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The sub-prime issues are starting to show in widening credit spreads.

This is in a very early stage. It is too soon to know if these spreads will become a contagion and reach into many sectors of the US economy.

They might. We are describing deterioration in over $1 trillion in debt.

We are seeing foreclosures and financial pressures that may reach into over 10 million households, more than 30 million people, over 10% of the US population. That’s big.

Some say this will be over quickly. We think not. We follow the futures pricing of housing and it is still trending downward over the next year.

Almost all regional markets continue to show weakness. And the food and energy budgets of those households are under serious stress. The mortgage interest rate reset has another two years to run before it starts to normalize. And remember that there is a lag time between when a household gets behind in a payment to when the actual foreclosure occurs. What we see in the debt market today was originated a year ago.

That is why it may be the tip of an iceberg.

Some say the Fed will bail everything out. We think not. The Fed is not in the business of guaranteeing a put to a house buyer. The Fed is rightfully looking at the intermediate term market based pricing of inflation. It has not declined to the Fed’s comfort zone. Were the Fed to ease now, it would undo many years of inflation fighting hard work.

That is why this Fed is determined to stay the current course. The Fed will only ease prematurely if there is a threat to the financial system.

Hedge fund failures and losses by investors are not necessarily a system wide threat. Failures of large banks or FNMA might fall in that category. We do not see a system wide meltdown. Thus the Fed will permit losses. That is why it is prudent to raise cash and underweight financials.

In order to minimize this risk exposure in our managed bond accounts, we are emphasizing only the highest credit quality instruments. This is true for tax-free municipal bonds and for taxable bond accounts. Our credit standards are much higher than the bench marks. We do now see how spreads narrow more; and we can construct many scenarios for spread widening. Under these conditions one does NOT chase yield by sacrificing credit quality.

Our duration benchmark for our managed bond accounts remains neutral or shorter. It is still too soon to buy very long term bonds. That time will come; patience will be rewarded. For now, we are maintaining the tight disciplines we have shown over the last 4 years. In mid-June of

2003 the 10-year US Treasury note traded to yield about 3%. It is currently yielding around 5%. Anyone who strategically lengthened duration during this period has lost money. We believe that June 2003 saw the generational lows interest rates. The trend has been higher since. That supports our bias toward shorter duration at this time.