Wednesday, June 29, 2011

Defensive Financial Planning

One aspect of financial planning that receives little attention is avoiding an unexpected depletion of your assets. It involves dull, boring stuff like insurance and taking care of yourself. Far more exciting are graphs showing the exponential growth of compounded savings and glossy magazines featuring lifestyles of those retirees who planned well. But in financial planning, a good defense can preserve the wealth you took so much effort to build. Consider the following.

INSURANCE. Okay, few things in life are as nauseating as insurance. Most of us would rather see the dentist than review our insurance coverage. But insurance protects our finances when bad things happen.

Health insurance
provides the means to get medical care. Health problems, not credit card craziness, are the number one reason why people end up in bankruptcy. Insurance doesn't necessarily prevent bankruptcy, but it makes it much less likely. A good health insurance policy also opens doors at the emergency room, and ensures that you get good care. Your recovery may be faster and you suffer less stress over availability and quality of care.

Disability insurance
provides income when you can't work. More often than you might think, people suffer from disabilities. Social Security disability isn't easy to qualify for, and the process takes a long time. Private disability coverage is often easier to qualify for and more generous.

Life insurance protects your family if you're no longer around to provide for them. Not everyone lives to 75, 80 or older. Life insurance feels like the biggest waste of money imaginable, unless your family needs it. Term life is usually the best choice. Permanent, whole, or universal life typically involve high commissions and other costs. Most people are better off buying term coverage and saving for retirement in other financial vehicles.

Auto insurance is required by law, but the amount of coverage you have to buy is often pretty low. Boosting your liability coverage will make sense as soon as you have any sort of respectable net worth. Without good liability coverage, a single accident can wipe out a lifetime of saving.

Homeowners/renters insurance provides liability coverage, and in the case of homeowners coverage, the funds to rebuild if your house burns down. Get a flood rider if there's any significant chance of flooding (and not just from a river, but also from sewer backups and the drainage ditch in the back yard). Buy earthquake coverage if you're in a high risk zone.

Umbrella policy. An umbrella policy provides liability coverage above and beyond your auto and homeowners policies. You can buy protection up to $10 million and perhaps even more. Umbrella coverage becomes a good idea once your net worth reaches a level you wouldn't be embarrassed for others to know about. Remember, a single car accident can wipe out a net worth of $500,000, $1 million or more, even if you have $300,000 of liability coverage from your auto policy. The umbrella policy puts a lot more protection over your head, and is worth thinking about if you start to get attached to your six or seven figure net worth.

Business liability coverage may make sense for those who are self-employed and work in circumstances where a customer or other person might be injured. For example, if you operate a catering business out of your kitchen, buy some insurance that covers the possibility of customers getting food-borne illness from your products. Accidents happen.

MAINTAIN YOUR HEALTH. As mentioned above, the single most common reason for personal bankruptcy is a health problem. Health insurance doesn't cover all expenses, and significant health problems can prevent you from working. Even if your uninsured health care expenses are modest, you still confront the mortgage, grocery bills, gas expenses, etc. So exercise, eat a balanced diet and avoid/quit smoking. Keeping your health as good as possible can make a real difference in your financial well-being.

Tuesday, June 28, 2011

Externalities and the Dysfunction of the Money Markets

Money is invested through mechanisms that appear to be markets. One observes supply (savings), demand (from borrowers and other people offering investments), and price (interest rates, dividends, IPO pricing, etc.). These mechanisms are even called the "money markets." But they're not really markets. At best, they're dysfunctional markets. The reason is externalities.

Externalities are costs not included in the pricing process. A familiar externality is air pollution from cars. The bad consequences of car pollution fall on people who, for the most part, are not involved the purchase of a car. That is, almost all the people who breath the pollution aren't involved in the sale of the car and can't demand a portion of the sale price to cover their damages and loss from the pollution. So cars, before the days of pollution controls, were underpriced in relation to the costs they imposed. More of them were sold because of the underpricing, and the problem of pollution was exacerbated.

The solution to this particular externality was emissions controls imposed by law. First, states where pollution was acute, like California, stepped up regulation. Then, the federal government joined the act. Cars today pollute at a tiny fraction of the rate of their predecessors 50 years ago. The muscle cars of yore were true classics, but you would literally choke if you got too near the exhaust pipes.

The externalities of the money markets have become all too apparent in recent years. Overly aggressive lending, in real estate, to municipalities, and to sovereign nations, coupled with negligence in risk management by banks, created enormous amounts of financial risk. Opaque derivatives markets multiplied these risks, and intertwined them in ways that regulators cannot comprehend. The effect of such interconnectedness is that any debt crisis must be ameliorated through government intervention, often at substantial cost to taxpayers. There no longer are market solutions to financial crises.

The potential for socialism in medicine pales by comparison to the socialism that has crept into the financial system. Prices for money are no longer set by market forces. Central banks dictate the price of money. These dictated prices do not incorporate the costs of government bailouts and other interventions. Thus, enormous externalities have emerged in the financial system. Banks, hedge funds and other financial firms lack the incentive to constrain their wilder and crazier sides, because they don't pay the price of catastrophe. How would people drive if they didn't have to pay the premiums for auto insurance?

We saw this in the financial crisis of 2007-08, when real estate lending reached maniacal levels because the rewards for mania, but not the risks and costs, were placed on the people (bankers and others) who behaved like maniacs. We see this today in the sovereign debt crisis in Europe, where the costs of high risk sovereign lending by Europe's major banks are being allocated in a mad scramble between creditors, taxpayers, government employees, retirees and other EU member nations, similar to a game of musical chairs. Except that there are almost no chairs, and the music is death metal.

Bank regulators are trying to boost capital requirements, in an effort to reduce the need for bailouts and other government aid. The FDIC has been trying to nudge up the premiumss paid by banks for federal deposit insurance. Banks, needless to say, are pulling every political string they can reach to avoid bearing the true costs of their business. After all, why be responsible if you can hire lobbyists and buy politicians to get rid of the large expense of true responsibility?

With central bankers keeping interest rates low and with bank regulation comparatively light, lenders have the incentive to be reckless, and borrowers have the incentive to be profligate. Externalities proliferate as a result. The straightforward way to internalize much of the externalized costs would be to raise capital requirements and interest rates. Fat chance that's going to happen, at least in a way that's meaningful. For the foreseeable future, we will have government administered price controls in the money "markets," with prices too low, and burgeoning externalized costs.

Externalities cannot be imposed indefinitely in ever increasing amounts. The innocent bystanders eventually get so mad about taking collateral damage that they fight back. In the case of air pollution, it was through substantial (but effective) government regulation. In the case of taxpayers and citizens looking at the high price of bailouts and austerity, political rebellion ensues. Today, demonstrators in Athens became rioters. Conservatives in Germany protest further bailouts for Greece. In America, Tea Partiers harp about federal deficits while liberals (and some conservatives) decry the government's failure to rein in too large to fail banks. The spirit of NIMBYism runs strong in these declamations. The essential point just about everyone makes is that "I" don't want to bear the costs.

Central bankers have been kicking the can down the road, hoping that their easy money policies delay the pain of the externalities long enough for the economy to revive and wash the pain away with brisk growth. But their very policies of artificially lowering the price of money makes things worse. Borrowers will borrow more to buy time, and bankers, relieved by the central banks' intervention of the need to manage risk, are glad to lend more, record more apparent "earnings" and pay themselves larger bonuses. The amount of externalized costs rises. Yet the economy responds only haltingly to these massive money prints.

It's clear there isn't going to be a singular event involving fishes and loaves. We'd probably be better off to take the pain of the losses embedded in the financial system, and get them behind us. Countries that took this approach (the "adult choice"), like Sweden in the early 1990s, have done well thereafter. Countries that externalized losses and tried to pretend they didn't exist (the "adolescent sulk") have bogged down (for further reading, see Japan). Anyone familiar with current events in Europe and America knows which way these nations are going, and it ain't toward a character building experience in the wood shed.

Central banks could start easing our way out of this mess by sharply increasing bank capital requirements and moving interest rates up. In so doing, they would begin to internalized today's virulent externalities. But experience teaches that they'll have no more than moderate success at elevating capital requirements. And by all indications, Ben Bernanke and his colleagues won't ever raise interest rates. The only central banker to bring true integrity to monetary policy, Paul Volcker, remains an outcast among his peers. The only bank regulator to emulate Volcker, Sheila Bair, is likely to share his fate. It's hard to predict how things will end. But if we keep increasing the amounts of externalized costs, the ending won't be fun.

Sunday, June 26, 2011

Traits That Lead to Financial Security

The road to financial security is pretty boring. Most people who have meaningful amounts of money got there by patiently saving and investing, month by month, year by year. There are some who had spectacular career success and hit it big with stock options. Others inherited their wealth. But the majority of the financially secure got the the point of perhaps facing estate taxes because, in part, of their personality traits. What are these traits?

Insecurity. Assiduous savers feel nervous if they don't have a healthy balance in their bank accounts. More than an award winning beer mug collection or a closet full of shoes, they want a lot of zeros to the left of the decimal point in their net worths. Why they feel insecure isn't that important. It could be that one or both parents were that way. It might stem from a financially unstable childhood. It could come from difficulties starting a career--hard times early in adulthood often instill lifelong caution. Whatever the reason, insecurity promotes saving.

Faith in the future. Paradoxically, perhaps, building wealth requires faith in the future. You have to believe that money you save today will be there ten, twenty, fifty or even more years from now. If you're insecure about the future, it might make sense to party now and eat dog food later. Having faith in the future doesn't mean you believe that there are magical, no lose investments. Never rely blindly on any particular asset or class of assets. Real estate, gold, stocks, the British pound, and the U.S. dollar have all waxed and waned. What you need is a belief that you'll find something worth investing in no matter what turns events take.

The ability to defer gratification. Success in almost anything requires the ability to defer gratification. Kids who do well in grade school not only are smart, but can forego playing in order to study and get As. Earning a college degree involves deferring the opportunity to earn money and enjoy life, while perhaps taking on a pile of debt, in order to have a higher income stream later in life. Career success often means giving up a lot of personal time early in one's working life, in order to build a solid foundation on which to progress professionally. And building wealth requires the ability to pass now on two-inch steaks, $100 bottles of wine, a luxury name plate on your car, designer brand names on your clothes, and an 86-inch TV, in order to have nice things later on.

Discipline. This is where things get really boring. The most reliable way to build wealth is to save early, often and relentlessly. This allows you to compound your earnings. Compounding is the investor's most powerful weapon (see A disciplined saver has a 4,368% greater chance of becoming well off than someone who is undisciplined.

We aren't talking about strategies or techniques. Always saving a portion of your paycheck, or assiduous use of retirement accounts can definitely make a difference in your financial well-being. (See, and But you must have certain personality traits to execute the right strategies and techniques effectively. If you don't have them, you won't succeed. It's part of the American way to believe that you can change and improve yourself. If you don't have the right traits now, work to acquire them. You have a lot riding on the outcome.

Friday, June 24, 2011

The Real Reason Why America Might Default on Its Debt

Yesterday, the Republicans in the House of Representatives engineered a vote against supporting the U.S. role in the NATO operation to assist the rebels in Libya. The same Republican Party that avidly supported George W. Bush's arrogant military idiocy in Iraq just gave aid and comfort to Muammar Gaddafi, a monstrous dictator, sponsor of terrorism, and protector of the Lockerbie bomber. America's NATO allies with military personnel over the skies of Libya must be mystified by the spectacle of America's war-making, union-breaking Republican Party all of a sudden trying to put flowers into rifle barrels. Good thing President Obama is insisting on a troop drawdown in Afghanistan because the Republicans just gave our NATO allies with troops in Afghanistan a convenient pretext for pulling out ahead of us. If we won't support NATO in Libya, why would NATO support us in Afghanistan?

The real reason for the Republican kidney punch is, of course, the extreme partisanship of today's politics. Whatever the Obama administration does, the Republicans oppose. Whatever the Obama administration doesn't, the Republicans advocate. Substance no longer matters. Style no longer matters--the last politicians with any style were Reagan and Kennedy. The only thing that matters is opposing the opponent. The Republicans claim to be seeking adherence to the War Powers Act of 1973. But President Clinton engaged in a much more active air bombardment during the Kosovo War without authorization under the War Powers Act.

A much, much larger issue than Libya is raising the debt ceiling. A default by the United States would be 22.5 on the Richter Scale compared to the 9.0 of a Greek default. But talks between Democrats and Republicans aimed at resolving the debt ceiling problem have broken down. Today, the President is reaching out to Senate leaders in an effort to restart the dialogue. But the right wing hot heads in the House will surely do their utmost to prolong the confrontation. After all, compromise would involve doing something other than oppose, and today's right wing Republicans are a one-trick dog that only growls and drools.

Don't be too quick to sell off your Euro-denominated investments. Even though the Euro bloc is courting longer term financial disaster by kicking the can down the road, its member nations are acting with a modicum of maturity in trying to find short term respite from the Greek sovereign debt crisis. They acknowledge that they're approaching an abyss and are actively trying to avoid belly flopping into it. The Republicans in the House want to use the debt ceiling problem as a vehicle to solve the federal deficit problem, all without any tax increase. This is like trying to send astronauts wearing only gym shorts and t-shirts to Mars on tricycles. The cost of this unyielding right wing onrush into tomfoolery would be the mother of all financial crises. But, given yesterday's House vote on Libya, that just might happen.

Wednesday, June 22, 2011

Avoid Vanishing Along With the Rest of the Middle Class

Statistics show that the richer are getting richer while middle class incomes stagnate. Income and net worth are increasing, sometimes dramatically, for the top 1% and 10% in America, while median incomes barely keep up with inflation (or don't). Mathematically, this means that the middle class are getting poorer relative to the well-off. But most middle class people don't need to see the math--they already know from their end of the month checkbook balancing frenzy that they're getting poorer. Add the strident calls from conservatives to slash Social Security, Medicare, unemployment compensation and other elements of the social safety net, and the middle class is starting to understand how the bison felt when hunters with breech loading rifles invaded the Great Plains 140 years ago.

But people--at least those who aren't herd animals--may have a way out. Let's assume you live in a household with $50,000 in annual income, which is about the median. Put $5,000, or 10%, annually into a 401(k) account that has a 4% employer match ($2,000 per year) over 40 years of work, invest in a diversified portfolio that generates a 6% return compounded annually (a modest amount by historical standards), and you'll have $1,080,000.

If you adjust this $1,080,000 for inflation of 3% per year, you'll find that it's worth the equivalent of $320,355 in today's dollars. But you can get around the inflation problem by increasing the amount you save each year by the inflation rate. Since most people's incomes tend to keep pace with inflation--even middle class incomes, although just barely--you can bump your retirement savings up pretty much in line with inflation. (And note that salary increases would also increase the dollar amount of the 4% employer match.) By increasing your contributions for inflation, you'll end up with the inflation adjusted equivalent of about $1,000,000 after 40 years. If you have a 401(k) without an employer match, or one with a smaller match, save more in some other account to make up the difference.

If you don’t have access to a 401(k) or similar plan, then this plan for a 25-year old could consist of saving the $5000 permitted per year in an IRA account until age 50 and then the $6,000 permitted per year for older folks until age 65. Increase your savings for inflation. Assuming a 6% return compounded annually, you’d have $797,084 after 40 years (or the inflation adjusted equivalent if you increase your saving in line with inflation). The amount is smaller because there is no employer match in an IRA. But if you save a bit more each year in another account or work a few years longer, you'll probably be a millionaire.

Only some 2.5% of the U.S. population has $1,000,000 in investable assets. But at least half the population, including many middle class households, have the potential to become millionaires. You have to be scrupulous about saving, and luck is a factor. Serious illness, disability, or other medical problems, aged parents who are unprepared for retirement, divorce, and other difficulties can blow up a financial plan. But a lot of folks who have the potential to be well-off in their golden years throw that chance away on big houses, cars, and TVs, nice vacations, frequent restaurant meals, fine clothes and other lifestyle enhancements. There's nothing inherently wrong with living large now, if you understand the consequences. But if you want to escape the multitude of middle class people being driven over a cliff by economic inequality, then think for yourself, act on your own, and separate yourself from the herd.

For more on how to build wealth, see the following: (a), (b), (c), (d), and (e)

If you think you really can't save, then take a look at

Monday, June 20, 2011

From Family Farm to Government Benefits to What Next?

It might be constructive if we could just, for a moment, step back from all the screaming and yelling, and look at our current fiscal situation from a historical standpoint. We got to our current social structure, with substantial governmental benefits and a substantial government budget, because of structural change in the economy. At the end of the 19th century, America's population was about 70% rural, living on the quintessential family farm. Multiple generations lived and worked together. Because the farm produced much of their basic needs, people were more self-sufficient than they are today, particularly if they diversified the crops they planted and kept a few hogs to sell for cash if needed.

The expansion of the industrial sector, particularly after the Civil War, when the robber barons consolidated entire industries under a single corporate roof or in collusive, oligopolistic arrangements, gave rise to a large worker class. These wage earners moved off the land, and into economic dependency. Their livelihoods depended entirely on the actions and abilities of remote corporate chieftains, and on the vagaries of business and financial markets cycles that were beyond the comprehension of most Americans. Astonishing exploitation of labor was commonplace in the 19th century and early 20th century, with employees paid poorly (and sometimes in company scrip rather than cash), required to work in dangerous environments, provided little or no benefits if injured on the job, and fired for any reason whatsoever. These practices reflected the harsh competitiveness of pure capitalism, and the big government we have today evolved gradually over the course of the 20th century to soften the cruelties of the unregulated marketplace. In so doing, big government made capitalism palatable for ordinary citizens.

Without a government stepping in and protecting the working class (and here we mean not only blue collar employees, but today's more numerous white collar workers, who are mostly blue collar workers with cleaner work environments), capitalism would likely not have survived in a democratic nation like America. The working class would have voted it out of existence. Indeed, Franklin Delano Roosevelt, so often lambasted as a traitor to his class, was in actuality the savior of the wealthy. His New Deal allowed the holders of capital to maintain their grip on economic power while ameliorating the distress of the less well-off. The big government, big benefits structure allowed capitalists to continue to operate with relative freedom to hire, fire, and transfer as they saw fit, thus facilitating flexibility and innovation in the U.S. economy. Although pure rapacity is largely prohibited, America's capitalists still can indulge their buccaneering urges to a greater extent than their counterparts in most other developed nations.

Then the train went of the tracks. The problem was debt. A lot of people got it into their heads that they'd be better off if they borrowed their way to a nice standard of living, instead of working for it. Max out credit cards, get a home equity loan, and presto, we're all living large. Bankers, who never more clearly demonstrated that they really are mostly from the middle of the b-school class, made this all very easy with exceptionally stupid lending standards and the dimwitted belief that real estate would never, on a nationwide basis, fall in value. Having drunk of this Kool-aid, the banks extended mountains of credit to one and all who had a pulse and a signature. Requiring borrowers to have the ability to repay was discarded as a quaint notion reminiscent of horses and buggies. Everyone forgot that no asset rises indefinitely in value and that debt eventually has to be repaid.

When illusions and reality collide, reality always wins. We're now stuck with shiploads of debt--mortgage debt, home equity debt, consumer credit, governmental debt, and commercial debt--that can't be repaid. There is enormous political and legal struggle over who should bear the burden of this bad debt. Borrowers unable to repay can't. Taxpayers are rebelling over the idea that they should bear more than they've already borne. Corporations and other business interests are trying to pull every political string, employ every legal tactic, and pressure every regulator in sight to shift their losses onto consumers and anyone who files a tax return. Things are ugly and getting uglier because the losses and other burdens must eventually be borne by someone.

One striking dysfunction is that losses no longer fall where market forces would have placed them--on creditors. Instead, losses are dumped on taxpayers via government bailouts and other government policies. You could say that combatants have been able to steer bullets and shrapnel away from themselves toward innocent bystanders. Why stop shooting if you won't take the hits? Why stop taking risks when the losses will be dumped on those who are less powerful while you collect the profits? With market forces in retreat, the specter of oligarchic plutocracy looms.

It was one thing for 20th century Presidents to ask American taxpayers to pay substantial costs in order to stabilize and improve the functioning of the capitalist system. This accommodated the dramatic structural changes industrial-scale capitalism was bringing to America and paved the way to greater prosperity for all. It's another to burden taxpayers with the costs of capitalist excess, while bailing out the financial system so Wall Streeters can resume collecting Brobdingnagian bonuses.

One episode of this sordid drama is being broadcast from Greece. Ordinary citizens are abandoning their government and taking to the streets because they have nothing left to lose. They face lower living standards if they knuckle under to the European Union's demands for fiscal austerity. With little or no stake in the EU any more, why wouldn't ordinary Greeks give their northerly neighbors a digital salute? One wacko truth is that if Greece walks away from its current debt and issues is own currency again, it will probably be able to resume borrowing soon in the international markets. Self-help bankruptcy, as it were. And if the debt contagion spreads to other countries, they may also conclude they're better off saluting as well.

The question now, as governments worldwide struggle with the problems of too much private and public debt, is what social structure will ameliorate today's problems while giving everyone a continuing stake in the system? This isn't a question of what produces the greatest economic efficiency, or the greatest short term economic growth (as measured by GDP, an increasingly meaningless figure). It's a question of what produces social equanimity. The answer matters to any nation that aspires to be a democracy. Plutocrats can't always have their way in a democracy.

The precise features of a workable system for the future aren't easily agreed upon, because everyone wants to eat their cake and have it too. Tea Partiers want tax and debt cuts, but no cuts in Social Security or Medicare. Many on the right resist cuts in defense spending, even while they propose major tax cuts. Dreamers on the left argue for more federal deficit spending, while ignoring the spectacle in Greece. There is such a thing as too much government debt, even for America, the nation that issues the world's reserve currency.

One reality is that economic growth may be modest or stagnant for quite a while. This is unavoidable because the burdens of excess debt are falling on our heads, and inhibit consumer spending. These burdens include higher unemployment, less government spending and lower government benefits, higher taxes (or revenue enhancements, or whatever euphemism becomes fashionable), and, consequently, less extravagant standards of living. It's clear, after three years of Fed money printing and federal fiscal stimulus, that there are no more magic bullets, no more bazookas.

What hope, then, is there for the future? The current political climate offers little reason to expect constructive action from the government any time soon. And Wall Street, by all indications, is determined to resume its bad old ways. The one avenue open to most Americans is to properly structure, and restructure if necessary, our own lives. Spend carefully, save plenty, avoid debt, and live well--but remember that living well doesn't mean displaying every tasteless urge to consume endless amounts of crap.

As a democracy, America is vulnerable to the irrationalities of crowds, and has taken big detours from the sensible and rational at times. At the same time, America has displayed a remarkable resilience and determination to survive and succeed, which carried it through a horrendous civil war, and a monumental world war with fascism. We will probably spend the next two or three decades fashioning the compromises needed for a new social structure. Trends toward greater inequality of income and wealth will come under scrutiny. Some economic inequality is inherent in capitalism and serves salutary purposes. But much of today's inequality doesn't come from market or commercial prowess. It comes from political influence and manipulation of regulatory processes. Such advantages are unfair in a democracy and will have to be reversed.

Until the process of reform is finished, keep a healthy balance in your emergency fund, and keep pumping part of each pay check into a retirement account. If you just take care of yourself, a lot of other problems won't seem so big.

Friday, June 17, 2011

Why Your Kid(s) Should Study Math

The unemployment rate among recent college graduates is about twice the 9% rate for the labor force as a whole. Many a recent recipient of a very expensive sheepskin has returned to the nest, bearing truckloads of debt and earning no regular income to repay it. Much has been written about their disillusionment; perhaps not enough has been written about those of their generation who found good jobs. Where are the high-paying jobs for holders of 4-year degrees? In engineering, computer programming and other science-oriented fields. What do these fields have in common? The need for good math skills.

Engineers can command starting salaries of $70,000 or more a year. People taking jobs in, say social work, earn half that or less. But they may have comparable debt loads. These statistics tell you who's going to be better off five, ten, twenty and more years after college.

Many liberal arts grads try to bail themselves out by taking on more student loans and going to law school or business school. Those with a facility for numbers will have the advantage. Most areas of law practice involve numbers. That's obviously so for those specializing in business, tax, trusts and estates, or torts. But math skills pay off even in areas like family law (try doing a prenup or a divorce without an understanding of money and finance), or criminal law (DNA matching is statistical, not literal, and sentencing issues can sometimes devolve into numerical arguments). As for finance and other business school subjects, take a look at options pricing models, and then bounce over to the math underlying a CDO, and then a CDO squared. If that's not enough fun, look at the modelling underlying high speed stock trading algorithms. Those who struggled with middle school algebra won't have a chance.

Even if you're not a college grad, math skills can be very important. Skilled blue collar work is increasingly computerized (look in the service bays of any car dealership, or the work stations in a machine tool shop). The manager of any franchise or retail business needs to keep track of sales, inventory, and employee schedules and hours worked. Even with computers, you can't do the work right unless you have a grasp of numbers.

All the nations that seem economically strong today emphasize math in their educational systems--China, South Korea, Singapore, and Germany are examples. America's state and locally controlled school systems don't place the same priority on math. That leaves only you as a parent. Too many students and parents focus on what it takes to get into the best college possible--being well-rounded, and having public service, internships, foreign travel and impressive references. Not enough focus on the step that follows: getting a freaking job.

Advanced economies become advanced through the application of science and math. Without science and math, we'd still be living in caves. People who understand the basis for advancement will do better as the future unfolds. Make sure your kids take as much math as they can stand. Not everyone needs to take calculus in high school, but the more mathematical facility a person has, the better that person is likely to do.

Tuesday, June 14, 2011

If Europe Wins the IMF Election, Europe Could Lose

The contest for the managing director post at the IMF has become a duel between Christine Lagarde, France's Minister of Finance, and Agustin Carstens, the head of Mexico's central bank. Lagarde is favored. Since the IMF was founded at the end of World War II, its top position has always been held by a European. Its international finance counterpart, the World Bank, has traditionally been headed by an American. Thus, the Allies in World War II divided the financial world, circa 1945.

Now, things have changed. The emerging markets members of the IMF are growing restless. They fear that Lagarde will be too Euro-centric in dealing with the European sovereign debt crisis, allowing the borrowers to control the lender. Many support Carstens with the hope of maintaining international balance. Since the emerging markets members are growing much faster than the European members, their influence is on the rise.

If Lagarde wins, the commitment of emerging markets members to the IMF could weaken just at the time the world needs strong international financial institutions. If Carstens wins, reality is that he would probably have to assist weak European nations to about the same extent as would Lagarde. The major banks of the world evidently have a great deal of exposure to the European sovereign debt morass, and the IMF, even if headed by a Mexican, would have little choice but to ride to the rescue. Such an IMF could do so with much less risk of offending emerging markets nations. And if Carstens would impose tougher conditions than Lagarde, that might be a good thing, as the European Union is by all appearances a one-trick dog that can only kick the can farther down the road.

The IMF is one of the few means by which emerging market powers like China, Brazil, India, South Korea and others provide aid to Europe. Having per capita income levels much lower than Europe's, the emerging markets nations can offer Europeans little or no direct aid lest they rile up their own citizenry. If their commitment to the IMF sags, its capacity to lend to needy nations could diminish.

The U.S. is in the hot seat. It likely has the voting power (16%) to turn the election one way or the other. America has deep financial and economic ties to Europe. Even though the Euro is a rival to the dollar, America would be deeply affected by any European financial crisis. But America's austerity driven politics today preclude any direct bailout. There won't be a 21st Century Marshall Plan. The IMF, indeed, is one of the few ways America can assist Europe. The smart play might be for the U.S. to support Carstens. After all, China holds trillions of U.S. dollar denominated securities. Brazil has recently been a fairly significant buyer of U.S. Treasuries. A rift with emerging markets nations is hardly in America's interests. We might soon need a bailout ourselves, and if so, it won't come from Europe.

Monday, June 13, 2011

Will Wall Street Weaken America's National Security?

The defense budget will shrink. That's inevitable, given the toxic swirl of today's federal budget/debt ceiling/tax laws politics. A lousy economy generates less tax revenue. Social Security, Medicare and Medicaid are hard to cut because you'd have to hurt a lot of voters. The federal payroll and the non-Defense, non-entitlement portions of the federal budget are relatively small. Cuts to them won't have much numerical impact. The Defense budget is large, and wears an obvious bullseye on its back.

Outgoing Secretary of Defense Robert Gates has already warned of cuts. He also gave our NATO allies a deserved lecture on increasing their defense capabilities so they can contribute more effectively to the alliance. When America stepped into the background, NATO's air campaign against Muammar Gaddafi sagged, and almost left the Libyan rebels high and dry. The major powers of Europe, unable to effectively spank a crummy tinpot dictator on the other side of the Mediterranean? Gates' admonishment to NATO is another signal that America won't have the resources to be the world's full-time peace officer.

Let's remember that all this goes back to the financial crisis of 2007-08, which originated from greed, recklessness, idiocy, and appallingly bad risk management on Wall Street. However much one might blame Presidents Bush and Obama for proposing taxpayer funded bailouts, however much one might criticize Alan Greenspan, Ben Bernanke and their colleagues at the Fed for printing money and creating asset bubbles and inflation, the root of the problem lies with the big banks. When executives from the major banks now whine about the costs of regulation and heightened capital requirements, bear in mind that America's international stature suffered gravely and will continue to suffer gravely because of the bank-spawned financial crisis. And America's ability to defend itself has been and will be reduced because the big banks weren't kept in line. This is a threat that shouldn't be allowed to recur.

Wednesday, June 8, 2011

Batten Down the Hatches for the Dog Days

This could be a stormy summer. Like the mortgage debt crisis three years ago that blew up and froze the financial markets, there's a nontrivial chance the government debt crisis could do the same this summer. Government debt, normally the investment of last resort, is starting to look hinky. With respect to the federal debt ceiling, some Republicans in Congress seem intent on provoking a default in August. Biting the hands that feed us--i.e., stiffing investors in U.S. Treasury securities--hardly seems like a good idea for a debtor nation. But "smart politician" is virtually an oxymoron these days.

More than America, the Euro bloc lurches inexorably toward default. For the moment, Greece is the only nation that is likely to formally default. However, all Euro bloc members have pretty much assumed de facto responsibility for all the sovereign debt and bank debt of all member nations. So a default by Greece is, in effect, a default by the entire Euro bloc. Such a development would not be well-received in the financial markets. But Euro bloc leaders are divided about what to do, and progress toward true resolution is seen about as often as the ivory-billed woodpecker.

Although another financial crisis is a low probability event, the simultaneous dysfunction in Washington and Europe could make things go haywire in the dog days of this summer. After all, nothing has been done since the last credit crunch that would preclude another one this year. What to do?

Love cash. Have a cash lovefest. Build up your emergency fund and put it in a bank (making sure it's 100% covered by FDIC insurance). Avoid non-essential big purchases for the next few months to increase cash on hand.

Be cautious with money market funds. If U.S. Treasury securities actually default, money market funds might have to break the buck. A sudden spike in interest rates could reduce the value of their T-bills and impose losses on the funds. Although the extent of such losses is likely to be comparatively small, given the very short maturities that money market funds are supposed to hold, it's not impossible that a freeze-up in the Treasury securities market could result in money market losses and perhaps momentarily limit access to your account. This is a low probability event, and fund management companies would probably go to great lengths to avoid breaking the buck. But it happened once in 2008. If you are likely to need funds in a money market account in the near future, consider moving the necessary amount into a federally insured bank account in July if the debt ceiling mess remains unresolved.

Invest defensively. Now's not the best time to take a flier, except if you have mad money you can easily afford to lose. Note how the Nasdaq market has, in recent days, been falling proportionately faster than the Dow and the S&P 500. Many risk assets are falling, literally, out of favor. Be careful about diving into emerging markets. China's economy is slowing, and India's and Brazil's governmental yield curves are inverting (seen by some as a sign of impending recession).

Avoid unnecessary financial commitments. If you're thinking of making a major financial commitment, like buying an annuity or a whole life insurance policy, consider stepping back and waiting to see how things play out over the next few months. If, for example, you buy an annuity now, and Treasury yields rise sharply later this year because of a U.S. government default, you may effectively have lost money because you would have bought at today's low interest rates.

Line up credit lines now. Credit could evaporate if things go gonzo. While borrowing is to be avoided if at all possible during a financial crisis, there sometimes are pressing reasons to go into hock. Line up any loans you'll need. Since it's even possible a bank might terminate the unused portion of a line of credit if the sky falls, you may want to draw down on credit lines now if you are absolutely sure you'll need the money and have no other way to get it. Make damn sure you can repay what you draw down. And keep the loan funds in a bank account, not a money market fund.

All this may sound on par with suggestions to stock freeze dried food and bottled water, and to start a garden in your back yard. But we haven't had to rely on subsistence farming in more than a century. Just three years ago, credit was crunched and the financial system almost failed. As far as money goes, take nothing for granted.

Tuesday, June 7, 2011

The (Second) Summer of Bernanke's Discontent

Today must have been tough for Federal Reserve Chairman Ben Bernanke. In public remarks at a conference in Atlanta, he didn't say anything. For a Fed Chairman who has made a priority of increasing transparency, having no news to announce was bad news.

Bernanke repeated the Fed's standard litany of the past two and a half years. Short term interest rates will remain at zero for an extended time, and the Fed stands prepared to "respond as necessary" to developments in the economic recovery. This isn't news. His acknowledgement of the economy's slowdown shouldn't have been news, either, although it did seem to contribute to a market drop at the close. The big problem, though, was that Bernanke didn't promise to wear a red suit and come down the chimney imminently with another bagful of gifts. No QE3. No other legerdemain that would amount to money printing. No promise to support current asset values.

Let's face it. The market, and economy, are addicted to government bailouts and subsidies. Everyone wants a federal guarantee for everything. Businesses want the Federal Reserve money printing press running 24/7 before they'll add a single person to the payroll. Investors want to see truckloads of cash moving off the Fed's loading dock before putting a penny in stocks. The big banks want the government's too-big-to-fail subsidy, but not the increased capital requirements and regulatory compliance costs that logically come with the unlimited support of taxpayers. Bernanke wanted to encourage people to invest in risk assets, but in actuality he's accomplished just the opposite. No one truly wants to take a risk any more. There's an easier way to make money--get Washington to guarantee profits.

Bernanke offered talk therapy, predicting that the economy would grow in the second half of 2011. He may be hoping that, if he can't add more money to the financial system to buy a recovery, he can psyche Corporate America into hiring more. But we've been stagnant for too long, and the Fed's been wrong on its predictions too many times.

Without financial methadone from Washington, the withdrawal symptoms could be painful. Scant growth, a good chance of rising unemployment, and falling stock prices. If the Fed adds more stimulus, the spectral presence of rising prices would shadow its every move.

Across the pond, the Euro sovereign debt crisis will either end badly, or worse. Wealthy northern Europe will absorb profligate Euro bloc member debt (possibly with a few token pennies thrown in the pot by creditors) and greater political power will be centralized in Brussels, or the Euro will go down in history as a very costly example of wishful thinking. Whatever the case, there won't be any stimulus to the U.S. economy from Europe. Economies in Asia are also slowing. We're on our own. What will happen?

We've already seen this video. Last summer, the same problems were tossing the economy and stock market around like rag dolls in a tornado--fading federal stimulus, sovereign debt crisis in Europe and everyone on Wall Street looking for a federal promise of profits. Ben Bernanke stepped up to the plate at the Federal Reserve's annual August conference in Jackson Hole, promised QE2, and hit what looked for a while like a home run. It's curving toward the foul pole now, but we don't yet have an official ruling from the umpire. If this summer follows the same path of economic stagnation and malaise in the stock markets, expect the Fed to step up to the table, bet its chips on a hard 8, and roll the dice one more time.

Sunday, June 5, 2011

It's the Economy, Stupid, and Republicans and Democrats Are Stupid

Politicians make their livings bashing other people, so it's only right and fair to bash them. There's a lot of grist for this mill.

Republican Congressional leaders were quick to criticize the Obama administration on Friday, June 3, 2011, after bad unemployment numbers were announced. Total job creation in May was 54,000, and the unemployment rate rose from 9.0% in April to 9.1% in May. The weak job creation number wasn't surprising, given other recent data signaling stagnation. The unemployment rate increase naturally flowed from the economy's need for a net increase of over 100,000 jobs every month simply to keep up with population growth (which increases the labor force). In addition, some previously discouraged workers may have jumped back into the labor force to actively look for work. That expands the labor force and raises the unemployment rate when there aren't enough jobs for them.

How did the Republicans shoot themselves in the foot? The private sector increased employment in May by a net of 83,000 jobs. That's not a great number, but it shows hiring exceeded firing. The reason for the lower total of 54,000 new jobs was that governments laid off a net 29,000 workers. This is due to state and municipal governments cutting back to meet austerity demands from primarily Republican governors and legislators. Do we think these government workers who lost their jobs because of Republican policies will blame the Obama administration? (Hint: take a look at recent events in Wisconsin politics.) Government employment levels have fallen for seven months in a row, and that's not because the Obama administration is laying off federal employees. If unemployment trends continue like this, expect the growing numbers of unemployed government workers, and many among their family and friends, to vote Democrat. Republicans hoping to see their party do well in 2012 should be careful what they wish for because the jobless have plenty of time to vote.

As for the Democrats, the Obama Administration announced on Saturday, June 4, that it would make a renewed push for principal reductions on defaulting mortgages, in an effort to keep more homeowners in their homes. This is meant to help not only struggling homeowners, but also to keep more houses off the foreclosure and resale markets, where distress sales continue to nudge home prices lower. But principal reduction has been a fools errand. It hasn't worked well in the past and isn't likely to work well now. The people who need principal reduction the most--the jobless--won't qualify because of their lack of income. Banks aren't required to reduce principal, and have little incentive to do so. There may be arguments why banks and mortgage investors lose less from principal reductions than from foreclosure. But the legal latitude banks have to make principal reductions on mortgages they have sold to investors is less clear than proceeding with foreclosure, and banks may be stuck with some or all of the loss to lenders when principal is reduced. In other words, banks may be in a riskier position with principal reduction than they would be with foreclosure (where they can generally pass the loss onto investors because banks mostly sell mortgages they originate). So why would they put themselves at increased risk in order to give a defaulting borrower a break? Never forget that on Wall Street, money talks and bullswaggle walks.

A second, and more important point for political purposes, is that the neighbors are watching. Yes, they want to see if the person next door has a better big screen TV than they, or if the person across the street is having an affair, or if the teenagers two houses away are getting out of control. But keeping up with the Jones would become most urgent if neighbors got a reduced mortgage because they didn't keep up with their monthly payments. Talk about envy. The defaulting Jones would get, perhaps, the equivalent of tens of thousands of dollars over time because they were deadbeats. Principal reductions could have a bandwagon effect--give one to the Jones, and others on their block will start defaulting so they, too, can get a principal reduction. After all, how can you tell your kid to borrow tens of thousands of dollars for college because you wouldn't stiff the bank like the folks next door? If entire neighborhoods start having mortgage default parties, bank earnings will fall and bankers contributions to the Republican Party will soar. Neighbors too proud or too protective of their credit ratings won't default. But they will likely vote Republican to assuage their anger.

So politicians are stupid. That's not news. The scary thing is they don't move up the learning curve. Governance failures are now in vogue. The Japanese government's dysfunction exacerbated its slow reaction to the nuclear crisis that followed the recent earthquake. The Euro bloc's weak governance structure makes bailouts without a true restoration of fiscal discipline the only way to cope with its sovereign debt crisis. This is not a solution, but a deferral of the train wreck to come. California's governance failure has pushed its budget crisis virtually beyond the realm of resolution. And, last but certainly not least, the mud-slinging, gotcha-politics in gridlocked Washington have imperiled the creditworthiness of the U.S. government and the strength of the U.S. dollar. The dumb thing about all this is that Japan, Europe, California and America are all very wealthy. They have the resources to solve their problems. But they can't make their political processes work in a constructive way. Forget all the predictions for the economy and the stock market you're now hearing. Politics has thrown a wild card into the game, and no one knows how things will turn out.

Thursday, June 2, 2011

When the Future Looks Grim, Invest in the Future

With economic growth slowing, unemployment levels persistently high, earnings stagnant, the stock market falling, and the housing market falling harder, it's no wonder people think the future looks grim. That, however, offers no reason to turn away from the future. Investing in the future is crucial to success and prosperity later on. Take a page from Ford, the car company that didn't want a federal bailout. CNNMoney reports that Ford will build a 3-cylinder, 1.0 liter engine, with performance comparable to today's 4 cylinder, 1.6 liter engines, to be offered a couple of years from now. That's a major investment at a time when auto sales are slowing. But it makes sense to build a more fuel-efficient gasoline engine, since true national infrastructure for electric cars remains decades away.

People, too, can benefit from investing in the future. Here are some ways.

Higher Education. The earning ability of people with college degrees compared to those with just high school diplomas remains highly favorable to the better educated. Of course, there are exceptions, and for people who have the inclination and ability to go into a trade like plumbing or being an electrician, vocational training may be a better choice. But no education beyond high school is a bad idea. Lots of analysis is available today indicating that the earning potential between an internationally known Ivy League school and a less well-known state university may well not be worth the cost differential. Going to a less expensive state school, or two years of community college and then two years in a four-year college, may be financially more astute than taking on the mega debt required for an expensive private school. A lower profile school that offers a nice scholarship/grant package instead of the bigger name, bigger tuition Ivy or equivalent, may pave the way for you to accumulate a higher net worth by middle age. What doesn't make sense is not continuing with your education beyond high school. Continuing education may be a good idea throughout your life. Our advanced economy rewards those with current knowledge and specialized training.

Save More. As the returns on your investments start or continue to look shaky, the best response is to save more. Saving less may be tempting. Why save more only to lose the money when you could have a big blowout of a weekend instead? Because come Monday, you'll have a nasty hangover and the same problem of financing your retirement. Saving more strengthens the foundation for your retirement. Investment returns ebb and flow--after bad times come good times. If you don't persist in expanding your pool of savings, you'll get less in returns when the financial markets go positive.

Maintain What You Have. It's important to maintain your major property items, like cars and houses. Making big ticket items last can eventually save you a lot of money. Do the routine maintenance recommended by the manufacturer of your car (but not necessarily the maintenance recommended by dealers, which often involves a lot of unnecessary b.s. meant primarily to lighten your wallet). Maintain your house--change the filters on the HVAC and have the equipment cleaned regularly, repaint as needed, repair bad roofs and defective plumbing, do battle with the crab grass, and deal with potential homewreckers like mold, termites, etc. The expensive upgrade of the kitchen and bathrooms may look good, but won't do that much to enhance the value of the house. Not doing maintenance can detract from the value of the house and force you to sell below market when you move.

Remember, there will be a future. It may be good, or not so good. You'll either be part of the future, or face an alternative that's worse. If you're going to get the most out of the future, you should invest in it. Otherwise, you aren't likely to have much of a future.