September 2007 Archives

Q: My wife and I had our first child a few months ago. After doing some research, we had all but pulled the trigger on one state's 529 college savings plan (Virginia) when we learned that as a gift, our family had already started and plans to continue giving to a another state's 529 (Minnesota - the state we live in.) Other than the need to make and keep track of the minimal annual investments for each, is there are any negatives to having two plans open at once? Right now, we only have one child, but do plan to have another in the future. Aaron

A: This is one of those times when you really can't go wrong financially. You researched 529s and liked the Virginia option the most. Your family chose Minnesota's 529 plan, but it is also well-regarded. So, there's no good reason just on the basic plans to choose one over the other.

The real advantage of going with one 529 is simplicity: It makes your bookkeeping life a hair easier and a bit more straight forward in communicating with any family, relatives, and friends who would like to contribute. That said, in some cases it can make sense to diversify with 529 plans to take advantage of different investment choices. For example, both the Minnesota plan and the Virginia college savings plan offer an aged-based savings option. It's a sensible choice that automatically invests more of your money in equities when your child is young and more in cash as the college tuition bill looms. If that's what you want to do, then I would go with one plan.

But Virginia also offers a broker-dealer option that lets you invest with mutual funds managed by the American Funds (for a higher fee). Now, I'm a fan of low-fee aged-based 529 plans. But the giant American Funds offers a number of well-respected investment options. You may want a different savings mix and you can create that option for yourself by investing in the two plans.

If you go to www.savingforcollege.com it has a nice feature that allows you to compare the basics of up to six 529 plans at once.

Q: What is your opinion on Single Premium Immediate Annuities? My wife and I are both 80 years old. I have a defined pension which started 20 years ago. I have had no increases in that time frame. We have a significant amount of money invested with Vanguard and Fidelity in various funds. We have significant money in a Bank Money Market Account. We also have two large 12 month CD's. Right now we have enough money coming in to meet our monthly expenses. Should I be looking into the future when that may not be the case? Thanks.

A: As readers of this column and listeners to Marketplace Money know, I'm not a fan of many types of annuities, especially variable annuities. A variable annuity is a tax sheltered insurance investment product wrapped around mutual funds and, despite their popularity, variable annuities have a number of drawbacks, including steep fees, limited financial flexibility, and the transformation of low-tax capital gains into high-tax ordinary income.

But there is a lot to be said in favor of single premium immediate annuities for retirees. The appreciation of immediate annuities has grown in recent years in the financial planning community, too. Basically, single premium means you make a lump sum payment and in return you get a predictable monthly income on that investment for the rest of your life. Like Social Security and an old-fashioned defined benefit pension plan, you can't outlive the annuity. It's an annuity product that offers financial security and piece of mind to many retirees.

There are a number of factors to consider before buying an immediate annuity. For instance, how much you can get monthly depends on a number of factors, including your age and how much you invest, whether the payouts are for your life or include your spouse, and if the investment is protected from inflation. You also should factor in a loss of control over the money you put into the annuity. Right now you can always cash in some of your mutual funds in an emergency--it's there to meet any unusual expenses. That won't be the case for any of the money you put into an annuity. You should only do business with a highly rated insurance company, one with a blue chip balance sheet.

Whether or not a single premium immediate annuity is a good investment for you is partly a matter of finances and partly temperament. First, I would go through your expenses and investments, and run the numbers to see if an immediate annuity is a financially savvy move on your part. And, of course, how much of your savings to annuitize. I would talk with a financial planner (preferably a fee-only Certified Financial Planner or CFP) to get expert guidance.

Take the psychological element seriously. I know people who put the bulk of their retirement savings into annuities for piece of mind. They did it so they could sleep at night during periods of extreme market volatility, such as the current credit fears over subprime mortgage loans. They also drew solace knowing that they couldn't outlive their next egg. But other people I've talked to over the years believe the steady income from Social Security pension is enough (and a traditional pension if they have one). They'd rather manage the rest of their money on their own. They like maintaining control over their investments.

August was brutal in the markets. Imagine getting a call from your Mom, "So, you still think this is a correction?" (Put plenty of disbelief into the word "correction".)

Yet all the major major stock market indicies ended the month higher.. The stock market total return figures below are August, past three months, and year-to-date, respectively.

S&P 500 1.50 -3.28 5.20

DOW JONES INDUSTRIALS 1.40 -1.44 8.80

NASDAQ COMPOSITE 1.97 -0.31 7.50

S&P REIT INDEX 5.83 -11.28 -7.91

RUSSELL 1000 INDEX 1.36 -3.65 5.29

RUSSELL 2000 INDEX 2.26 -6.13 1.39

RUSSELL 3000 INDEX 1.44 -3.86 4.95

Data: Aronson+Johnson+Ortiz

So far, I am in the camp that thinks much of the Wall Street whining and criticsim of Ben Bernanke this past month is misplaced. The Fed has been straightforward in its actions. The Fed stepped up--along with other central banks--and made sure that the global credit squeeze didn't turn into a financial collapse. Many hedge funds and lenders have lost money or gone out of business.

Now, with today's employment report--a decline of 4,000 plus revising down previous months--the Fed will begin a round of benchmark rate cuts at its Septemebr 18 Federal Market Open Committee meeting. The combination of declining home prices and falling employment is worrisome.

On yesterday's Marketplace Morning Report host Scott Jagow and I talked about one of the best ideas I've come across in dealing with families facing foreclosure. The idea comes from liberal economist Dean Baker, co-director of the Center for Economic and Policy Research in Washington. It has has been picked up by Andrew Samwick, a conservative economist at Dartmouth University and formerly a member of President Bush's Council of Economic Advisors. This joint op-ed piece lays out the argument.

THE MORTGAGE-MARKET meltdown has gotten big enough that even Congress is taking notice. Members of Congress, especially those running for president, are now racing to propose bills that promise relief to the millions of homeowners who can't pay their mortgages.

It also manages to benefit homeowners in crisis without also rescuing the financial institutions that were speculating in mortgages gone bad. This will give the presidential candidates, and other members of Congress, a clear choice between helping distressed homeowners or bailing out financial institutions that should have known better.

You can learn more about this suggestion by going to Dean Baker's blog at the American Prospect website or to Andrew Samwick's blog. And here's a nice reference to the Morning Report discussion by Samwick.

Own-to-Rent on the Marketplace Morning Report
Economics correspondent Chris Farrell got the main points of the Own-to-Rent proposal across yesterday on Marketplace Morning Repot and added a bit of his own spice. From the transcript:

And I would add--the proposal does not force the taxpayer, whether directly through a government bailout or indirectly through greater involvement of Fannie Mae or Freddie Mac, to take a financial hit. This is what most makes it appealing to me, of all the different proposed interventions I have seen.

I would add, I hope this idea gains traction in Congress.

The headlines note that the unemployment rate was unchanged at 4.6%.

Still, by some other measures published by the Department of Labor, the unempoyment rate is higher than that. Indeed, by the government statistician's broadest measure, the total unemployment rate is 8.4%.

Here are the three main alternatives to the official, baseline unemployment rate of 4.6%,

1) Total unemployed plus discouraged workers, as a percent of the civilian labor force plus discouraged workers: 4.9%

2) Total unemployed, plus discouraged workers, plus all other marginally attached workers, as a percent of the civilian labor force plus all marginally attached workers: 5.5%

3) Total unemployed, plus all marginally attached workers, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all marginally attached workers: 8.4%

Will we get a meaningful tax reform discussion? Will Congress get rid of the terrible tax law known as the Alternative Minimum Tax (AMT). Hope springs eternal....

This story from Bloomberg says Representative Rangel will try. I also hope that the recommendations of the (buried) White House tax reform task force from several years ago gets a re-airing....

Imagine if the President had tried to make the tax code simpler rather than crusade against Social Security....

The devil is always in the details... but Rangel in on the right track....

Rangel Plans to Abolish Minimum Tax in `Mother of All Reforms'

Rangel said that for him, ``a one-year patch is not on the radar screen at all.''

New Census Bureau data shows that nearly one-in-four people between the ages 65 and 74 were in the labor force. That's an increase from 19.6% in 2000. It will be interesting to try and parse out how many are working because their finances are poor, and how many are continuing to work to stay active. Of course, for many people it could be a combination.

The American Community Survey is a vast resource of data, including employment, housing income and other economic and social variables.

Another highlight: More than half of California's homeowners spent 30% or more of their household income on mortgage payments and other mortgage costs. The average for the United States as a whole is 37%. Minnesota stands at 34%. The bottom of the list is North Dakota at 23%.

Since 1975, the Home Mortgage Disclosure Act has required public disclosure of mortgage lending practices in metropolitan areas. Over the years, the data has become more comprehensive. A forthcoming article in the Federal Reserve Bulletin will lay out the results from 2006. The report offers a wealth of data. But I want to focus on an ongoing disturbing result: Evidence that minority borrowers are still systematically discriminated against in the mortgage market. The Fed cautiously offers up lots of qualifications to the data's results, but it's still clear that discrimination is at work.

Earlier, the Fed did say that it was referring to the Justice Department five lending discrimination cases for investigation. Maybe a crackdown is coming following all the damage from the subprime mortgage debacle in a number of minority neighborhoods around the country.

Here are some highlights from the report:

The 2006 HMDA data, like the 2004 and 2005 data, indicate that black and Hispanic borrowers are more likely, and Asians borrowers less likely, to obtain loans with prices above the HMDA pricing reporting thresholds than are non-Hispanic white borrowers. These relationships are found for both home-purchase loans and refinancings. Gross differences in the incidence of higher-priced lending between non-Hispanic whites, on the one hand, and blacks or Hispanic whites, on the other, are large, but borrower-plus lender-modified differences are substantially reduced.....

....For home-purchase loans in 2006, the gross mean incidence of higher-priced lending was 53.7 percent for blacks and 17.7 percent for non-Hispanic whites, a difference of 36.0 percentage points. Borrower-related factors included in the HMDA data accounted for about one-sixth of the unmodified difference. Controlling further for lender reduces the remaining gap to 12.6 percentage points. In comparison, in 2005, the unmodified mean incidence of higher-priced lending for such loans was 54.7 percent for blacks and 17.2 percent for non-Hispanic whites, a difference of 37.5 percentage points. For 2005, borrower related factors accounted for about one-fifth of the unmodified difference, and controlling further for borrower and lender reduced the remaining gap to 10 percentage points, a somewhat smaller "unexplained" difference than that found in the 2006 data.
...

With regard to the sex of applicants, sole male applicants have nearly the same denial rate as sole females. For home-purchase loans, co-applicants, whether male or female, have somewhat lower denial rates than single individuals.

The banking system is shedding jobs at a rapid rate.

According to data from Challenger, Gray and Christmas job cuts in financial services have totaled 102,758 year-to-date. That compares with a layoff figure of 33,346 in 2006. The layoff high was in 2001 at 116,515.

It's a safe bet that bank layoffs will head even higher.

Economists are almost unanimous in their agreement that the credit crunch will translate into slower economic growth. The differences are in degree. Economists like Martin Feldstein of Harvard University put high odds on a recession since in the post World War 11 era downturns in the housing market have usually ended in recession. The financial and psychological impact of changes in home prices is bigger than other assets. On the upside, rising home prices spur all kinds of consumer spending and a willingness to borrow; but on the downside the negative impact is equally substantial.

The more optimistic camp, such as Wall Street economist Ed Yardeni, believe there is still ample credit and liquidity in the global capital markets. Once the credit turmoil stablizes growth will resume.

I think the credit squeeze is subsiding, although the calm will be punctuated by periodic eruptions of trouble. And there is a lot of hedge fund/risk money being gathered to buy bad debts on the cheap from banks, investment banks, and other lenders eager to shed their non-performing loans.

The fed is most likely to cut its benchmark interest rate by a quarter point tomorrow. Here's why: 1) The downturn in the housing market; 2) signs of trouble in the labor market with payroll employment averaging only 44,300 a month over the past three months; 3) China's central bank continuing to tighten policy in an attempt to cool off speculative fever in the Asian giant. The latter is critical because China's rapid growth has helped contain the economic impact of the global credit squeeze. But at some point, central banks always succeed in slowing down an economy. The real question is by how much and how fast. The oft-hoped for soft-landings is the exception, not the rule; and 4) a half-point move would signal that the problems in nthe credit market run much, much deeper than even pessimists now believe. The move carries the risk of backfiring badly on the Fed. .

The Center for Retirement Research at Boston College has released a new Issue in Brief: "The Role of Private Insurance in Financing Long-term Care". It's by a former Business Week colleague, Howard Gleckman.

Here are the key findings:

Long-term care insurance would allow people to preserve assets and choice over providers; and take pressure off Medicaid spending.

However, long-term care insurance has not been widely popular due to:
high costs; misperceptions that Medicare and Medigap will cover long-term care; and the availability of Medicaid.

Private insurance is likely to play only a niche role in financing long-term care.

Well, as everyone knows by now the Fed opted for a dramatic half point cut in its benchmark interest rate. And the stock market loves it--so far.

I've been catching up on my reading, and I came across this entry on Bruce Nussbaum's blog. Bruce is Business Week's innovation and design maven. (By the way, it's a terrific blog). Anyway, here's what Bruce had to say about Greenspan:

Does Alan Greenspan Belong In The Pantheon of Innovation Greats?

I'm not going to take sides on this controversy but raise another--was Greenspan one of Great Innovators who deserves to be in the ranks of Jobs, Brins, Gates (you know what I mean here) and others who've created our modern, high-tech economy? My answer is Yes.

I love the juxtoposition of Greenspan and Jobs. And I agree with his insight.

Here's what I wrote about the Greenspan Era back in 2005. I do believe that all the attempts to blame Greenspan for the housing bubble (among conservatives) or for giving cover to the Bush tax cuts (among liberals) is largely beside the point.

Alan Greenspan, Wizard or Villian?

Once it seemed the Fed chairman could do no wrong. Now critics say his policies will bring on a major bust. Both views may be off base.

Look, Greenspan is no economic wizard, and this isn't a brief to defend him. He has made his share of mistakes, although fewer than many of his predecessors. But what should be defended is the economics of growth. Remember, not all price increases are bubbles, booms are better than busts, and growth is not only good -- it's vital.

What story is the market telling us? The stock market rallied on the Fed rate cut of half-a-point. So far, so good.

But bond investors aren't happy. Long-term bond yields, as well as the rate on fixed-rate mortgages, rose on inflation worries following the Fed easing. Similarly, the dollar spiraled lower and the price of gold is up.

One of these markets is wrong about the outlook for inflation. But which one?

Do you feel that you haven't had a real raise in years? There's good reason. Here are some numbers drawn from the latest issue of Business Week.

Since 2001, average health insurance premiums for employees covering a family of four are up almost 85%--a $1,500 increase to $3,281.

Wages, in sharp contrast, are up 19% over the same period. Inflation is up 17%.

I expect premiums will go up at least double (and more likely higher than that) the rate of inflation next year. But wages? No way. And any increase will go to pay for health insurance anyway.

The dollar dropped to another record low against the Euro. It also hit a 15-year low against a basket of currencies representing America's six major trading partners.

Normally, the value of the dollar doesn't garner a whole lot of consumer attention. That's not true this time.

Case in point: I was at the live broadcast of A Prairie Home Companion this past Saturday, and in his opening remarks Garrison Keillor talked about the Canadian currency reaching parity with the dollar. Not only is this remarkable, he added it does mean Canadian geese will be able to afford better accomodations down south. (If you ever get the chance, go to A Prairie Home Companion broadcast. It's a great radio experience.)

A lower dollar is a boon to our domestic manufacturing industry and overall exports are an economic bright spot. Still, there's a haunting fear in parts of the global capital markets that the dollar is poised to plunge. If it did, that could--okay, would--spark another global credit crunch.

Dartmouth University economist Andrew Samwick has a good post on the dollar on his blog.

In almost all cases, the sky is not falling. Prices adjust so that it hangs lower and grayer.

Expect the dollar to decline until the U.S. current account imbalances shrink substantially. Expect some of this decline to happen as major exporting countries become less willing to organize themselves around holding dollars in exchange for their goods. Expect these countries to diversify their new investments and some of their existing ones, but not to dump their dollar holdings. No other country's short-term economic interests are served by devaluing its own asset holdings, and no exporting country's long-term economic interests are served by inviting a nationalistic, political response from the U.S.

I think this is the right approach to take on the dollar's current turmoil.

Do you think a recession is coming with the downturn in housing? Or are you in the camp that believes the worst is behind us?

Well, you can watch the betting on a recession at Intrade. It's one of the many prediction markets created by this betting firm. It looks like there isn't much activity, so I'm skeptical the "market" is giving reliable signals. But it's still fun to check out.
alt="Price for US Economy in Recession at intrade.com"
title="Price for US Economy in Recession at intrade.com" border="0">

Healthcare insurance premiums are poised to head higher next year. To be sure, the latest Hewitt Associates study shows that health care cost rate increases hit a nine year low in 2007. But that's small comfort, considering that the average health care rate increase for employers of 5.3% was about double the rate of inflation. Hewitt is projecting that rates will surge by an average of 8.7% in 2008.

To put that figure in dollars and cents, the average health cost per person for major companies will increase from $7,982 in 2007 to $8,676 in 2008. And, according to the report, the amount employees will contribute in 2008 will be $1,859--approximately 21% of the overall health care premium. Average employee out-of-pocket costs, such as copayments, coinsurance and deductibles, will also increase from $1,576 in 2007 to $1,738 in 2008.

For employees, here's the bottom line: Overall, employees' total health care costs — including employee contribution and out-of-pocket costs — are projected to be $3,597 in 2008, up 10.1% from in 2007.

And here's the money quote, from Jim Winkler, practice leader of Hewitt's Health Management Consulting business.

"However, one of the primary ways employers have been accomplishing this is by passing a significant percentage of costs to employees, and we're seeing evidence that this strategy is prompting an increasing number of employees to forego necessary preventative care and/or not comply with prescribed medications. While some cost shifting is appropriate, it's critical that companies design their health care programs in a way that encourages employees to use them — and use them wisely. Otherwise, they are essentially trading preventative care now for 'rescue care' later, which will lead to unhealthy employee populations, a decrease in employee productivity and ultimately — higher health care costs."

Who said, "Individual investors lose. Mutual fund managers win." Consumer advocate Ralph Nader? Crusading New York State attorney general Eliott Spitzer? No, it was David Swensen.

Don't worry if your reaction is "David who?" The chief investment officer for Yale University's endowment fund isn't a household name. But he should be.

In the past year, for the 12 months ending June 30th, the fund generated a 28% return, the highest in seven years. Over the past decade, Swensen earned an average annual return of nearly 18%, and Yale's endowment nearly tripled to $25.5 billion. That's not all. Over the past two decades, Yale's endowment has averaged a nearly 16% average annual return vs 10% for the average endowment fund. "David Swensen has had the best record at any established investment institution in the world over the past 20 years," says Barton Biggs, managing partner at hedge fund Traxton Partners in New York.

The performance is stunning. And several years ago, Swensen set out to impart his investment knowledge to individual investors. The book he came out with is called Unconventional Success: A Fundamental Approach to Personal Investment. It's a book that should be on every investors bookshelf.

The title is misleading, however. Swensen's reputation is that he is a Wall Street rarity--a true investment contrarian. Most endowments invest the bulk of their portfolio in domestic stocks and bonds. Swensen commits substantial sums to alternative, often highly illiquid investments, such as private equity, foreign stocks, and timber.

Yet he recommends individuals shun his approach as too impractical, too costly, and too time-consuming. Instead, he preaches the virtues of diversification, investing for the long haul, owning index funds, and keeping fees low. Swensen may make an unusually strong case for these investment verities, but it's hardly unconventional advice.

The book should have been called "The Great Fund Rip-Off" or something along that line. For Swensen is scathing in his criticism of for-profit mutual funds. He believes the standard advice that individuals fare best when they turn over their money to the mutual fund managers is wrong. It's a bromide guaranteed to lose individuals money. Worse yet, American workers are saving for retirement through for-profit mutual funds in their 401(K)s, 403(b)s, 457s, and the like. If he's right in his dismal judgment--and I think he's disturbingly on targe--then the retirement security of millions of Americans is at risk to a rapacious mutual fund industry.

Now, this is an uncompromising, unconventional argument for an investment professional. In essence, Swensen believes the fundamental conflict of interest between for-profit mutual fund managers and their shareholders is irreconcilable. Management will always choose lining their own pockets over their customers' interests through outrageous fees, opaque charges, excessive trading, and other financial shenanigans. "When a sophisticated provider of financial services stands toe to toe with a naive consumer, the all-too-predictable conclusion resembles the results of a fight between a heavyweight champion and a ninety-eight-pound weakling," he writes. "The individual investor loses in the first round knockout."

Swensen supports his dark take with plenty of detail and examples. Among the more intriguing sections is a history of the industry. Scandals have a long pedigree in the mutual fund industry. For instance, in the 1920s and 1930s Wall Street dealers took advantage of their shareholders through a two-tier pricing system. In the '40s, '50s, and '60s large investors routinely took advantage of old prices to reap extra profits. The same goes for the mutual fund scandals of the early 2000s. "The abuses have existed decade after decade," says Swensen.

Of course, there have been reforms over the years. But Swensen isn’t buying any optimistic future, though. "Regulatory authorities prove no match for profit seeking charlatans," he says.

What is an individual investor to do? For now, Swensen recommends buying index funds, preferably through low-fee not-for-profit fund companies like Vanguard and TIAA-CREF. Unconventional Success should be required reading for every graduating senior in college before they start investing for their retirement. It should also be required reading for Congress and in executive suites. America's retirees deserve better than the system they have now.

Jim Paulson, head of Wells Capital Management, is always thoughtful. He's been thinking about something I've been wondering about the past few days:

What does the stock market seem to suspect that "Wall Street rhetoric" doesn't? Why, when so many seem fearful of recession, are stock markets the globe over again nearing new all-time highs while being led by their highest beta sector (technology) and two of their most economically sensitive sectors (industrials and basic materials)? Why are commodity prices surging to new all-time record highs? Why have weekly unemployment claims remained remarkably low? What if Mr. Market and the weekly claim numbers are correctly reflecting an "offsetting" rise in manufacturing jobs (consistent with recent evidence of a broader recovery in both U.S. trade and manufacturing) which has not yet, but could surface in the months ahead?

Just something to ponder...............

Well his answer in his latest newsletter is provocative. It's manufacturing to the rescue. It's worth contemplating:

Will Manufacturing Jobs Rescue Crisis???

Clearly, as this chart implies, U.S. trade improvement positively impacts the fortunes of domestic manufacturing including (at least historically) manufacturing employment. Since U.S. trade has been improving for the last year, during which time the ISM survey has risen, industrial commodity prices have soared, factory industrial production and utilization rates have improved and manufacturing profitability has increased, why shouldn't manufacturing job creation also soon begin to rise?

Every month I get a long list of return numbers from the investment boutique Aronson+Johnson+Ortiz. The latest rows of figures are all positive. Here are there comments:

Stocks up sharply in September, everything and everywhere

Markets near highs; year looks strong. August seems a distant memory, hmmm....

Now, giant financial institutions like Citigroup and UBS are writing off their subprime/credit crunch mistakes. I'll also bet they're taking advantage of this moment to get rid of little black mark on the books. It's clean-up time. The credit squeeze is still on; but the credit crunch is fading.