NEW YORK — This year’s steep drop for stocks means that so-called tax-loss harvesting is more popular than ever.

The tactic of selling securities at a loss to reduce long-term capital gains tax is a common year-end option for burned investors. As portfolio managers weed out losing stocks, financial advisors are hearing from a rising number of clients who want to know how to use the tax strategy to buffer losses.

Both stocks and mutual funds are fair game, though the rules are a bit different for each. Mutual fund shareholders may stand to benefit this year if they hold funds hit by a lot of redemptions.

Don Weigandt, wealth advisor at JP Morgan Private Bank in Los Angeles said his firm is doing tax-loss selling as it rebalances client portfolios as part of its third-quarter investment performance reviews.

“We expect to be doing more of this through the balance of the year,” said Weigandt.

As with any tax strategy, loss harvesting isn’t something that should drive investment decisions. Rather, Weigandt and other advisors say it should be used to complement an overall approach.

It’s particularly important this year to know what tax result will arise from selling a stock, according to Melbert E. Schwarz, national tax partner in the Washington, D.C. office of Grant Thornton LLP.

Keep good records and know how much of a gain or loss each sale will produce.

In order to figure capital gains on a stock, the taxpayer must know its cost basis, essentially the amount originally paid for it. Someone who sells a bunch of shares he bought in a company over time may have bought a few of the shares at $100, some at $50, some at $150 and some at $20.

“Obviously, I’m going to have different results for all these,” said Schwarz.

On stock sales, the taxpayer reports capital losses on Schedule D of Form 1040. Brokerage statements or confirmations from a broker who executed the trades is the usual documentation. Ideally, the record should show the taxpayer designated which shares he wanted to sell.

Currently, the only thing the broker reports to the Internal Revenue Service is the gross amount of proceeds from the sale. Starting in 2011, brokers will be required to report the cost basis of certain securities as well.

Taxpayers can claim a net capital loss of up to $3,000 each year. The loss offsets ordinary income that would otherwise be taxed at a rate as high as 35%. Losses over $3,000 can be carried over to subsequent years indefinitely.

Kaye Thomas, said many people have the misconception that they must limit losses to $3,000 each year.

“I tell people “No, it’s better to have a capital loss over $3,000, so that you have a capital loss carryover you can use in future years,’” says Thomas. “It expires when you do.”

On the other hand, a taxpayer with losses under $3,000 for the year may be tempted to sell additional appreciated stocks in order to “use” more capital losses in the current year. This isn’t a great idea if he doesn’t really want to sell the stock, according to Schwarz.

The wash sale rule is a potential tripwire in tax-loss harvesting. It penalizes anyone who sells a stock and buys it back within 30 days. A common strategy to avoid running afoul of the rule is to replace the stock that’s been sold with another that looks likely to perform the same way. Caveat: Using a too-similar stock breaks the rule.

Mutual fund investors who are thinking about harvesting their losses now may be better off waiting until they know more about how funds will handle their own capital gains, said Rich Rosso, a vice president and financial consultant in a Houston branch of Charles Schwab Corp. (SCHW).

Many fund companies will soon say whether they plan to pass capital gains from sales of stocks in the funds through to shareholders. Faced with a capital gains pass-through, an investor may want to switch to a more tax-efficient mutual fund or exchange-traded fund, said Rosso.

“It comes as a big surprise to some people when a fund they hold is down but they owe capital gains tax on it,” said Rosso.

End-of-year capital gain distribution by mutual funds can present a particular problem in down years like this. A mutual fund with a lot of redemptions may need to sell long-term holdings to raise cash. This results in capital gains that must be passed through to a smaller pool of shareholders.

Loss harvesting may be appropriate in such situations, according to Schwarz.

Mutual funds that tout themselves as tax-efficient, he added, can be particularly susceptible to this problem, because they may have avoided selling appreciated shares until forced to by net redemptions.

Extreme volatility in the stock market means there’s potential to be burned by tax loss harvesting now. The wash sale rule may prevent one who sells a stock from capturing an upswing days later.

On the other, it’s something that should get a look from anyone with big losses in a taxable account.

By Arden Dale
A DOW JONES NEWSWIRES COLUMN

With many retirement accounts in the tank this year, presidential candidates and other lawmakers have called for all sorts of measures aimed at helping people pick up the pieces of their broken nest eggs.

Sens. John McCain and Barack Obama have proposed waiving the requirement that Americans age 70-1/2 and older must take a minimum distribution from their traditional IRAs.

Waiving required minimum distributions, or RMDs, would be a boon to many older Americans who must calculate their 2008 distribution based on the value of their traditional IRAs as of year-end 2007, a value that was likely much higher on Dec. 31, 2007 than now.

But tax experts are not holding their breath for that perk. Instead, they’re turning their attention to other tax breaks available to IRA owners in the aftermath of all this market turmoil.

There’s even some question as to whether the next president will be able to get the change to RMDs put in place. “I’m not sure the IRS has the power to make the change, since the requirement to make distributions is in the law,” said Barry Picker of Picker, Weinberg & Auerbach, CPAs, and author of “Barry Picker’s Guide to Retirement Distribution Planning.”

Kaye Thomas, president of Fairmark Press, said, “I’d be a little surprised to see Treasury take this action [waiving RMDs]. It’s less crucial than many of the other kinds of relief that have been granted or are being considered.”

Besides the sheer complexity of changing the RMD law this late in the year, there are all sorts of logistical nightmares. For instance, Thomas said that many people (including those who own inherited IRAs and must take RMDs as well) have already taken their RMDs for the year and might be put out seeing people who delayed their distributions until late in the year get out of the requirement. “People who have already taken their RMD could perhaps re-deposit their RMD back into the IRA, all taxes and penalties voided,” he said. But that’s unlikely.

What’s more, Thomas questioned whether firms that manage IRAs or other retirement plans could handle a change in the rules on such short notice. Again, highly unlikely.

Fortunately, IRA owners do have some tax breaks available to them, according to the most recent issue of Ed Slott’s IRA Advisor and other experts. Here are seven such perks:

1. Year-End Roth IRA Strategies

If you have a traditional IRA, 401(k) or some other employer-sponsored retirement from which you are eligible to take a distribution, the money is invested in stocks and your 2008 income is less than $100,000 on a single or joint return, you can convert those retirement accounts into a Roth IRA now at a lower tax cost. Typically, you would have to pay ordinary income tax on the amount being converted. Since the value of your traditional IRA is likely lower now than at year-end 2007, the tax hit will be lower as well.

“There’s another benefit to a Roth IRA conversion that occurs at or near year-end for a taxpayer establishing their first Roth,” according to Slott’s newsletter. “All 2008 Roth IRA conversions have a Jan. 1, 2008, starting date, regardless of when the conversion occurs during 2008. Roth IRA distributions are completely tax-free five years after a conversion, as long as the account owner is at least 591/2 years old.”

Some other points to consider: the amount being converted counts as income and so 1) make sure you have the money to pay the tax bill due from accounts other than the IRA account you are converting and 2) consider a partial Roth IRA conversion if the amount you want to convert might push you into a higher tax bracket.

Also, to make sure the conversion counts as a 2008 Roth conversion, the funds must be withdrawn from the IRA or company plan by year-end 2008. (You have to deposit those funds within 60 days in the Roth for it to count as a 2008 Roth conversion.)

2. Roth Re-Characterizations And Re-Conversions

If you are among those who think stocks — and thus the value of your IRA or company retirement plan — are headed lower and you think you might get a better deal by converting your IRA later, there’s this option: You can convert by year-end and then reverse or “re-characterize” at any time up until Oct. 15, 2009. By doing that, you would get the taxes back that you paid. Also, if you already converted from a traditional IRA to a Roth IRA, it might be worth re-characterizing now, while the market is down and your Roth IRA is worth less, said Slott’s newsletter.

Another point to consider: “Roth IRA conversions are available in 2008 and 2009 only to taxpayers with $100,000 or less in income (not counting the conversion income itself or any RMDs from IRAs). That $100,000 is modified adjusted gross income (MAGI) but in many cases your MAGI number will be the same or very close to your AGI.”

One more note of caution: If you convert and pay taxes with money from an IRA to pay the tax bill, and then decide to re-characterize your Roth conversion, you won’t be able to put the funds used to pay taxes back into the IRA.

3. NUA Opportunities

If you’ve been laid off and have a lot of company stock in your retirement plan, you might be eligible for another tax break, Slott said. It’s called the net unrealized appreciation or NUA benefit. If you have a lot of appreciated employer stock in your retirement plan, then you can take a lump-sum distribution in a single calendar year and get a big tax break, Slott says.

Here’s how it works: Let’s say you have $500,000 in your retirement plan, $250,000 of which is employer stock and has a cost basis of $100,000. You ask for lump-sum distribution and request what’s called an in-kind distribution of the employer stock. In essence, you will be transferring your employer stock into a taxable account and rolling over the non-company stock assets into an IRA.

By doing this, you will pay taxes on the basis of the stock, $100,000, at ordinary income tax rates instead of on the appreciated value. Then, when the stock is sold you’ll pay Uncle Sam his due at the presumably more favorable long-term capital gains rate.

Another point to consider: If you plan to take capital losses in your taxable account, you might be able to use those losses to offset any capital gains realized as part of your NUA strategy, Slott said. Check with your CPA before doing this at home, but here’s how it would work: Transfer the NUA stock into a taxable account and sell the shares to raise the cash necessary to pay the ordinary income tax bill due. Then sell the stock and use the gain to search for stocks that you could sell at a loss to offset the gain. Doing so could mean owing no tax at all.

4. Year-End RMD Planning

If you turned 70-1/2 in 2008, Slott said you must begin taking RMDs from your IRAs by April 1, 2009. The first distribution will be based on your IRA balance on Dec. 31, 2007. And then you have to take another distribution before Dec. 31, 2009 based on your IRA balance on Dec. 31, 2008. Typically, it’s better to take the first RMD in 2008. But it might make sense, especially if your income will be much lower in 2009, to “bunch” distributions in 2009.

5. 72(t) Adjustment For Lower Values

If you are in the middle of taking what are called “substantially equal periodic payments’ from your IRA and the value of your IRA has declined, it might be possible to adjust your payment plan. Under what’s also called the 72(t) payment plan, IRA owners can take money out of their account for at least five years or until age 59-1/2 using one of three distribution methods — amortization, annuity, or RMD.

“But if the balance [in your IRA] has severely declined, causing the annual 72(t) payments to become a much larger percentage of the IRA balance, there is relief,” Slott said. The IRS permits a one-time switch from either the amortization or annuitization methods to the RMD method. Switching to RMDs could help lower the amount that you take out, thus saving the IRA from being depleted too quickly.

6. “Alternate Valuation” Estate Tax Break

If you inherited assets from someone who just died, Slott writes that you might be able to save yet again on your estate tax bill by using what’s called the “alternative valuation date.” When someone dies, you either value all their assets at the time of date or six months after the actual death. If the value of the estate, including the IRA, at date of death creates a tax burden, it might be worth using the alternative valuation date, especially if the IRA (and possible other assets) have declined in value. Again, make sure you consult a qualified professional before attempting try this technique at home.

7. Future RMDs

It’s likely IRA owners will face a similar situation again, where the value of their IRA has declined and they must calculate their RMD using a higher year-end balance than is in the account at the time of the distribution. For those people, Picker recommends keeping the RMD portion of the account liquid, in cash.

By Robert Powell
A DOW JONES COLUMN

WASHINGTON — The Federal Reserve on Wednesday slashed interest rates to four-year lows, capping a dramatic policy turn in October as the U.S. confronts a severe financial crisis and almost-certain recession.

Fed officials even left the door open to additional rate cuts to levels not seen in a half-century, putting rates on a once-unthinkable path towards zero.

The Federal Open Market Committee voted unanimously to lower the target federal funds rate at which banks lend to each other by 0.5 percentage point to 1%, its lowest since between June 2003 and June 2004. That outcome was universally expected by Wall Street economists in a Dow Jones Newswires survey.

The Fed also reduced the discount rate charged for direct loans to banks by 0.5 percentage point to 1.25%, responding to requests from Fed district banks in Boston, New York, Cleveland and San Francisco.

“The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures,” the FOMC said in a bleak assessment of the economy, while the financial crisis “is likely to exert additional restraint on spending.” Officials also alluded to “weakened” industrial production in recent months and “damping” prospects for U.S. exports.

Though the fed funds rate was 1% as recently as 2004, few if any on Wall Street had thought officials would revisit those levels again.

After all, the 2001 to 2003 easing campaign was seen by some, in hindsight, as an overreaction to the mild 2001 recession and over-hyped deflation fears. Those cuts and the slow pace of tightening thereafter were criticized as the root cause of the ensuing U.S. housing bubble, the collapse of which is at the heart of the current economic storm.

But this time is different. Far from a mild downturn, the U.S. economy is poised to contract sharply. Economists expect third quarter gross domestic product figures, due for release Thursday, to show a 0.5% contraction, at an annual rate. The forecasting firm Macroeconomic Advisers expects an accelerated decline of 2.8% in the current quarter followed by another GDP dip in early 2009.

The Fed “can go below 1%”on fed funds,said Brian Bethune, economist at IHS Global Insight. “They can go to 0.5% and they can even go to zero if they have to,” he added.

“We’re in the eye of the storm so they’ve basically got to use all of the ammunition they have to turn the situation around,” Bethune said.

Meanwhile, the unemployment rate is expected to climb well above 7% in coming months from its current level of 6.1%. And inflation rates, though still quite elevated on an annual basis, should come down quickly in response to falling oil and gasoline prices.

“In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability,” the Fed said. Wednesday’s statement made no reference to inflation risks as previous ones had.

As recently as the FOMC’s last scheduled meeting, on Sept. 16, officials had warned that inflation remained a “significant” concern. But as the credit crunch claimed more victims and showed signs of spilling over to consumer and business spending, Fed officials on Oct. 8 — in an unprecedented joint rate cut with other major central banks including the European Central Bank and Bank of England — lowered official rates by 0.5 percentage points.

Those global actions as well as Wednesday’s rate cut and “extraordinary liquidity measures’ should promote a return to moderate economic growth, the Fed said, though “downside risks to growth remain.”

Fed officials will monitor the economy and markets and “act as needed” to promote economic growth and price stability, the Fed said.

“The door is open to further easing,” said Ian Shepherdson, chief U.S. economist at High Frequency Economics. He expects another half-percentage-point fed funds reduction at the next FOMC meeting on Dec. 16.

The Fed has also announced a series of programs to help ailing short-term debt markets, particularly by easing corporations” access to loans they need to fund their daily operations. The market for those IOUs, or commercial paper, has suffered as money market funds — the largest group of investors in the market — remain spooked in wake of the collapse of Lehman Brothers. Some money funds had incurred significant losses from defaulted Lehman debt.

Under the Money Market Investment Funding Facility the Fed announced last week, the Fed will provide funding to help money market funds purchase certificates of deposits and commercial paper. And through its Commercial Paper Funding Facility, a complementary program that started Monday, companies such as American Express (AXP) and General Electric (GE) can sell their three-month commercial paper to the Fed.

The Fed has also extended loans to banking organizations to purchase asset-backed commercial paper, started paying interest on banks” required and excess reserve balances and boosted the size of its Term Auction Facility auctions — all in effort to encourage lending.

There are preliminary signs the Fed’s backstop programs are working. A key lending rate, the London interbank offered rate, for instance, was lower Wednesday, extending a streak of consecutive daily declines over the past two weeks.

“The real story regarding the Federal Reserve is its various liquidity operations; the federal funds rate is second fiddle,” said Miller Tabak bond strategist Tony Crescenzi in a research note before the FOMC decision.

Still, the fed funds rate remains a powerful tool given the new global nature of rate cuts. Until recently, the U.S. was largely alone in easing rates given that the root cause of the global downturn has been the bursting of the U.S. housing bubble.

And even if the Fed is entering the final phase of its 13-month fed funds easing cycle, other central banks may just be starting. China’s central bank lowered rates Wednesday for the third time in two months, following an unexpected rate reduction on Monday by the Bank of Korea. Norway’s central bank also lowered rates Wednesday.

The ECB and BOE are expected to cut interest rates further when those central banks meet next month.

Text Of Federal Reserve’s Interest Rate Decision

NEW YORK — The following is the text of the Federal Reserve’s decision on interest rates released Wednesday, Oct. 29:

The Federal Open Market Committee has decided to lower its target for the federal funds rate 50 basis points to 1%.

The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures. Business equipment spending and industrial production have weakened in recent months, and slowing economic activity in many foreign economies is damping prospects for U.S. exports. Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit.

In light of the declines in the prices of energy and other commodities and the weaker prospects for economic activity, the Committee expects inflation to moderate in coming quarters to levels consistent with price stability.

Recent policy actions, including today’s rate reduction, coordinated interest rate cuts by central banks, extraordinary liquidity measures, and official steps to strengthen financial systems, should help over time to improve credit conditions and promote a return to moderate economic growth. Nevertheless, downside risks to growth remain. The Committee will monitor economic and financial developments carefully and will act as needed to promote sustainable economic growth and price stability.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Elizabeth A. Duke; Richard W. Fisher; Donald L. Kohn; Randall S. Kroszner; Sandra Pianalto; Charles I. Plosser; Gary H. Stern; and Kevin M. Warsh.

In a related action, the Board of Governors unanimously approved a 50-basis-point decrease in the discount rate to 1-1/4%. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Cleveland, and San Francisco.

-By Brian Blackstone and Maya Jackson Randall, Dow Jones Newswires

Sen. John McCain wants to help Americans use their nest eggs to cope with the current economic turbulence.

McCain, R-Ariz., the Republican presidential nominee, today released a pension and family security plan.

One provision in the McCain proposal calls for the government to let taxpayers ages 60 and older pay a tax rate of just 10% on 2008 and 2009 withdrawals from individual retirement accounts and 401(k) plans.

The low withdrawal rate would apply to the first $50,000 withdrawn, according to a summary of the proposal prepared by the McCain campaign staff.

McCain’s Democratic opponent, Sen. Barack Obama, D-Ill., proposed Monday that all taxpayers be permitted to take up to $10,000 in retirement account hardship withdrawals in 2008 and 2009.

Under the Obama plan, the usual tax penalties would be eliminated, but the taxpayers taking the withdrawals would have to pay the usual income taxes on the amounts withdrawn.

Like Obama, McCain is proposing that the government suspend a requirement that normally would require retired taxpayers to start withdrawing assets from retirement accounts at age 70.5.

“Forcing seniors to sell at this time guarantees less to live on during retirement and could affect over 4 million seniors,” the McCain campaign says in the McCain economic proposal summary. “John McCain believes this [rule] should be immediately waived.”

NU Online News Service, Oct. 14, 2008

Many older 401(k) plan participants have entered the bear market with most of their plan assets invested in stock.

That point emerged today during a House Education and Labor Committee hearing on the effects of the steep drop in the stock market on employees who participate in defined benefit pension plans and defined contribution retirement plans.

“It’s clear that their retirement security may be one of the greatest casualties of this financial crisis,” Rep. George Miller, D-Calif, chairman of the committee, said today at the hearing. “The current financial and housing crises are stripping wealth from American families at a record rate.”

“Particularly for those workers whose savings were held in too risky a portfolio for their savings goals, or for those who were not well-diversified, these are difficult times,” said Rep. Howard McKeon, R-Calif., the highest ranking Republican on the committee.

Jack VanDerhei, research director at the Employee Benefits Research Institute, Washington, noted that conventional wisdom holds that older workers should shift toward bonds, cash and other conservative asset classes as they near retirement age.

But, in 2006, 27% of the oldest 401(k) participants – participants who were ages 56 to 65 – had 90% or more of their 401(k) assets in stock or stock funds, and another 21% had 80% to 90% of their 401(k) holdings in stock or stock funds, VanDerhei said.

Target-date funds, which are supposed to adjust portfolios as investors with similar expected dates of retirement age, “are likely to become much more common,” especially as the Pension Protection Act, which allows for automatic enrollment of employees in a 401(k) plan, is fully implemented, VanDerhei said.

Target-date fund portfolio diversification “can help avoid excessive exposure to financial market risks,” said Peter Orszag, director of the Congressional Budget Office. “By design, however, workers in defined contribution plans must inevitably bear the risks associated with broad market fluctuations.”

The difficulties created by the market meltdown also affect those guiding employee retirement plans, said Jerry Bramlett, president BenefitStreet Inc., San Ramon, Calif.

“Given how this turmoil is impacting large insurance companies and banks, plan fiduciaries need to make sure that, when offering a so-called stable value or fixed interest fund, such funds are diversified across a large number of financial institutions,” Bramlett told the committee. “What we have learned over the last couple of weeks is that very large institutions can fail no matter how stable they may appear on the surface.”

Bramlett reported that some retirement funds, including some real estate investment funds, have announced that they are frozen and not available for distributions to participants due to a lack of liquidity from their underlying assets.

“This means that current participants cannot change their investment and retirees cannot get distributions,” Bramlett said. “Congress should examine whether investments subject to this susceptibility are appropriate.”

BY MATT BRADY
Washington Bureau

NEW YORK — U.S. consumer confidence fell to an all-time low in October, after a slight rise a month earlier, and expectations are even bleaker, a report released Tuesday said.

The Conference Board, a private research group, said its index of consumer confidence for October dropped to 38.0, compared with a revised reading of 61.4 in September. Economists surveyed by Dow Jones Newswires expected a reading of 51.5.

The 23.4 point drop in the index was the third largest monthly drop in the series’ history, the board said.

The consumer expectations index for the state of economic activity over the next six months declined to 35.5 in October from 61.5 in September.

“The impact of the financial crisis over the last several weeks has clearly taken a toll on consumers’ confidence,” said Lynn Franco, director of the Conference Board Consumer Research Center. “Their earnings outlook, as well as inflation outlook, is also more pessimistic, and this news doesn’t bode well for retailers who are already bracing for what is shaping up to be a very challenging holiday season.”

The sharp confidence fall is causing economists to cut their estimate for consumer spending in the fourth quarter.

Ian Shepherdson of High Frequency Economics estimated that if the expectation index remains at 35.5, real consumer spending would fall at an annual rate of about 3.5% this quarter, worse than the 3% drop he expects in the third quarter.

But what may help the outlook, he said, is the decline in gasoline prices and the belief that stock prices won’t continue to fall as badly as they have already.

Even so, the damage to household finances has already been done.

“A consumer-led recession is upon us, and it promises to be a serious one,” said Joshua Shapiro of MFR.

The present situation index, a gauge of consumers’ assessment of current economic conditions, fell to 41.9 from 61.1 in the prior month.

Consumers took a very dismal view of the current job market. The percentage who think jobs are hard to get rose to 37.2% in October from 32.2% in September. At the start of 2008, only 20.6% thought jobs were hard to get.

The report was released as the Federal Reserve started a two-day meeting to set monetary policy. The sharp fall in confidence bolsters the view that the Fed will cut the fed funds rate by 50 basis points, to 1%.

-By Riva Froymovich, Dow Jones Newswires

NEW YORK — The piles of money being pulled out of the stock market are going into investments that seem to have a common denominator: a guarantee from Uncle Sam.

Government-backed investments including Treasurys; institutional and retail money market funds, which are among the most recent beneficiaries of Washington largess; savings accounts and certificates of deposit, have all been gaining or holding assets.

Other traditional safe havens, like commercial paper and municipal bonds to name two, have been snubbed this time around by investors who remain wary of the credit markets where the recent economic problems began.

“When there is this type of tension, people go for the safest most liquid instrument,” says Ibbotson Associates Chief Economist Michele Gambera. “Something everybody sees as exactly like cash.”

While Wall Street likes to blame individual investors for being quick to panic, economists say the size and scope of the recent stocks market declines — hundreds of points on many days — suggest institutional sellers are responsible.

Losses in other investments, such as complex derivatives, can send these investors on a desperate errand to raise cash to avoid spooking their own creditors. Selling stocks is often the easiest way to do that.

“If you have any sort of call, if you need to demonstrate capital on your books, where do you go?” says Zachary Karabell, president of River Twice Research. “The irony is the equity markets are collapsing because they are working.”

In past market storms, these investors might have favored a range of investments, but this time they are focusing disproportionately on Treasurys.

As a result, yields have grown razor thin. Yields on 1-month bills were 0.31% Monday. While that’s up from a mid-October low of 0.05% two weeks ago, it’s well below inflation which is almost 5%, meaning investors are sacrificing purchasing power for security.

“It’s safe, but you’re not earning anything,” says Moody’s Economy.com analyst Scott Hoyt.

Another vehicle that’s kept institutions’ trust are money funds that themselves invest in Treasurys or other government-backed bonds — in stark contrast to “prime” funds that buy commercial paper.

The failure of one “prime” institutional money fund to maintain a net asset value of $1 in September caused a stampede, with investors pulling almost $263 billion from these funds in a single week. Since then, Washington’s promise to temporarily back money market fund assets has stemmed withdrawals.

But because the guarantee applies only to assets already in funds when the panic began, institutions have been steering new dollars almost exclusively to government-oriented funds, with $19 billion pouring into these during the week ended Oct. 21, compared with just $609 million for prime funds, according to iMoneyNet.

While individual investors may not move their money swiftly enough to drive the stock market hundreds of points in a day, there is little doubt they have been seeking cover just like larger players.

These investors pulled about $77 billion from conventional stock mutual funds during the third quarter and another $14 billion in the past two weeks, according to AMG Data Services. While in another bear market that money might have gone into bond funds, that hasn’t been happening this time. During the past two weeks investors actually pulled $15 billion from bond funds, slightly more than they yanked from stock funds.

“Normally investors are concerned about maximizing their fixed income,” says AMG President Robert Adler. “In this market they’re more concerned about protecting principal.”

Like supposedly more-sophisticated institutions, these investors seem to be looking for reassurance from Uncle Sam. Besides putting more money into retail government money market funds — about $900 million last week — investors are also steering dollars to holdings that carry guarantees from Washington.

Since last October, when the stock market peaked, savings deposits increased more than 5% to $4.03 trillion from $3.84 trillion through September. Assets in certificates of deposit rose 3.6% to $1.26 trillion from $1.21 trillion, according to data from the Federal Reserve.

Both types of investment are backed by the Federal Deposit Insurance Corp. up to $250,000, a temporary increase prompted by the financial crisis from the previous maximum of $100,000.

By Ian Salisbury
A Dow Jones Newswires Column

NEW YORK — Tempted by attractive yields and hints the credit freeze could be thawing, retail investors appear to be moving back to municipal bonds, helping fuel a rally that began earlier this week.

Sharply rising prices have driven yields slightly lower, but they remain close to all-time highs. Triple-A rated, 30-year municipal bonds yielded 5.37% on Wednesday, down from 5.94% last week, according to Municipal Market Data, which produces daily benchmark yield calculations. Yields were expected to fall another 0.05% to 0.15% Thursday, according to Randy Smolik, chief market strategist at MMD.

“We’re buying selectively,” says Hildy Richelson, president of Scarsdale Investment Group Ltd., a Blue Bell, Pa., firm that shops for bonds on behalf of individual investors. “We’ve seen some phenomenal yields come down the pike that we haven’t seen for years.”

Individual investors also appear to be willing to take a second look at municipal bond mutual funds. Two weeks ago the average tax-exempt close-end fund was trading 26% below the cumulative value of its holdings, a level Thomas J. Herzfeld Advisors Inc. analyst Cecilia Gondor calls “just incredible.” Since then, the average discount has closed considerably, to about 10.8%, suggesting retail investors have been buying the funds.

“When we saw the panic, investors that sold everything and bought treasuries, a lot of those were fixed-income investors,” says Gondor. With yields in Treasurys razor-thin, “they’re starting to come back.”

Open-end funds don’t tell quite the same story. Investors pulled about $1.1 billion out of municipal bond mutual funds during the week ended Wednesday, according to AMG Data Services. Still, that was a smaller loss than the $3.4 billion investors yanked during the previous two weeks.

While still-attractive yields may be luring investors, there is still reason to be cautions, according to Richelson.

“The full impact on municipal bonds will be felt later. As the economy contracts, local governments will experience problems,” she says. Moreover, downgrades of insurers like MBIA Inc. (MBI) and Ambac Financial Group Inc. (ABK), has made picking bonds much trickier.

“You used to be able to say that if the bond was insured and the insurer was AAA” — the highest grade — “you could rest safely,” she adds. “Now you need to look at the bonds’ underlying ratings and evaluate those.”

Richelson says she is comfortable with highly rated general obligation bonds, which pledge borrowers’ taxing power to repay creditors.

Currently, investors can buy 30-year, triple-A-rated general obligation bonds from Schaumburg, Ill., yielding 5.4% or Bellevue, Wash., yielding 5.2%, according to Schwab.com. Both bonds have double AA or AAA underlying ratings.

Bonds issued by top universities like Yale and Harvard, may also be attractive, says Smolik. These bonds, which are highly-rated and also boast large endowment funds to help back them, were yielding as much as 6.1% last week.

Not everyone is sold on muni bonds just yet.

“We’re very cautious,” says John Bacci, president of Linthicum, Md.-based Foundation Financial Advisors Inc.

“When Arnold Schwarzenegger gets up and says California is broke, that doesn’t give me a warm and fuzzy feeling,” he adds, referring to Gov. Schwarzenegger’s recent suggestion that his state might need an emergency federal loan.

Bacci says the risk of buying muni bonds that actually go into default is slight, but he thinks there is a chance some muni bonds could be downgraded by ratings agencies, meaning investors who didn’t want to hold the bonds to maturity could take a price hit when they try to sell.

He also doesn’t like the fact the bonds’ prices have fallen so sharply. While that means bonds may be cheap right now, it also suggests they could still be highly volatile, something most fixed-income investors don’t want.

“If you buy now you are buying for growth,” he says. “If I am looking for stock market returns, I will buy stocks.”

Blue-chip stocks are also offering attractive yields with better opportunities for growth, according to Bacci. Among his picks: Shares of Pfizer Inc. (PFE) yielding 7.5% and General Electric Co. (GE) yielding 6.5%. Of course, those yields are taxable.

By Ian Salisbury
A DOW JONES NEWSWIRES COLUMN

The extreme volatility in the financial markets combined with the general and sharp increase in yields over the past six weeks has led to significant issues with pricing of bonds held in your brokerage accounts.

Brokerage firms use services such as IDC (Interactive Data Corp). Price levels are derived primarily from large trades but only a fraction of the millions of bonds out there trade everyday but the bonds still need to be priced somehow.

The pricing service address this with a computerized matrix approach which essentially takes an actual large trade and uses that price to determine values of bonds which had no trades but are similar in terms of maturity, interest and credit quality. If your financial institution uses these services, which all do, they cannot adjust prices just because they think it may be too high or low, they live with them. The only real time you know what your bond is worth is when you actually go to sell it.

The past two months have seen unprecedented volatility in the bond markets especially in the municipal bond market. For many reasons including the credit crisis, the liquidation of hedge fund positions and the absence of buyers like Lehman, AIG and Bear Stearns the pricing of bonds have been all over the place. In there desire to liquidate one institution may sell a block of bonds at fire sale prices causing the same bond in your account to be priced at the same level. This can occur even if you just bought the bond in the morning only to see it re-priced in the afternoon.

These price discrepancies have been pervasive in recent months.

When you see a bond priced on your brokerage statement remember that these are meant to be approximate values. When you try to sell the bonds you can get bids on what others are willing to pay for them. You can also visit www.investinginbonds.com and enter the cusip to get the same information yourself.

When price dislocation occurs like it is now, there is no quick fix but understanding why a bond is priced in your account at a certain level may help stop the clenching of the heart when you open your statements. Unfortunately, I can not explain away the same for your equity portfolio. That remains accurate if still unbelievable.

WASHINGTON — Grilled by lawmakers examining the causes of the financial crisis, former Federal Reserve Chairman Alan Greenspan on Thursday admitted some mistakes in assumptions about deregulation while rejecting the idea that he is personally responsible for what he termed a “once-in-a-century credit tsunami.”

In testimony to the House Government Oversight Committee, Greenspan acknowledged that the crisis “has turned out to be much broader than anything I could have imagined. It has morphed from one gripped by liquidity restraints to one in which fears of insolvency are now paramount.”

“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity (myself especially) are in a state of shocked disbelief,” according to Greenspan.

The panel chairman, Henry Waxman, D-Calif., criticized Greenspan’s approach to mortgage regulation while he was Fed Chairman. The Fed “had the authority to stop the irresponsible lending practices that fueled the subprime mortgage market,” Waxman said, but Greenspan “rejected pleas that he intervene.”

Greenspan said he raised concerns about the dangers of the “underpricing of risk” as early as 2005.

But when Waxman pressed “were you wrong” about the benefits of deregulation, Greenspan responded, “partially.” The “flaw” in the assumptions he had over four decades, Greenspan said, was that lending institutions themselves were best able to protect the interest of their shareholders.

Thus what looked like a solid edifice to his thinking broke down, Greenspan said.

Greenspan said there should be more regulation of credit default swaps, but also noted that excluding those instruments, the derivatives market is functioning well.

Turning to the economic outlook, Greenspan suggested the financial crisis currently gripping the U.S. will take many months to improve, meaning higher unemployment and softer consumer spending is likely ahead.

“Given the financial damage to date, I cannot see how we can avoid a significant rise in layoffs and unemployment,” Greenspan said in the text of prepared testimony to the U.S. House Government Oversight and Reform Committee.

That, in turn, “implies a marked retrenchment of consumer spending as households try to divert an increasing part of their incomes to replenish depleted assets, not only in their 401Ks but in the value of their homes as well,” Greenspan said.

While Greenspan assured lawmakers that “this crisis will pass” and that the U.S. will end up with a “far sounder financial system,” he warned that it won’t come quickly.

Greenspan said a “necessary condition for this crisis to end is a stabilization of home prices in the U.S.”

“At a minimum, stabilization of home prices is still many months in the future,” he said.

 By Brian Blackstone
Of DOW JONES NEWSWIRES