front 5% commission. Why do investors buy these annuities? Because insurance companies GUARANTEE a return, say of 6%. How can they make this guarantee? Well, they invest this money in a diversified pool that includes stocks, because stocks have earned 10% over the long term, real estate, because it has earned about 8% over the long term. And they invest in bonds, too. So, if insurance companies pay a GUARANTEED 6% to the buyer of the annuity, and they have to pay a commission of 5% to the selling agents, and they have to pay their employees and make a profit too, they have got to earn at least 8% on their investments. Have they been earning this 8% to justify the guarantee they have been making? Let’s ask some simple questions.
First, how did the insurance companies investments perform? Their stock portfolios must be down about 50%, unless they are magicians. How about their real estate? You know that has tanked big time too. And their bonds? They are paying 1% or 2% if they invested in governments. If they bought corporates, they are not doing well at all. So, how can they still claim to pay a GUARANTEE 6% or higher rate? They can’t. Unless the insurance companies thought they could eliminate all the risk of their investments by buying guarantees themselves. From whom? Have you ever heard of AIG?
Insurance companies have built a house of cards. Imagine the poor investors who believed those promised guarantees. Which brings me to my first question: Who can we trust?
As I was writing this, my wife arrived home. In striking up a conversation, I casually asked where she spent the afternoon and she replied that she was shopping with a friend. When I asked if she bought anything, she said, “No.”
I am shaking at my own thoughts. Can I trust what my wife said?
If I can help you with your financial planning and/or investments, please email to professor@ulivi.com or just call me at (714) 771-6000.