NEW YORK — Preferred stocks cut both ways.

Case in point: Legendary investor Warren Buffett’s going to earn a hefty 10% dividend yield from his newly acquired Goldman Sachs Group Inc. (GS) preferred shares. But Fannie Mae (FNM), Freddie Mac (FRE) and Lehman Brothers Holdings Inc. (LEHMQ) investors likely won’t see a dime. Lehman’s in bankruptcy, and the government bailout eliminated Freddie and Fannie dividends.

Even in less extreme situations, preferred stock is problematic because of its lack of liquidity and correlation to interest rates. Investors need to understand its limitations and not be lured by promises of higher returns.

“I always tell investors if you’re getting paid a higher than average rate of return, you’re taking a higher than average rate of risk,” says Patrick McVeigh, president and chief investment officer of Reynders, McVeigh Capital Management LLC in Boston.

While he generally avoids preferred stock because of the added risk, they’re attractive to many investors, who like the “ongoing stream of interest payments,” which are often more than twice as high as the return on CDs or Treasurys.

Preferred stock is in an interesting position, a rung above common equity, but not as secure as a bond. “It’s a mix between being a bondholder and a common stock holder,” says McVeigh.

Companies issue common and preferred stock. Common stock gets capital appreciation if its value increases above its purchase price. The shares potentially pay a dividend, often quarterly, but that’s not guaranteed. Another benefit: Stockholders get to vote on company issues and officers.

In contrast, preferred stock guarantees a regular dividend, which is not tied to the market. In a liquidation, preferred stockholders get paid before common stockholders.

However, preferred stock owners do not get to vote, and the dividends typically are taxed at a person’s ordinary income tax rate rather than the lower capital gains tax rate.

Despite what happened at Lehman, Fannie Mae and Freddie Mac, Kenneth Winans, president of money-management firm Winans International, thinks informed investors should consider preferred stock.

“Right now you’re looking at one of the better opportunities to buy some of these (preferred stock) because prices are low,” says Winans, the author of “Preferreds: Wall Street’s Best-Kept Income Secret.”

Winans likes them because preferred stock “are in many ways in step with long-term paper” but they’ve historically outperformed corporate bonds. Between 1980 and 2006, preferred stocks earned on average 14% annually compared with corporate bonds, which earned 12%.

He says an investor who is comfortable with an average to moderate risk “should not have a problem having some preferred (stock) in the portfolio.” He recommends sticking with larger, high-quality companies. Two caveats: don’t overpay for the stock and always check for call dates.

“I’m not saying rush in and buy a bunch of bank stock, but there are non-financials and non-real estate (preferreds) with yields of 8% to 10%,” he says. “Mr. Buffett got a great deal, but there are a lot of great deals out there.”

Ron Roge, a financial advisor and chief executive of R.W. Roge & Co. in Bohemia, N.Y., thinks the risks outweigh the benefits. He avoids preferred stock and works them out of clients’ portfolios. Among other things, he doesn’t like that preferred stock have limited liquidity.

“You may not be able to sell it at the price you want,” he says. “Some of these things don’t even trade from day to day.”

He recommends that consumers look at the value at which it’s traded on a daily basis before making an investment. “They could go into a corporate bond fund or a junk bond fund, which is well diversified,” says Roge.

Another consideration: The dividends have interest rate risks, says Larry Glazer, managing partner at Mayflower Advisors in Boston. They rise as interest rates fall, and vice versa. The stock typically is held for many years, and rates could fluctuate.

Glazer says advisors “push them because the high yields are very attractive to people.”

“There’s a role for these if you’re trying to blend it with other investments,” he says. “This is a way to get a higher income, but it comes with a cost.”

That was the case with Fannie Mae and Freddie Mac, which was offering double the returns of CDs. But as part of the government’s rescue plan, the common- and preferred-stock dividends were eliminated.

Winans says one option is for an investor to consider a preferred stock index. But consumers need to do their homework. Some of the funds have underperformed because they are over weighted in preferred stocks from financial companies.

The Winans International Preferred Stock Index, or WIPSI, has about 50% utilities and 33% financials so it was hit hard in recent weeks. Freddie and Lehman will be the first stocks in the fund to stop paying a dividend. While Bear was converted to J.P. Morgan and Merrill Lynch was bought out by Bank of America, both preferred stocks continue to pay. WIPSI was down 22% year-to-date as of last Friday, the most recent numbers available.

By Jilian Mincer
A DOW JONES NEWSWIRES COLUMN

In this environment it is fair for families to question whether or not the insurance that they have paid into for years and years will be there when they need it. The upheaval of the financial services industry which sparked the demise of Bear Stearns, Lehman Brothers, Fannie Mae, Freddie Mac Merrill Lynch and AIG, the first insurer to go off the board, is sparking fear amongst the owners of insurance policies and it is quite understandable.

While Senator’s Obama and McCain are running around trying to make political hay from the situation by blaming this person or that for the problems we find ourselves in, many of us are looking for real answers to real questions that will affect our lives and our families. We’re not looking for a promise to do this or that that will probably be forgotten in a week or two.

So lets clear a few things up.

State laws are designed to protect the interest of policyholders first, before investors. The number one job of state insurance regulators is to make sure that the insurance companies that operate within their state are financially sound. If there is the possibility that a company will not be able to fulfill the promises it made to it’s policy holders, the regulators will step in.

The regulators have numerous actions they can take to prevent failures. This includes taking over management of the insurance company through a conservation or rehabilitation order with the goal of being able to get the company back into a strong financial position.

Claims from individual policyholders are given priority over other creditors. In the event that there is not enough money in the insurance companies accounts to pay a claim, the state has a safety net in place to protect the consumer and it’s called the state guaranty fund.

Every state has a fund of this type. Insurance companies pay for the fund with a fee of 1-2% of the net insurance it sells in that state. So every state is different. If an insurance company is unable to pay a claim, the guaranty fund will pay instead subject to certain limits. These limits are different for every state but upon investigation $300,000 for property casualty and $500,000 for life insurance and annuity contracts seem to be the norm.

Each state has its own plan though and it can vary substantially from those limits I mentioned above. For instance, some states don’t cover annuity benefits at all, and some do. Some may have a limit per person, or a limit per policy so someone may own three policies and get paid for all three.

It is important to remember that these do not replace your current policy, more so back up your policy with another type of substitute coverage. If you have a $2,000,000 life insurance policy, you may only collect $500,000 if the state is required to use the state guaranty fund to pay you.

Client’s assets invested in variable annuity separate accounts are not subject to creditors  and are segregated by law and protected although still subject to market performance.

Fixed annuity accounts and all fixed products are invested in the insurer’s general account and subject to creditors. These assets may be used upon the approval of state regulators for liquidity concerns of the insurance company.

Death benefits on both annuities and life insurance are funded in part by the insurers’ general account and may be reduced if the insurer goes into receivership.

If there was ever a time to educate yourself about your state’s policies for paying a claim from the state’s guaranty fund, it is now. Insolvency is an unfortunate reality. Things may calm down or may get worse. I will not be the one to predict that, but I want all to understand that when it comes to your ability to collect a claim from a troubled insurance company, your state has an option and it’s best to understand your states particular rules and claims paying practices.
 

WASHINGTON — The Federal Reserve on Tuesday held interest rates steady and in a disappointment to Wall Street didn’t appear to signal that rate cuts are forthcoming anytime soon.

Though officials continued to warn about inflation risks, they also signaled that economic concerns have intensified in the wake of the collapse of Lehman Brothers Holdings Inc. (LEH) and a steep selloff in equity markets Monday.

“The downside risks to growth and the upside risks to inflation are both of significant concern to the Committee,” the Fed said in a statement.

The Federal Open Market Committee voted unanimously to keep the target fed funds rate for interbank lending unchanged at 2% for a third-straight meeting. The Fed took no action on the discount rate for loans to brokers and commercial banks, which stands at 2.25%.

It was the first unanimous interest rate decision in one year. Dallas Fed President Richard Fisher, who had dissented in favor of higher rates the previous five meetings going back to January, voted with the majority this time.

That doesn’t mean the Fed’s inflation worries have evaporated despite good news in August, and a rate cut is by no means assured even if financial conditions worsen.

Still, Tuesday’s decision marks a reversal in the interest rate outlook. As recently as a couple of weeks ago, financial markets were betting that the next move would be toward higher rates in late 2008 or early 2009, a scenario encouraged by Fed officials in remarks and meeting minutes.

But that was before the housing and credit crisis claimed new victims including Lehman, which filed for the largest bankruptcy in U.S. history; Merrill Lynch & Co. (MER), which agreed to be bought by Bank of America Corp. (BAC); and mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), which were taken over by the government earlier this month.

In the wake of the Lehman collapse, the Dow Jones Industrial Average shed more than 500 points Monday, its biggest point decline since just after the Sept. 11 attacks.

That again raised the specter of what Fed officials call an adverse feedback loop — when credit market strains weaken the economy which then in turn puts even more pressure on markets in a downward spiral.

Aiming to head that off, the Fed in a late Sunday announcement expanded its liquidity tools, agreeing to accept corporate equities as collateral at the discount window for investment banks to ease credit market strains.

Some economists had expected the Fed to follow that up with a rate cut Tuesday, as it did in the days following the Bear Stearns collapse six months ago.

But conditions have changed since then. For one, the fed funds rate is already at a very low level and a further cut might not have done much good to the economy. And by standing pat the Fed sends another signal that officials want Wall Street to heal itself without too much government involvement.

Still, the economic outlook has worsened considerably in the past few weeks. The unemployment rate rose to a five-year high last month as companies shed jobs for an eighth-straight month. Meanwhile consumers have pulled back spending while the key sector keeping the economy from contracting so far this year — exports — is likely to soften as the U.S. slowdown spreads to other countries.

Tight credit, the housing slump and “some slowing” in exports “are likely to weigh on economic growth,” the Fed said.

In contrast, inflation has improved since August, albeit from very high rates of growth. The consumer price index fell last month for the first time in almost two years, the government said Tuesday, led by declines in energy, automobiles and housing.

Inflation should moderate further in September as the slide in oil prices intensifies — oil prices are more than $50 below their July peak — and the weak economy takes pressure off labor costs.

“The Committee expects inflation to moderate,” the Fed said, but the outlook “remains highly uncertain.”

By Brian Blackstone andMaya Jackson Randall
Of DOW JONES NEWSWIRES

NEW YORK — The next U.S. president will be confronted on inauguration day in January with slow growth, high unemployment and an economy teetering toward recession, according to a survey of 51 private economists surveyed by the Wall Street Journal.

If the forecasts turn out to be correct, pumping up the economy will be the first challenge facing either Democrat Barack Obama or Republican John McCain as president. That’s likely to place tax cuts and elevated government spending high on Washington’s agenda, and push to the backburner measures that could add to business costs, such as reforming the health-care system and fighting global warming.

The Wall Street Journal’s latest monthly survey paints gloomy picture of the economic outlook through the first half of 2009. While economists say the tax rebates distributed in the second quarter provided some help to consumers, the economy is on course to post four straight quarters of annualized economic growth below 2%, the longest stretch of such subpar growth since the recession of 2001.

They put 60% odds on an outright recession, expect the economy to shed 19,000 jobs a month for a year and say the jobless rate, which jumped in August to 6.1%, will keep rising to 6.4% by midyear, passing its 6.3% peak after the last recession.

The worst stretch of the next few months, they say, as the Congressional and Presidential elections shift into high gear. Annualized growth in the nation’s gross domestic product in the fourth quarter is projected at a measly 0.7%. A few months ago, forecasters thought the economy would be growing at a much faster clip by then.

By inauguration day, on Jan. 20, 2009, the situation won’t improve much, they say. Growth in the first quarter is projected at a 1.3% annual rate.

“Rapidly rising unemployment; rebates behind us; falling house prices; falling stock prices; general loss of confidence and much tighter credit conditions. None of it looks good,” says Paul Ashworth of Capital Economics. Not all the news is bad. Inflation is expected to moderate. Economists forecast oil prices to be down around $102 a barrel by the end of this year, and below $100 a barrel by June 2009, which has the potential to take substantial pressure off stretched households.

Even so, consumers are likely to be hurting. They’ve been stung not only by rising food and energy prices, but also by a deteriorating job market, tighter credit and falling home prices.

Yvette Perera, 39, of Vallejo, Ca., was laid off in January from her job handling help wanted ads for a small local paper, and has since been unable to find work. Her unemployment benefits are up Nov. 1. “I’m looking for anything,” she said. “Anything.” On supermarket runs, she’s trying to limit herself to spending just $40.

The two presidential candidates have presented different formulas for dealing with economic woes. Sen. McCain would cut corporate taxes to 25% from 35%, and retain all the Bush tax cuts on individuals, figuring that would give a boost to business. Sen. Obama would hike rates for those making more than $250,000 and use the proceeds for a host of tax cuts aimed at moderate-income workers. Helping them would pump up the economy through consumer spending, his advisers argue.

On average, the survey respondents expect a -0.1% contraction in consumer spending during the third quarter. It would mark the first such retrenchment by consumers in 17 years. Consumers kept spending during the last recession, to the surprise of many economists. They expect 0.1% growth in consumer spending in the fourth quarter as holiday shopping season kicks in.

Retailers posted weak August same-store sales amid a disappointing back-to-school season. On Friday, the Commerce Department is set to release official retail sales numbers for August. Economists surveyed by Dow Jones Newswires expecting an anemic monthly advance.

Nearly one-third of economists surveyed said the consumer retrenchment may not be reversed for years, a problem that could quickly rise to the top of the next president’s agenda.

The Federal Reserve has already cut interest rates sharply, meaning any future stimulus might need to be driven out of the White House. But choosing a fiscal policy course will be tricky. A rising budget deficit could constrain the next administration. Meantime, tax rebates proved to be only fleeting help.

Sharon Green, 49, who lives with her two kids in Detroit, Mich., said she isn’t excited about the prospect of more rebates.

“Yeah, the extra money would help,” she said, “but the minute you get it it’s gone. It’s nothing you can save.” She’s been working at a local McDonald’s for several years, since getting laid off from her job as a stitcher operator in a nearby factory.

The majority of economists — 66% — said a second stimulus package, currently being debated in Congress and supported by Sen. Obama, isn’t the right move. Most support extending or making permanent President Bush’s tax cuts, as does Sen. McCain. (Even so, 57% of the 37 economists who answered the question, said they thought Sen. Obama would win the election.)

Among the economists who support a new round of stimulus, none said that it should primarily be based on rebates to individuals, as Sen. Obama would do. His $115 billion plan includes $65 billion in rebates, and $50 billion split between aid to state and local governments, and infrastructure spending. He’d pay for the rebates by taxing oil company profits. Sen. McCain has said he’s open to a stimulus plan, but hasn’t committed to any specific proposal.

Thirteen% of the economists who support a stimulus plan said it should include infrastructure spending, which some argue has more bang for the buck, while 2% said it should focus on extending unemployment insurance and food stamps. Nineteen% said it should include some mix of rebates, infrastructure and benefits.

“You can’t afford to bail out the financial system and the real economy at the same time,” said Mr. Ashworth.

Some still see a turnaround next year.

“The best news out there is that some of the bad news is abating,” said Diane Swonk of Mesirow Financial “By next year, housing starts and sales may start turning around. Plus, it should be a pretty good environment for profits. Wages stagnating but productivity is up.” She also noted that oil prices are off their peak, taking some heat off the consumer.

By Phil Izzo andKelly Evans
Of THE WALL STREET JOURNAL