Wednesday, August 27, 2008 - Vol. 10, No. 204 Today's comment is by David Newman, Market Analyst for The Sovereign Society. Insurance is one of those things that's supposed to help you sleep at night. It's right up there with putting locks on your doors and installing airbags in your teenager's new car. It should mean that you've got one less thing to worry about. So when you find out that the insurance policy itself may be at risk, it's basically like hearing all those precautions were just a huge waste of time. All chances of a good night's sleep are gone forever. That brings me to FDIC insurance. Nine banks have already failed this year, so how "safe" is your FDIC insurance? When you pull back the covers on the FDIC insurance program, what exactly will you find backing up every dollar in your bank account? I'll get to that in just a moment. But first a little history... Where Did the FDIC Come From? The FDIC (Federal Deposit Insurance Corporation) is an independent agency of the federal government. So even though it's technically independent of the federal government, it was the U.S. government's brainchild. Congress first created the FDIC in 1933 in response to the thousands of bank failures in the 1920s and early 1930s. For as long as the FDIC has existed, its primary goal has been to: "...Preserve and promote public confidence in the U.S. financial system by insuring deposits in banks and thrift institutions for at least $100,000." And to give them their due...they've done a pretty good job of it. Just a year after Congress created the FDIC it also created the Federal Savings and Loan Insurance Corporation, FSLIC...remember them? The savings and loan crisis of the 1980s bankrupted the agency, after thousands of Savings and Loan Banks had to close their doors forever. It was just more than the insurance could handle - the safeguards failed and the FSLIC insurance program closed. As usual, the American taxpayers picked up the tab for this failed organization, paying US$160 billion. President George H.W. Bush requested and Congress agreed to abolish FSLIC. They decided the healthier, better-staffed counterpart for the banking industry (aka the FDIC) should watch over these deposits from now on. Poof! - the FSLIC simply disappeared. Fast-Forward to FDIC Insurance in 2008 This year, the FDIC is celebrating its 75th Anniversary with its "Face Your Finances" coast-to-coast road show. They're also celebrating with a new website and big full-page ads in papers like The Wall Street Journal. Unfortunately, there's really not a lot to be celebrating... When banks fail, the FDIC steps in to (remember their motto) "Preserve and Protect public confidence..." They have to move fast to accomplish all this. A bank can close their doors on Friday and technically be wiped from memory by Monday. If a bank goes insolvent on Friday, the FDIC bank regulators scramble over the weekend. They freeze every account and work diligently to sort out the bank's balance sheets. Then by 9 a.m. Monday morning, you suddenly have a new bank with a different name on the door. Other than that, it's business as usual. The FDIC works diligently to give you back your insured funds. In other words, any account in your name up to US$100,000 (per holder on the account), and US$250,000 for any retirement account. (Concerned about the minimums? Our friends at EverBank may have a solution for you. But where does all this insurance money come from? A Vicious Banking Cycle The FDIC levies a fee on all U.S. Banks. These are the reserves that insure your deposits. But here's the problem: The reserves are running low this year. As of today, the FDIC's reserves reported it had US$45.2 billion of reserves covering 1.01% of all deposits. This is considered historically low. The failure of just one bank last month - IndyMac - is going to wipe out 10-15% of all reserves. That's just one bank (let's not forget that the S&L bailout cost us over US$160 billion). Consider that nine have already failed this year. In fact, I see on the FDIC website another bank failed on Friday. When the reserves that insure your bank deposits drop 1.15%, then by mandate the FDIC must come up with an action plan. If you do the math on this, you'll find we're already there. But what "actions" can they take? They don't have that many choices. Remember they get their reserves by levying a fee on their member banks. That can be a vicious cycle. Let me explain... Congress gave the FDIC the mandate to replenish their reserves by charging higher premiums on their members. The current fee that most banks pay is five cents for every US$100 of insured deposits. But high-risk banks now pay up to 43 cents to insure that same US$100. That high-priced insurance is killing them. Especially since FDIC-insured lenders reported a net income of $4.96 billion this quarter, down 87 percent from $36.8 billion in the same quarter of last year. If the banks are called to increase their cost for insurance the money has to come from somewhere. So here's the problem: The FDIC needs more cash, but it comes from the banks. Right now, the banks need all their funds so they can make loans and clean up their balance sheets so they can stay in business. But the FDIC has to appear rock-solid, which means they need more than enough cash to cover all the banks. The FDIC can't let their reserves fall much lower. FDIC Chairman Sheila Blair said yesterday that they may need to borrow money from the Treasury due to "short-term liquidity issues", but this is just a temporary fix. The value of assets belonging to lenders on the ‘problem list' has tripled to US$78.3 billion in the last quarter alone. That's roughly twice the amount that the FDIC could currently cover. They're going to have to raise fees and the inevitable outcome will be more bank failures. This is a real mess without an easy solution. It seems only the strong will survive. So make sure your money is secure at one of the stronger banks. You can get more information about your bank here. DAVID NEWMAN, Market Analyst EDITOR'S NOTE: All these banks failing is just one more piece of evidence that we're no where near the end of this bear market. Today, David hosted a special video broadcast, alongside Executive Editor, Justin Ford, to give you real-time solutions to these disturbing market trends. Thousands of listeners joined the call at noon today, but you can listen at your convenience absolutely FREE, just by clicking here.

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Offshore:

Where In the World is Vanuatu? Part I Depending on who you believe (and how they define them), there are any number of "tax havens" in the world. "Tax havens" are defined as financially attractive jurisdictions that impose low or no taxes. They also typically roll out the welcome mat for foreigners willing to invest, bank or do business there. With all the pressure put on European tax havens such as Liechtenstein in recent years, , some folks seem to be looking for alternative havens - especially the ones you might call the "far-out tax havens." Perhaps these adventuresome folks think they can run and hide, but my advice is to be very careful where you go. For instance, in the last few months I've received several inquiries about the Republic of Vanuatu. My readers want to know if it could be a good place for their offshore banking, asset protection plans and estate planning. I can hear you now -- where in the world is Vanuatu? -- assuming it is in this world. Vanuatu is a tropical archipelago group of 80 islands (about 65 of them inhabited). These islands cover 12,200 sq km (slightly larger than Connecticut) in the South Pacific Ocean, about three-quarters of the way between Hawaii and Australia. The capital city is Port-Vila (on the island of Efate). Some 215,446 people live there, split between English and French speakers. The different languages reflect Vanuatu's colonial heritage when it was known as The New Hebrides. Multiple waves of colonists migrated to the New Hebrides in the millennia preceding European exploration in the 18th century. The British and French, who settled there in the 19th century, agreed in 1906 to an Anglo-French Condominium, which administered the islands until independence in 1980. At that time, the new Republic of Vanuatu was born. At its height, about 12,000 expatriates lived in the islands. But after Vanuatu declared its independence, only people of Vanuatu could own land there. Therefore the mainly French and British expat community shrank to less than 3000. Today, the expat population is about 8000 and growing, with heavily taxed Australians and New Zealanders in particular finding the island's lifestyle -- and lack of taxes -- to their liking. So now that you have a little background on this far-out haven, is it truly an offshore haven? Tune in tomorrow and I'll give you my assessment. BOB BAUMAN, Legal Counsel P.S. Looking for a tax haven of your own? I can tell you all about those other suitable and useful offshore financial centers in my book, Tax Havens of the World: Where to Stash Your Cash.

Wealth:

2008 Has Been a Great Year for Short-Sellers For the first time since 2002 investors who sell short or bet against rising stock prices are basking in some real profits. Betting against the market using reverse index funds is a highly-skilled discipline that the majority of hedge funds and investors fail to master. Most investors, even equity long/short hedge fund managers, are typically long-only investors. They're getting trashed along with everyone else in this lousy market. Thus far, 2008 has been the first year stocks have declined since 2002. The S&P 500 Index has declined 13% this year while the MSCI World Index has plunged 17%. Worse, developing economies have been ravaged, led by stunning losses in China, Russia and India among many others. The MSCI Emerging Markets Index is down a dizzying 21%. If you managed to speculate with reverse indexes or exchange traded funds (ETFs) that bet against these and other indices, then you're sitting pretty. Even better, some of these reverse ETFs have twice the inverse correlation, meaning that they can boost your returns in a bear market. For example, the ProSharesUltraShort MSCI EAFE ETF (EFU) has surged 45% this year as the benchmark EAFE Index (Europe, Australia and the Far East) has tumbled 21% without leverage. If two times leverage isn't your game, then EFZ or the ‘ProShares Short MSCI EAFE' ETF, can still pack a big punch in a bad year for international equities. The safest and most responsible way to use reverse-index ETFs is to hedge or protect your equity portfolio in a bear market. But figuring out exactly how much you should allocate to these volatile products can be a tough balancing act. Your answer depends on how much exposure you have in stocks - domestic and foreign - and how much you have invested in fixed-income, commodities, currencies and other assets. Basically, your asset allocation, age, income needs and tolerance for risk will dictate this strategy. With stocks already down 20% from their October 2007 highs, it might be too late to buy this sort of protection. But then again, if I owned a portfolio of stocks there's no way I'd leave myself without some sort of downside protection even at these low levels. This is a bear market and we can still decline another 10% or more. ERIC ROSEMAN, Investment Director

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