Investing Curiouscatblog

Category: Financial Literacy

  • Is Productivity Growth Bad?

    Why Rising Productivity Is Cause for Worry

    But history also tells us something else: Massive economic disruptions are typically accompanied by weak or negative productivity growth, because businesses have trouble raising money and operating efficiently. Output per hour stagnated in the two deepest postwar recessions, 1974-75 and 1981-82. During the worst of the Great Depression, 1929 to 1933, productivity plunged.
    …
    But there may be another, less benign, reason for rising productivity. In past downturns, educated professionals have escaped mainly unscathed. This time businesses are relentlessly hacking at their professional workforce—a tactic that boosts short-term productivity while hurting long-term growth. Rising productivity may be a sign of weakness, not strength.

    Over the past year the number of employed professionals has fallen by 0.7%, a rare decline. Outside of the still-growing education and health-care occupations, the number of employed professionals has dropped by a dramatic 3.6%.

    Cutting productive staff for short term rewards is definitely a negative for long term productivity. My guess is the management ranks are not as productive as the non-management ranks are however. My sense is their is more room to eliminate non-value added activity from management positions which will not harm long term productivity growth.

    A good way to improve productivity is to reduce excessive pay for senior executives. As the money wasted on exorbitant pay that senior executives lavish on themselves is reduced the capital wasted on them can be better deployed in ways that will improve productivity.

    Related: The Real Threat Is Decreased Productivity – Manufacturing Productivity (data accuracy) – Manufacturing Contracting Globally
    (more…)

  • Bogle on the Retirement Crisis

    John Bogle was the founder of Vanguard Group and a well respected investment mind. He has written several good books including: The Little Book of Common Sense Investing, Common Sense on Mutual Funds and Bogle on Mutual Funds. This interview from 2006 discusses the state of the retirement system, before the credit crisis.

    John Bogle: The whole retirement system, in fact, in the country is in, I think, very poor shape, and it’s going to be the next big financial crisis in the country, I honestly believe. … The private pension plans are underfunded by an estimated $400 billion, and the state and local government plans are underfunded by an estimated $800 billion. That’s a $1.2 trillion shortfall between the assets the plans have and the liabilities they will have to the pensioners as they pay out their retirement checks over the rest of their lifetimes.

    Frontline: How do they get away with that? Don’t they have to fund them?

    John Bogle: No, they don’t, because a lot of it is based on assumptions. Our corporations are now assuming that future returns in their pension plan will be about 8.5 percent per year, and that’s not going to happen. The future returns in the bond market will be about 4.5 percent, and maybe if we’re lucky 7.5 percent on stocks. Call it a 6 percent return — before you deduct the cost of investing all that money, the turnover cost, the management fees. So maybe a 5 percent return is going to be possible, in my judgment, and they are estimating 8.5 percent.

    Why? Because when they do it that way, corporation earnings become greatly overstated, and all the executives get nice, big bonuses. They are using pension plan assumptions as a way to manage corporate earnings and meet the expectations of Wall Street.

    Frontline: So if a company overstates the value of its pension plan assets, it makes the company look better to Wall Street, so there’s an incentive to kind of exaggerate, if not cheat.

    John Bogle: That is precisely correct. And let me clear on the cheating: It’s legal cheating; it’s not illegal cheating. In other words, you can change any reasonable set of numbers — and corporations have done this, have raised the pension assumption from 7 percent to 8.5 percent — and all of a sudden that corporation will report an earnings gain for the year rather than an earnings loss that they would otherwise have. Simple, legal.

    The entire PBS series (from 2006) on 401(k)s (including interviews with Elizabeth Warren, David Wray and Alicia Munnell) is worth reading.

    In February of 2009 he spoke to the House of Representatives committee exploring retirement security.
    (more…)

  • Mortgage Rates: 6 Month and 5 Year Charts

    mortgage rate chart - late 2008 to May 2009Showing mortgage rates over the last 6 months. Red: 30 year fixed rate. Blue: 15 year fixed rate. Tan: 1 year adjustable rate.

    mortgage rate chart - May 2004 to May 2009Showing mortgage rates over the last 5 years. Red: 30 year fixed rate. Blue: 15 year fixed rate. Tan: 1 year adjustable rate. From Yahoo Finance, for conventional loans in Virginia.

    The 6 month chart shows that mortgage rates have been declining ever so slightly. Rates on a 1 year adjustable mortgage fell from 5.5 to 4% and have stayed near 4% for all of 2009. 30 and 15 year rates (15 year rates staying about 25 basis points cheaper) have declined from 6.5%, 6 months ago to about 5% at the start of the year and have moved around slightly since. This is while the yield 10 year government treasuries have been rising (normally 30 year fixed rate mortgages track moves in the 10 year government bond). The federal reserve has been buying bonds in order to push down the yield (and stimulate mortgage financing and other borrowing).

    Mortgage rates certainly could fall further but the current rates are extremely attractive and I just locked in a mortgage refinance for myself. I am getting a 20 year fixed rate mortgage; I didn’t want to extend the mortgage period by getting another 30 year fixed rate mortgage. For me, the risk of increasing rates outweigh the benefits of picking up a bit lower rate given the current economic conditions. But I can certainly understand the decision to hold out a bit longer in the hopes of getting a better rate. If I had to guess I would say rates will be lower during the next 3 months, but I am not confident enough to hold off, and so I decided to move now.

    Related: Mortgage Rates Falling on Fed Housing Focus – posts on mortgages – 30 Year Fixed Mortgage Rates and the Fed Funds Rate – Continued Large Spreads Between Corporate and Government Bond Yields – Lowest 30 Year Fixed Mortgage Rates in 37 Years –

  • Unemployment Rate Increased to 8.9%

    Nonfarm payroll employment continued to decline in April, and the unemployment rate rose from 8.5 to 8.9 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Since the recession began in December 2007, 5.7 million jobs have been lost. In April, job losses were large and widespread across nearly all major private-sector industries. Overall, private-sector employment fell by 611,000.

    The number of unemployed persons increased by 563,000 to 13.7 million. Unemployment rates for April for adult men reached 9.4% and for adult women 7.1%. The number of long-term unemployed (those jobless for 27 weeks or more) increased by 498,000 to 3.7 million over the month and has risen by 2.4 million since the start of the recession in December 2007.

    The civilian labor force participation rate rose in April to 65.8 percent, and the employment-population ratio was unchanged at 59.9 percent. The employment-population ratios for adult men and women showed little or no change over the month. However, since December 2007, the men’s ratio was down by 440 basis points, while the women’s ratio was down by 130 basis points. Since those that stop looking for work (retire or just stop actively looking) are not counted as unemployed the participation rate is a useful statistic to examine in conjunction with the unemployment rate.

    Much of the commentary on the April job losses have been that the decrease in the number of job losses from previous months shows the economy is stabilizing. While it is true losing 611,000 jobs is better than losing 700,000 jobs, losing 611,000 is still very bad. The unemployment rate increased to 8.9% and long term unemployment is increasing drastically. This is hardly good economic news. It is true that there is hope that the economy is turning around, but the employment data we have so far is hardly positive (employment data is a lagging economic indicator so it is not surprising employment data does not recover before other signs point to improvement).

    Related: Another 663,000 Jobs Lost in March in the USA – USA Unemployment Rate Rises to 8.1%, Highest Level Since 1983 – Over 500,000 Jobs Disappeared in November – What Do Unemployment Stats Mean?

  • What if Your Life Insurance Company Goes Bankrupt?

    Your Life Insurance Policy May Not Be Protected by Ben Levisohn, Business Week

    Sometimes, though, failures are far more substantial. When Executive Life went belly-up in 1991, states couldn’t raise enough to cover its obligations. Annuity and life insurance policyholders in California recovered as little as 70 cents on the dollar or were forced to accept modified terms with alternative providers. “I wouldn’t put a tremendous amount of credence in guaranty funds,” says Adam Sherman, president of advisory firm Firstrust Financial Resources in Philadelphia.
    …
    Insurance customers need to be more vigilant. Stop focusing only on cost and service and start worrying about solvency. Check such agencies as Standard & Poor’s (MHP), Fitch Ratings, Moody’s, and A.M. Best to find the highest-rated companies, and be alert for downgrades. Then dig deeper. Find out about an insurer’s exposure to real estate and mortgages and make sure its debt holdings are investment-grade. “Everyone’s under the false assumption that it doesn’t matter what company you buy from,” says Thomas Archer, chairman of financial-services firm Archer Financial Group in New York. “It does.”

    AARP: Is My Money Safe?

    The insurance industry is regulated by the states. Most states require insurance companies to participate in a state guarantee fund or association. State guarantee funds step in to pay claims in the event that an insurance company fails. A state may have one or more guarantee associations, with each association responsible for a certain type of insurance. While there may be differences among states, most states set basic coverage guarantee limits of:

    • $300,000 in life insurance death benefits
    • $100,000 in cash surrender or withdrawal value for life insurance
    • $100,000 in withdrawal and cash values for annuities
    • $100,000 in health insurance policy benefits
    • $300,000 in homeowners benefits
    • $300,000 in auto insurance benefits

    One option is to diversify your insurance coverage, just like you diversifying investments. Historically insurance company failures have been rare, and even it is even rarer that state funds don’t cover the insurance. But if you have large amounts of insurance you can be a bit safer by having your life insurance needs covered by multiple insurers.

    Related: Personal Finance Basics: Long-term Care Insurance – Insurers Raise Fees on Variable Annuities – Personal Finance Basics: Health Insurance – How to Protect Your Financial Health
    (more…)

  • Failure to Regulate Financial Markets Leads to Predictable Consequences

    It seems to me the situation that lead to the current economic problems are due to the overthrown of the Glass-Steagal and other long time sensible regulation put in place to restrict economy wide destruction caused by a few large financial firms (well, that plus incredibly poor management by people that paid themselves many times more than anyone else and other factors – huge consumer debt…). But the most significant systemic problem was failure to regulate even close to sensibly. I have several posts on this topic on previously: Congress Eases Bank Laws, 1999 – Treasury Now (1987) Favors Creation of Huge Banks – Canadian Banks Avoid Failures Common Elsewhere and Greenspan Says He Was Wrong On Regulation.

    Capitalism requires sensible regulation. Regulation is not a friction on capitalism it is a necessary component. Poor regulation is a friction that is waste that should be excised. Unfortunately that is a very challenging task and when you allow those with the most gold to set the rules it is no surprise you have them saying they should not be regulated but should be protected. The failure of financial regulations do show the very obvious problem we have currently of those that donate huge amounts to politicians are granted favors that are paid for by the economy overall.

    The widespread failure to regulate financial markets recently is almost certain to lead to this exact type of situation every time. Companies will over-leverage, take huge risks, take huge pay while times are good and just go bankrupt when times are bad. Think about how a bank makes money. They charge fees for things like: writing a loan, overdraft charges on your account, arranging financing (loan or stock sale)… They charge more for in interest than they pay. Some money there but really they are doing nothing special so they should not be able to charge too much. Even the ridicules fees companies pay (often those in the companies have arrangements to get personal special deals – allocations of IPO’s, jobs later…) for arranging stock sales do not have a systemic risk. Those risks should be very easy to manage sensible.

    They speculate in currency markets, commodities markets, futures, derivatives… If you want a stable economy if you allow huge speculative investments to be assumed to such an extent they risk the economy you are in trouble. If you refused those risks to limited liability companies perhaps your limited regulation model might work. Where those profiting on products with negative economic externalities would personally go bankrupt prior to the losses becoming economically crippling. But I doubt even that would work. And we don’t have that now. We allow people to setup limited liability corporations, drain them of capital on speculation of potential value and then walk about with hundreds of millions of dollars if the company fails. And the negative externalities (due to huge leverage) are huge.

    Regulation seems the obvious solution. And it works when applied. It wasn’t until the USA decided to abandon the financial system regulation and enforcement that the problems became systemic. And see the current Canadian banking system for what happens, even while the world economy is collapsing if you required banks to remain banks instead of massively leveraged speculators paying huge bonus to the executives based on their claims of profitability.

    I agree trying to control risk is dangerous. There are however, very sensible measures to take. Do not allow huge financial companies to exist (we have laws on anti-trust, anti-competitive behavior…). Do not allow banks to speculate (more than a careful controlled regulated amount). Do not allow massive leverage of massive amounts of money. Do require audited financial records. Do require companies that want to speculate to be much smaller than regulated bank, and bank-like companies. Do elect politicians that will appose allowing companies to undertake systemic risks to the economy for short term financial gains.

    We continue to elect politicians that provide large favors to those giving them money at the expense and risk to the rest of us. Therefore we are bringing this upon ourselves. When we chose to stop supporting politicians that behave in that way then we will get different behavior. Until that point it will continue. We don’t seems to be in any mood to change what we have been doing.

    Comments on Note to Regulators: Beware the Montana Paradox

    Related: More on Failed Banking Executives – more posts on regulation in capitalist economies – Credit Crisis the Result of Planned Looting of the World Economy – Bad Behavior

  • The Value of Home Ownership

    Home Ownership Shelter, or Burden?

    The collapse in house prices matters most directly to two overlapping groups: those who bought property at the peak of the market and now face “negative equity”; and those (in America) who took out subprime mortgages. Roughly 10m Americans are in negative equity—ie, the cost of their mortgage exceeds the value of their home. In Britain about 3% of households are in negative equity. For homeowners, negative equity makes houses more like a trap than a piggy bank. Those who cannot meet their payments lose their house, their savings and (in America, usually) their credit rating for seven years.

    The other area of concentrated distress is subprime mortgages, which increased their share of the American mortgage market from 7% in 2001 to over 20% in 2006. According to the Mortgage Bankers Association, the delinquency rate was 22% in the fourth quarter of 2008, compared with only 5% for prime loans.
    …
    “Perhaps the most compelling argument for housing as a means of wealth accumulation”, argues Richard Green of the University of Southern California, “is that it gives households a default mechanism for savings.” Because people have to pay off a mortgage, they increase their home equity and save more than they otherwise would. This is indeed a strong argument: social-science research finds that people save more if they do so automatically rather than having to choose to set something aside every month.

    Yet there are other ways to create “default savings”, such as companies offering automatic deductions to retirement plans. In any case, some of the financial snake oil peddled at the height of the housing bubble was bad for saving.

    The debate over whether home ownership is a wise investment or not, is contentious (more so in the last year than it was several years ago). I believe in most cases it probably is wise, but there are certainly cases where it is not. If you put yourself in too much debt that is often a big problem. I also think you should save a down payment first. If you are going to move (or have good odds you may want to) then renting is often the better option.

    The “default saving” feature is one of the large benefits of home ownership. That benefit is destroyed when you take out loans against the rising value of the house. And in fact this can not just remove the benefit but turn into a negative. If you spend money you should have (increasing your debt) that can not only remove you default saving benefit but actual make your debt situation worse than if you never bought.

    Related: Your Home as an Investment – Nearly 10% of Mortgages Delinquent or in Foreclosure – Housing Rents Falling in the USA – Ignorance of Many Mortgage Holders

  • Immediate Annuities

    Life Insurers Profit as Retirees Fear Outliving Cash by Alexis Leondis

    Sales of so-called immediate annuities are climbing as retirees are drawn to lifetime payments guaranteed by U.S. insurance companies. Immediate annuities pay a periodic fixed amount of money for life in exchange for a lump-sum payment.
    …
    Payouts among insurers vary significantly, said Weatherford of NAVA. Monthly payments range from $629 to $745 for a $100,000 investment by a 65-year-old male, according to a survey of six issuers by Hueler Companies, a Minneapolis-based data research firm and provider of an independent annuity platform.

    An annuity is a comforting in that you cannot outlive your annuity payment. However, there are drawbacks also. Having a portion of retirement financing based on annuity payments does help planning. Social security payments are effectively an annuity (that also increases each year, to counter inflation). While living off social security payments alone is not an enticing prospect, as a portion of a retirement plan those payments can be valuable. If you have a pension that can also serve as an annuity.

    It can make sense to put a portion of retirement assets into an annuity however I would limit the amount, myself. And the annuity payout is partially determined by current interest rates, which are very low, and those now the payout rates are low. If interest rates stay low, then you lose nothing but if interest rates increase substantially in the next several year (which is certainly possible) the payout for annuities would likely increase.

    Choosing to purchase an annuity is something that should be done after careful study and only once you understand the investment options available to you. Also you need to have saved up substantial retirement saving to take advantage of the option to buy enough monthly income to contribute substantially to your retirement (so don’t forget to do that while you are working).

    Related: Many Retirees Face Prospect of Outliving Savings – Spending Guidelines in Retirement – Retirement Tips from TIAA CREF – Social Security Trust Fund

  • Credit Crisis the Result of Planned Looting of the World Economy

    Fluke? Credit crisis was a heist by James Jubak

    What we’re now living through, though, is the result of a conscious, planned looting of the world economy. Its roots stretch back decades. And it wouldn’t have been possible without the contrivances of the bought-and-paid-for folks who sit in Congress.

    Of course, just because the plan blew up on the looters, taking off a financial finger here and a portfolio hand there, you shouldn’t have any illusion that they’ve retired. In fact, in the “solutions” now being proposed — by Congress — to fix the global and U.S. financial systems, you can see the looters at work as hard as ever.

    He is exactly right.

    Question: Why weren’t state insurance regulators more aggressive in regulating AIG?

    Answer: Because the federal government had forced them to back off. An aggressive interpretation of the definition of insurance could have let state insurance agencies regulate the derivatives contracts that AIG’s financial-products group was writing out of London. These were, in fact, insurance policies that guaranteed the companies taking them out (banks, other insurance companies, investment banks and the like) against losses on securities in their portfolios.

    But Congress had made it very clear in the Commodity Futures Modernization Act — supported by then-Federal Reserve Chairman Alan Greenspan, steered through Congress by then-Sen. Phil Gramm, R-Texas, and signed into law by President Bill Clinton in December 2000 — that most over-the-counter derivatives contracts were outside the regulatory purview of all federal agencies, even the Commodity Futures Trading Commission.

    With the new law on the books, the market for credit default swaps exploded from $632 billion outstanding in the first half of 2001, according to the International Swaps and Derivatives Association, to $62 trillion in the second half of 2007.

    Question: Wasn’t anybody worried about the risk to the financial system posed by a market that dwarfed the assets of the sellers of this insurance?

    Answer: Worry about leverage? You’ve got to be kidding.

    In 2004, the Securities and Exchange Commission, after hard lobbying by Wall Street, reversed its 1975 rule limiting investment banks to leverage of 15-to-1. The new limit could be as high as 40-to-1 if the investment banks’ own computer models said it was safe.

    Understanding the people paid lots of money to politicians and then (after they got lots of money) those politicians enacted laws that endangered the economy to favor those giving them lots of money. Now maybe these politicians just like letting exceptionally wealthy people endanger the economy for personal gain. Maybe they think that is a good idea. I tend to think instead they do what those they give them lots of money want. But maybe I am wrong on that.
    (more…)

  • Add to Your 401(k) and IRA

    The recent performance of investments can be discouraging. However, the most damaging reaction to your financial future is to reduce your contributions to retirement savings. IRAs and 401(k)s are great ways to save for retirement. In fact the recent performance has convinced me to increase my contributions. This is for two reasons.

    First, I had been somewhat optimistic in my guesses about investment returns. The current decline means that investments in the S&P 500 have returned about 0% over the last 10 years. That is a horrible performance and it will take many years to even bring that up to a bad performance. So if you reduce your long term investment performance expectations you need to add more while you are working (or reduce your retirement expectations – or work longer).

    Second, I think now is a very good time (long term) to be investing. I think the declines in the markets (both the stock market and real estate market) now provide good investment opportunities. Of course I could be wrong but I am willing to make investments based on this believe. And I believe there are plenty of place real estate prices may still be too high, but I believe there are also good buys.

    A third reason worth considering is the damage done to the economy over the last 10 years and the costs of dealing with that today. Those costs are going to have long term impacts. Likely the economy will be stressed paying for the over-indulgences of the past for quite a long time. That means the risks to those in that economy will increase. And therefore having larger reserves is a wise course of action to survive the rough times ahead. Those rough times include a substantial risk of inflation. Investing to protect against that risk is important.

    I would recommend starting with at least a 200 basis point increase in retirement contributions. For example, if you were saving 10% for retirement, increase that to 12%. If you have not added to your IRA for 2008, do so now (you have until April 15th to do so). In fact, if you haven’t added to your IRA for 2009, do so now.

    Related: How Much Will I Need to Save for Retirement? – Nearly half of all workers have less than $25,000 in retirement savings – Investing – What I am Doing Now