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  • Soros on Financial Crisis and Markets

    The New Paradigm for Financial Markets is George Soros‘ newest book. Here is an interview with him in May of this year, on PBS, Financial World Shifts Gears Amid Economic Tumult, about the ideas in the book and the current crisis.

    JUDY WOODRUFF: How do you assess the strength of the financial system today?
    GEORGE SOROS: I think this is the most serious crisis of our lifetime. It’s not just a housing crisis, but a crisis of the financial system.

    GEORGE SOROS: The regulators have failed to regulate, and they really have to — they left it to the market. That was this market fundamentalist philosophy, that markets will take care of themselves.

    And I contend that there’s been what I call a super bubble that has been growing over the last 25 years at least, which basically consisted of an extension in credit, increasing use of leverage. That was the trend in reality.

    And the misconception that credit is that markets can be left to their own devices. Now, in fact, they are given to excesses, and occasionally they create crises, but each time the authorities intervene and bail out the failing institutions, provide fiscal stimulus, monetary stimulus.

    So it seems like the market corrects itself, but it’s actually the intervention of the authorities that saves the market.

    Related: Soros on the Financial Market CollapseJim Rogers on the Financial Market MessLeverage, Complex Deals and Mania

  • Personal Finance Basics: Dollar Cost Averaging

    With the recent turmoil in the financial market this is a good time to look at Dollar cost averaging. The strategy is one that helps you actually benefit from market volatility simply.

    You actually are better off with wild swings in stock prices, when you dollar cost average, than if they just went up .8% every single month (if both ended with stocks at the same price 20 years later). Really the wilder the better (the limit is essentially the limit at which the economy was harmed by the wild swings and people decided they didn’t want to take risk and make investments.

    Here are two examples, if you invest $1,000 in a mutual fund and the price goes up every year (for this example the prices I used over 20 years: 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20, 22, 24, 26, 28, 30, 33, 36,39) you would end up with $40,800 and you would have invested $20,000. The mutual fund went from $10 a share to $39 over that period (which is a 7% return compounded annually for the share price). If you have the same final value but instead of the price going up every year the price was volatile (for example: 10, 11, 7, 12, 16, 18, 20, 13, 10, 16, 20, 15, 24,29, 36, 27, 24, 34, 39) you end up with more most often (in this example: $45,900).

    You could actually end up with less if the price shot up well above the final price very early on and then stayed there and then dropped in the last few years. As you get close to retirement (10 years to start paying close attention) you need to adopt a strategy that is very focused on reducing risk of investment declines for your entire portfolio.

    The reason you end up with more money is that when the price is lower you buy more shares. Dollar cost averaging does not guaranty a good return. If the investment does poorly over the entire period you will still suffer. But if the investment does well over the long term the added volatility will add to your return. By buying a consistent amount each year (or month…) you will buy more share when prices are low, you will buy fewer shares when prices are high and the effect will be to add to your total return.

    Now if you could time the market and sell all your shares when prices peaked and buy again when prices were low you could have fantastic returns. The problem is essentially no-one has been able to do so over the long term. Trying to time the market fails over and over for huge numbers of investors. Dollar cost averaging is simple and boring but effective as long as you chose a good long term investment vehicle.

    Investing to your IRA every year is one great way to take advantage of dollar cost averaging. Adding to your 401(k) retirement plan at work is another (and normally this will automatically dollar cost average for you).

    Related: Does a Declining Stock Market Worry You?Save Some of Each RaiseStarting Retirement Account Allocations for Someone Under 40Save an Emergency Fund

  • Would the Dow Dump General Motors?

    Would the Dow Dump General Motors?

    General Motors may get dumped by the Dow Jones Industrial Average if the nation’s biggest carmaker strikes the wrong kind of bailout deal with the government.

    At this point, it’s not clear if the government will be willing to take on the horribly mismanaged automaker. It’s one thing to save a financial firm that continues to make money and another thing to rescue a business that for decades has been unable to control labor and legacy costs or deliver a product that consumers want. GM could be allowed to declare bankruptcy.

    But for some reason nostalgic Americans refuse to let the carmakers take a hit and learn from their mistakes. A bailout seems to be preferred. It worked so well for Chrysler.

    Is it important to the Dow editors to keep an auto presence in the index?

    And since the Dow is meant to be a barometer of the U.S. market, Toyota and Honda can’t be considered. Then again maybe they should leave a bankrupt company in the Dow. It might be the most accurate barometer of the market yet by tracking all the blue chips that have gone bankrupt.

    I discussed dropping GM from the Dow Jones Industrial Average in December of 2005: “I agree removing GM makes sense, though I see no reason to wait.”

    Related: Dow Jones Industrial Average ChangesAnother Great Quarter for Amazon (July 2007)Stop Picking StocksCurious Cat Investing Web Search

  • FDIC Details Plan To Alter Mortgages

    FDIC Details Plan To Alter Mortgages

    Officials at the Federal Deposit Insurance Corp. yesterday detailed a plan to prevent 1.5 million foreclosures in the next year by offering financial incentives to companies that agree to sharply reduce monthly payments on mortgage loans.

    Agency officials estimated the cost to the government at $22.4 billion.

    The mortgage industry is concerned that any new modification plan will persuade some people to stop making mortgage payments in addition to helping people who already have stopped making payments. The industry argues this will translate into higher interest rates because investors will demand compensation for the increased risk of loan defaults. That, in turn, would limit the number of people who can afford mortgage loans.

    FDIC estimates that 1.4 million borrowers with such loans are at least two months late on their payments, and another 3 million borrowers will miss at least two payments by the end of next year. The agency estimates that half those borrowers, or about 2.2 million people, would receive a loan modification under the program, and that about 1.5 million will successfully avoid foreclosure.

    Under the terms of the proposed FDIC program, lenders would reduce monthly payments primarily by cutting the borrower’s interest rate to a minimum rate of 3 percent. If necessary, the company could also extend the repayment period on the loan beyond 30 years, reducing each monthly payment. Finally, in some cases, companies could defer repayment of some principal. The borrower still would be on the hook for the full value of the loan.

    Officials said their experience at IndyMac showed that principal reductions were not necessary. So far, FDIC has modified about 20,000 IndyMac loans. In 70 percent of the cases, FDIC was able to create an affordable payment solely by reducing the interest rate. In 21 percent of the cases, the agency also extended the life of the loan. In 9 percent of the cases, it delayed repayment of some principal.

    An interesting proposal I would support. Ideally this type of action would not be necessary but since banks were allowed to degrade their standards so far and allowed to grow so large their failures threaten the economy some radical actions are being taken. Compared to many others this is sensible.

    Related: How Much Worse Can the Mortgage Crisis Get?JPMorgan Chase Freezes Mortgage ForeclosuresFed Plans To Curb Mortgage Excesses (Dec 2007)

  • The Economy is in Serious Trouble

    It doesn’t take much effort to notice the economic news is increasingly dire. And this is not just a few alarmist reports, the economy is in serious trouble. The decades of spending beyond their means (for consumers and those the consumers elected to run government) are creating a very difficult situation. And the credit crisis precipitating the current slide has brought to light many failures to properly regulate the economy. U.S. Slump May Be Longest in Decades as Growth Fell Off ‘Cliff’

    The U.S. downturn will be the longest in three decades, and the drought in consumer spending may be the worst ever, according to economists surveyed by Bloomberg News.

    The implosion of credit markets last month will cause the economy to shrink at a 3 percent annual rate in the fourth quarter and decline at a 1.5 percent pace in the first three months of 2009, according to the median estimate of 59 economists surveyed Nov. 3 to Nov. 11. Following last quarter’s 0.3 percent drop, the slump would be the longest since 1974-75.

    Falling demand will cause an even bigger increase in unemployment than projected last month. Economists surveyed forecast the jobless rate will rise to 7 percent in the first quarter of 2009, up from last month’s forecast of 6.6 percent. The rate will climb to 7.7 percent by the end of 2009, the highest level since 1992, the survey showed.

    The jobless rate rose to 6.5 percent in October, the highest since 1994

    There is little doubt the economy is in for serious trouble. What investment moves are wise now is less obvious. I have been buying during the decline and continue to do so. I bought some Google yesterday at the same price I first bought Google for several years ago. I think in 10 years that will pay off quite well, but time will tell. My purchases of Google earlier this year would obviously have been better if I had made them yesterday than when I did.

    I discussed the Economic Crisis on my Curious Cat Management Blog last month:

    With personal finance I still believe the same smart personal financial decisions last year, or five years ago are wise today: avoid credit card debt, have an emergency fund of 6 months of expenses, save for retirement, have proper health insurance, don’t buy what you don’t need and can’t afford… The biggest change I see is that the risks of failing to do these things (and the risks of failing to have done them in the past) are increasing greatly.

    One of the challenges with personal financial matters is they are by nature long term issues. What you did over the last 5 years cannot be fixed in a few weeks, most likely it takes years.

    Related: Stock Market DeclineBad News on Jobs

  • Consumer Debt Gets Bailout Attention

    Consumer debt gets bailout attention

    Treasury Secretary Henry Paulson said Wednesday that the government would broaden the reach of its $700 billion bailout plan to support non-bank financial institutions that provide consumer credit, such as credit cards and auto loans.

    “Approximately 40 percent of U.S. consumer credit is provided through securitization of credit card receivables, auto loans and student loans and similar products. This market, which is vital for lending and growth, has for all practical purposes ground to a halt.”

    The Next Meltdown: Credit-Card Debt

    The next horror for beaten-down financial firms is the $950 billion worth of outstanding credit-card debt—much of it toxic.

    Innovest estimates that credit-card issuers will take a $41 billion hit from rotten debt this year and a $96 billion blow in 2009.

    Risky borrowers with low credit scores account for roughly 30% of outstanding credit-card debt, compared with 11% of mortgage debt. More than 45% of Washington Mutual’s credit-card portfolio is subprime, according to Innovest.

    Related: Americans are Drowning in DebtHow to Use Your Credit CardCredit Crisis (Aug 2007)Curious Cat Economics Search Engine

  • Easiest Countries for Doing Business 2008

    Singapore is again ranked first for Ease of Doing Business by the World Bank. For some reason they call the report issued in any given year as the report for the next year (which makes no sense to me). The data shown below is for the year they released the report.

    Country 2008 2007 2006 2005
    Singapore 1 1 1 2
    New Zealand 2 2 2 1
    United States 3 3 3 3
    Hong Kong 4 4 5 6
    Denmark 5 5 7 7
    United Kingdom 6 6 6 5
    Ireland 7 8 10 10
    Canada 8 7 4 4
    other countries of interest
    Japan 12 12 11 12
    Germany 25 20 21 21
    France 31 31 35 47
    Korea 23 30 23 23
    Mexico 56 44 43 62
    China 83 83 93 108
    India 122 120 134 138
    Brazil 125 122 121 122

    The rankings include ranking of various aspects of running a business. Some rankings for 2008: starting a business (New Zealand 1st, Singapore 10th, USA 6th, Japan 64th), Dealing with Construction Permits (St. Vincent and the Grenadines 1st, Singapore and New Zealand 2nd, USA 26th, China 176th), Employing Workers (Singapore and the USA 1st, Germany 142, Korea 152), protecting investors (New Zealand 1st, Singapore 2nd, Hong Kong 3rd, Malaysia 4th, USA 5th), enforcing contracts (Singapore 1, Hong Kong 2, USA 6, China 18), getting credit (Malaysia 1; UK and Hong Kong 2; Singapore, New Zealand and USA 5th), paying taxes (Maldives 1, Hong Kong 3, USA 46, Japan 112, China 132).

    These rankings are not the final word on exactly where each country truly ranks but they do provide a valuable source of information. With this type of data there is plenty of room for judgment and issues with the data. Several of my posts, from my other blogs, that I recommend on this topic: The Future is Engineering, Science and Engineering in Global Economics (more…)

  • What Does That Say About the Field of Economics?

    So few economists foresaw the current credit disaster, New York Times interview of James Galbraith.

    NYT: there are at least 15,000 professional economists in this country, and you’re saying only two or three of them foresaw the mortgage crisis?
    Dr. Galbraith: Ten or 12 would be closer than two or three.

    NYT: What does that say about the field of economics, which claims to be a science?
    Dr. Galbraith: It’s an enormous blot on the reputation of the profession. There are thousands of economists. Most of them teach. And most of them teach a theoretical framework that has been shown to be fundamentally useless.

    NYT: You’re referring to the Washington-based conservative philosophy that rejects government regulation in favor of free-market worship?
    Dr. Galbraith: Reagan’s economists worshiped the market, but Bush didn’t worship the market. Bush simply turned over regulatory authority to his friends. It enabled all the shady operators and card sharks in the system to come to dominate how we finance.

    Related: Rodgers on the US and Chinese EconomiesGreenspan Says He Was Wrong On RegulationLeverage, Complex Deals and ManiaWhat is Economics?

  • Why America Needs an Economic Strategy

    In a recent article in Business Week Michael E. Porter makes some excellent points – Why America Needs an Economic Strategy:

    First, the U.S. has an unparalleled environment for entrepreneurship and starting new companies.

    Second, U.S. entrepreneurship has been fed by a science, technology, and innovation machine that remains by far the best in the world. While other countries increase their spending on research and development, the U.S. remains uniquely good at coaxing innovation out of its research and translating those innovations into commercial products.

    Third, the U.S. has the world’s best institutions for higher learning, and they are getting stronger. They equip students with highly advanced skills and act as magnets for global talent, while playing a critical role in innovation and spinning off new businesses.

    Fourth, America has been the country with the strongest commitment to competition and free markets.

    An inadequate rate of reinvestment in science and technology is hampering America’s feeder system for entrepreneurship. Research and development as a share of GDP has actually declined, while it has risen in many other countries.

    A creeping relaxation of antitrust enforcement has allowed mergers to dominate markets. Ironically, these mergers are often justified by “free market” rhetoric. The U.S. is seeing more intervention in competition, with protectionism and favoritism on the rise. Few Americans know that the U.S. ranks only 20th among countries in openness to capital flows, 21st on low trade barriers, and 35th on absence of distortions from taxes and subsidies

    I have discussed similar idea in this blog and the Curious Cat Science and Engineering Blog: The Future is EngineeringEngineering the Future EconomyScience GapNot Understanding Capitalism