A cautionary tale

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Investors seek stable returns in new investment climate

WASHINGTON - As complex and far-reaching as the collapse and subsequent federal rescue of global investment bank Bear, Stearns and Co. Inc. may prove, in some ways it's also a simple cautionary tale.

The cautionary tale, according to stockbroker and financial manager Lynn Dee Rapp, is that tribal leaders should look their financial managers in the eye and ask what would happen with tribal investments if they were confronted with ''illiquidity'' on a Bear, Stearns scale - that is, if ''illiquidity'' threatened their investment portfolios with losses as it almost pushed Bear, Stearns into bankruptcy?

''The major investment houses are 'dumping' their troubled debt and bond portfolios for significant discounts,'' she said. ''How does a consumer, a tribe or tribal member, who holds problem bonds in their portfolio dispose of the problem securities, those with very large losses? They are not able to 'clean up their balance sheets' as easily as a major financial firm can do it.''

The difficulty in getting rid of stocks and bonds and other financial instruments that have gone bad, forcing their holders to continue absorbing losses, is the essence of ''illiquidity'' as financial professionals use the term.

''We know that the buffalo is no more,'' Rapp said, drawing the familiar analogy with tribal gaming wealth, ''and we know the dislocations that caused it could happen again.''

She noted that the Federal Deposit Insurance Corp. reports a 60 percent increase in the number of employees in its bank failures division - hardly a swarm of locusts descending, given that FDIC employees in that particular field are few to begin with. But then again, surprise and uncertainty are part of the current financial landscape; and Bear, Stearns was one of the top five U.S. investment banks only two months ago, trading at almost $60 a share one day and at $2 a share the next. Under new ownership and with guarantees from the Federal Reserve Bank, the share price has risen slightly since.

The rumor persists that a so far unidentifiable tribe or tribes had $100 million with Bear, Stearns. Rumor isn't fact, and even if it proved to be fact, the key issue, according to several financial professionals in Indian country, would be how the money was invested - if Bear, Stearns were only an intermediary for investment in third-party instruments, for instance, instead of having packaged up the money as mortgage-backed securities or high-risk hedge funds, losses could be minimal if any.

''To whatever degree that [rumor] is true, and to whatever degree the tribe or tribes may be burned,'' said Native American Bank president and chief executive J.D. Colbert, ''I just want to position ourselves as that voice of prudence ... to protect tribal investments. ... Tribes could lose their hard-earned wealth.''

A lot of tribes lost considerable sums once before, during the ''dot-com'' bust of technology stocks in the first years of the new century, said Dante Desiderio, economic development policy specialist for the National Congress of American Indians. Since then, he said, tribes have done a good job of improving their investment policies, and a similar opportunity is now at hand. ''I think it's a really good time for tribes to take a second look at their investment policies.''

Their policies must emphasize the tribal ownership of assets, including a clause to the effect that tribes must own the underlying assets that are leveraged as investment instruments, in the jargon of high finance. That is the best way to minimize the risk of investment in so-called ''highly leveraged'' instruments whose backing revenue streams, based on at-risk assets, have become tenuous, Desiderio said. Otherwise, Wall Street brokers and investment bankers will continue to seek out high-risk, high-reward investments, often without providing enough information to tribes about the risk.

In any case, said Raj Gupta, a partner of Rapp's in SeaCrest Investment Management, diversification of investments is critical for tribes. By that, he means more than a diversity of stocks in any one investment portfolio; tribes should also invest in a diversity of asset classes, in certificates of deposit, Treasury notes and well-backed government securities, in ''illiquid'' instruments designed to harvest profit over a period of years (if all goes well) and in ''liquid'' deposits that can be cashed out at will (if all goes less well, as at present).

Risky investment strategies are giving way to stabilization, Raj said. ''There's a significant amount of illiquidity in the market ... that has brought about a dramatic flight to quality.''

In short, investors are seeking stable sure returns instead of the dramatic gains and losses that come with a tolerance for risk, a strategy Colbert referred to as ''stick to your knitting.''

''The smart money in this country ... is headed for the sidelines, hunkering down,'' Colbert added. ''Fundamentally, that's where I'd like to position the tribes.''

The next step in the positioning of tribal investments is a critical one, Gupta said. ''It is clear the Fed [Federal Reserve Bank and its board of governors] will do what it takes to protect the U.S. financial system.'' But in a truly global economy, the Fed has less influence on international monetary systems, and danger still haunts the capital markets in the wake of Bear, Stearns. While other investment banks have rallied, no one can be certain the crisis is really over, Gupta said.

''Indian country is not immune by any means from what's happening,'' Colbert said. ''We don't want to be alarmists, we don't want to be Chicken Littles, but we do want to be that voice of prudence.''

Rapp and Colbert, along with other leading financial professionals in Indian country, presented their case for a ''flight to quality, stick to your knitting'' strategy in tribal investments at a Native American Finance Officers Association conference in San Diego in late March; and Rapp said they are scheduled for an hour on the agenda of the National Indian Gaming Association trade show and convention in San Diego, April 20 - 23.

Full disclosure is that they are also founding members of Eagle Opportunity, a fledgling company formed to promote Indian and Native financing, financial management and legal work. Rapp said current members are the Native American Rights Fund, the Native American Bank, Sycuan Fund and Native American Capital, with other tribes and organizations poised to become members soon. Desiderio said NCAI doesn't endorse businesses, but works with companies of all sizes to ''build and serve the market'' for Indian skills and opportunities. ''A trend we're trying to encourage is Native-owned companies like Lynn's.''

Both Colbert and Gavin Clarkson, a University of Michigan professor and managing director of Native American Capital, expect the U.S. economy to right itself eventually. In this they join Ben Bernanke, chairman of the Federal Reserve Board of Governors, who recently indicated that a recession is likely before the economy rebounds at the end of the year.

Colbert said tribes that are wise with their money could pick up some bargain investments once the stock market straightens out. True to his own professorial bent, Clarkson provided a detailed prognosis:

''It may at first look paradoxical to say this, but historically, when the capital markets are in retreat, or at their low point, the best venture capital and private equity returns have occurred. This is because the competition for venture capital and private equity sharpens significantly. Entrepreneurs become very capital-efficient and the quality of business projects seen by venture funds such as NAC improve significantly. Entrepreneurs get more disciplined and produce better business plans, better deals, better business models and structures. Native American Capital expects to benefit fully from these broad market dynamics.''