Effor.com

I ran across this tonight and just had to post it here.  I nominate Richard Fisher as the replacement for Helicopter Ben.  Finally, someone who can add!

I don’t have explicit permission to post this, so if Mr. Fisher objects I will remove it immediately - but this is very important, and I think it deserves the widest possible audience.  What follows is a direct copy and paste from the link above.  It’s long, but very readable - PLEASE take a few minutes and read it.

gk

Richard W. Fisher

Storms on the Horizon Remarks before the Commonwealth Club of California San Francisco, California May 28, 2008 Thank you, Bruce [Ericson]. I am honored to be here this evening and am grateful for the invitation to speak to the Commonwealth Club of California. Alan Greenspan and Paul Volcker, two of Ben Bernanke’s linear ancestors as chairmen of the Federal Reserve, have been in the news quite a bit lately. Yet, we rarely hear about William McChesney Martin, a magnificent public servant who was Fed chairman during five presidencies and to this day holds the record for the longest tenure: 19 years. Chairman Martin had a way with words. And he had a twinkle in his eye. It was Bill Martin who wisely and succinctly defined the Federal Reserve as having the unenviable task “to take away the punchbowl just as the party gets going.” He did himself one up when he received the Alfalfa Club’s nomination for the presidency of the United States. I suspect many here tonight have been to the annual Alfalfa dinner. It is one of the great institutions in Washington, D.C. Once a year, it holds a dinner devoted solely to poking fun at the political pretensions of the day. Tongue firmly in cheek, the club nominates a candidate to run for the presidency on the Alfalfa Party ticket. Of course, none of them ever win. Nominees are thenceforth known for evermore as members of the Stassen Society, named for Harold Stassen, who ran for president nine times and lost every time, then ran a tenth time on the Alfalfa ticket and lost again. The motto of the group is Veni, Vidi, Defici—“I came, I saw, I lost.” Bill Martin was nominated to run and lose on the Alfalfa Party ticket in 1966, while serving as Fed chairman during Lyndon Johnson’s term. In his acceptance speech,[1] he announced that, given his proclivities as a central banker, he would take his cues from the German philosopher Goethe, “who said that people could endure anything except continual prosperity.” Therefore, Martin declared, he would adopt a platform proclaiming that as a president he planned to “make life endurable again by stamping out prosperity.” “I shall conduct the administration of the country,” he said, “exactly as I have so successfully conducted the affairs of the Federal Reserve. To that end, I shall assemble the best brains that can be found…ask their advice on all matters…and completely confound them by following all their conflicting counsel.” It is true, Bruce, that as you said in your introduction, I am one of the 17 people who participate in Federal Open Market Committee (FOMC) deliberations and provide Ben Bernanke with “conflicting counsel” as the committee cobbles together a monetary policy that seeks to promote America’s economic prosperity, Goethe to the contrary. But tonight I speak for neither the committee, nor the chairman, nor any of the other good people that serve the Federal Reserve System. I speak solely in my own capacity. I want to speak to you tonight about an economic problem that we must soon confront or else risk losing our primacy as the world’s most powerful and dynamic economy. Forty-three years ago this Sunday, Bill Martin delivered a commencement address to Columbia University that was far more sober than his Alfalfa Club speech. The opening lines of that Columbia address [2] were as follows: “When economic prospects are at their brightest, the dangers of complacency and recklessness are greatest. As our prosperity proceeds on its record-breaking path, it behooves every one of us to scan the horizon of our national and international economy for danger signals so as to be ready for any storm.” Today, our fellow citizens and financial markets are paying the price for falling victim to the complacency and recklessness Martin warned against. Few scanned the horizon for trouble brewing as we proceeded along a path of unparalleled prosperity fueled by an unsustainable housing bubble and unbridled credit markets. Armchair or Monday morning quarterbacks will long debate whether the Fed could have/should have/would have taken away the punchbowl that lubricated that blowout party. I have given my opinion on that matter elsewhere and won’t go near that subject tonight. What counts now is what we have done more recently and where we go from here. Whatever the sins of omission or commission committed by our predecessors, the Bernanke FOMC’s objective is to use a new set of tools to calm the tempest in the credit markets to get them back to functioning in a more orderly fashion. We trust that the various term credit facilities we have recently introduced are helping restore confidence while the credit markets undertake self-corrective initiatives and lawmakers consider new regulatory schemes. I am also not going to engage in a discussion of present monetary policy tonight, except to say that if inflationary developments and, more important, inflation expectations, continue to worsen, I would expect a change of course in monetary policy to occur sooner rather than later, even in the face of an anemic economic scenario. Inflation is the most insidious enemy of capitalism. No central banker can countenance it, not least the men and women of the Federal Reserve. Tonight, I want to talk about a different matter. In keeping with Bill Martin’s advice, I have been scanning the horizon for danger signals even as we continue working to recover from the recent turmoil. In the distance, I see a frightful storm brewing in the form of untethered government debt. I choose the words—“frightful storm”—deliberately to avoid hyperbole. Unless we take steps to deal with it, the long-term fiscal situation of the federal government will be unimaginably more devastating to our economic prosperity than the subprime debacle and the recent debauching of credit markets that we are now working so hard to correct. You might wonder why a central banker would be concerned with fiscal matters. Fiscal policy is, after all, the responsibility of the Congress, not the Federal Reserve. Congress, and Congress alone, has the power to tax and spend. From this monetary policymaker’s point of view, though, deficits matter for what we do at the Fed. There are many reasons why. Economists have found that structural deficits raise long-run interest rates, complicating the Fed’s dual mandate to develop a monetary policy that promotes sustainable, noninflationary growth. The even more disturbing dark and dirty secret about deficits—especially when they careen out of control—is that they create political pressure on central bankers to adopt looser monetary policy down the road. I will return to that shortly. First, let me give you the unvarnished facts of our nation’s fiscal predicament. Eight years ago, our federal budget, crafted by a Democratic president and enacted by a Republican Congress, produced a fiscal surplus of $236 billion, the first surplus in almost 40 years and the highest nominal-dollar surplus in American history. While the Fed is scrupulously nonpartisan and nonpolitical, I mention this to emphasize that the deficit/debt issue knows no party and can be solved only by both parties working together. For a brief time, with surpluses projected into the future as far as the eye could see, economists and policymakers alike began to contemplate a bucolic future in which interest payments would form an ever-declining share of federal outlays, a future where Treasury bonds and debt-ceiling legislation would become dusty relics of a long-forgotten past. The Fed even had concerns about how open market operations would be conducted in a marketplace short of Treasury debt. That utopian scenario did not last for long. Over the next seven years, federal spending grew at a 6.2 percent nominal annual rate while receipts grew at only 3.5 percent. Of course, certain areas of government, like national defense, had to spend more in the wake of 9/11. But nondefense discretionary spending actually rose 6.4 percent annually during this timeframe, outpacing the growth in total expenditures. Deficits soon returned, reaching an expected $410 billion for 2008—a $600 billion swing from where we were just eight years ago. This $410 billion estimate, by the way, was made before the recently passed farm bill and supplemental defense appropriation and without considering a proposed patch for the Alternative Minimum Tax—all measures that will lead to a further ballooning of government deficits. In keeping with the tradition of rosy scenarios, official budget projections suggest this deficit will be relatively short-lived. They almost always do. According to the official calculus, following a second $400-billion-plus deficit in 2009, the red ink should fall to $160 billion in 2010 and $95 billion in 2011, and then the budget swings to a $48 billion surplus in 2012. If you do the math, however, you might be forgiven for sensing that these felicitous projections look a tad dodgy. To reach the projected 2012 surplus, outlays are assumed to rise at a 2.4 percent nominal annual rate over the next four years—less than half as fast as they rose the previous seven years. Revenue is assumed to rise at a 6.7 percent nominal annual rate over the next four years—almost double the rate of the past seven years. Using spending and revenue growth rates that have actually prevailed in recent years, the 2012 surplus quickly evaporates and becomes a deficit, potentially of several hundred billion dollars. Doing deficit math is always a sobering exercise. It becomes an outright painful one when you apply your calculator to the long-run fiscal challenge posed by entitlement programs. Were I not a taciturn central banker, I would say the mathematics of the long-term outlook for entitlements, left unchanged, is nothing short of catastrophic. Typically, critics ranging from the Concord Coalition to Ross Perot begin by wringing their collective hands over the unfunded liabilities of Social Security. A little history gives you a view as to why. Franklin Roosevelt originally conceived a social security system in which individuals would fund their own retirements through payroll-tax contributions. But Congress quickly realized that such a system could not put much money into the pockets of indigent elderly citizens ravaged by the Great Depression. Instead, a pay-as-you-go funding system was embraced, making each generation’s retirement the responsibility of its children. Now, fast forward 70 or so years and ask this question: What is the mathematical predicament of Social Security today? Answer: The amount of money the Social Security system would need today to cover all unfunded liabilities from now on—what fiscal economists call the “infinite horizon discounted value” of what has already been promised recipients but has no funding mechanism currently in place—is $13.6 trillion, an amount slightly less than the annual gross domestic product of the United States. Demographics explain why this is so. Birthrates have fallen dramatically, reducing the worker–retiree ratio and leaving today’s workers pulling a bigger load than the system designers ever envisioned. Life spans have lengthened without a corresponding increase in the retirement age, leaving retirees in a position to receive benefits far longer than the system designers envisioned. Formulae for benefits and cost-of-living adjustments have also contributed to the growth in unfunded liabilities. The good news is this Social Security shortfall might be manageable. While the issues regarding Social Security reform are complex, it is at least possible to imagine how Congress might find, within a $14 trillion economy, ways to wrestle with a $13 trillion unfunded liability. The bad news is that Social Security is the lesser of our entitlement worries. It is but the tip of the unfunded liability iceberg. The much bigger concern is Medicare, a program established in 1965, the same prosperous year that Bill Martin cautioned his Columbia University audience to be wary of complacency and storms on the horizon. Medicare was a pay-as-you-go program from the very beginning, despite warnings from some congressional leaders—Wilbur Mills was the most credible of them before he succumbed to the pay-as-you-go wiles of Fanne Foxe, the Argentine Firecracker—who foresaw some of the long-term fiscal issues such a financing system could pose. Unfortunately, they were right. Please sit tight while I walk you through the math of Medicare. As you may know, the program comes in three parts: Medicare Part A, which covers hospital stays; Medicare B, which covers doctor visits; and Medicare D, the drug benefit that went into effect just 29 months ago. The infinite-horizon present discounted value of the unfunded liability for Medicare A is $34.4 trillion. The unfunded liability of Medicare B is an additional $34 trillion. The shortfall for Medicare D adds another $17.2 trillion. The total? If you wanted to cover the unfunded liability of all three programs today, you would be stuck with an $85.6 trillion bill. That is more than six times as large as the bill for Social Security. It is more than six times the annual output of the entire U.S. economy. Why is the Medicare figure so large? There is a mix of reasons, really. In part, it is due to the same birthrate and life-expectancy issues that affect Social Security. In part, it is due to ever-costlier advances in medical technology and the willingness of Medicare to pay for them. And in part, it is due to expanded benefits—the new drug benefit program’s unfunded liability is by itself one-third greater than all of Social Security’s. Add together the unfunded liabilities from Medicare and Social Security, and it comes to $99.2 trillion over the infinite horizon. Traditional Medicare composes about 69 percent, the new drug benefit roughly 17 percent and Social Security the remaining 14 percent. I want to remind you that I am only talking about the unfundedportions of Social Security and Medicare. It is what the current payment scheme of Social Security payroll taxes, Medicare payroll taxes, membership fees for Medicare B, copays, deductibles and all other revenue currently channeled to our entitlement system will not cover under current rules. These existing revenue streams must remain in place in perpetuity to handle the “funded” entitlement liabilities. Reduce or eliminate this income and the unfunded liability grows. Increase benefits and the liability grows as well. Let’s say you and I and Bruce Ericson and every U.S. citizen who is alive today decided to fully address this unfunded liability through lump-sum payments from our own pocketbooks, so that all of us and all future generations could be secure in the knowledge that we and they would receive promised benefits in perpetuity. How much would we have to pay if we split the tab? Again, the math is painful. With a total population of 304 million, from infants to the elderly, the per-person payment to the federal treasury would come to $330,000. This comes to $1.3 million per family of four—over 25 times the average household’s income. Clearly, once-and-for-all contributions would be an unbearable burden. Alternatively, we could address the entitlement shortfall through policy changes that would affect ourselves and future generations. For example, a permanent 68 percent increase in federal income tax revenue—from individual and corporate taxpayers—would suffice to fully fund our entitlement programs. Or we could instead divert 68 percent of current income-tax revenues from their intended uses to the entitlement system, which would accomplish the same thing. Suppose we decided to tackle the issue solely on the spending side. It turns out that total discretionary spending in the federal budget, if maintained at its current share of GDP in perpetuity, is 3 percent larger than the entitlement shortfall. So all we would have to do to fully fund our nation’s entitlement programs would be to cut discretionary spending by 97 percent. But hold on. That discretionary spending includes defense and national security, education, the environment and many other areas, not just those controversial earmarks that make the evening news. All of them would have to be cut—almost eliminated, really—to tackle this problem through discretionary spending. I hope that gives you some idea of just how large the problem is. And just to drive an important point home, these spending cuts or tax increases would need to be made immediately and maintained in perpetuity to solve the entitlement deficit problem. Discretionary spending would have to be reduced by 97 percent not only for our generation, but for our children and their children and every generation of children to come. And similarly on the taxation side, income tax revenue would have to rise 68 percent and remain that high forever. Remember, though, I said tax revenue, not tax rates. Who knows how much individual and corporate tax rates would have to change to increase revenue by 68 percent?   If these possible solutions to the unfunded-liability problem seem draconian, it’s because they are draconian. But they do serve to give you a sense of the severity of the problem. To be sure, there are ways to lessen the reliance on any single policy and the burden borne by any particular set of citizens. Most proposals to address long-term entitlement debt, for example, rely on a combination of tax increases, benefit reductions and eligibility changes to find the trillions necessary to safeguard the system over the long term. No combination of tax hikes and spending cuts, though, will change the total burden borne by current and future generations. For the existing unfunded liabilities to be covered in the end, someone must pay $99.2 trillion more or receive $99.2 trillion less than they have been currently promised. This is a cold, hard fact. The decision we must make is whether to shoulder a substantial portion of that burden today or compel future generations to bear its full weight. Now that you are all thoroughly depressed, let me come back to monetary policy and the Fed. It is only natural to cast about for a solution—any solution—to avoid the fiscal pain we know is necessary because we succumbed to complacency and put off dealing with this looming fiscal disaster. Throughout history, many nations, when confronted by sizable debts they were unable or unwilling to repay, have seized upon an apparently painless solution to this dilemma: monetization. Just have the monetary authority run cash off the printing presses until the debt is repaid, the story goes, then promise to be responsible from that point on and hope your sins will be forgiven by God and Milton Friedman and everyone else. We know from centuries of evidence in countless economies, from ancient Rome to today’s Zimbabwe, that running the printing press to pay off today’s bills leads to much worse problems later on. The inflation that results from the flood of money into the economy turns out to be far worse than the fiscal pain those countries hoped to avoid.   Earlier I mentioned the Fed’s dual mandate to manage growth and inflation. In the long run, growth cannot be sustained if markets are undermined by inflation. Stable prices go hand in hand with achieving sustainable economic growth. I have said many, many times that inflation is a sinister beast that, if uncaged, devours savings, erodes consumers’ purchasing power, decimates returns on capital, undermines the reliability of financial accounting, distracts the attention of corporate management, undercuts employment growth and real wages, and debases the currency. Purging rampant inflation and a debased currency requires administering a harsh medicine. We have been there, and we know the cure that was wrought by the FOMC under Paul Volcker. Even the perception that the Fed is pursuing a cheap-money strategy to accommodate fiscal burdens, should it take root, is a paramount risk to the long-term welfare of the U.S. economy. The Federal Reserve will never let this happen. It is not an option. Ever. Period. The way we resolve these liabilities—and resolve them we must—will affect our own well-being as well as the prospects of future generations and the global economy. Failing to face up to our responsibility will produce the mother of all financial storms. The warning signals have been flashing for years, but we find it easier to ignore them than to take action. Will we take the painful fiscal steps necessary to prevent the storm by reducing and eventually eliminating our fiscal imbalances? That depends on you. I mean “you” literally. This situation is of your own creation. When you berate your representatives or senators or presidents for the mess we are in, you are really berating yourself. You elect them. You are the ones who let them get away with burdening your children and grandchildren rather than yourselves with the bill for your entitlement programs. This issue transcends political affiliation. When George Shultz, one of San Francisco’s greatest Republican public servants, was director of President Nixon’s Office of Management and Budget, he became worried about the amount of money Congress was proposing to spend. After some nights of tossing and turning, he called legendary staffer Sam Cohen into his office. Cohen had a long memory of budget matters and knew every zig and zag of budget history. “Sam,” Shultz asked, “tell me something just between you and me. Is there any difference between Republicans and Democrats when it comes to spending money?” Cohen looked at him, furrowed his brow and, after thinking about it, replied, “Mr. Shultz, there is only one difference: Democrats enjoy it more.” Yet no one, Democrat or Republican, enjoys placing our children and grandchildren and their children and grandchildren in harm’s way. No one wants to see the frightful storm of unfunded long-term liabilities destroy our economy or threaten the independence and authority of our central bank or tear our currency asunder. Of late, we have heard many complaints about the weakness of the dollar against the euro and other currencies. It was recently argued in the op-ed pages of the Financial Times [3] that one reason for the demise of the British pound was the need to liquidate England’s international reserves to pay off the costs of the Great Wars. In the end, the pound, it was essentially argued, was sunk by the kaiser’s army and Hitler’s bombs. Right now, we—you and I—are launching fiscal bombs against ourselves. You have it in your power as the electors of our fiscal authorities to prevent this destruction. Please do so. About the Author Richard W. Fisher is president and CEO of the Federal Reserve Bank of Dallas. Notes The views expressed by the author do not necessarily reflect official positions of the Federal Reserve System. William McChesney Martin, “Alfalfa Club Dinner Script,” delivered at the Alfalfa Club Dinner, Washington, D.C., Jan. 22, 1966, Box 163, William McChesney Martin Collection, Lyndon Baines Johnson Presidential Library, Austin, Texas. “Does Monetary History Repeat Itself?” Commencement Day Luncheon of the Alumni Federation of Columbia University, June 1, 1965, New York City. “The Euro’s Success Could Also Be Its Downfall,” by Harold James, Financial Times, May 18, 2008.

I get an email every day from a financial website called the Daily Reckoning.  It’s mainly good stuff, once in a while they go a little off (as Aussies sometimes do) but it’s mainly good reading.

The email I received yesterday contained this:

“Buffett says inflation is exploding,” according to CNNMoney.

What can people do? A report in today’s news tells us that many are “delaying health care.” Probably a good move for the oldsters. If they put it off long enough, they won’t need it at all.

You could hang George W. Bush for inflation too. It would be fine with us. He let government spending get out of control. “Deficits don’t matter,” said his #2, Dick Cheney. More new federal spending and US financial commitments were added in the Bush years than under all the rest of America’s presidents put together; and more new money was created while George W. Bush was president than in all the years since the Declaration of Independence combined. Legally, we don’t know if that charge is enough to hang a man. Besides, it seems extreme. In the middle ages, if the keeper of the mint allowed monetary inflation, the king had him castrated. That seems like punishment enough.

Buffett says he is supporting Obama.

I like it!  Nice touches of sarcasm along with supporting data.  I don’t think I’m an Obama supporter, but I know that Bush has sucked - and he’s not likely to grow a pair before the election this fall.

There’s no real point to this post.  I just liked the email and wanted to share my thoughts on it. 

gk

I read a good article today in the NY Times.  Here’s the opening paragraph:

If the United States were any other country, these would surely be days of panic and austerity in Washington. With debts spiraling higher, a trade deficit exceeding $700 billion a year, and its currency plunging for years, the government would be forced to cut spending and jack up interest rates in a frantic bid to attract investment.

Very true, unfortunately the day when we’ll be forced to do just that is coming.  It might be later this year, or it may be 10 or more years away, but no one that I’m aware of has repealed the law of supply and demand.

The article mentions this, saying on page 2: Yes, foreigners have been lending alarming amounts of money to Americans, who have spent extravagantly in excess of their means, economists say. One day, balance will be restored in line with the basic laws of economics — perhaps chaotically, and probably via a substantial fall in the dollar’s value.  (emphasis mine)

If you want to know why the dollar is eventually doomed, read this:  When Americans head to the mall, backed by foreign largesse, they drive there burning gasoline made from oil pumped abroad, notably the Middle East. They drive home carrying electronics and clothing churned out in Chinese and Japanese factories. Making these goods absorbs commodities — energy from Australia and Africa; cotton from Texas and California; iron ore from Brazil and India.

That explains a lot to those unfamiliar with international finance - it even touches (in part) on why commodity prices have risen so drastically in the past few years.

Regardless of when it happens, we will eventually be forced to raise interest rates and borrow less from overseas.  Even if we eventually do that, inflation will still be rampant - it’s the only way the government can pay its’ debts. 

Inflation makes old debt cheaper to pay off, because you’re paying it off with inflated dollars.  Neat scheme (everyone from the Pharaoh’s to the Romans, to us has tried it) but it always fails.  No nation has ever inflated it’s way to prosperity.  And all paper money eventually returns to its’ intrinsic value - zero.

gk

I read an article on Business Week saying that the dollar may be at a bottom.  Huh? 

I read the entire article, but I don’t see anything that suggests we’re going to quit borrowing $1.45 billion per day - and that’s at the national level alone.  Coupled with the American consumers’ ability to live beyond their means, and we continue to spend more than we produce.  Individually, and at the city, county, state, and national levels.

 Why’s that bad?  Because someone is forking over money when you charge something on your Visa card, someone is paying when you take out a second mortgage, someone is paying when you do a no money down deal on a new car….  Where is the money coming from?

Overseas.  We (Americans) are flooding the world markets with debt instruments.  It doesn’t matter if it’s  bonds sold by the US Government, or bonds sold by Citigroup, or bonds sold by AMBAC, someone has to have the money to lend - and that someone is overseas investors.

As long as “helicopter Ben” keeps printing money, and as long as Americans overall refuse to live within their means, the dollar will continue a downward spiral.  There will be days and weeks (like the last couple of weeks) in which the dollar rises, but nothing has changed regarding the long term fundamentals.

These articles where pundits are calling a bottom in the dollar remind me of the financials since last fall.  How many times have we heard that “this is a kitchen sink” quarter?  “All the bad news is out there now” and “this is the end of the writedowns” has been said countless times by the financial press.

Here’s the bottom line:  The financials ain’t done writing off losses, and the dollar ain’t done falling. 

gk

Wow, I know the NY times is not a fan of deregulation (in any form) but they’re piling on in the past few days.  Check out this editorial calling for more federal regulation on credit cards.

As an example of why more regulation is needed, they provide an anecdote of a stupid man in Chicago.  Here’s a quote:

At a recent news briefing in Washington, a Chicago man told about what happened when he charged a $12,000 home repair bill in 2000 on a card with an introductory interest rate of 4.25 percent. Despite his steady, on-time payments, the rate is now nearly 25 percent. And despite paying at least $15,360, he said that he had only paid off about $800 of his original debt.

Despite paying at least $15,360, he’s only paid about $800 of the principal?   The only way this is possible is if he’s been paying the minimum for the past 8 years.  If that’s what he’s done, he’s a moron! 

I suppose we should look to the government to bail him out too? 

The story is all over the news tonight.  Here’s the Washington Posts’ take.  A few choice quotes:

“But he (McCain)declined to embrace the kind of government intervention for individuals and institutions favored by Clinton and Obama, arguing that “it is not the duty of government to bail out and reward those who act irresponsibly, whether they are big banks or small borrowers.”

It’s about time someone said that the government shouldn’t bail out stupid people.  However, I don’t agree with McCain on who is deserving of being bailed out.  McCain also said “We have a responsibility to take action to help those among them who are deserving homeowners.”

Many (probably most) of those facing foreclosure were never “deserving homeowners”, they were idiots who lived beyond their means, they took out interest only or adjustable rate loans, and they somehow act surprised when the bill for their overspending comes due.  See my post earlier tonight for a prime example of this.

So obviously I disagree with McCain on the details, but at least he’s saying that not everyone should be bailed out.  On the other hand, Obama and Clinton seem to be in a contest to see who can give away more taxpayer money.

The same story attributes this to Clinton: ”McCain’s plan, she said, does virtually nothing to ease the credit or housing crisis. “It seems like if the phone were ringing, he would just let it ring and ring and ring,” she said.”

Cool - the less the government does to “ease” the credit and housing “crisis” the better I feel about it.

And - in what has to be one of the most futile efforts ever - Obama today “outlined what he called a second stimulus package that would cost about $30 billion and include assistance to individuals and areas hard hit by the housing crisis.”

Idiot. The Fed loaned $38 billion today, and is approaching $500 billion in new money give aways since September.  That much money hasn’t headed off the current credit and housing problems - and the $160 billion stimulus package coming soon to a mailbox near you won’t make a dent in it either - so why would Obama think $30 billion will have any impact?

Let’s put it this way:  All three major candidates are wrong on these issues.  The only consolation is that McCain is less wrong than Obama and Clinton.  But none of them have a clue, and I don’t see any hope that they’ll get smarter before election day.

gk

Here’s another case of someone buying more house than they could afford and now they’re whining.  According to the story “She has had to take extreme measures to pay for her interest-only mortgage of $2,500 a month.”

Let’s take a second and do the math on this.  Which is something Patricia Guerrero should have done before she bought the house.

According to the article, she made $70,000 per year - great money!  I’m assuming that was her gross pay, so let’s deduct 8% for SSI and Medicare taxes, another 15% for Federal taxes, and 9.3% (!) for California income tax according to BankRate.com.

$70,000 x 8% = $5,600 in SSI and Medicare taxes.  $70,000 x 15% = 10,500 in Federal income tax, and (assuming CA allows you to deduct Federal taxes) her CA taxable income was $53,900 x 9.3% state tax = $5,012.

Add it all up, and she had about $49,000 per year in take home pay - assuming she wasn’t putting anything into a 401K or company stock, health insurance, etc.  In other words, that’s about the most she could take home under any circumstances.

$49,000 per year is $4,083 per month.  I don’t know about you, that’s pretty good money where I come from!  But anyway, the standard rule of thumb is that your house payment should be no more than 25% of your gross pay, or no more than 33% of your take home pay.  A $2500/month house payment is way above that - it’s 43% of her gross and a whopping 61% of her take home pay!

When you factor in utility bills, a car payment or two, insurance, property taxes, etc, she couldn’t afford that house when she had a job!  Although the article doesn’t mention other bills, she almost had to be ringing up credit card debt each month just to stay afloat - kinda like banks borrowing from the Fed to stay afloat, but that’s a different topic….

To top it off, she has an interest only loan, so she wasn’t making any progress in paying down her mortgage.   But I guess we’re supposed to feel sorry for her, because now she’s broke.  To be honest, she was broke before - she was simply refusing to recognize what was staring her in the face.

Sorry, I have no pity for Patricia.  She spent more than she made for too long, and now she has to face the music.  She wasn’t a home owner, she was a squatter, and that home will be auctioned off when it goes into foreclosure.  Why should we (taxpayers) pay to bail her out of her self-made mess?

gk

Reading this story on FoxNewsreminded me to post my thoughts on the growing cries for more government regulation of the mortgage and brokerage industries.  Basically, I think we need to stop the Fed interventions and roll back the regulations we have now.

That comes with a caveat though - no regulation and no intervention also implies no bailouts.  That means that Bear Stearns would have shut their doors last week. That means that Citi and JP Morgan wouldn’t be able to dip their hands into the Fed’s cookie jar to stay afloat.  That means that more home owners would be in foreclosure.  But I happen to think that those are all good things.

The trillions of dollars of CDO’s, CDS’s, and derivatives that are based on bad mortgages (and that are being propped up by the Fed’s intervention) need to reflect the losses they’re actually sustaining at some point.  You can’t carry a bad mortgage on the books as an asset at full face value forever, and the longer they delay writing off the losses, the longer it will take to sort through this mess.

Get it out there, get it over with, and move on. 

gk

As regular readers know, I think that the price of “stuff” will go up long term as the dollar continues to fall - and the dollar will continue to fall long term, as our governemnt prints more pretty green pieces of paper.   So why have commodities (gold, silver, oil, wheat, etc.) dropped so much over the past 2 days?

The short answer is that I don’t know.  How’s that for sticking my neck out? 

From what I’ve read and heard, it’s a combination of two distinct factors:

1) The market had priced in a 1% drop in interest rates, and the Fed only dropped 3/4%.  So traders think that the Fed is now hawkish on inflation.  (Yup, I think it’s weird too.)

2) The US is definitely going into a recession.  That means that demand for commodities will drop as consumers spend less. 

Of the two reason given for the drop, I’m inclined to think that #2 has more validity than #1.   Not that I think that’s a bad thing!  The US needs to spend less.  The average US consumer is in over their head with debt.  Collectively we need to stop spending more than we earn - and the same goes for the US Government.  If the dollar is to rise long term, we need to stop spending more than we make.

We need to pay off old debt and stop taking on new debt for awhile.  We need to accumulate capital so that our banks don’t have to drop their trousers and bend over for money from Sovereign Wealth Funds in order to stay in business.  A little actual capital would have prevented Bear Stearns from being bought out for $2/share.  Of course, that was us (the US) doing the “buying”, but now we’re all on the hook for $30 billion of Bear Stearns’ over-valued mortgages.

I don’t know what the next shoe to drop will be - or how the markets will react to it.  In spite of the fact that CIT Group (not to be confused with CitiGroup as I did at first!) today announced that they didn’t have any money on hand and needed to borrow $7.3 billion to stay afloat, the US stock markets all went up today.  And the commodities all dropped. 

Side note:  I like the headline on the CNN article I linked to - “CIT Borrows $7.3 Billion to Repay Debt“  I’m still trying to figure out how borrowing money to repay debt works….

Anyway, despite the news of yet another financial company having problems, the stock market shrugged it off and the DJIA soared 261 points.  XLF (an ETF that tracks all the financial stocks in the S&P 500) was up an astounding 6%!  But I think that we’ll see this sector plumet at some point as this mortgage inspired credit crisis unfolds.

Remember that very few of the ARM’s and Option ARM’s that were handed out at the peak of the housing bubble (2005 through 2007) have reset to higher rates yet.  A lot of those mortgage holders are making minimum payments on their interest only loans.  This is far from over, and I’m hanging on to my gold ETF.  I’m also buying silver when I find it cheap on eBay.

In other words, I’m using this drop in commodities as a buying opportunity.  I don’t know about oil, wheat, or corn (they depend too much on the economy) but I expect to see a big rebound in precious metals sometime soon.  And when that happens, I’m betting that the rebound in precious metals will coincide with a drop in the financials.

gk

Given the posts I made earlier tonight, I’ve been thinking that instead of just outlining the problems of today (and how much worse it’s going to get) I should talk a bit about what to do with your money to allow you to keep more if it during this downturn - or worse - of the economy.  So shooting from the hip, here are my thoughts.

1) Pay down debt.  If you’re one of the idiots who bought more house than you could afford, or who took out HELOC’s and second mortgages to “access your home equity” this doesn’t apply to you.  You’re toast.  You’re the problem.  For anyone who has a reasonable amount of debt - which I’ll arbitrarily define as totaling no more than 50% of your gross annual pay - I suggest paying it down as fast as possible.

When the shit hits the fan, you need to be able to live as long as possible on your savings.  Just imagine how much money you’d have each month if you didn’t have any payments!  If you’ve got a car payment, sell the freaking car to get rid of the debt and payments.  Buy a cheap car that runs good. Build up a small emergency fund by making minimum payments on everything and saving every dime you can.  You need at least one month’s worth of expenses saved up. 

Then (as Dave Ramsey would say) “act your wage”.  Live on less than you make so you can start paying off the debts.  Stop eating out, stop renting movies, get rid of your cable or satellite service, collect coupons, etc.  Cut your bills to a minimum and get out of debt.

2) Pile up cash.  Continue your frugal budget and save at least 6 months worth of expenses.  This money needs to be in your local FDIC insured bank in a simple savings account.  I don’t care about the interest rate - the object here is to save money, not grow it.  It needs to be easily accessible, so that means no CD’s or other investments.  This is your cushion for the dismal day when you don’t have a job.

That 6 months of expenses you save gives you time to plan, to look for a better job, to avoid despair, if and when you don’t have an income.

3) Fund your retirement.  Save at least 10% (and you’re much better off if you can save 15 or 20%) of your gross pay in an IRA.  Use your 401k at work if you have one.  Most employers have some sort of matching program, so be sure to contribute enough to get the full employer match.  Put the rest into a self funded IRA - you can open an account online with for as little as $50.  I use Scottrade and TD Ameritrade, but there are dozens of others.  Just do it!

I think a Roth IRA is best - taxes WILL be going up over the coming decades.  A Roth IRA is funded with after tax dollars, and the earnings are tax free.  That might not be much difference right now, but it will when tax rates hit 50 and 60%.  (If that seems extreme and alarmist to you, just wait.  I’ll have more to say later!)

If you’re putting in a big pile of money, be sure to spread it out among various large funds.  Be sure to include international funds (to take advantage of the tanking dollar) and I don’t think you can go wrong in the long run by putting a decent chunk (say 10%) into a gold or silver fund.  10 years from now you’ll be glad you did. 

Personally, I’d stay away from Asia, as the tightly regulated economy (and zero transparency in the numbers the governments provide) will eventually drag them down.  The China bubble may be popping now - although most “experts” say that the Chinese government will keep things propped up through the Olympic games later this year.

If you’re just starting out, pick a few good index funds and contribute each month.  You’ll be automatically dollar cost averaging, which in effect allows you to buy at a lower average price.

4)  Invest in staples.  No, not the office supply company (I don’t have an opinion on them) I mean consumer staples - the things everyone needs regardless of the economy or job situation.  This is stuff like food and clothing.  As times get tougher, people will spend as little as possible on everything - but they have to eat. 

Where’s the cheapest place to buy food and clothing?  Wal Mart.  As sales go down at the Gap, Dillards, Kroger, etc, look for them to go up at Wal Mart.  Target might be ok as well, but I think Wal Mart sales will grow faster - so the stock price should rise more over time.  McDonalds and other cheap fast food should also do better than average.

5)  Stuff.  I don’t have time to get into this in the detail it deserves right now, but “stuff” will become more valuable as the dollar is inflated away.  By stuff I mean things like farm land, apartment buildings, and rental property.  We’re nowhere near the bottom yet in the real estate market, so there’s no hurry on this one.  But in a year or two you should be able (if you’ve saved and invested) to pick up valuable property for 50 to 60% off today’s prices.

Look for property in retirement areas, such as Florida, southern California, and Arizona.  Look for farm land in Nebraska and Kansas - possibly areas of Texas and Oklahoma that receive adequate rain.  If it’s in a windy area, so much the better, as you may be able to lease small sections to energy companies for wind turbines.  It may sound crazy right now, but there will be fortunes made in wind energy over the next 20 years.  There’s too much to go into here, but Google “peak oil” sometime.  We’ll need energy, and wind is relatively cheap.

6) Tin foil hat stuff.  I don’t know what the price of gold or silver will be next month or next year.  But in my opinion, we are watching an epic devaluation of the dollar.  Until we stop spending more than we make (at the personal, local, state, and federal levels) the dollar will continue to lose value.  Conversely, things priced in dollars will continue to rise long term.  Things like gold and silver and oil.  It’ll be a bumpy ride, but 20 years from now, all of these will be much higher than they are today.

1/10 oz gold coins on eBay are going for about $100, while 1 oz silver coins are about $20.  Pick one and buy a coin or two every month.  This isn’t something to turn around for a quick profit - this is your insurance against a 1930’s type depression, or (more likely IMHO) hyperinflation like 1930’s Germany, or Argentina in the 1980’s.  We’re inflating the money supply faster than ever, and the law of supply and demand hasn’t been repealed. 

Remind me to talk more about inflation, deflation, and peak oil sometime.  It involves M3 and the huge unfunded Social Security and Medicare mandates - which are the major reasons the dollar will continue down.  Deficit?  You ain’t seen nothing yet!

gk

Pay as you go?  Spend less than you make?  Sounds like a different way of saying “act your wage” to me.   This article is in the NY Times today, and it’s been picked up by a lot of other news sources and newspapers.

Here’s another good story that ran today on TheStreet.com.

Both articles are good, and I recommend reading both of them.  Since it’s election day, I’ll probably be following the news tonight, but (as you can probably tell from my previous posts) I’m sure I’ll talk about this subject again later.  I also want to read more about the market sell off today.  Is this the capitulation that those of us on the sidelines have been waiting for?

gk

I wonder how Doug Kass is feeling about this advice he gave on Jan 14th?

http://www.thestreet.com/s/kass-katch-buy-the-financials-yes-buy/newsanalysis/investing/10398482.html

Yup, you read that right - he said to “Buy the Financials. Yes, Buy”.  Since Mr. Kass published his story on the 14th, the Financial Sector Index (XLF) is down more than 8% - and it was down 10% at one time Friday.  I may be wrong (I often am!) but I don’t think buying on the 14th would have been a good idea….

I think it’s waaay to soon to be looking at this sector.  Personally, I think we’ll see a couple of big bank failures before the financial house of cards has collapsed fully.  No, I don’t know who it will be, but I do know that you don’t make money in the long run by borrowing money (especially at today’s higher rates) to pay down debt.  Eventually you run out of willing lenders (can you say credit crunch?) and you have to face the music.

Banks and other lenders have been putting off the inevitable for quite awhile, and they may be able to postpone it a bit longer, but borrowing from Peter to pay Paul still works the same way it did 100 years ago.  It doesn’t.  Infusions of capital from the Middle East, reductions in the Fed Funds Rate, and issuing corporate bonds simply makes the eventual crash worse.

In my humble opinion, we’re heading into a very rough period for almost all asset classes, but “soft” things like made up financial assets and corporate profits (measured in the dollar) will fare much worse than “hard” assets, such as commodities.  Another 20% to 30% decline from here is not out of the question, so sell some stocks and put the proceeds into simple money market funds or commodities.  In other words, it’s time to keep your powder dry (conserve your capital) so you can afford to pick up some bargains when this train wreck is over.

gk