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Debt Downgrade: Message to Clients

August 6, 2011

This weekend you will have a difficult time avoiding what will likely be salacious talk about the impact the S&P downgrade of US debt obligations to AA+ status will have on foreign and domestic markets in coming days. To be sure, this action by a major rating agency will amplify the concerns the economy faces which have led to the volatility we have seen over the past several weeks. I want, though, to review a couple of points that should temper our desire as investors to make dramatic changes to our existing investment policies.

•Perhaps most importantly, the heat of the moment is rarely, if ever, the appropriate time to make changes to well thought out, prudent plans of any type. Making thoughtful decisions in times of calm, allows us the freedom to avoid emotional decisions when storms come…and we know that the storms will come.

•This downgrade combined with the less than favorable GDP revisions and employment reports in preceding days will create continued volatility in the equity and fixed income markets over the short term and may increase the likelihood that we head further down a double-dip recession path.

◦However, we anticipate volatility in the equity markets, which is why Terra Firma Financial (TFF) does not allocate money that is to be used for your personal goals within five to seven years to that asset class. Equities are long-term investments. They always have been and they always will be. Should we see significant market dislocations, we will work to identify appropriate measures to benefit from such conditions.

•A significant risk of a credit downgrade is that we will see a rise in interest rates that the United States is required to pay its creditors, and furthermore, that these elevated rates will filter through the economy to make borrowing more difficult for US consumers. When evaluating this risk, though, we should consider:

◦The Central Bank has every reason to keep interest rates low and it is likely they will do what is required to maintain rates at close to current levels in order that the government’s debt payments remain feasible.

◦Even in the face of this downgrade, US Treasury instruments have remained a safe haven for investors the world over. As recent as Friday, investors wishing to reduce risk have sought out United States Treasury instruments to the point that real rates on short term notes were driven to negative levels. There are few, if any, alternatives for investor safe havens, and little reason to expect US debt to be replaced by a foreign entity in this respect. Continued demand for our debt as economies of the world face continued pressures should hold downward pressure on interest rates.

•Based on S&P published reasoning, political brinksmanship during the debate over the debt ceiling played a major role in the downgrade. There is NO QUESTION, but that our representatives in Washington require a wake-up call of one sort or another in order to more effectively serve our country. There is a reasonable chance that this downgrade could be that wake-up call and serve as a catalyst for more effective – or less dysfunctional – leadership inside the Beltway.

• Terra Firma Financial remains confident in our line-up of world class asset managers on the fixed income and equity sides of your investment portfolios. Allocations to US Treasuries among fixed income holdings are limited. Short duration bonds – which respond less to changes in interest rates – are overweight among fixed income holdings. Equity portfolios remain tilted toward high-quality domestic large cap companies with strong balance sheets.

As we head into a week of unknowns draw confidence in the process that has led to your being wise investors. To be sure, we will continue to monitor the markets and how our portfolios and underlying managers are positioned and look for opportunities to benefit from the volatility that lies ahead.

We remain grateful for the position of trust you have granted us in your lives and look forward to being in touch as we continue down this road together, remembering that your life pursuits are our objective. If you have questions regarding assets thar are held outside of our firm, don’t hesitate to give us a call.

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