November 2007 Archives

The stock market is struggling today. But its performance in recent months--including October--is remarkable considering the high price of oil, the housing slump, and prospects for a consumer retrenchment. For instance, over the past 12 months the S&P 500 has returned 14.56% while its long-term average annual return since 1926 is 10.4%.

* Stocks up again

*Growth up again--in all categories

*International strong

*Emerging markets on fire!

So far, equity investors have been right about the economy, too.

Here are the numbers, courtesy of Aronson+Johnson+Ortiz: Download file

This is good news. Clive Crook, the Financial Times' Washington columnist, now has a blog. Crook is an astute commentator on the intersection of politics and economics.

I learned about this from economist Brad DeLong.

Another Star Tribune Q & A column.

Q: I will be coming into about 50,000 from the sale of a home. I do not have a will but want to be certain that if something happens it will go to my dependents. I would like to try a 'do it yourself will' sort of will using some software. How do you recommend I rate the various software programs that will make a will? Kevin

A: First of all, congratulations on pulling together a will. Everyone needs one, and I consider a will the foundation of all financial planning.

Now, there are a number of good "do-it-yourself" products on the market. I have used in a pinch the one of the products created by Nolo Press, a long-time publisher of consumer-oriented self-help legal guides (www.nolo.com). Nolo offers several will writing products ranging in price from $39.99 to $73.73. When I used Nolo I found the directions comprehensive and easy to follow. I haven't personally used them (although I've played around with them), but other well-known products include legalzoom.com (at www.legalzoom.com, with prices ranging from $69 to $119) and buildawill.com (www.buildawill.com, with a basic price of $19.95). All of these products work best for simple estates.

That said, I remain a fan of hiring a lawyer for doing a will, especially when children are involved and some basic assets are owned, like a home. The reason, as I wrote above, is that a will is a critical foundation for a personal financial plan. You want to make sure you get it right, that you address all contingencies, and that you get any questions answered. So, while I have nothing against the do-it yourself wills, in many cases I still believe prudence dictates hiring a competent attorney.

Q: Is there any downside to increasing one's line of credit besides the inherent psychological boost of the upper spending limit? Will increasing my credit limit hurt, help, or have no effect on my credit rating? I recently called in to my card service provider... and was given the option of increasing my credit line. The offered increase was much larger than I would have expected, so I guess I'm just wondering: what's the catch? Zachery

A: In one sense you are fine. The credit limit does come into play in calculating your credit score with credit cards and other revolving debts. The credit score formula looks at the gap between your credit limit and the amount of credit you're actually using. "The bigger the gap between your balance and your limit, the better," writes Liz Pulliam Weston in her book, Your Credit Score.

Here's what's really going on. I attend the American Economics Association annual meeting every other year. Several years ago it was in New Orleans, and I sat in a session on some research by economists into credit limits. What they found is that consumers that carry a balance tend to have a psychological tendency to spend a set percent of their credit limit. Let's say you had a credit limit of $10,000 and you routinely carried a balance of $1,000. You were comfortable spending 10% of your credit limit. The credit card company knows this. If it increases your credit limit to $20,000, the odds are you'll still carry a 10% balance of your credit limit--but now that adds up to $2,000, an increase that makes your credit card company happy--very happy.

Bottom line: Only raise your credit limit with good reason. Otherwise, leave it alone.

Q: Hi Chris. I'm 50, my wife is 52 and has Multiple Sclerosis, daughter 16 and daughter 14 has type 1 diabetes. We have a home with a value of $400,000. 1st mortgage at 5% with a balance of 53,000. Home Equity loan $18,000. In January 2007 we sold a townhome with a net profit of $50,000. My income is $50,000. and my wife's is $10,000. We have a 401k with a value of $158,000. Our home is in Hennepin County and it includes seven acres, so for us that could be potential retirement income.
We have plenty to think about for the future. Two chronic illnesses, college for two, and retirement. First priority is what to do with the $50,000 townhome profit. We have some folks saying to buy an annuity. I have invested in real estate before and would consider it again. Thanks, Greg.

A: You do face a lot of financial issues. In thinking over your email question, I've realized I can't really advise you on whether an annuity is a good move or investing in real estate. Both offer different trade-offs between financial risk and financial security. For instance, I do think over the next several years people with cash and real estate savvy are going to have opportunities to do well by taking advantage of financially stressed households and lower home vales. Nevertheless, there are risks associated with that kind of investment. On the annuity side, you'd get some financial security but you'd also give up financial flexibility with the $50,000 profit.

Here's what I would recommend. Spend the next couple of months (and it might take that long) researching and finding a fee-only certified financial planner (CFP) that has worked with people with multiple illnesses. The reason is that you need a comprehensive blueprint to guide future savings and investing decisions, guidance that includes both thinking through and understanding the financial and emotional trade-offs you face.

There are two online places to start your search. The first is the National Association of Personal Financial Advisors at www.napfa.com. The other is the website of the financial planning association at www.fpanet.org. I like the CFP designation since it implies a level of comprehensive education into the whole financial planning process--and that's what you need rather than a broker or life insurance agent. You can also ask people you respect who they consult with when it comes to their finances.

Q: A good friend of mine from college recently passed away after being diagnosed with pancreatic cancer. She leaves behind a husband and 5 children under the age of 13. My question is how to best help fund the children's college education without causing tax issues and is the 529 fund the best way? Ed

A: I think you are on the right track. I would encourage the husband to set up a 529 plans for the children if they don't have them yet. And it costs very little money to set up a plan. The big advantage of a 529 plan is that anyone can contribute. The money will grow sheltered from taxes and its tax-free money if it's withdrawn for qualified educational expenses. It's a good, thoughtful idea.

Zvi Bodie is a leading finance professor comfortable in the quantatative world of finance theory and practice. Still, he's strongly committed to giving impartial conservative advice to the average saver. He recently taped a series of tutorials on annuities--a confusing and important topic.

The "television" isn't exactly dynamic. But the information is superb.

Toggle bonds are back. Even as the major Wall Street firms and banks come clean on their subprime mortgage loans, investors are snapping up the riskiest of junk bonds. These so-called Toggle bonds let borrowers pay interest in cash or with more debt. The security was a poster child for how out-of-control the debt markets had become when so much cash was ignoring risk several months ago. No more.

Bloomberg has a good story on the return of Toogles:

Companies raised about $4.4 billion in the past six weeks selling toggle bonds, securities that allow borrowers to pay interest in cash or with more debt, data compiled by Bloomberg show. Demand dried up in July and prices fell as much as 16 cents on the dollar as defaults on subprime mortgages contaminated global credit markets, according to data compiled by Bloomberg.

Companies that issued the debt include Indianapolis-based auto-parts maker Allison Transmission, the Dallas-based power producer formerly known as TXU Corp. and human-resources manager Ceridian Corp. in Minneapolis.

One way of looking at this is investors are assuming that financial institutions with a big exposure to subprime losses are coming clean (finally) after the Merrill Lynch and Citigroup debacles. It's kitchen sink time. Consequently, these same investors are betting that the news won't tank the economy. If they're right, its a shrewd bottom-fishing play.

Another horrifying story about a contaminated toy made in China. Here's the headline story from the Wall Street Journal:

Retailers around the world scrambled to pull a popular toy called Bindeez off their shelves Wednesday after a chemical in some shipments of the Chinese-made product was found to mimic the effects of the so-called date rape drug.

Sad to say, although it's hardly surprising, but Washington is still dithering over what to do. So is the toy industry. The only power that will stop this epidemic of contaminated toys made in China is the power of the consumer purse.

There have been so many stories like this in recent months. Yet far too little is being done. The only thing that will get the toy industry, major retailers, and Chinese manufacturers undivided attention is a parental boycott this upcoming holiday season of toys made in China. Parents, look at the label and if it says made in China, put it back. And then let the retailer know about your decision. Nothing captures managements attention like falling sales, falling profits, and dsgruntled consumers.

I am a strong believer in open borders and free trade. But that doesn't mean consumers can't reject the products that are being sold them. That's why its called a free market.

Charles O. Prince 111, the ousted head of beleaguered Citigroup and, by most measures, a poorly performing chief executive officer, is yet one more failed CEO walking away with a gold-plated goodbye present. Here's what the New York Times has to say:

Mr. Prince, arguably the person most responsible for Citigroup's enormous problems, can expect at least a $12.5 million cash bonus, compared with last year's cash payout of $13.8 million.

And as he awaits his official retirement next month, Mr. Prince can rest assured that he will leave with $68 million, including his salary and accumulated stockholdings; a $1.7 million pension; an office, car and driver for up to five years -- all in addition to the bonus. That is on top of $53.1 million he has taken home in the last four years, a period when $64 billion in the company's market value has evaporated

The subprime mess that is roiling Citigroup happened on his watch. The rest of the company isn't doing too well, either. Billions in shareholder wealth has vaporized. And he gets rewarded with riches beyond the imagination of most hard working people.

Bloomberg has a story this morning on Experian, the world's largest credit checking company. Experian's stock fell a whopping 19% in London after saying sales growth is slowing. Another sign that credit is tough to come by, even for creditworthy borrowers.

I have a book review of Robert Kuttner's new book, "The Squandering of America: How the Failure of Our Politics Undermines Our Prosperity." Here's my bottom line: "Kuttner has written a passionate broadside for restoring widespread prosperity to the middle class and reviving a dispirited democracy. That his argument isn't completely convincing doesn't mean his ideas aren't worth grappling with during the coming campaign for the White House."

The Conference Board is awfully cheery about the upcoming holiday shopping season:

Nov. 20, 2007... U.S. households are expected to spend an average of $471 on gifts during the holiday season, up from last year's estimate of $449, The Conference Board reports today.

"Consumers are in a festive mood heading into the Thanksgiving holiday," says Lynn Franco, Director of The Conference Board Consumer Research Center. "And, it appears they are willing to spend more than last year, though retailers can still expect a fair share of bargain hunters will be lining up for the traditional kickoff this Friday."

I don't buy it. I think the message in the declining stock market and in the falling real estate market is that consumers are wary of spending. If those two factors weren't enough to chill spending, banks are forcing consumers to tighten their belts. Debt is harder to come by for even well-off creditworthy households with banks reeling from millions and millions of dollars in bad subprime loans. What's more, the retail sales reports are downbeat at stores like Target. Finally, retailers are offering a lot of enticements to convince consumers to open their wallets--and we're not even at Thanksgiving.

All and all, the Conference Board is hitting a discordant note.

Jim Paulson, chief investment officer at Wells Capital Management, is consistently one of the more thoughtful commentators among Wall Street money managers. His latest newsletter makes a number of intriguing points that are worth thinking about as gloom envelopes the markets.

First, he thinks the current subprime crisis is a mile deep but only an inch wide. He notes that housing and automobilies, the two collapsing sectors of the economy, account for only 9% of gross domestic product. The remaining 91% is relatively healthy--especially exports.

He also believes that a "new paradigm" is emerging. The basic idea is that the too-indebted consumer will fade as the key factor driving economic growth and that exports will take their place. "Chronic international trade worsened slowly but steadily worsened U.S. household balance sheets. In a similar fashion, chronic and steady U.S. trade improvements could slowly improve savings and lower debt burdens 'without' necessarily collapsing economic growth," he writes. Indeed, during the last year, U.S. net exports have added almost 1% to U.S. GDP growth.

Last, Paulson doesn't see the crisis on Wall Street turning into an economic disaster on Main Street:

Although Wall Street appears increasingly "VIXed" by volatile financial markets, most of Main Street, while nervous, remains OK! If this crisis has morphed into primarily a Wall Street crisis, its ultimate economic outcome should prove far better than feared. Both the 1987 stock market crash and the 1994 Orange County crisis were predominantly Wall Street crises. In both cases, even though fears were pronounced, the resulting economic fallout was minimal. In 1998, economic growth remained very strong despite the shocking stock market collapse of 1987! And in 1995, despite a Wall Street derivative crisis in 1994, annual real GDP growth never weakened much beyond the current growth rate during the last year. The contemporary crisis will soon need to progress beyond housing and Wall Street, or similar to past Wall Street panics, it too will fade.

Is he right? I don't know, but his ideas are intriguing. I do think that the consumer debt boom of the past quarter century will slow going forward. The cover story by Mike Mandel in the latest issue of Business Week makes a convincing case that a battered banking system will no longer feed the consumer's insatiable appetite for debt. Here's the key idea:

It's been a glorious run for the consumer. In the past 25 years, Americans have kept shopping through good times and bad. In every quarter except one since 1981, consumer spending rose over the previous year, adjusted for inflation. The exception was the first quarter of 1991, and even then the decrease was a mild 0.4% dip.

What comes next could be scary--the largest pullback in consumer spending in decades, perhaps as much as $200 billion to $300 billion, or 2%-3% of personal income. Reduced access to credit will combine with falling real estate values to hit poor and rich alike.

Will trade replace the consumer? If the dollar's decline doesn't turn into a rout--and that is a big "if"--there is a good chance that U.S. multinational corporations and export-savvy businesses will pull the economy out of its funk.

Economist Ed Yardeni asks, "Is this the worst housing recession since the Great Depression?" His answer? "Not so far."

But he's hardly optimistic. The bad news keeps on coming. Yardeni and a colleague looked at the data on housing starts from 1959 through October of this year. Here are their results:

(1) Since 1959, there have been 10 housing recessions with P/T declines exceeding 10%. The range of the downturns has been minus 13.0% to minus 64.7%.

(2) So far, housing starts are down 46.4% during the current recession from 2.29 million units during January 2006 to 1.23 mu during October of this year.

(3) So far, there have been four housing recessions more severe than the current one.

So, this housing recession could turn out to be the worst on record. The subprime mortgage slime has oozed into every corner and under every door of the mortgage market. The latest casualty is Freddie Mac.

Henry Paulson was a legendary dealmaker and chief executive of Goldman Sachs, Wall Street's most profitable firm. But he's been a bust as U.S. Treasury Secretary. For instance, he tried to revive talks on Social Security reform, and the conversations went nowhere.

Now, his big initiative is the superfund to prevent a market meltdown of Strucrured Investment Vehicles (SIVs) that are stuffed with mortgage- backed loans. Citigroup, JPMorgan Chase, and Bank of America have agreed to participate in the multibillion dollar fund that will support the market by providing back-up financing to the SIVs. But the superfund is largely an accounting gimmick that will benefit the banks, but not beleaguered homeowners.

Today's Wall Street Journal has an interview with Paulson on the subprime mess. This paragraph caught my attention:

While he stopped short of endorsing a proposal by Sheila Bair, chairwoman of the Federal Deposit Insurance Corp., to have mortgage companies freeze the interest rate on the two million mortgages due to reset to higher rates between now and the end of 2008, he said that's "one idea." Mr. Paulson said he supports finding some way to develop "standard criteria that's going to allow for modification and workouts."

Paulson is fiddling while Rome burns. Look, the proposal by the FDIC is sound and it has the virtue of simplicity. In essence, it says that homeowners that can make their adjustable rate payments at 8% can't when the ARMs interest rate adjusts at 11% or 13%. So, let's forget all this talk of voluntary standards--especially considering how banks continue to abuse their troubled customers--and make it mandatory. Homeowners will continue to make their 8% payments, and the upward adjustment is written off by the banks. After all, bank balance sheets can absorb the write-down easier than household balance sheets. And, with the 10-year Treasury note below 4%, an 8% loan is nothing to sneeze at.

Homeowners on the brink of an upward, unaffordable adjustment in their ARMs need bold action from Washington. Question is, when will Paulson finally take the initiative. So far, he seems far more concerned about his old pals on Wall Street than with homeowners.

The S&P/Case-Shiller U.S. National Home Price Index posts a -4.5% annual decline in the third quarter of 2007. That's a record drop. Here's the link: Download file