Just as the media and regulators continue to discuss the use of alternative investments and the active trading of hedge funds in contributing to the downfall of the economy and the stock market, many private investors are seeing each as a way to help protect themselves from recent market uncertainty (see New York Times article). While a more conservative trading mentality has been the norm for high net worth investors, many are now questioning its usefulness in the current market environment. Many investors who in the past have relied on a simple mix of stocks, bonds, and cash, and now turning to managed futures, financial futures, hedge funds, funds-of-funds, mutual hedge funds, currencies, commodities, and other avenues for gaining exposure to alternative investments.

Maybe even more interesting is how these same investors are becoming aggressive in moving away from a strict buy-and-hold approach, and instead are looking to take advantage of short-term trading opportunities - a move that indicates in part that such investors are not only opportunistic, but also worried about placing longer-term bets on the markets. As mentioned by Paul Speargas, senior client at WMS Partners:

“The buy-and-hold strategy, which was almost universally accepted by the investment and academic community over the past several decades, is no longer the sole investment strategy to be employed in order to deliver solid investment returns. A thoughtful balance between long-term investing and short-to-intermediate term trades is likely the recipe for investment success in the volatile years ahead.”

Given the interest by clients to still utilize hedge funds, commodities, futures, and alternative investments, not to mention the desire of the Fed and Treasury to have investors step-up and provide capital to purchase distressed assets, it might be good to pause and reflect before slapping or over-regulating the trading hands that are still willing to check the temperature of the investment waters.

The Washington Post reports today how the Congressional Budget Office Director, Peter Orszag, feels that Fannie and Freddie will likely cost taxpayers less than $25 billion, but further deterioration in the housing market could force an infusion beyond $100 billion. The quote of the day comes directly from Orszag: "There is significant uncertainty involved here," Orszag said. The cost "could be zero. It could be $100 billion." At least he is honest. Like the market, no one really knows. Of possible contention in the recently drafted legislation is how the protections for taxpayers were not specifically spelled out but were left to the Treasury to define.

Source: ClipSynidcate / Bloomberg
At the end of Q1, both Fannie and Freddie had liabilities of $1.6 trillion, plus mortgage guarantees and investments totaling $5.2 trillion. Unfortunately, the excess of their assets over liabilities may have fallen to $7 billion. Still, the $25 billion estimate may also end up overstating the cost since it does not reflect the value to the government of any purchased stock received for their $25 billion investment (assuming the company needs to be taken over). As quoted in the article:

"If we do this right, taxpayers will not spend any money because the markets will be confident in the vitality of Freddie Mac and Fannie Mae, and the markets will correct themselves," said Sen. Judd Gregg (R-N.H.). "But if the markets don't correct and Fannie Mae and Freddie Mac become unstable, then we've got very serious problems well beyond anything in this estimate."

Of course, if the government does step in, then the confidence has been lost, and the value of the stock at that point is most likely less than their bailout investment. As argued, it still appears the issue comes down to a matter of confidence (to some extent), which partially explains the need for Treasury to have an open checkbook, or at least give that impression. Open checkbooks are nonetheless scary, and often end up being used to buy more than you originally went to the store for, but in this instance, they may have no choice. Too little, and confidence is lost. Too much, and either the market gets scared, and/or moral hazard starts to creep in. I wonder if Treasury Secretary Paulson is missing his Manhattan corner office right now?

Today I got a chance to watch a little more of CNBC and other financial news shows and noticed a few things. First, there is a growing chorus about whether or not we have reached a bottom in the financial companies, and the market in general. There is a lot of talk about how "just think, if you had bought Fannie or Feddie or JPM or LEH last week, you would be up x%." It is common to do "what if" scenarios, but the coverage seems to be a little more intense today.

There was also a comment today on CNBC from Bill Seidman that was interesting. When asked about the recent actions of the Treasury Secretary, he mention that while current moves could positively affect the market near-term, even over the next year, the proposed actions are a longer-term disaster. He gave the analogy of how Secretary Paulson was running the Treasury like he ran Goldman Sachs, making sure he makes his numbers next year. Great stuff. While not mentioned by Seidman, you might also be able to make the same argument regarding the Fed, which seems to be managing quarterly GDP numbers and not focusing on controlling inflation and supporting the dollar for fear of occasional lower growth.

The NY Times and Wall Street Journal are reporting that the Treasury Department will propose giving the Federal Reserve broad new authority to oversee the financial markets and insure their stability.

As one step, the plan would merge the SEC with the CFTC (Commodity Futures Trading Commission). This will no doubt raise some objections. As a carrot, these agencies would also be given greater flexibility to regulate themselves and streamline the approval of new products. I can just see all the new ETFs. EFTs of ETFs anyone ....... but I digress.

The Fed would also be granted greater power, allowing it to examine the practices and bookkeeping of brokerage firms, hedge funds, the commodity exchanges, or for that matter, any institution that might pose a risk to the system (Does this include Congress? Just a thought.). There is also interest in allowing the Fed to have additional access to information from those securities firms and investment banks that might borrow money from the central bank. Maybe this will make it easier in the future to tell whether Bear Stearns is worth $2 or $10 dollars ...... but I digress again.

The proposal also calls for a Mortgage Origination Commission to evaluate state governments in regulating mortgage brokers. It would also eliminate the distinction between banks and thrift institutions, close the Office of Thrift Supervision (which regulates federal thrifts), and merge it with the Office of the Comptroller of the Currency (which regulates national banks). Given that the lines between these two are close already, this change may offer less debate.

But we are not done yet. The proposal would also create a national regulator for insurance companies, something currently done at the state level. Like with mortgages, there is a trend in the proposal to move regulatory authority from the states to the federal level. Somewhat of an unusual move for the current administration, but given the current mess, probably not totally unexpected.

It is believed that the proposal will take years to implement, given the depth of change and debate that is likely to ensue, so who knows what will become of it. There is already an expectation that some in Congress will want investment banks to fall under some of the same oversight currently placed on commercial banks. I imagine this debate will begin/continue in earnest.

Finally, most of the proposals are pitched as being geared toward streamlining regulation, but as we know, just because you take two or three existing agencies and create one larger one, you don't always get more efficiency. Unlike companies, which hope to cut waste after mergers (not always successfully), government agencies rarely do. Since they cannot typically layoff the employees, where would they go anyway? You often just get bloated agencies with even more layers of approval. I hope I am wrong, but I am certainly not optimistic.