Wednesday, December 29, 2010

The Secret to Making Itsy Bitsy Bargains Add Up

Any halfway decent shopper knows of small bargains that keep a little more cash in your pocket, or add a few bucks to your bank balance. For example:

Twin bladed razors. Twin bladed razors, either of the disposable variety or the replaceable blades--are much, much, as in much, cheaper than razors with three, four or five blades. If you keep your eyes peeled, you might find generic twin-bladed razors for one-tenth (as in 1/10) the price of something with more blades. And none of the mega-multiple bladed razors are ten times better or last ten times longer than twin-bladed razors. Why pay $2.50 or more for a razor?

Non-perishables on sale. Non-perishable foods with long shelf lives, such as tuna, peanut butter, and pasta, should be bought in quantity when on sale. Unless you live in a tiny home with no storage space, never pay full retail for non-perishable foods you eat often.

Home cooking. Learn to cook, and you'll save lots of money. In addition, you'll probably put less sugar, fat, salt, msg and other bad stuff in your meals, so your health care costs may be lower. For more, see

Prepaid cell-phone service. Contrary to popular depiction in the mass media, most Americans don't walk around with their faces buried in smart phones, stumbling into light poles and fire hydrants as they text away furiously or catch up on their favorite soaps. Keep a record of how much you actually use your cell phone. A prepaid plan, where you pay for a fixed amount of minutes, may actually be much cheaper than the standard all-you-can-text-and-call plan.

Regular coffee. Lattes are an expensive way to gain weight. Regular coffee, especially without sugar or cream, can give you a nice caffeine boost without larding up your bottom.

Of course, you can think of many other examples of small savings. For more ideas on smart spending, see

How can you make all these small economies add up? By sweeping your checking account every month. Have a savings account (or maybe a money market account) in the same bank where you have a checking account. At the end of each month, transfer all extra funds from the checking account to the savings account. For example, let's say you keep a minimum of $1,000 in your checking account, either because you want a buffer against overdrafts or because it helps you avoid banking fees. If, because of your smart money management, there is $1,125 in the checking account at the end of the month, move $125 into the savings account. Avoid spending the money in the savings account (except to make investments or in dire emergencies). This monthly account sweep prevents you from frittering away the fruits of your frugality. Over time, the swept amounts grow and compound. Compounding is your best financial friend. See By separating the money you save from the money you'll spend, you become richer. And that's better than the alternative.

Wednesday, December 22, 2010

Will the Fed's Easy Money Slow the Economy--Again?

It is widely believed (albeit not at the Fed) that easy money policies by the central bank have contributed substantially to the asset bubbles and busts of the past decade. Tech stocks, real estate, consumer credit (remember the days when anyone with a pulse and a signature could get a loan?), and commodities (especially oil) all boomed and busted partly because of low interest rates fostered by the Fed. Each cycle enriched financial markets insiders, but weakened consumers and the broader economy. Nevertheless, the Fed is at it again with quantitative easing (i.e., buying Treasury securities in the open market) and history may be repeating itself.

Oil prices have risen above $90 a barrel, and predictions for $100 oil are becoming fashionable. Regular gas is more than $3.00 a gallon. Metals prices have been rising, and today's Wall Street Journal (P. C1) reports that holdings of metals have become concentrated, suggesting a flare-up of speculative buying. With the economy still struggling to climb out of the septic tank, the liquidity the Fed has been pouring into the financial system apparently isn't being used to build factories or develop software, or for badly needed repairs of bridges and highways. It evidently is going into short term financial market plays, the same kind of stuff that's bedeviled the economy for the past decade.

The Fed wants inflation to stimulate consumer spending. It may well get a dose of inflation this year, if oil and other commodities prices keep rising. But that isn't beneficial inflation. As gasoline, heating oil, diesel and aviation fuel go up, consumers spend more on energy and less on everything else. Oil producers get wealthier (perhaps increasing funding for Iran's nuclear weapons program), while American businesses struggle to keep sales up. Hiring may slow, retarding the recovery of employment levels. The economy could stumble. This is what happened in 2008 and it could easily happen again.

Just when everyone thought fiscal stimulus was dead, the Republicans ignored the mandate from voters in the recent mid-term elections and agreed to a tax deal with President Obama that increased the federal deficit. Okay, so the increase was necessary to give tax relief to the wealthiest Americans, who are major targets of campaign fundraisers now that the Supreme Court has ruled that political sugar daddyism is a Constitutional right. But it demonstrates that fiscal expansiveness lives. John Maynard Keynes' legacy may yet be vindicated by the GOP.

The Fed has powerful monetary tools. These tools, however, can have powerful unintended consequences. Need the Fed pile on with more easy money?

As a bank regulator, the Fed has appropriately been leaning on its regulatees to be more prudent. Perhaps, just perhaps, it ought to consider whether prudence might not be a weapon in its monetary arsenal as well.

Monday, December 20, 2010

An Omen of Financial Stress?

Something strange is happening in the short end of the Treasury securities market. Treasuries maturing in about 1 month are yielding around 0.01%. Just a couple of weeks ago, yields were above 0.10%. Perhaps this may all seem like peanuts (and it is, if you have, say, $10,000 invested). But a yield of 0.01% was last seen during the dark days of the credit crunch in late 2008 and in 2009, when the world's banking system faced a funding crisis. Such a low yield signified that no one trusted anything except the obligations of the U.S. government; that investors didn't care about getting a return. They just want to keep their money safe. The recent 90% plus drop in the short end of the Treasury yield curve in less than two weeks may be a sign that something is rotten somewhere.

Economists and other fortune tellers are raising their estimates for growth next year. Stock prognosticators are full of holiday cheer, predicting rosy returns for stocks in 2011. Consumers may be loosening their purse strings a bit for this year's holiday season. Recent tax legislation will widen the deficit for next year, ensuring that the federal spending spigot won't slow down. All systems are go, it would seem. What's to get stressed about?

Euro Mess. The European response to the Euro bloc sovereign debt crisis, generously assessed, has been tentative and muddled. The only clear impact has been to transfer risk of loss to European taxpayers and give the can a hard kick down the road. The continued uncertainty makes the U.S. greenback look good by comparison (once again demonstrating that it's easy to lose faith in America, until you look at the rest of the world). If you're going to dump Euros for dollars, it makes sense to buy the short end of the Treasury yield curve, where you're not competing against the Fed's quantitative easing program.

One group of potentially nervous investors would be money market funds that hold commercial paper of banks in shaky Euro bloc nations, like Greece and Portugal. Amazingly, in spite of the money market fund credit crunch in 2008, many money market funds bought this foreign issued commercial paper. (One wonders what happened to prudence, but then again prudence is something isn't brought up in polite company.) Those money market funds now may be quietly easing out of Euro bloc bank commercial paper and shifting into Treasuries before year end, when they'd have to disclose their holdings to investors.

Muni Mess. The muni market has fallen, about 5% in the past month. That may not sound like much, but if you held munis and it was your 5%, you'd be peeved. The future for munis isn't pretty. The federally subsidized Build America Bonds program turns into a pumpkin at the end of this year, and there won't be a fairy godmother for it next year. That means states and municipalities will face the harsh winds of the muni market without a quick fix from Uncle Sam. Many financially troubled states are still struggling with their budget problems. To make things worse, questions over states' pension accounting could compel larger state contributions to employee pension funds. Muni investors with battered portfolio syndrome may be seeking a port in the growing storm and heading for the safety of Treasuries.

Bond Mess. The bond market has fallen since early November, when the Fed formally announced its quantitative easing program. Investors who bet that QE would extend the 30 year bull market in bonds may now suspect that this time, things really are different. Those that aren't ready for the quicksands of the stock market may be parking at the short end of the Treasury curve, waiting to see whither the winds blow.

It's unclear that any of this will push the financial system back into the septic tank. Any analysis of that question would require information about who's holding what exposures in the derivatives markets. (Query: are major banks holding the hot tamale because they took the wrong end of the wrong credit default swaps?) But those markets are as opaque as ever, notwithstanding the enactment of the Dodd-Frank financial reform legislation this past summer. All we know is that the short end of the Treasury yield curve is at 0.01%, and the last time that happened, canaries in the mine were gasping.

Sunday, December 19, 2010

Year End Financial Checkup

Before you become too friendly with the nearest bowl of eggnog, give your finances a quick year end checkup. That way, you can roll into the new year hungover, perhaps, but with some idea of where you are financially and where you want to go. Admittedly, money issues bring less cheer than the bubbly stuff that makes the cork pop. Ignoring one's finances, though, won't lead to wealth.

A lot of year end financial advice focuses on tax planning or prognostications for next year. Like many things, though, a solid foundation in financial basics is more important than doing some transactions that invite an IRS audit or believing in the latest self-appointed soothsayer. Get the basics right and other things become easier.

Calculate your net worth. This is the where sound financial planning begins. If you don't know where you stand, you can't tell if you're making progress (or losing ground). If things are going well, you can give yourself a pat on the back. If not, save more and perhaps change what you're doing. Calculate your net worth every three months. For more, see

Ensure adequate cash reserves. Make sure you have at least six months worth of living expenses set aside in an emergency cash fund that you never tap except during a crisis. Better yet, considering today's continuing albeit not-officially-recognized recession, have nine or twelve months of living expenses set aside. Unemployment remains a serious problem. Even though high ranking government officials are quick to tout even a tiny smidgen of improvement in employment levels, lots of people are still being laid off. Thrifty squirrels are the ones that survive winter.

Review portfolio diversification. Your portfolio's asset allocation may have changed as a result of market shifts. Most recently, bonds have been falling (contrary to every effort of the Federal Reserve to push them higher), while stocks have been rising. Consider whether you should adjust your allocations.

You may have different asset allocations for different pools of assets. The way you diversify a college fund for your kid(s) could be different from the ideal asset allocation for retirement savings. Keep these differences in mind.

Go over your benefits. Make sure you understand where you stand with Social Security and, if you have a pension, with your pension benefits. Maybe you don't believe either will be around by the time you retire. Well, people thought the same thing 30 and 40 years ago, and they're now retiring with Social Security and, sometimes, pension benefits. Figure out how to maximize your benefits. Then, maximize them as much as possible.

Review privacy. The Internet, by all indications, is becoming less private by the day. In an implicit but sharp rebuke to the private sector for its failure to display even a modicum of propriety, U.S. government regulators are now talking about setting federal standards for online privacy. Think about limiting your use of the Internet for financial matters (this includes banking, stock trading, online shopping and other online use of credit cards, debit cards, bank account numbers, and other financial transactions). The less often you do financial transactions on the Internet, the fewer opportunities you give bad guys to steal your money and/or identity. The Internet is unquestionably a convenience, but being robbed by cybercrooks can be highly inconvenient. If you must do transactions online, use the best security measures available.

A report in this weekend's Wall Street Journal (P. C1) indicates that smart phones (like the iPhone and Android) may be significantly less secure than computers. Apparently, some apps may sneak off with your name and other highly personal information without telling you or getting your permission. Avoid doing financial transactions on a smart phone, at least until security is greatly improved. If you must do financial transactions on your smart phone, check account balances and activity often. This means at least weekly and perhaps even daily for your bank accounts, credit card accounts and whatever accounts you use through your smart phone.

A cyberthief can make off with savings you took years to accumulate. Protect yourself.

Think about saving more. One of the best protections you have against an uncertain future is a nice, warm, fuzzy and large pool of savings. The more you save, the sooner you'll be able to retire and the nicer your retirement lifestyle will be. See and

Thursday, December 16, 2010

The Miracle of the Assumption of the Debt

Once upon a time, the peoples of a continent decided to cast the money changers from their lands. They struggled and strove for many a year, after decades creating an economic and monetary union. Then they rested, thinking it was a mighty union.

But humankind had not cast avarice, envy, corruption or deceit from their souls. Cunning and crafty investments were begat, which were multiplied by the chicanery of money changers and the mendacity of borrowers. A few voices cried out in the wilderness, warning of the dangers of cupidity and the trickery of false prophets who promised endless wealth and prosperity from borrowing and spending.

But the people continued to dream of opulence, and worshiped debt all the more. The flow of guileful investments became a flood, and the wickedness of these investments emerged as a rising potential for default. Many peoples of the monetary union were threatened with calamity. They were sore afraid.

They turned to the wealthy northerly people of the union, and pleaded for manna. The northerly people, who felt as if they were being asked to feed a multitude with a few fishes and loaves, hesitated, protesting that the yoke of a bailout would be difficult and the burden heavy. They said that the spendthrifts in the union were reaping the harvest of their extravagance, and that the deluge of bad debt was punishment for their covetousness. But the high priests of the monetary union proclaimed that if the northerly people failed to render aid, trumpets would sound, and chaos and darkness would cover the Earth.

The northerly people did not see themselves as a shepherd feeding his flock. They insisted that the profligate in the monetary union cease their avaricious ways and purify their national budgets of deficits. They demanded that lenders bear some losses and be made to wash the feet of lepers. To protect the prosperity they had worked hard to attain, the northerly people offered only temporary assistance, making no commitments beyond three years.

The waters of the deluge of bad debt kept rising, threatening more and more peoples of the monetary union. Soothsayers prophesied swarms of locusts, plagues, poisonous serpents, and the wrath of the bond markets. From the skies came flashes of lightning and peals of thunder.

The northerly people trembled, and as the twelve days of Christmas approached announced they would join with the rest of the monetary union to build an ark, a permanent fund to support the common currency. While many details of this covenant remain to be worked out, the ark appears intended to save all the peoples of the monetary union.

The good tidings swept across the continent. Debtors were elated and shouted to one another, "Fear not. For unto us is borne this day by others the burdens of our debts. Our iniquity is pardoned. Hallelujah!"

It was a miracle, the miracle of the assumption of the debt. While the waters of the deluge of bad debt have yet to part, if the monetary union can truly be fiscally moral, and not morally hazardous, it may indeed attain a state of grace.

Tuesday, December 14, 2010

How Tight Money is Hindering Recovery

It is axiomatic among students of financial history that tight money policies by central banks aggravated the economic downturn of the 1930s and pushed the world from a deep recession into the Great Depression. Policy makers, especially the Federal Reserve, have sworn on many stacks of many books to avoid the mistakes of the 1930s by maintaining an easy credit policy. Yet credit is tight, in some respects very tight. While the tightness isn't pushing us into a depression, it makes recovery very difficult. At its meeting today, the Fed Open Market Committee promised to keep short term rates at zero as far into the future as one can imagine, and to continue its program of quantitative easing by buying longer term U.S. Treasuries. Its accommodations, however, will do little to ease credit conditions.

Where is the tight money? Everywhere. Mortgage loans are subject to strict underwriting requirements, which may be getting stricter as the real estate market continues to soften. Credit cards are issued only to customers with sterling credit ratings. Business lending may be easing slightly, but the smaller businesses that can't directly access capital markets (like the S&P 500) find that bank credit is somewhere between almost inaccessible and absolutely unattainable.

The tightness of money is a reaction to the credit binge of the 2000s, when anyone with a pulse and a signature could get a loan. After the financial tsunami of 2008, banks, regulators and mortgage underwriters like Fannie Mae and Freddie Mac found prudence in their hearts. With the fervor of the newly converted, they now hew to the straight and narrow, dribbling pinches of credit only to right-thinking, clean living, pure-hearted borrowers who've never said a cuss word in their lives.

The tightness of credit is good for taxpayers, who are directly or indirectly on the hook for just about every liability of every bank in America (and perhaps some banks in Europe if the Euro crisis isn't resolved soon). And it's good for rebuilding America's balance sheet. The nation's banks, consumers and governments all are deleveraging, and another credit bingeapalooza is the last thing we need. Relaxing credit standards to accelerate economic recovery could easily foster a faux prosperity that would collapse when reality inevitably trumps fantasy.

The Fed's easy money isn't being loaned out much. To a large degree, it sits in banks' accounts at their local Federal Reserve bank, where it likely serves as a buffer against real estate losses the banks are afraid they'll have to book. The Fed surely knows this. So what is it doing, triggering battered savers syndrome from sea to shining sea? One suspects that it's deliberately trying to create inflation, in order to scare catatonic consumers into spending. The Fed's nightmare is deflation, which can inhibit consumer spending and thereby worsen a downturn. Instill the fear of inflation and consumers presumably will buy in order to avoid higher prices later.

The theory may be tidy. But what if consumers are afraid of losing their jobs? A new high-end washer/dryer combo won't make you feel very good if you're laid off the week after it's delivered. Even with the threat of inflation, consumers may choose to save (and invest in the best inflationary hedge they can find). The Fed has to contemplate the limits of monetary policy, and consider whether it's doing more harm than good. Its quantitative easing program has driven long term interest rates up, raising mortgage rates, cutting off refinancings and reducing the pool of qualified buyers of homes. That, in turn, may push real estate prices lower and cause credit standards to tighten even more. In other words, quantitative easing may be making credit tighter--and retarding recovery.

At the same time, if quantitative easing does trigger inflation, we could end up with much dreaded 1970s style stagflation. Then, leisure suits might come back, multiplying the horror of the situation.

In matters economic, the law of unintended consequences is remorseless and inflexible. Its judgments are rendered swiftly, with nary a thought given to mercy. The Fed normally likes to keep all its options open. But this time it seems hellbent on spending $600 billion smackeroos on Treasury securities, come something or shinola. The Fed is steering the toboggan toward slippery slopes. Hang on tight.

Sunday, December 12, 2010

Still Searching for the Gold Standard

Contrary to popular belief, the gold standard lives on. Not as a linkage of paper currency to a precious metal, but as the human search for certainty in the value of currency. And the results today are as convoluted as earlier experiences with the gold standard.

The gold standard--making a unit of a paper currency convertible into a fixed amount of gold--was used first and foremost to provide assurance against uncontrolled printing of money and the inflation that could follow. Such inflation could be created by whoever issued the paper money--be it a bank or a government--and gold convertibility was seen as stabilizing the value of the currency.

Gold, however, doesn't ensure absolute certainty of value. When large amounts of gold become available (from mining or other sources), price inflation can result. The Spanish conquest of much of Central and South America in the 1500s resulted in massive amounts of Aztec and Incan gold and silver flowing to Spain. Price inflation followed, even though Spain used gold and silver currency.

Gold as a reserve for paper currencies has not always provided a foundation for stability. In the 1930s, central banks protecting the gold standard acted too conservatively to combat the growing economic depression. In doing so, they may have aggravated the deflation that resulted from the stock market crash and accompanying economic downturn, which in turn hindered recovery from the depression. Eventually, the U.S. and other nations had to devalue their currencies to help foster recovery. What happened here was that the nation issuing the currency had gone into a depression and the real world value of its currency had correspondingly fallen. The conversion value of its currency into gold had not changed, so the currency was overvalued and deflation ensued. Ultimately, the gold standard did not prevent paper currencies from falling in value because paper currencies takes their true value from the economic strength of the issuing nation.

Gold can serve as a currency because people think it's valuable and accept it as a medium of exchange. The same is true for anything people accept as valuable--tobacco, cotton, deer skins, beaver pelts, sea shells, and American cigarettes all have served as currency at various times and in various places.

People want their currency to be stable. It doesn't really matter what is used as currency. Most currency today consists of electronic entries in computer systems. But people believe these little bits and bytes of data have value, so they accept them as a medium of exchange.

What hasn't changed from the days of the traditional gold standard is the desire for certainty. And that's the problem. The Euro bloc, in which 16 nations have adopted the Euro as a common currency, is simply a reincarnation of the gold standard. By adopting the same currency, issued by a central bank that supposedly must limit its responsibilities to maintaining the value of that currency, the Euro bloc nations hope for an island of stability in the raging seas of the currency markets. But these nations can't reach Avalon unless all members row their oars together and pull their own weight. That hasn't been happening and the ship is foundering.

China and other nations that link the values of their currencies to the U.S. dollar also seek to create a latter day gold standard. Although now a distant memory, there was a time (the 1970s and 1980s) when the dollar was seen in some parts of the world as rock solid. In the Soviet Union and Communist China, U.S. currency was coveted and hoarded, while local currencies were regarded with suspicion and disdain (China has a long history of currency inflation). As China integrated market forces into its economy, it linked its currency to the dollar, not as an export weapon so much as an anchor against inflation. Some Latin American nations that struggled with inflation did the same thing at various times. (Most notable among these were Argentina and Mexico.)

China's dollar link was crucial to its ability to grow. It removed the risks of currency fluctuations, encouraging American businesses to invest in China. The Chinese very much wanted American investment in order to obtain American know how and technology. The intellectual capital gained by China from American (and other foreign) investment leveraged its rate of growth. On its own, China could never have achieved prosperity as quickly as it did.

Of course, as China grew, its currency became more valuable in relation to the dollar and China's dollar link conferred an exporting advantage that is now essential to its economic model. Despite increasing inflation and foreign political pressure, the Chinese want to protect their exporters, because they don't have internal markets to substitute for the export markets they would lose from a stronger yuan. To combat inflation, the Chinese have employed alternatives, such as higher reserve requirements for their banks, price controls, consumer subsidies and sales from state food reserves (the latter a tradition from the days of dynastic China).

Americans shouldn't think that their own government isn't implicated in China's search for a contemporary gold standard. The U.S. government was for a time quiescent about China's exchange rate policies in order to encourage China to ally itself with America against the Soviets, and to open up China to U.S. investment. Moreover, the inflow of inexpensive Chinese goods has helped keep inflation low in America, which in turn permitted low interest rates and booming real estate values. Okay, so not everything turned out wonderfully, but the 2008 financial crisis wasn't the fault of the Chinese. Indeed, they lost money investing in American mortgage-backed securities.

In spite of the financial turmoil of the past three years, Europeans and Asians still cling to their gold standards, looking for certainty in the value of currencies. Gold standards can have short term benefits. Long term, economic conditions change and so do currency values. The squabbles of the Euro bloc over bailouts, quantitative easing, haircuts for creditors and the growing disquiet of German taxpayers, are a struggle over who will bear the costs of maintaining Europe's latter day gold standard. China's accumulation of a vast hoard of U.S. debt securities (and their attendant investment risks), along with the fiscal costs of consumer subsidies and state-owned food stocks, are China's costs of maintaining its 21st Century gold standard.

The gold standard protects savers, investors and creditors. Pure fiat currencies tend to favor borrowers and spenders. Thus creditor nations prefer a gold standard. Borrowing nations argue for free-floating currency rates. A gold standard doesn't necessarily favor exporters--they are better off or not depending on where the exchange or conversion rate is set. The Euro bloc includes both creditor nations and borrowing nations; hence the conflicts that may yet cause the Euro to collapse. The dollar bloc similarly includes creditor nations and borrowing nations; its tensions, too, are palpable.

Ultimately, there is no permanent gold standard or other absolute reservoir of value. The never-ending quest for certainty is trumped by the incessant process of change, mutation and evolution in the economy. (See But the process of human advancement can be said to be a long struggle for certainty. Deliverance from the vicissitudes of hunting and gathering, the extremes of the weather, the unpredictability of farming, the dangers of aggressive peoples, the horrors of plagues and other deadly illnesses, the volatility of the business cycle, and the capriciousness of financial markets all underlie the imperative for human advancement. All the bug-eyed, rifle-cleaning, ridge-dwelling, fringe group wackos panting for the gold standard can wipe the drool from the sides of their mouths and rest easy. It's alive and kicking, and will continue to bedevil central banks, high ranking government officials, policy makers, business executives, and the rest of us as far into the future as one can see.

Friday, December 10, 2010

Even in Ponzi Schemes, the Rich End Up Richer

If you're going to invest in a Ponzi scheme, look for the biggest and most exclusive ones. Find scams in which really wealthy people and large, prominent financial institutions are involved. A swindle in the Hamptons or Palm Beach is a much better choice than a scam in Moline, Ill. or Tulsa, Okla. Why? Look at what's happening in the Bernie Madoff case.

Irving Picard, the trustee in bankruptcy for the case, has collected about $1.5 billion so far. The time for him to file claims to recover money for injured investors is expiring, and he has recently brought a flurry of additional cases. Big banks, like J.P. Morgan Chase, UBS and HSBC, have been sued. Other financial firms and people that may have fed investors into the scheme have been targeted. Overall, Picard has filed claims for over $50 billion recently. Since he reportedly estimates actual cash losses from the scheme in the range of $20 million, he's trying to collect more than the actual losses (evidently on the theory that some actors, like those soliciting or providing investors, may have liability for damages). His chances of recovering 100 cents on the dollar of actual losses is likely to be low, and the chances to obtain damages probably lower. Nevertheless, many of the recently named defendants are important players in the financial services industry with reputations to protect. If their cases go to trial, unflattering information about them might be revealed in court. They could have strong incentives to settle. Many of them, like the large financial institutions, can't claim inability to pay. That means they will have to pay something.

We're still a long way from the end of the Madoff case. But his victims, who two years ago may have thought they had lost everything, may receive non-pathetic recoveries. For many, recovering 20 or 25 cents on the dollar could bring a little champagne and a new leased Mercedes into their lives. The Bentley may not reappear. But dog food (other than for the pet) could be dropped from the grocery budget.

In the grand scheme of things, being duped in a big and brazen scam of the wealthy is better than being ripped off by a guy selling investments in the parking lot of a big box store. When the wealthy are victimized, other wealthy people and large institutions can possibly be made defendants. Such defendants will often be inclined to settle. Con artists who practice their chicanery in middle class settings are likely to spend the money as fast as it comes in, and there's nothing to collect when the house of cards collapses. Even when victimized by con artists, it would seem, the rich end up richer than everyone else.

Tuesday, December 7, 2010

The Balanced Federal Budget: Easy Come, Easy Go

If you keep up with the news, you might remember something about balancing the federal budget. Like maybe some commission chaired by a couple of old guys made a proposal for the government to stop borrowing so much g.d. money. But that austerity stuff is so last week. Economic stimulus has come back into vogue, and the smart set in Washington is doing the supply side shuffle. President Obama has been accused of being Keynesian. But he offloaded his outdated economic advisers and has apparently gone Reaganesque. His deal with Congressional Republicans for a two-year extension of the Bush II tax cuts, a one-year 2% cut in Social Security taxes, plus an extension of unemployment benefits for another 13 months, guarantees that the federal deficit will yaw wide or wider. A mild version of the federal estate tax (35% with a $5 million exemption) is supposed to be reinstated. But the parameters of this tax are designed to raise less money than the increase in the deficit this deal will foster.

The Democrats in Congress, who seemed to have dallied with the notion that they and the President belonged to the same party, are ripsh . . . well, very upset, about being excluded from the President's back door negotiations with Republicans. That, evidently, is the price those frumpy Dems pay for not being au courant. Wanting to have the pre-Bush tax brackets apply to people who made $250,000 plus, or, heck, even just those at $1 million or more, makes the Dems strangely look prudent. Oh well, federal debt securities really are soignee, if you look at them the right way.

The concept of this deal as economic stimulus produces cognitive dissonance. Since the deal would continue the status quo (the Bush tax cuts being currently effective and unemployment benefits having continued through November), and add only a 2% Social Security tax cut while reimposing an estate tax, the new deal (small caps intended) doesn't change much. And the government can't cut spending, can it? Because spending cuts would reduce stimulus, and stimulus is now all the rage.

Sure, the President and Republicans would say that they are serious about deficit reduction and the current deficits are just a temporary measure while the economy is swooning. But, in Washington, temporary measures that benefit important constituencies tend to have long life spans. Federal agricultural price subsidies, to take an example, were a temporary measure instituted when Franklin Delano Roosevelt was jauntily waving his cigarette holder. They still live on like welfare queens that never have a health problem.

If you listen closely, you might hear a little mouse in the corner of the Oval Office clearing its throat and muttering something about voodoo economics. Somehow, one gets the sense that somewhere, someone has made a doll called American prosperity and has a pin posed over it. The new supply side economics aren't like the Laffer yucks of yore. We now have a Federal Reserve that never saw an interest rate it didn't want to bash down (although that's turned into a game of whack-a-mole with today's rising rates). Plus a federal government that never misses a chance to borrow. The Fed is, more or less, monetizing the federal debt (i.e., printing money to buy federal debt, which brings a risk of inflation), although it would vehemently deny doing so. Having the First National Bank of Accommodation fund the giddiest of big spenders may well be a formula for disaster. And depression. The bond market dropped today. Stocks bought into the hype for most of the trading day, but sobered up as the market closed.

Tea Partiers and other pro-Republican voters from the mid-term elections might be fighting a touch of queasiness in their tummies. There isn't much in this deal for them. Ambitious Democrats are surely making preliminary estimates of their chances in the 2012 presidential primaries, and might be quietly chatting with a fund raiser or two. The President and the Republicans are trying to pitch their proposal as bipartisanship. But, in truth, it's just an old-fashioned political deal, like the kind made in the smoke-filled back rooms of yesteryear, done more to avoid problems (like reinstatement of the higher pre-Bush tax rates) than to accomplish anything. And like so many back room deals, it may ultimately create more problems than it solves.

Sunday, December 5, 2010

Looking for Bernie Madoff

If you could get the candid assessment of the financial markets from a lot of investors today, it would probably be something like returns are low and risks are high. That explains why so much money, especially that held by individual investors, remains in bank accounts, money market funds, ultra short bond funds and other relatively low risk places. The financial markets have given us so many unpleasant surprises in the last 3 years, people are afraid the future holds more.

At the same time, with incomes stagnant and inflation increasing (regardless of government statistics and what high ranking government officials claim), many are under pressure to seek higher returns from their savings. There's nothing wrong with looking for a better return. Just remember that, even though we now live in the era of the endless bailout, there still isn't a free lunch. Unless you're a major bank, a sovereign nation, or a very large business corporation. Stocks and lower rated bonds might offer greater potential for profit, but they also offer greater potential for loss. Risk and reward walk hand-in-hand down Wall Street.

Some investment products include guarantees against loss. These often are touted by insurance companies and should be scrutinized closely. The promise against loss is going to cost you. It could be in the form of tight limits on upside returns (i.e., if the product generates a return, the insurance company is going to keep a good portion of it), stiff penalties for early termination or withdrawal, and in other forms. Remember that if the markets perform poorly and your return is zero, even though your losses are also zero, you would have been better off in passbook savings. (That's not a theoretical point; anyone who put money in passbook savings ten years ago instead of stocks is ahead of the market.) While no one knows what the future will bring, investing in a no-lose product doesn't mean you'll win.

Even though many insurance companies might want to sell you a lousy deal, in general they aren't fraudsters. The worst thing you could encounter in your quest for higher returns is the markets magician who claims to consistently produce good, albeit not spectacular yields, day in and day out, year after year. No one can do that, period. If you meet anyone who says he or she can, put your hand on your wallet and run away. Fast. No matter how tempted you are, and no matter how good the sales pitch sounds, don't invest.

The biggest frauds are perpetrated, not because the bad guy lies, but because investors lie to themselves. They convince themselves that lead can indeed be turned into gold. They brush aside contrary evidence and the rationality of naysayers. They want to hear, however improbably, that good returns can be secured with no risk. They seek out the con artists who promise the sun, the stars and the moon.

Bernie Madoff didn't have to find many of his victims. They found him, and they were ready to believe every word of his web of lies. He'll be in prison for the rest of his life. But there are plenty of latter day Bernie's around. Often, the gullible and greedy will find them. As a matter of law, the con artist is liable and should be punished sternly. As a matter of reality, if you go looking for a latter day Bernie Madoff, you'll probably find him. And you'll regret it.

Thursday, December 2, 2010

Where the Deficit Commission Missed the Boat

The National Commission on Fiscal Responsibility and Reform hasn't issued its final proposal (that comes after a vote tomorrow on its contents). But the draft report, available at, shows that the commission missed the boat in several important respects.

End the Bush Wars. The federal deficit has been eliminated three times in the past 100 years: in the 1920s, in the late 1940s and most of the 1950s, and in the 1990s. Each instance followed the conclusion of a major war (World War I, World War II and the Cold War). Wars are expensive, and peace dividends are large. The federal budget hasn't been balanced in over a century without giving peace a chance. The deficit commission made wonky recommendations about putting national security and war spending on budgets, overlooking the fact that nations don't fight wars on a budget. War is an emotional process where combatants spend their way to ruin rather than lose (see fall of the British Empire for more information).

Our national security and military budgets are large, probably larger than the public realizes--many details are obscured in order to keep potential adversaries in the dark. The best way to reduce defense spending is to reduce the reasons for defense spending. America has no real stake fighting the Taliban in order to secure Hamid Karzai's power. And wealth, which he may be enhancing by siphoning off American aid, along with payoffs he reportedly extracts from the Iranians. American troops, it would seem, now fight and die for the greater prosperity of Hamid Karzai. The Taliban haven't tried to launch attacks on America. Al Queda (remember them?), now operationally located in Yemen, is our adversary. American forces should concentrate on the real enemy, and not fight people who would leave us alone if we left them alone.

Nor should U.S. troops maintain a significant presence in Iraq. If Iraq descends into civil war, do we really think American troops will roll out of their bases and intervene? Would the American public stand for more casualties just because the Shiites and Sunnis in Mesopotamia still don't get along after centuries of strife? Some 50,000 American troops remain in Iraq. Bring them home. It's time to end the Bush Wars. They've taken too many lives and too much money, and produced too little. The deficit commission wanted to avoid involving itself in war policy. But balanced budgets and wars don't mix. If we really want to reduce the federal deficit, we have to stop fighting wars that really don't matter to us.

Emphasize innovation, research and development, and growth. The deficit commission acknowledges that innovation, R&D and economic growth are worthy goals. But it does not seem to understand the importance of prosperity to reducing federal deficits. Earlier periods of balanced budgets enjoyed robust expansions of the economy. Growth boosts national income, and therefore tax revenues. Increasing federal cash flow may run counter to the conservative agendas of some commission members, who seem to favor doctrinal parsimony over practicality. But ideology is a poor substitute for results. Cutting and slashing federal spending simply can't reduce the deficit all that much. Boosting federal tax revenues, preferably through accelerated growth, is essential.

This is an instance where the best defense is a good offense. The deficit commission should have placed more emphasis on government policies and programs that would promote growth. More incentives and funding for research and development, including basic research, are needed. Transportation and communications infrastructure need to be repaired and improved. Greater civilian access to technologies developed for military use may offer big payoffs--the Internet and GPS are classic examples of Defense Department projects that evolved into highly valuable civilian sector systems. America's economic future rests on the efficient production and distribution of high value added products and services. The government should do more to move the nation down this path.

Deal with demographics. America's population is aging, and this changing demographic aggravates the problems of financing Social Security and Medicare. The deficit commission doesn't address the demographic question. It says nothing about family friendly policies. Raising kids is a ton of work, but it's a lot better than poverty in old age. The commission says nothing about immigration. Okay, this is a political red hot potato. But the immigration of the past 30 to 40 years is an important reason why America's demographics are still fairly sound, compared to the potentially catastrophic situations in some other industrialized nations. Immigrants are mostly young, and a well thought out policy favoring valuable workers could help significantly to keep America young, and not just at heart.

The deficit commission's parsimonious scoldings land like lumps of coal on the holiday season. Frowning a dour, parental austerity that clashes with America's heritage of optimism and faith in the future, the commission obsesses over myriad wonky prescriptions that bring to mind the over-attentiveness to detail of the Carter Administration and the national self-flagellation it seemed to encourage. In the past, America attained fiscal balance not by diving into policy minutiae but by ending wars, growing through innovation and risk taking, and absorbing the talented, ambitious and hard working from around the globe. Political reality is that many, and probably most, of the commission's proposals won't survive the legislative process. The ones that are enacted will probably leave large deficits in place. We simply can't cut our way to a balanced budget. They're like walks and singles where a home run is needed. We might as well swing for the fences.

Wednesday, December 1, 2010

The Stock Market is Like a Duck Billed Platypus

In today's looney bin of a stock market, what was thought to be truth has turned out to be fiction. And fiction writers couldn't have invented what seems to be true. Here's a sampling.

1. First, ignore all the economists. There are no economists with consistently strong records of predicting the direction of the economy. There are no economic models that explain much of anything. Forget what the economists say.

2. Be a Liberal. If there is one force that has supported the economy and uplifted the markets, it's government. The emergency credit offered by the Fed and central banks of other major economic powers, along with the bailouts and fiscal stimuli provided by the U.S. and other governments, pulled the world economy out of its biggest downswing since the time of Prohibition. Today's revelation that in 2008 and 2009, the Fed loaned out $9 trillion, or $3 trillion, or however one wants to total up the numbers, to support everyone from Goldman Sachs to McDonald's to Europe's central banks illustrates that in times of crisis a strong Fed can make a difference. Whatever one might think of GS or Europe, America without Big Macs and fries with that would be a disaster.

Fair questions have been asked about the Fed's current adventure in quantitative easing. On one level, it is apparently a stock market manipulation designed to induce consumer spending by creating a wealth effect. In general, governments don't manipulate asset values without eventually producing catastrophic consequences (see 2008 real estate crisis for further reading). But today's stock markets embrace governmental action and become deliriously exuberant whenever another bailout or easing is announced.

News reports tonight indicate that the United States is now prepared to join in a bailout of the Euro bloc, since Portugal, Spain and who knows what other countries seem to be in line for a handout. The stock markets should soar at the prospect of another federal giveaway.

3. Mind the debts. The past twenty or so years, a/k/a the Age of Leverage, saw shiploads of bad loans made to home buyers, credit card customers, businesses, nations, states, cities and anyone else not previously mentioned. These debts, in gigantic amounts, remain with us, and lurch around the financial system looking for someone or something to crush. Every time they look like they're circling a victim, the markets shudder. Ireland's recent "rescue" (which was really a rescue of banks holding Irish debt) is illustrative. As before, governments and central banks mounted up and sallied forth, with the William Tell Overture playing in the background. Dealers in the financial markets had a nice profit opportunity, trading the markets down and then up. Investors might have been left feeling like hit-and-run victims. The herd of bad debts will be with us for years. Indeed, as bailout follows bailout, the can is being kicked down the road only to haunt us farther into the future.

4. Statisticapalooza. The markets obsessively fixate on all variety of statistical minutiae, ranging from retail sales results for a single day to self-declared sentiments of consumers to inflation figures that exclude any items that might reveal inflation to the differences in borrowing costs between, say, Belgian and German debt. Small bits of information become large symbols. Rational analysis is kicked into the gutter.

The stock market is like a duck billed platypus. If you look at it, you think it can't be true. But apparently it is. Weirdness is the world. The only certain way to make money is to be the Fed and print it. Everyone else might think about eating cake.

Monday, November 29, 2010

Bondholder Bonanza in Europe

If you believe in reincarnation, think seriously about coming back as a holder of Euro-denominated bonds. (Or, skip the reincarnation part and just buy some.) Today, the bailout of Ireland makes clear that every nation in the European Union guarantees the obligations of every other EU nation, and also the obligations of every bank in every EU nation. Holders of European debt are in Heaven, dancing cheek to cheek with EU taxpayers.

The Germans (and French, kind of) made some noise about bondholders sharing in the losses from future national financial crises. But when push comes to shove, which could be in a week or two with Portugal, it's essentially a certainty that the dour Chancellor Merkel and frenetic President Sarkozy will hold their noses and sign another blank check. That's because the real beneficiaries of these bailouts aren't Ireland, Greece or whoever. They're German, French and other EU banks, which hold shiploads of Irish, Greek, etc. debt. A default by these nations would put the banks down the street from Chancellor Merkel's or President Sarkozy's office at risk, and those banks and their various constituencies are the real reason the wealthy EU nations are spreading Christmas cheer to the poorer EU nations.

It doesn't have to be this way. The sovereign debt crisis began with a dust up in Dubai about a year ago. While Dubai's problems quickly moved off the front page with the revelations of Greece economizing on the truth about its budget deficit, a workout continued quietly. Not long ago, the Dubai debt problem was resolved with some bond holders taking losses. Farther back in time, international financial crises in Latin America during the 1970s and 1980s involved banks taking losses on their loans. There is nothing magical about being a creditor that necessarily insulates one from loss.

The distressed nations can't devalue their currencies to boost their economies through exports (a standard maneuver in such circumstances). They all use the Euro, and its value is maintained by the European Central Bank. Only the long, poorly paved road of austerity and higher taxes is open to them. Without bailouts, defaults would loom and the debtor nations might have to leave the Euro bloc. Since Germany and France want the Euro to work, they are left with little choice except to make nice-nice with bondholders.

But just as American taxpayers are tired of bailing out bankers in New York, German taxpayers may eventually tire of bailing out the money men in Frankfurt. The poorer EU nations aren't leaving the Euro bloc--with Germany backstopping them, they have every incentive to stay. The Germans may, in the end, be the ones who leave. The more the Germans bail out profligacy in other nations and reckless lending by their own banks, the more their own financial condition will deteriorate. If Germany guaranteed all EU sovereign and bank debt, it would be in lousy shape. Since it more or less implicitly has done just that, it is. German taxpayers have already carried the substantial burden of incorporating East Germany in the West. They very possibly won't want the burden of incorporating the entire EU into Germany.

Tuesday, November 23, 2010


Turkey Day approaches, so let's see who's thankful.

GS to Feds. Goldman Sachs surely is thankful to the federal law enforcement personnel who are so assiduously pursuing suspected insider trading by hedge funds and other money managers. This evidently could be a big case, big enough to make the investing public forget all about ABACUS-2007-AC1 and Fabrice Tourre's juvenile e-mails.

Fed to Ireland. The Federal Reserve may be quietly grateful that Ireland is having such well-publicized debt problems. It's brought Europe's sovereign debt crisis back onto the front page, and if liquidity problems crop up as a result, the Fed will have more justification for its quantitative easing program.

G-20 to North Korea. The gonzo maniacs in North Korea, by revealing their uranium enrichment plant and shelling a South Korean island, have pushed the G-20 and the possibility of a currency devaluation war right out of the news. The potential for a real shooting war in Korea forces the international community to think about what it has in common, at a time when it should give that issue careful thought. Indeed, just days after they acrimoniously failed to reach a trade agreement, South Korea and the U.S. are vividly reminded that they are allies.

Lisa Murkowski to Palin (Bristol). The voting controversy over "Dancing With the Stars" has completely overshadowed any voting controversies in Alaska. For once, a Murkowski may be grateful to a Palin.

Charles Rangel to His Democratic Colleagues. One can't help but suspect that Congressman Rangel might be quietly thankful he's being tried and punished by a House of Representatives controlled by the outgoing Democratic majority. Things could well have been a lot tougher for him if he had stalled the proceedings into the next term.

David Cameron to William and Kate. The prospect of a royal wedding contrasts brightly against the dour grayness of governmental austerity. The prime minister may be grateful for the loss of some front page coverage.

NBA to LeBron. Just about everyone likes seeing a big talker taken down a notch. LeBron has provided this spectacle to basketball fans from sea to shining sea. Schadenfreude spurs growing fan interest with each Miami loss.

America to Salehis. We haven't seen Tareq and Michaele Salehi, the alleged White House party crashers, in the news for quite a while. That's something to be thankful for.

Sunday, November 21, 2010

The Euro at Gettysburg

The sovereign debt crisis in Europe is evolving into a struggle over European union. Despite decades of increasing commercial and financial harmonization, Europeans haven't resolved many of their underlying differences and the harmonies are becoming dissonant.

The initial problem was Greece. When Greece adopted the Euro, it hoped to benefit from a stable currency it could use to borrow at comparatively low rates. The key word here is borrow. Germany and other wealthy Euro bloc nations initially welcomed Greece, thinking they were getting easier access to an export customer. Everything worked fine as long as Greece could borrow enough to finance its purchases from Germany and other exporters. The tough task of building Greece's economy to balance its consumption of goods from other nations with industries and businesses of its own that would attract foreign customers somehow got lost in the glow of apparent short term prosperity.

Bailing Greece out required Germany to stop averting its eyes to the ultimate flaw in its strategy of growth through exports: a continuing trade imbalance with the rest of the world cannot be sustained indefinitely. Obdurate exporters sooner or later have to finance their export customers. Japan and China have financed America's consumption. Germany found out the hard way that many of its banks had financed Greece's consumption. Even though much of the German electorate went Tea Party, the German government ultimately joined in a bailout of Greece in order to bail out Germany's banks.

Now Ireland, bogged down in a real estate crisis, has been compelled to seek a bailout. Although the Irish government has the liquid resources to cover its debts until next year, it made the mistake of guaranteeing the obligations of Ireland's banks. This temporarily kept those banks from collapsing. But Irish banks are, to a large degree, mortgage banks. Ireland's real estate crisis may be more severe than America's, and the liabilities of Ireland's banks are enormous for a nation of Ireland's size. By backing Irish banks, Ireland's government transferred their potential insolvency onto itself. It now has little choice but to take a bailout the EU has been pressing upon it.

One of the weird things about the Irish crisis is that the bailers have been urging the bailee to take the handout. That's because the EU has much bigger problems that the Irish mess is exacerbating. Bond vigilantes see a row of dominos to exploit. If Ireland falls, Portugal is likely to be next, and Spain could follow. The EU desperately wants to forestall the domino effect. While it can keep Greece, Ireland and Portugal afloat, add Spain and all bets could be off.

The EU isn't limiting itself to assistance. It can't resist the temptation to seek change. Ireland has been urged by other EU nations to raise the level of its corporate income tax, which is set at a low rate to attract foreign investment. Other EU nations view the Irish corporate tax as a competitive threat. Ireland has firmly refused to raise its corporate taxes, fearing a further diminution of its now fading prosperity. Although everyone publicly insists that Ireland raising the corporate tax rate isn't a condition to the bailout, discussion of this point will likely not end with the bailout.

The intimations of other EU nations that Ireland raise its low corporate rate is a sign that the EU in its current iteration cannot last. Either the union becomes more centralized, with greater control exercised from Brussels, or the Euro must be abandoned and national currencies reinstated. Ireland's defiant refusal to change its tax laws tells us that the outcome isn't without doubt.

The bailers want more. Germany's chancellor, Angela Merkel, recently convinced other EU nations to agree that bond investors might have to share losses from sovereign debt defaults. The bond market threw a hissy fit. Its consternation was surely fueled by the experience of Dubai debtholders (remember the Dubai debt crisis, only a year ago but now seemingly so distant?), who recently had to compromise their claims. There is ultimately nothing golden about sovereign debt, and bondholders may be facing a loperamide moment as they attain a deepened appreciation of their risks. Unhappy bond investors may try to force the issue of union--either the EU becomes more like a single nation and its debt market stabilizes, or short sellers and their derivatives cousins clean up.

In a way, the European debt crisis resembles the battle of Gettysburg. Like the first day of the Civil War battle, the struggle over Greece's debt is where the lines were drawn and positions were taken. In the second day at Gettysburg, the fight went to the periphery. The far left flank of the Union line held at Little Round Top, and then the far right flank held in the contest for Culp's Hill. Europe's current problems are with nations on the periphery of the EU: Ireland and Portugal. Thus far, the EU seems to be holding. But the battle will be determined if and when it reaches the large nations of the EU. Spain may become the first large European nation to be targeted by bond speculators. It's trying to cope with a virulent real estate downturn. A trillion Euros of public debt and another trillion in private debt held by foreigners takes Spain's debt burdens beyond the capacity of existing EU bailout facilities. The willingness of Germany and other wealthy EU members to pony up more bailout money is by no means clear. Chances are they would only if they could impose greater centralized control.

The European imperative for union is in no wise as powerful as America's in 1861. (Remember Yugoslavia? Czechslovakia? The Soviet Union?) The EU has no heros, no 1st Minnesotas, or 20th Maines or Third Brigades from New York. Individual field commanders at Gettysburg--Buford, Reynolds, Hancock, Chamberlain and Greene--took turns acting on their own initiative to hold the line for the Union. But individual national leaders in the EU haven't such latitude; they must act collectively or not at all. If the crisis morphs into its third phase (i.e., Spain), the EU will be put to the test. By the third day of Gettysburg, the Union Army was buoyed by confidence from its successes on the first two days, and it met Pickett's challenge resolutely. But the desire for unity among EU nations is, at best, a work in progress. Before the Civil War, America was known as "these United States." Afterward, it was "the United States." Is Europe ready for that?

Wednesday, November 17, 2010

Stress Test Your Retirement

With stocks going nowhere for the past ten years or more, we now understand that retirement planning involves more than seeking the highest returns. Risk has to be managed. Savings must be protected. This is especially so as one grows older. With fewer working years left, those who have living memories of seeing or wearing leisure suits should think about downside risk as well as upside potential. It's a good idea to stress test your retirement.

A stress test would estimate how well your finances would look in adverse circumstances. There are different ways to do this, and some can become quite complex. There is no magical formula or golden number(s). Much depends on your appetite for risk, your life expectancy and your retirement goals. Let's start with individual factors.

1. Stocks. Assume a 50% drop in the stock market. That's not an unrealistic assumption since stocks dropped a bit more than that at their worst point in the 2008-09 financial crisis. They could drop like that again, notwithstanding every assurance from Wall Street and high ranking government officials. What impact would that have on your finances? If the answer is too much for your comfort level, then reduce your exposure to stocks until you feel comfortable.

2. Bonds. Assume a 20% loss of your taxable bond portfolio. This would be a very large loss for bond holdings, but could happen if the Fed has to raise interest rates sharply in order to combat inflation. (Indeed, the Fed's ongoing quantitative easing program--the purchase of Treasury securities with printed money in order to lower interest rates--has anomalously resulted in increased interest rates, suggesting bond investors expect inflation from the QE.) What impact would a 20% drop in your taxable bond holdings have on your equanimity? If the answer isn't conducive to equanimity, dial back your bond exposure.

3. Municipal Bonds. Assume a 20% loss in the value of your muni bond portfolio. This, too, would unusually large. But the growing crisis over state and municipal deficits, and the possibility that interest rates may rise because of or in spite of the Fed, could produce significant muni bond losses. How would this affect your sense of financial security? If you don't like the answer, trim your muni holdings.

4. Money Market Funds and Similar Products. As we know from the 2008-09 financial crisis, money market funds can go under. Less well-known similar products, most notoriously auction rate securities, may be less safe than money markets. Assume a liquidity crisis for your holdings of money market funds and other short term investments. What would you do if you couldn't get to these assets? If the answer is ugly, transfer your liquid assets to money market funds that invest only in U.S. Treasury securities, or to bank or credit union accounts and CDs that are fully insured by the federal government. Don't mess around searching for incremental increases in yield. Make sure your liquid assets are truly safe (because they may not be liquid otherwise).

5. Insurance Products. Insurance products are subject to the creditworthiness of the insurance company. Insurance companies make mistakes. If, like AIG, they make big enough mistakes and put the international financial system at the edge of the abyss, they will be bailed out by the government. But most insurance companies can't put the touch on taxpayers like that. Try to figure out how much you could salvage from your annuity or other insurance products if the insurer goes belly up. You might have to research the law of the state where the insurance company is chartered for the coverage provided by its guaranty association for life insurance. (One place to start is the website for the national umbrella organization for these associations, called the National Organization of Life & Health Insurance Guaranty Associations, The amount of coverage may be between a maximum of $100,000 to $500,000, depending on the state. If that limit spurs major heartburn, either avoid making a big investment in insurance products, or look to boost the non-insurance portion of your portfolio. Be cautious about exiting insurance products you've already bought, because the insurance companies may whack you with painful termination fees. But pay those fees if your exposure to insurance products makes you queasy.

6. Pension. Let's say your employer goes bankrupt and ditches its pension plan. Can you live with the reduced payments you might end up with? Figuring out how much your pension might be reduced in such a circumstance could be difficult and the stress test might have to be done with just an approximation (factoring in the limitations in coverage from the Pension Benefit Guaranty Corp., if applicable; see You could try assuming your pension payments turn out to be half of what you expected. Then, increase your current savings a lot because the loss of half a pension would be painful for just about anyone.

7. Social Security and Medicare. Social Security and Medicare will not disappear. They will be here as long as the Stars and Stripes fly. Of course, some modifications will surely be made, particularly in light of the recent mid-term elections. These modifications won't give you a warm glow. Assume your benefits are reduced by 15%. If that would increase your antacid budget, save more.

8. Health Insurance. If you're under 65, consider the impact of losing your health insurance. (Just about everyone 65 or older has Medicare coverage.) If you're in a group plan, research the cost of buying replacement coverage (which would be an expensive individual policy for most people). Then save more. If the health care reform of 2010 survives Republican attack in 2011 largely intact, you'll probably be able to get good coverage. If the 2010 health insurance reform is significantly cut back, you could be in a tight spot.

9. House. If your home is part of your retirement finances, consider the impact of a 25% drop in its value. Many homes have dropped more than that in the past few years. Don't think it can't happen again. Factor in the mortgage, home equity loan(s) and other liens on the house. If a 25% loss would ruin your day, save more.

We all know that, in a financial crisis, more than one asset class may go sour at the same time. Estimate the combined impact of such a morass. One thing that is certain is we will have another financial crisis like 2008-09. When is anyone's guess. But an enduring lesson of 2008 is that there are no new paradigms in the world of investments and finance. Sooner or later there will be another financial crisis. Those that prepare for it will probably do okay. Crisis deniers surely won't.

Where is there safety? Money market funds that invest solely in U.S. Treasury securities for one. Bank and credit union accounts and CDs that are fully insured by the federal government are another. See Longer term U.S. Treasury securities will be paid in full upon maturity, but are subject to interest rate risk during their terms. Gold and silver may look attractive at the moment, but their values have historically been extremely volatile. Invest in commodities at your peril.

If you don't like the results of your personal stress test, save more. That, more than anything else, will strengthen your finances. A diversified portfolio is prudent (stocks and bonds can help with your long term financial needs). But diversified doesn't necessarily mean high risk. Having 20% in stocks and 30% in bonds, with the rest in safe assets, may be as diversified as some people want to get, especially those over 70. All the nice looking statistics and charts that financial planners can generate about long term gains don't mean diddly if we're stuck in one of the decade long or longer time periods when financial assets sag. Allocate your assets in the way that facilitates sleep. You'll sleep better for it.

Sunday, November 14, 2010

Fallout From the G-20's Failure

Last week's G-20 meeting in Seoul was a failure. Basically, nothing got done, except for an exchange of volleys of antagonistic pronouncements. The major exporting nations--especially China and Germany--criticized America's profligacy and continued monetary easing. America called for structural change from the exporters, demanding that they boost domestic consumption and depend less on selling in America. U.S. officials scolded China for artificially depressing the value of its currency. The group as a whole issued a statement that muttered something about one for all and all for one. But the casual observer might wonder how many members had their fingers crossed behind their backs when they signed the statement.

As the meeting broke up, France's president, Nicholas Sarkozy, began a one-year term as the leader of the G-20. He immediately announced that the tasks at hand would take more than a year to complete, thereby absolving himself of responsibility for producing results. This inspiring act of leadership made clear that there ain't gonna be much happening soon G-20wise.

Perhaps we shouldn't have expected much. The history of the U.N., and before that the League of Nations, teaches that international organizations are always partial to dysfunction. Nevertheless, some world leaders raised expectations. The potential fallout from the failure isn't pretty.

Cranky Financial Markets. In the last couple of weeks, as it became increasingly clear that the G-20 meeting would be unsuccessful, the financial markets hesitated and then fell. Stocks and bonds are both lower (after anomalously rising together). Commodities have fallen back. This isn't surprising. For the past two years, governments worldwide have been transferring risk and losses from the financial markets to taxpayers. Speculators were probably hoping the G-20 would give them yet another undeserved windfall. But taxpayers in Europe and America have rebelled. Faced with risks that aren't being dumped on innocent bystanders, financial market players have apparently chosen to trim their sails.

Policy Makers, Be Not Proud. One thing is for sure, today's financial and economics policy makers are dead set on avoiding the governmental mistakes of the 1930s, which today's conventional wisdom holds responsible for turning a nasty recession into the Great Depression. Most central bankers and other policy makers seem to think they know what their predecessors did wrong, and how to avoid making the same mistakes. But the failure of the G-20 meeting is disquieting.

The member nations were simply doing what was in their interests. They weren't intent on messing up the world's economy, nor did they want to exacerbate the already rising tensions among them. They simply couldn't levitate themselves above their conflicting national interests to the supranational lovefest that the G-20 is supposed to foster. Each nation's domestic politics dictated its views. With the world economy too small a pie for every nation to get as much as it would like, we're now edging toward an international game of musical chairs.

And that's the way it was in the 1930s as well. None of the central bankers and other policy makers of that era whose mistakes are now so routinely and condescendingly decried meant to create a train wreck. Like their modern counterparts, they consulted with each other and tried to find common ground for constructive action. But they were driven, like today's policy makers, by the interests of their own nations. They looked at the rest of the world from differing frames of reference, each crafted by parochial interests. Yes, they blew it. But they weren't gonzo idiots. They simply did what nations generally do in times of international disagreement.

The G-20's failure last week is a disconcerting reminder of the way things fell apart in the 1930s. The G-20 also failed to find common ground, and their pledge to continue working together seemed like little more than press fodder to divert financial reporters while world leaders caught their flights out of Seoul. Before the Fed, the Treasury Department, and other policy makers in America and elsewhere confidently conclude they know how to avoid the mistakes of the 1930s, they ought to step back and think about what just happened. Human nature hasn't changed in the last 80 years. Even though the Fed is taking a sharply different tack from the Fed of the 1930s, its most recent quantitative easing program may provoke the currency, trade and other economic conflicts among nations that hindered recovery during the 1930s. The doyennes of central banking and fiscal policy should be not proud. Their deep and prolonged studies of the Great Depression, and the advantage of hindsight, may still be insufficient to keep us from falling into the abyss. When a group cannot agree on shared sacrifice for the greater common welfare, divided they will have to make their individual ways in a treacherous world.

Wednesday, November 10, 2010

Did Someone Forget to Tell the Bond Market About Quantitative Easing?

The idea behind the Fed's quantitative easing program is the Fed will print money that will be used to buy long term Treasury bonds. Its purchases, to total as much as $600 billion by September 30, 2011, are supposed to push down interest rates, thereby stimulating the moribund economy with lower borrowing costs.

A problem, it would appear, is that someone forgot to tell the bond market. A month ago, the yield on the 30-year Treasury bond was about 3.75%. Today, it trades around 4.25%. The 10-year Treasury note was yielding around 2.4% a month ago. Today, it hovers in the range of 2.6%. Are the bond traders crazy? Received wisdom in the financial markets is never to fight the Fed. But the bond market seems to be determinedly paddling upstream.

Then again, what if bond traders have it right? What if quantitative easing will be inflationary? It increases the quantity of dollars in the financial system, which is a precondition to inflation. Additionally, it puts downward pressure on the dollar, which raises the price of imports. That will have an inflationary impact. Bond investors demand higher yields when confronted with the prospect of inflation. And higher interest rates dampen economic growth. So QE, before it's hardly out of the gate, has already made things worse.

The Fed, however, has a reply: raising expectations of inflation would be good, since that would stimulate consumer spending. Beleaguered consumers, desperately trying to save some of their stagnant or shrinking incomes as a buffer against hard times, will be strong armed into spending their money whether or not they like it. It's for their own good, and the Fed is destroying their financial security in order to save them.

So quantitative easing is a win-win for the Fed. If QE lowers long term interest rates, it stimulates the economy by lowering borrowing costs. If QE increases inflationary expectations, it coerces consumers into spending. With the U.S. economy 70% consumption, a revival of consumption means revival of the economy. Of course, this works only if the Fed can prevent inflation from spinning out of control. High inflation doesn't produce prosperity--the late 1970s, a time of double-digit inflation, were an American nightmare, not the American Dream. The Fed has to produce Goldilocks inflation: not too hot and not too cold. Chairman Bernanke insists the agency can do that.

We must be in Lake Wobegon, where all monetary policy is above average. Here, a pure money print, which is what QE amounts to, cannot produce a bad result. One would have thought that conjuring up money from thin air would be undesirable. At least, so it would appear to those of us who had always thought money was supposed to be earned from productive work.

When the Federal Reserve comes across like a late night TV ad for no money down real estate, we know we're in trouble. The enduring foundational principle of all economics is that there ain't no such thing as a free lunch. The Fed is coming close to transgressing this, the most fundamental of the laws of economics. Those who put themselves above the law set themselves up for a fall. Perhaps it is true that actual national wealth can be created by flushing printed money into the financial system and deftly removing it when inflation flares. Then again, desperate times are when hope is most likely to triumph over experience. When it does, experience can administer painful lessons.

Tuesday, November 9, 2010

Will the Fed's Quantitative Easing Enrich Asia?

Just as leaves on a plant turn toward sunlight, capital seeks out the highest returns. The Fed's recently renewed quantitative easing program will dump $75 billion a month of printed money into the financial system between now and Sept. 30, 2011. That money will go somewhere, and overseas is a very likely destination.

The mechanism for this journey is the carry trade: speculators borrow dollars at the ultra low rates provided courtesy of the Fed, convert those dollars into the currency of a nation where higher returns are available, and invest in that nation. Since the highest returns generally available these days are in Asia, carry trade dollars will head across the Pacific. If higher returns were available in America, these dollars wouldn't go west. But the stagnation here makes Asia appear sunnier.

Some of the dollars will likely be invested in China, stimulating its already red hot economy. China, however, maintains currency controls that prevent unlimited capital inflows and outflows. Consequently, some carry trade dollars will flow to other Asian nations, stimulating their economies.

The carry trade has worked the other way. In the first half of the past decade (around 2001 to 2006), the Japanese central bank lowered interest rates to zero and tossed in some quantitative easing to boot, in a largely futile effort to revive Japan's economy. Speculators borrowed yen cheaply, converted it into currencies of nations with higher interest rates and invested in those nations to profit from the difference between national interest rate levels. America was a one beneficiary of the yen carry trade. Possibly, Japan's quantitative easing, leaving behind the stagnation in its native land, contributed to America's recent real estate and credit bubbles. Now, the Fed's quantitative easing is sparking fear in Asia of asset bubbles and heightened inflation.

Presumably, the Fed is aware of the potential for its quantitative easing program to stimulate other nations instead of America. Perhaps it hopes that juiced up Asian nations will import more from American exporters. That probably will happen to some degree. But there's no way of knowing how much benefit America will receive from such a circuitous route.

With the dollar being the world's reserve currency, the carry trade is easily done and easily unwound. Its biggest up front risk may be a revival of the dollar. But with the Fed publicly committed to quantitative easing, a strengthening of the dollar seems about as likely as confirmation of the Yeti.

The more ebullient carry traders become, the less likely quantitative easing will help America. Much of the Fed's big money dump could simply fly away overseas. Then what?

Sunday, November 7, 2010

How Much Do You Need For Retirement?

A pretty simple way to estimate how much money you need for retirement is:

1. Calculate how much annual income you want (or need) in retirement, using current dollars.

2. Subtract the amounts of Social Security benefits (including your spouse's benefits, if you're married), and pension income, if any, you (and your spouse, if married) expect.

3. Multiply by 30; we'll call the result your nominal target.

4. Adjust for inflation between now and your anticipated retirement age, by multiplying 1.03 by itself the number of times equal to the number of years until your retirement (i.e., 1.03 to the exponential power equal to the number of years until your retirement), and next multiplying the resulting number by the nominal target.

The number you end up with is your inflation adjusted target. Here's an example.

Let's say you'd like the inflation adjusted equivalent of $50,000 (in current dollars) a year for retirement. Your estimated Social Security benefits are $15,000 a year. You're lucky enough to have a pension that will pay $10,000 a year when you retire. Subtracting $15,000 and $10,000 from $50,000 leaves $25,000. Then multiply $25,000 by 30, getting $750,000. We assume inflation will be 3% a year (that's the approximate average annual inflation rate since World War II). We'll also assume you have 20 years to go before retirement. Multiply 1.03 by itself 20 times (that would be 1.03 to the 20th power, exponentially speaking). The result is about 1.8061, which you multiply with $750,000, getting $1,354,500 as your approximate inflation adjusted target.

If you have no pension, which is the case for most Americans, you'd subtract your $15,000 Social Security benefits from $50,000, getting $35,000. That figure multiplied by 30 yields $1,050,000. Multiply by 1.8061 to account for inflation, and your target becomes $1,896,400.

Note that your target number is in future inflation adjusted dollars. Since most people's incomes tend to keep pace with inflation, reaching the target isn't quite as hard as you might think. You can use this target without having to think about investment options or diversification strategies. Tired of stock market volatility? Slick financial advisers make you nervous? Don't want to invest in derivatives contracts or no money down real estate deals? That's okay. Save in CDs and money market accounts if you want. Work a second job, or drive the same car for 20 years. Don't splurge on a McMansion and learn the virtues of home cooked meals. Inherit the money, win the lottery, or get it any other way that's legal. It doesn't matter how you get the money, so long as you have enough.

This formula is just an approximation, and is meant to give you a ballpark sense of where you need to go. We assume that you're retiring in your early 60s (most people do so around age 62). That's why we use a multiplier of 30--many financial advisers would use a multiplier of 25, but they're assuming retirement at age 65 or later. The multiplier of 30 also helps account for the fact that most pensions are not increased for inflation, so they lose value over time. We also assume that once you've accumulated the needed total, you invest it in a conservatively diversified portfolio during retirement. If you want to stick with all CDs in retirement, you should use a larger multiplier, like 35 or 40. Of course, this money isn't for your kids' college expenses or other non-retirement uses. That has to be saved in addition to your retirement money.

It isn't easy to save for retirement. Then again, nothing worthwhile comes easily. Most people go through life and then retire on whatever they have available when retirement time rolls around. Even if you can't imagine how you'd ever hit your target, starting to prepare is the first step in ultimately being prepared. Many folks would be happy to accumulate half their target. But they have to start saving to get there. The worst thing you can do is nothing. For more on retirement, see
, and Good luck.

Thursday, November 4, 2010

How Gridlock in Washington Endangers the Economic Recovery

The political gridlock that just was elected to office could make things worse. By definition, gridlock means the status quo is preserved, because nothing can be done to change it. The status quo is a mess, and preserving it is exactly what we don't need. Let's look at some of the key economic issues.

Real estate. The real estate market and its associated mortgage crisis were the origins of the Great Recession. When the credit carousel stopped turning in 2008, trillions of dollars of losses cascaded on banks, investors, homeowners and ultimately taxpayers. Financial crises such as this work themselves out through the allocation and realization of those losses. Losses must be taken by someone or they will continue to hover over the economy, discouraging consumption and investment, and hindering recovery. Over the past two years, some of the losses have been taken, by banks writing down loans and other assets, investors seeing lower prices on mortgage-backed investments, homeowners suffering falling home values, and taxpayers subsidizing all of the foregoing. But there remain tons of unbooked losses, and also the painful problem of what to do with Fannie Mae and Freddie Mac (i.e., to what extent will taxpayers provide future subsidies to the housing market). Liberals can't envision a U.S. housing market without federal support, and conservatives can't stomach perpetuation of such massive subsidies and bailouts. The current chaos and confusion in the real estate market, amplified by the burgeoning foreclosure mess, will continue. The process of loss allocation and realization will continue, but in the haphazard, ad hoc, unfair and lunatic way it now operates. Consequently, real estate and housing will stay sick puppies, dragging on economic recovery.

Fiscal Policy. The Bush tax cuts will be extended for almost everyone. If the Republicans have their way, they'll be extended for everyone. But doing so will conflict with a cherished Republican goal of shrinking federal deficits. In theory, deficits could be reduced by cutting spending. In fact, the newly elected coalition government in the U.K. is taking this approach. But Britain's parliamentary system of government enables such decisive action. America's Constitutional limitation and division of authority acts in the opposite direction, permitting the electorate to choose a chief executive and chambers of the legislature from different parties. Gridlock will preclude major spending cuts. Fiscal policy will remain the mosh pit it is today and deficits will lurch on.

Even in situations where Congress can act, it won't have easy choices. Federally funded unemployment benefits for the long term unemployed will expire at the end of this month. Congress has three weeks to act. Extending benefits would help keep the economy muddling forward. Cutting off benefits would help reduce the deficit (although not by much, maybe a couple billion, which in context is peanuts). But it will also increase the doom and gloom among the electorate. Lengthening the line at the food bank won't spur consumer spending, even if passbook savings accounts pay 0.00001% per annum.

Monetary Policy. The Fed, being somewhat insulated from politics, will continue with monetary policy, and its recent announcement of $600 billion of quantitative easing reflects a clear, if not unanimous, choice to provide more stimulus. Congressman Ron Paul, cynosure of libertarians and Tea Partiers, and soon to be the chairman of the House Subcommittee for Domestic Monetary Policy and Technology, has already announced that he plans to scrutinize the Fed closely, questioning the fundamental premises of its policies and actions. Paul travels leagues farther than mainstream Republicans in challenging conventional monetary policy, subscribing to the gold standard and doubting the wisdom of central banking at all. Chairman Bernanke can look forward to providing the subcommittee with the pleasure of his testimonial company on a regular basis. The Fed's renewed program of quantitative easing will face head winds from the direction of Capitol Hill.

The last industrialized nation to suffer a financial crisis and recession like America's was Japan. The Japanese government reacted indecisively, often sinking into dysfunction because each of its options was painful and it was reluctant to impose the costs of washing the crisis' losses out of the economy. So it allowed the losses to linger, dampening economic recovery to this day. The gridlock soon to settle into Washington could easily lead to similar dysfunction, letting the economic recovery meander. The Japanese central bank lowered interest rates to essentially zero and also conducted quantitative easing. But, in a dark omen for the Fed, monetary policy in Japan wasn't enough.

If the government is capable at all of restoring prosperity, a question not without doubt, it will have to act with unity of purpose and decisive amounts of fiscal stimulus as well as monetary accommodation. That ain't gonna happen. Have an umbrella ready for the next two years because storm clouds are gathering. And recall that old timers who lived through the Depression would often carry a roll of hundreds of dollars in their pockets, simply because cash money felt good. When times are tough, cash talks and just about everything else walks.

Wednesday, November 3, 2010

November 2010

This month, the San Francisco Giants, a team few people outside of the Bay Area notice, with a roster of players few people outside of the Bay Area notice, brought home San Francisco's first World Series title. Improving as they progressed through the playoffs, the Giants determinedly won the championship, conceding only one game of the final series to the Rangers. Edgar Renteria, an aging Giants infielder on the verge of retirement, hit the winning home run in the last game, going out like the champion he became. It was a lyrical, magical victory, befitting the golden city by the bay, poetically inevitable and long to be remembered by baseball fans of all persuasions.

And, oh yeah, there were mid-term elections yesterday. As expected, the Republicans took control of the House of Representatives. Not unexpectedly, the Democrats kept control of the Senate. Gridlock is in our future. Then, today, the Federal Reserve announced that it would print $600 billion and use it over the next eleven months to buy long term U.S. Treasury securities in an effort to stimulate the economy. Various Wall Street analysts had prognosticated that the Fed would announce at least $500 billion, which is financial markets speak for saying they wanted more than $500 billion. The $600 billion was a tepid ante up by the Fed. The Dow Jones Industrial Average offered fair commentary, rising 26 points, or less than 0.25%. In spite of all the headlines, soundbites, points and counterpoints, nothing really surprising happened in the world of politics or in the financial markets. Nor will any of it be remembered like the Giants' World Series win.

Sunday, October 31, 2010

Will a Republican Congress Smack Down the Fed?

Expectations are high that the Republicans will take control of the House of Representatives in the mid-term elections two days from now, and perhaps the Senate as well. Victory celebrations, however, will last only one night. The next morning, the victors, whoever they may be, will face an ornery electorate clamoring for action.

Action will be hard to come by. With a Democratic White House, and the Democrats either controlling the Senate or holding almost half its seats, gridlock is inevitable. Further fiscal stimulus is off the table. Tax "policy" will consist of chaos and lunacy. Congress will regress from its recent productive (albeit controversial) mode to its norm of swapping trash talking soundbites and issuing self-congratulatory press releases, while incessantly searching for the next photo op and more campaign contributions.

The only active part of the government, in regard to economic policy, will be the Federal Reserve. The worst kept secret in Washington is that next week the Fed will renew its program of quantitative easing, possibly beginning with the purchase of $500 billion of Treasury securities. Although Chairman Bernanke and other Fed officials wrap this policy in elegant bureaucratese, it amounts to printing money, pure and simple. Roll the lettuce out of the printing press and move it off the loading dock. Grumpy old skeptics mutter under their breath about inflationary risk, and point to gold's escalating price. But senior Fed officials repeatedly offer solemn assurances that they've got things under control.

Newly elected and emboldened Republicans, especially the ideologues, may see the Fed as a convenient target. It failed to spot the mortgage crisis until things blew up, then bailed out Wall Street at the expense of Main Street, next successfully lobbied for increased power under the Dodd-Frank financial regulatory reform bill, and more recently missed the foreclosure mess. Some conservatives, economists and others, view the Fed's easy money policy as the primary reason for the past decade's asset bubbles, and the Fed's regulatory failings as crucial reasons why those bubbles were so damaging. A few far right wing purists would find the printing of money to stimulate the economy indistinguishable from sorcery.

Majority control of the House would give the Republicans control over committee hearings. Some of them might delight in holding Congressional hearings where they could berate Fed witnesses on C-Span and score points with their constituents. Since the Fed may be the only hope Democrats and President Obama, in particular, would have for a revival of the economy, some Republicans might see advantages to intimidating the central bank. The Fed, by law, is independent of Congress. But the law and political reality don't necessarily correspond closely. The Fed might be subdued by a barrage from Republican/Tea Party evening news headliner wannabes. If that happens, expect a lot of asset classes--stocks, bonds, gold and other commodities--to fall in value. The financial markets now depend heavily on government intervention to sustain prices. As a policy matter, that's not a good thing. But it's not easily undone. If political pressure smacks down the Fed, it could also smack down the markets.