Portfolio manager Cale Smith on investing, Spoke Funds®, and Islamorada in the Florida Keys.

From a WSJ article on a new report by Harvard professor John Coates on the non-partisan Committee on Capital Markets Regulation.

On taxes paid by investors in mutual funds:

I was struck as an investor as much as an academic by how unfair the process is, especially for middle-class people. We’ve set up a system that punishes people who can’t afford to invest in hedge funds.

The article continued:

Mr. Coates said the U.S. mutual-fund industry is hampered by tough restrictions imposed by the Investment Company Act [of 1940] that make the industry dependent on the Investment Management Division of the SEC for growth and innovation. The SEC division hasn’t kept pace with the growth of the fund industry, Mr. Coates said.

Long live Spoke Funds®.

From Bloomberg here:

Standard & Poor’s backtracked on ratings cuts issued last week and raised the ranking on commercial mortgage-backed debt from three bonds sold in 2007.

The securities, restored to top-ranked status, had been downgraded as recently as last week, making them ineligible for the Federal Reserve’s Term Asset-Backed Securities Loan Facility to jumpstart lending.

In other words, one of the rating agencies whose previous negligence and/or greed was near the core of the global financial blow-up would like folks to believe that these securities actually deserved to go from being top-rated, or AAA, to BBB- and then back to AAA in the space of a single week.

Pay no attention to the fact those securities were owned by institutions that paid Standard & Poor’s to rate them and that given the dour state of commercial real estate, those institutions really, really need access to TALF.

Here’s more on the deeply flawed ratings agencies.

Island Investing
Cale Smith, MBA
July 25, 2009
KeysWeekly.com

We’re continuing to answer the question, “What are derivatives and why should I care about them?”

Last week I began to discuss the derivatives that contributed to The Great Recession we are now in. I described the entire multi-trillion dollar mortgage market as a three-story building in a flood zone. The most conservative investors owned the top floor and earned reasonable rent. For a long time, however, no one wanted to own the ground floors, because they’d get wiped out in a flood.

Enter the geniuses on Wall Street.

By effectively combining all of the ground floors in of all the buildings in the flood zone through the use of derivatives, investment banks were able to slice and package even the riskiest investments into bundled products that sounded much less risky than they really were.

Because the agencies in charge of rating those investments were paid by the same institutions that created them, ratings were inflated and even conservative institutional investors started to buy ground those floor properties.

After all, the logic went, if you own one building and it floods, you have a big problem. If you own a thousand properties and one floods, you’ll barely notice. Eventually, those institutional investors had bought every ground floor in every building in the flood zone.

Then the rain came. Risky mortgage investments started to show increasing defaults. The ground floor properties started to flood, sending those investors fleeing. The panic was contagious. After all, you only need to see a dozen or so of your neighbors running maniacally down the street before you drop the remote and start running, too. Chaos and gridlock descend quickly throughout the flood zone.

Because of derivatives, risks that were believed to have been eliminated actually got bigger – so big, in fact, that they ultimately destroyed our economy.

We’ve seen the effects of the failure of certain derivatives – RMBS, CDOs and CMOs, specifically. But still little has been done to address an even bigger class of derivatives known as credit default swaps.

And if you weren’t angry at Wall Street yet, wait until next week.

Cale Smith is the portfolio manager for the Tarpon Folio and Gecko Folio. His firm’s website is www.islainvest.com and his blog is www.caleinthekeys.com.