In light of the fall of investment banks, I wanted to give you a glimpse of how it was during their glory days.
Here's a video about investment bankers and their heated rivalry with consultants.
http://www.youtube.com/watch?v=ROlDmux7Tk4
The only investment banks left standing are Goldman Sachs and Morgan Stanley. Although there's a lot of uncertainty about their role in the future, Goldman doesn't seem very concerned. It is the only investment bank that was able to withstand the storm and actually turn in a profit for the year as whole - although it did post its FIRST ever loss this past quarter (They're the cream of the crop of investment banks recruiting all the top MBA grads from Harvard, Pennsylvania, MIT, etc). As such, Goldman is paying its employees an average of $400,000 this year.
p.s. I work in consulting now. Good thing I didn't go into banking. Although I could probably never get in anyway.
- Sean
Wednesday, December 17, 2008
Tuesday, December 16, 2008
PONZI SCHEME! …or shall we now call it MADOFF scheme
If you don’t know who Madoff is, watch these videos:
http://www.youtube.com/watch?v=oNYCw3rK1m0
http://www.youtube.com/watch?v=JOjC7zTOIJA
Bernard Madoff was a well-respected, and well-liked man that ran a giant ponzi scheme through his investment firm Bernard L. Madoff Investment Securities LLC. The scam he committed was of epic proportions - estimates right now say it was around $50-55 billion dollars in lost investments.
I think, in this day and age, for a scam this big to not get exposed is really unacceptable. There were certain due diligence groups that discovered multiple red flags regarding Madoff’s investment practices (click link to see interview about one firm that discovered some red flags). They notified the primary regulator, the Securities and Exchange Commission regarding such matters but the agency never dug deep enough to discover the truth. Also, one of the main reasons he stayed under the radar was because of his reputation and career accolades. Before becoming a money manager several decades ago, he was the chairman of the NASDAQ, the US’ electronic stock exchange. Madoff was also part of a 25-member advisory committee for the SEC itself. I guess working with the regulatory agency helped him build the rapport and trust necessary to go through with this.
How did he get exposed?
In the end, what ultimately doomed him was the financial crisis. Essentially, he ran his investment group like a hedge fund. Naturally, all investments funds were doing bad this year so a lot of people wanted to pull their money out of investments funds. (Ironically, it goes against the adage of “buy low, sell high” huh?) So when investors want to pull out money, they usually have to inform him beforehand and he has some time before he has to provide them that money. The request is called a redemption and usually hedge funds and more risky firms are given more leeway in terms of the time-frame in which they have to give the money to the investor. Ultimately, Madoff had $7 billion in redemption requests and he didn’t have enough money to meet them so he basically gave up and told his sons that it was just a big giant lie, a Ponzi scheme.
Sadly, if the financial crisis did not happen, this scam would probably not have been exposed for a while.
Surprisingly, it appears as though he ran this whole scam operation by himself. Supposedly, neither his sons, family, friends, business partners nor auditors knew about this scam. As this story unfolds, we'll find out if it was really just him.
Who is affected by this scandal?
The list of victims is growing by the minute and it includes charities, hedge funds, fund of funds (“FOFs”), banks, rich investors and regular people like you and I.
Here's a list of who is exposed and the amount they invested:
Madoff's Victims
Will they get their money back?
Madoff said he’s broke, and selling his investment firm won't begin to cover any significant part of the losses. They'll most likely go after his property and all his other assets.
Unfortunately, a lot of the victims will not get a lot of money back. In fact, the people who cashed in and got out are not out of the woods either. They are probably going to have to return the profits they earned because the profits were not really realized and were part of a fraud.
This case will be intensely disputed in the court of law for years and the most likely candidates to give up some money are the FOFs right now. The FOFs are basically mutual funds that invest in hedge funds. What makes this ridiculous is that they charge fixed fees (usually 2%) to manage the fund and they also charge performance fees (usually 10%). This is crazy because they invest in hedge funds which already charge fixed and performance fees (usually 2% and 20% respectively). Therefore, people who invest in FOFs are getting charged double. Anyway, FOFs can be held accountable if they determine that the FOFs didn’t do their due diligence before they invested in hedge funds - FOFs are held to a higher standard and are supposed to research and make sure the hedge funds they invest in are good investments.
Well, luckily, ordinary investors that don’t have billions invested in Madoff may have some hope. We have this agency called the Securities Investor Protection Corporation (“SPIC”) that will cover up to a maximum of $500,000 for each customer in this case.
So How did he do it? How did he fool people?
It all comes down to human psychology.
Excerpt from WSJ Article:
"Robert Cialdini, a psychology professor at Arizona State University and author of "Influence: Science and Practice," calls this strategy "a triple-threat combination."
The "murkiness" of a hedge fund, he says, makes investors feel that it is "the inherent domain of people who know more than we do." This uncertainty leads us to look for social proof: evidence that other people we trust have already decided to invest. And by playing up how exclusive his funds were, Mr. Madoff shifted investors' fears from the risk that they might lose money to the risk they might lose out on making money.
- Sean
http://www.youtube.com/watch?v=oNYCw3rK1m0
http://www.youtube.com/watch?v=JOjC7zTOIJA
Bernard Madoff was a well-respected, and well-liked man that ran a giant ponzi scheme through his investment firm Bernard L. Madoff Investment Securities LLC. The scam he committed was of epic proportions - estimates right now say it was around $50-55 billion dollars in lost investments.
I think, in this day and age, for a scam this big to not get exposed is really unacceptable. There were certain due diligence groups that discovered multiple red flags regarding Madoff’s investment practices (click link to see interview about one firm that discovered some red flags). They notified the primary regulator, the Securities and Exchange Commission regarding such matters but the agency never dug deep enough to discover the truth. Also, one of the main reasons he stayed under the radar was because of his reputation and career accolades. Before becoming a money manager several decades ago, he was the chairman of the NASDAQ, the US’ electronic stock exchange. Madoff was also part of a 25-member advisory committee for the SEC itself. I guess working with the regulatory agency helped him build the rapport and trust necessary to go through with this.
How did he get exposed?
In the end, what ultimately doomed him was the financial crisis. Essentially, he ran his investment group like a hedge fund. Naturally, all investments funds were doing bad this year so a lot of people wanted to pull their money out of investments funds. (Ironically, it goes against the adage of “buy low, sell high” huh?) So when investors want to pull out money, they usually have to inform him beforehand and he has some time before he has to provide them that money. The request is called a redemption and usually hedge funds and more risky firms are given more leeway in terms of the time-frame in which they have to give the money to the investor. Ultimately, Madoff had $7 billion in redemption requests and he didn’t have enough money to meet them so he basically gave up and told his sons that it was just a big giant lie, a Ponzi scheme.
Sadly, if the financial crisis did not happen, this scam would probably not have been exposed for a while.
Surprisingly, it appears as though he ran this whole scam operation by himself. Supposedly, neither his sons, family, friends, business partners nor auditors knew about this scam. As this story unfolds, we'll find out if it was really just him.
Who is affected by this scandal?
The list of victims is growing by the minute and it includes charities, hedge funds, fund of funds (“FOFs”), banks, rich investors and regular people like you and I.
Here's a list of who is exposed and the amount they invested:
Madoff's Victims
Will they get their money back?
Madoff said he’s broke, and selling his investment firm won't begin to cover any significant part of the losses. They'll most likely go after his property and all his other assets.
Unfortunately, a lot of the victims will not get a lot of money back. In fact, the people who cashed in and got out are not out of the woods either. They are probably going to have to return the profits they earned because the profits were not really realized and were part of a fraud.
This case will be intensely disputed in the court of law for years and the most likely candidates to give up some money are the FOFs right now. The FOFs are basically mutual funds that invest in hedge funds. What makes this ridiculous is that they charge fixed fees (usually 2%) to manage the fund and they also charge performance fees (usually 10%). This is crazy because they invest in hedge funds which already charge fixed and performance fees (usually 2% and 20% respectively). Therefore, people who invest in FOFs are getting charged double. Anyway, FOFs can be held accountable if they determine that the FOFs didn’t do their due diligence before they invested in hedge funds - FOFs are held to a higher standard and are supposed to research and make sure the hedge funds they invest in are good investments.
Well, luckily, ordinary investors that don’t have billions invested in Madoff may have some hope. We have this agency called the Securities Investor Protection Corporation (“SPIC”) that will cover up to a maximum of $500,000 for each customer in this case.
So How did he do it? How did he fool people?
It all comes down to human psychology.
Excerpt from WSJ Article:
"Robert Cialdini, a psychology professor at Arizona State University and author of "Influence: Science and Practice," calls this strategy "a triple-threat combination."
The "murkiness" of a hedge fund, he says, makes investors feel that it is "the inherent domain of people who know more than we do." This uncertainty leads us to look for social proof: evidence that other people we trust have already decided to invest. And by playing up how exclusive his funds were, Mr. Madoff shifted investors' fears from the risk that they might lose money to the risk they might lose out on making money.
If you did get invited in, then you were anointed a member of this particular club of "sophisticated investors." Once someone you respect went out of his way to grant you access, says Prof. Cialdini, it would seem almost an "insult" to do any further investigation. Mr. Madoff also was known to throw investors out of his funds for asking too many questions, so no one wanted to rock the boat.
This members-only feeling blinded many buyers of Mr. Madoff's funds to the numerous red flags fluttering around his operation. When you are in an exclusive private club, you do not go rummaging around in the kitchen to make sure that the health code is being followed.
Here we have the biggest dirty secret of the "sophisticated investor": Due diligence often goes undone. For a brief window in 2006, the Securities and Exchange Commission required hedge funds to file standardized disclosure forms. William Goetzmann, a finance professor at Yale School of Management, found that hedge funds disclosing legal or regulatory problems and conflicts of interest ended up with lower future performance. But the disclosure of these risks had no impact at all on how much money flowed into the hedge funds.
In other words, investors were getting useful information -- and paying no attention to it. Amaranth Advisors LLC, the commodity hedge fund that collapsed in 2006 with $6 billion in losses, did not even file the required SEC form at the beginning of that year, a clear signal that something might be wrong. Instead of standing pat or pulling money out, investors poured more money in.
Last year, the Greenwich Roundtable, a nonprofit that researches alternative investments, conducted a survey of consultants, pension plans, "family offices," funds of funds and other large investors who shop for hedge funds. It's hard to imagine a more sophisticated crowd.
Yet one out of five investors in the survey reported that they "always follow" not a formal checklist or analytical procedure, but rather "an informal process" of due diligence.
That's for sure. One out of four investors surveyed will write a check without having studied the financial statements of the fund. Nearly one in three will not always run a background check on fund managers; 6% may not even read the prospectus before ever committing money.
"Due diligence," says Stephen McMenamin of the Greenwich Roundtable, "is the art of asking good questions." It's also the art of not taking answers on faith.
If you invest with anyone who claims never to lose money, reports amazingly smooth returns, will not explain his strategy, refuses to disclose basic information or discuss potential risks, you're not sophisticated. You're an oxymoron."
- Sean
Saturday, December 13, 2008
A solution for the financial crisis
Alright, so the government has basically undergone a series of bailouts that has saved the financial sector. Yet, you may be asking yourself -- how come the economy looks just as bad, if not worse than a few months ago??
Other relevant, and good questions might be: Has the government implemented any long-term solutions? and.. Why can't we draw from prior experiences and adopt those solutions?
How come the economy looks just as bad, if not worse than a few months ago?
What the government has done so far is just help the financial sector in hopes that they'll continue ordinary business operations. Yet, they're being somewhat short-sighted and not looking at the source or origin of the issue. Bottom line, the economy is getting worse because the real estate sector is getting worse and people are not able to make their monthly payments.
Has the government implemented any long-term solutions?
No, the government hasn't really addressed the root of the problem; it has only responded by bailing out companies where the risk of failure has been greatest (ie AIG, Fannie/Freddie, Citigroup etc). None of these actions are solutions for the long-term. Put another way, they are merely bandages applied to a severe wound.
Why can't we draw from prior experiences and adopt those solutions?
Everybody compares this crisis to the Great Depression. First off, this comparison is somewhat warranted because of some similarities such as the stock market crash, large loss of consumer confidence, financial sector issues and high unemployment rate, but we shouldn't get carried away just yet. The extent of the issues I listed are not as severe as in the Great Depression and we now have policies and reforms specifically implemented during the Great Depression that have largely prevented the scenario from playing out the same way - ie Federal Deposit Insurance Corporation ("FDIC").
So with that in mind, why can't the government use prior experience, or more specifically, the Great Depression itself, to solve the current financial crisis? Well, the answer to this question is two-fold; First, Ben Bernanke is an expert on the Great Depression, and he has used his knowledge and expertise on that subject to his advantage. While this is certainly not a consensus, economists have generally attributed the length and severity of the Great Depression to the failure of the banks and the lack of money or liquidity in the economy. Ben Bernanke and the Treasury have done all they can in these areas; they have saved the banks and they have pumped a lot of money into the economy. So why hasn't it worked? Well, it may stop us from going into a depression so in that sense it will serve its purpose. But, essentially, the facts and circumstances are different this time.
Secondly, economics is an imperfect science, or what some may call a soft-science. What I mean by this is that you can't run experiments of countries and just throw in different factors (policies) to determine the net effect on the economy. The only data economists have is empirical, or from observation of past events. This is a problem, because not only are the facts and circumstances different, but our country has also only gone through 1 or 2 crises that are mildly comparable. The first was the Panic of 1893 which we don't have much data on, but our economy was a lot different so the data might be moot anyway. The second is the Great Depression. However, the issue with the Great Depression is not only that the facts are different, but that we do not really understand or know how we got out of that. There's a myth that people know for sure that Keynesian economics or large government spending brought us out of the that crisis. Others say the war and the large spending and employment during that period helped our economy recover. It may also be that the crisis was solved by time itself, but we will never know.
So we can't draw much out of the Great Depression because even if it is comparable, it is only one instance that we do not really grasp fully. (if you have one data point in statistics you know how unreliable that can be)
What is the solution?
I came upon the writings of professor Stephen Finglewsi, an NYU finance professor and his proposed solution to the financial crisis. His is the first reading I've found that I completely believe in because it makes economic sense and is very intuitive to understand; There's a clear goal and practical approach to solve the crisis.
So in his paper he provides a great analogy that I briefly referenced in my earlier post to describe the situation we have. Essentially, the financial sector troubles can be compared to what insurance companies experience with natural disasters.
So, let's say an insurance company offers insurance against hurricanes hitting homes. If hurricanes were to hit all the homes that the company provided insurance to, the company would have huge losses as it would use all its money (cash reserves) to cover the insurance policies . However, if everybody were to claim their insurance at the same time, the insurance company might not have enough cash to pay everybody so it goes into bankruptcy. At the same time, even if it were able to pay off all its claims, it would have problems running its business as it now has no money. It might have to lay off employees and it would need to raise more money to continue to issue new insurance contracts.
The same principle applies to the financial sector. Basically, they invested in the mortgages through securities and now have to bear the losses. For some companies, the losses were too much so they went into bankruptcy (see Lehman Brothers). Either that or they were bought out by another company or bailed out by the government (see AIG, Citigroup, Merrill Lynch, etc.)
The ones that could bear the losses, were crippled financially and do not have enough money to continue ordinary business. Also, they're scared that the companies they lend money to will go into bankruptcy as well so that limits business as well.
Alrite, so let's go onto what he proposes. (Sorry for the technical verbiage. It would be hard to describe in more simplistic terms)
Figlewski's plan:
The plan focuses on disconnecting the real estate sector from the financial sector: "When an electrical device catches fire, the first thing to do is to disconnect the power. The financial system is connected to the real estate sector by mortgage loans, and it is being severely damaged by the uncertainty over how many of those loans will default and how much the lenders will lose when defaults occur."
To accomplish this overarching goal he has several proposals for the Federal government to "step between the homeowner and the mortgage lender to remove the risk from the mortgage payments": (read his paper if you want to know more of the details)
Fairness: Is it fair to bailout homeowners that bought houses they could not afford and payments they could not meet? A lot of people feel the bailout of the banks was not fair, so are they willing to go along with this plan? If the government is changing the terms of the contracts, how is that fair for other homeowners?
Well, Figlewski's plan makes the government bear the immediate losses, and does not lower the total overall payment so in that sense it is fair. Plus, it would be beneficial overall to go through with this because everybody would be better off in the end.
As Figlewski's mentioned, the purview of his plan is not all encompassing - so it is not a panacea - but it ultimately stops the source of the problem and prevents our situation from getting significantly worse than it already is.
What will happen if we implement this plan? What other issues exist?
The US economy will continue to have problems after we implement this plan mainly because of US consumers and exports. Businesses need people to buy their products and services to make money. People will spend a lot less because of the economic crisis so that will keep GDP down for a while.
- Sean
Other relevant, and good questions might be: Has the government implemented any long-term solutions? and.. Why can't we draw from prior experiences and adopt those solutions?
How come the economy looks just as bad, if not worse than a few months ago?
What the government has done so far is just help the financial sector in hopes that they'll continue ordinary business operations. Yet, they're being somewhat short-sighted and not looking at the source or origin of the issue. Bottom line, the economy is getting worse because the real estate sector is getting worse and people are not able to make their monthly payments.
Has the government implemented any long-term solutions?
No, the government hasn't really addressed the root of the problem; it has only responded by bailing out companies where the risk of failure has been greatest (ie AIG, Fannie/Freddie, Citigroup etc). None of these actions are solutions for the long-term. Put another way, they are merely bandages applied to a severe wound.
Why can't we draw from prior experiences and adopt those solutions?
Everybody compares this crisis to the Great Depression. First off, this comparison is somewhat warranted because of some similarities such as the stock market crash, large loss of consumer confidence, financial sector issues and high unemployment rate, but we shouldn't get carried away just yet. The extent of the issues I listed are not as severe as in the Great Depression and we now have policies and reforms specifically implemented during the Great Depression that have largely prevented the scenario from playing out the same way - ie Federal Deposit Insurance Corporation ("FDIC").
So with that in mind, why can't the government use prior experience, or more specifically, the Great Depression itself, to solve the current financial crisis? Well, the answer to this question is two-fold; First, Ben Bernanke is an expert on the Great Depression, and he has used his knowledge and expertise on that subject to his advantage. While this is certainly not a consensus, economists have generally attributed the length and severity of the Great Depression to the failure of the banks and the lack of money or liquidity in the economy. Ben Bernanke and the Treasury have done all they can in these areas; they have saved the banks and they have pumped a lot of money into the economy. So why hasn't it worked? Well, it may stop us from going into a depression so in that sense it will serve its purpose. But, essentially, the facts and circumstances are different this time.
Secondly, economics is an imperfect science, or what some may call a soft-science. What I mean by this is that you can't run experiments of countries and just throw in different factors (policies) to determine the net effect on the economy. The only data economists have is empirical, or from observation of past events. This is a problem, because not only are the facts and circumstances different, but our country has also only gone through 1 or 2 crises that are mildly comparable. The first was the Panic of 1893 which we don't have much data on, but our economy was a lot different so the data might be moot anyway. The second is the Great Depression. However, the issue with the Great Depression is not only that the facts are different, but that we do not really understand or know how we got out of that. There's a myth that people know for sure that Keynesian economics or large government spending brought us out of the that crisis. Others say the war and the large spending and employment during that period helped our economy recover. It may also be that the crisis was solved by time itself, but we will never know.
So we can't draw much out of the Great Depression because even if it is comparable, it is only one instance that we do not really grasp fully. (if you have one data point in statistics you know how unreliable that can be)
What is the solution?
I came upon the writings of professor Stephen Finglewsi, an NYU finance professor and his proposed solution to the financial crisis. His is the first reading I've found that I completely believe in because it makes economic sense and is very intuitive to understand; There's a clear goal and practical approach to solve the crisis.
- From an Approach to a Plan: The Key is Fairness (Full paper if you're willing to read it)
So in his paper he provides a great analogy that I briefly referenced in my earlier post to describe the situation we have. Essentially, the financial sector troubles can be compared to what insurance companies experience with natural disasters.
So, let's say an insurance company offers insurance against hurricanes hitting homes. If hurricanes were to hit all the homes that the company provided insurance to, the company would have huge losses as it would use all its money (cash reserves) to cover the insurance policies . However, if everybody were to claim their insurance at the same time, the insurance company might not have enough cash to pay everybody so it goes into bankruptcy. At the same time, even if it were able to pay off all its claims, it would have problems running its business as it now has no money. It might have to lay off employees and it would need to raise more money to continue to issue new insurance contracts.
The same principle applies to the financial sector. Basically, they invested in the mortgages through securities and now have to bear the losses. For some companies, the losses were too much so they went into bankruptcy (see Lehman Brothers). Either that or they were bought out by another company or bailed out by the government (see AIG, Citigroup, Merrill Lynch, etc.)
The ones that could bear the losses, were crippled financially and do not have enough money to continue ordinary business. Also, they're scared that the companies they lend money to will go into bankruptcy as well so that limits business as well.
Alrite, so let's go onto what he proposes. (Sorry for the technical verbiage. It would be hard to describe in more simplistic terms)
Figlewski's plan:
The plan focuses on disconnecting the real estate sector from the financial sector: "When an electrical device catches fire, the first thing to do is to disconnect the power. The financial system is connected to the real estate sector by mortgage loans, and it is being severely damaged by the uncertainty over how many of those loans will default and how much the lenders will lose when defaults occur."
To accomplish this overarching goal he has several proposals for the Federal government to "step between the homeowner and the mortgage lender to remove the risk from the mortgage payments": (read his paper if you want to know more of the details)
- "Government would eliminate risk of default and prepayment by guaranteeing all mortgage payments to be made in full and as scheduled."
- The main thing we need to do is to continue the mortgage payments - whether in full or at least a significant portion of it but that's all in the details.
- Why? Because these payments are crucial for the financial sector. The ultimate investors are financial institutions and because they're losing a lot of money from these investments so they cannot perform their functions as financial intermediaries.
- We cannot re-structure or change the investment terms to make the payments less because they are very complex and have a lot of moving parts.
- The main thing we need to do is to continue the mortgage payments - whether in full or at least a significant portion of it but that's all in the details.
- "Government would work with homeowners that are at risk of default to reschedule and reorganize loan size and payments. The objective is to keep as many families in homes as possible and to avoid the costly process of foreclosure, evictions and fire sales of repossessed properties."
- "The standard mortgage has a "level pay" structure, in which the monthly payment of interest and principal is constant over the life of the loan. For example, a 30 year conventional mortgage with an interest rate of 7% calls for a monthly payment of $1330."
- "But this is a little strange. No one renting a house or an apartment would expect to pay the same rent every month for the next 30 years. Simply allowing the monthly mortgage payment to grow in the future would make it possible to lower it substantially right now. We can restructure the payment schedule and still satisfy the principle that "A deal's a deal." As long as the loan is fully paid off over its lifetime and the agreed interest rate is always paid on the outstanding principal balance, the government intermediary would be receiving the same economic value from the borrower over time that it is paying to the lender."
- "For example, rescheduling the monthly payment in the first year to be just equal to the interest on the loan, but to grow at a rate of 1.3% a year thereafter, would reduce the payment on the 7% 30-year loan by $163, to $1167 in the first year. This simple change in the pattern of mortgage payments would represent no real cost to the taxpayers at all. But it could make it easier for many homeowners to meet their mortgage obligations."
- The government could go even further and make mortgage payments even lower with higher growth rates. "For example, with a growth rate of 3% or 5% a year, the first 5 year's payments go down to $974 or $769 per month, respectively. These schedules still represent fair exchanges, in that there is no reduction of principal or interest involved. However, because the government would continue to pay $1330 a month to the lender, the homeowner would be gradually building up a debt in the early years, which would be paid off over time."
- If the homeowner cannot meet the above mentioned restructured mortgage payments, the government could convert a house to a rental unit in the interim, allowing homeowners to stay in their homes until they are financially viable.
- This would lower mortgage payments to rental payments and would give the government temporary ownership of the house.
- So the government would pay the difference between the scheduled mortgage payments and the rental payments to satisfy the ultimate investors who are dependent on those cash flows.
- There is also the issue of "upside-down" or "underwater" homeowners whereby the current market value of the house is less than the outstanding mortgage loan they have. For instance, if you took out a loan for $250,000 in 2006 for your house that was worth $300,000 at the time: but now, the house is only worth $200,000, so you have an incentive to just default because even if you sell the house, you'll only get $200,000 and you'll still owe more money.
- This is more complicated because we do not know how each person will act, but presumably, homeowners bought a house because they liked it in the first place so they would continue to make payments if they could.
- Also, there's the cost of moving out of the house and to find another place to live
- Finally, a person's credit rating goes down the tubes if they default on a home.
Fairness: Is it fair to bailout homeowners that bought houses they could not afford and payments they could not meet? A lot of people feel the bailout of the banks was not fair, so are they willing to go along with this plan? If the government is changing the terms of the contracts, how is that fair for other homeowners?
Well, Figlewski's plan makes the government bear the immediate losses, and does not lower the total overall payment so in that sense it is fair. Plus, it would be beneficial overall to go through with this because everybody would be better off in the end.
As Figlewski's mentioned, the purview of his plan is not all encompassing - so it is not a panacea - but it ultimately stops the source of the problem and prevents our situation from getting significantly worse than it already is.
What will happen if we implement this plan? What other issues exist?
The US economy will continue to have problems after we implement this plan mainly because of US consumers and exports. Businesses need people to buy their products and services to make money. People will spend a lot less because of the economic crisis so that will keep GDP down for a while.
- The unemployment rate is extremely high and will continue to rise. The unemployed will definitely cut back significantly and only stick to necessities. This is apparent.
- Unfortunately, the problem is magnified by the real estate and stock market crash. Economists have studied how price drops in both of these have decreased spending in the past. They measure this by a statistic called the Marginal Propensity to Consume (MPC).
- A MPC of 0.50 means, for every dollar drop in price, consumers will spend 50 cents less overall.
- An assistant NYU finance professor Stijn Van Nieuwebrugh shows the MPC for real estate is between 0.05 and 0.15 while the MPC for stocks is between 0.02 and 0.04.
These numbers may not seem that large, but given the crash that has occured, they will have a sizable effect on the overall economy. (read his article here) - Exports will also decrease because the dollar is strong right now, so for foreigners it costs them more now to buy goods from US companies.
- Sean
RE: bailout
I started this as a comment and then it got too long. Anyway, I have to agree with Dan and won't reiterate his points. It's reached the point where Japanese companies even make better trucks and SUVs, which is just absurd .. the whole situation is a mess.
There are good reasons for bailing out Detroit, bu doing so would require a very high level of gov control, and I don't know if we're ready.
I think there is a case to be made that not having a solid US auto industry would hurt us in terms of defense... as one congreesswoman put it, we're gonna go from dependence on foreign oil to dependence on foreign automobiles. (for a quick history lesson, search for "the arsenal of democracy".. if you're lazy, I'll give you 3 guesses as to guesses as to which company built the jeeps and tanks and planes that helped win WW2)
If we're gonna be in a war (a real war, not like Iraq), we'll need the machinery we have in detroit, not a ghost town.
what could the gov do? we could steamline the big 3 into one company auto with the best cars, and have them heavily invest in the volt (if it really exists). We could then use the rest of the machinery to rebuild our infrastructure, replace it with a green infrastructure, one of the critical things we need to do to be competitive in the next century.
I wish we were closer to the action, we'd have a better idea of who'd be getting these gov contracts...
There are good reasons for bailing out Detroit, bu doing so would require a very high level of gov control, and I don't know if we're ready.
I think there is a case to be made that not having a solid US auto industry would hurt us in terms of defense... as one congreesswoman put it, we're gonna go from dependence on foreign oil to dependence on foreign automobiles. (for a quick history lesson, search for "the arsenal of democracy".. if you're lazy, I'll give you 3 guesses as to guesses as to which company built the jeeps and tanks and planes that helped win WW2)
If we're gonna be in a war (a real war, not like Iraq), we'll need the machinery we have in detroit, not a ghost town.
what could the gov do? we could steamline the big 3 into one company auto with the best cars, and have them heavily invest in the volt (if it really exists). We could then use the rest of the machinery to rebuild our infrastructure, replace it with a green infrastructure, one of the critical things we need to do to be competitive in the next century.
I wish we were closer to the action, we'd have a better idea of who'd be getting these gov contracts...
Friday, December 12, 2008
Bailout....fails?? What?
Oops. I guess I should've learned from the original TARP bill that Congress is pretty much autonomous and does not give into political pressures.
Days after news organizations promulgated that the Auto bailout bill was going to pass, Congress, or more appropriately, the Republican party, vehemently decried the terms of the Auto bailout bill and advised the Auto companies to pursue Chapter 11 Bankruptcy (Click link to read explanation).
The Republican party is a strong proponent of free-market economics and its ideology has been severely challenged by this crisis; It took major efforts to convince them to pass the TARP in the first place. Also, given how recent events have played out -- no real tangible signs of improvement or stabilization in the economy -- the party is hesitant to dole out more cash for companies that it feels are a lost cause.
The events are interesting because it is strange how people's views have changed so quickly. America, a country built on capitalism and free-market enterprise, has resorted to socialist measures to try and and solve its issues (bailing out companies and banks). Almost everyone is also endorsing this idea as if it is our only option and because we do not want to face the consequences of what makes capitalism work in the first place - sacrifice.
Maybe a silver lining in all this is that there is still a system of checks and balance among the government and I must say, it takes a lot of guts to stand firm on your ideas when you're going against the will of the people, the treasury secretary, the president and the president elect.
Alas, the Republican party's resistance will only delay the bill because right now, the treasury secretary, Henry Paulson, is considering using some of TARP's funds for the provision of the auto bailout. If that does not come to fruition, Obama's administration will do something. However, GM has already said that they may not survive this month without the money. I guess we'll just have to wait and see what happens.
Days after news organizations promulgated that the Auto bailout bill was going to pass, Congress, or more appropriately, the Republican party, vehemently decried the terms of the Auto bailout bill and advised the Auto companies to pursue Chapter 11 Bankruptcy (Click link to read explanation).
The Republican party is a strong proponent of free-market economics and its ideology has been severely challenged by this crisis; It took major efforts to convince them to pass the TARP in the first place. Also, given how recent events have played out -- no real tangible signs of improvement or stabilization in the economy -- the party is hesitant to dole out more cash for companies that it feels are a lost cause.
The events are interesting because it is strange how people's views have changed so quickly. America, a country built on capitalism and free-market enterprise, has resorted to socialist measures to try and and solve its issues (bailing out companies and banks). Almost everyone is also endorsing this idea as if it is our only option and because we do not want to face the consequences of what makes capitalism work in the first place - sacrifice.
Maybe a silver lining in all this is that there is still a system of checks and balance among the government and I must say, it takes a lot of guts to stand firm on your ideas when you're going against the will of the people, the treasury secretary, the president and the president elect.
Alas, the Republican party's resistance will only delay the bill because right now, the treasury secretary, Henry Paulson, is considering using some of TARP's funds for the provision of the auto bailout. If that does not come to fruition, Obama's administration will do something. However, GM has already said that they may not survive this month without the money. I guess we'll just have to wait and see what happens.
Monday, December 8, 2008
Informative Podcast
I found this interesting podcast that may be helpful for all of you. It's hosted by this financial services group called Vanguard. Vanguard was started by the famous investor John Bogle. They employ a very conservative investing strategy so keep that in mind. There's a lot of podcasts on practical things like retirement, health, college saving. Check it out.
http://www.podcastdirectory.com/podcasts/17632
haha watch this video:
Bailout song for the holidays
http://www.podcastdirectory.com/podcasts/17632
haha watch this video:
Bailout song for the holidays
hollatchu!
Can it happen? IS Brian going to post two days in a row on blogger and not at all on yelp? HAHA, I'll post on yelp later. Now for a recap on today...semi-bust... on my predictions but:
DJIA did hit a high of 9026.41 (touched it) and closed at 8934.81.
NASDAQ hit a high of 1583.81 (touched it) and closed at 1571.74.
S&P500 hit a high of 918.57 (touched it) and closed at 909.7.
WHAT THE MONKEY. I SAVED 2 pictures and was going to show you guys/gal how I came up with predictions. Guess I have to tell you how. You go to finance.yahoo.com And then there's an Asia tab. I like looking at HongKong and the Japanese index. Furthermore there are Futures for each of these 3 indeces up there (right column) at http://www.bloomberg.com/. Futures means, it predicts what is going to happen the next day.
I have saved the pictures if you guys want it. Anyways this link also provided some clues as well:
http://www.bloomberg.com/apps/news?pid=20601087&sid=a89EKb15mzdc&refer=home
Also, there was news that OPEC was going to cut supply and make the price per barrel go up. The cut will happen on the meeting date (dec. 18th) I think. THey think $70 per barrel is reasonable. That would raise it back to around $3 a gallon. So be happy while it's low yeah? And rising oil means rising solar stocks and oil refinery companies.
Solar: SOL, TSL, LDK, CSIQ, CSUN, AKNS, ESLR, STP, SPWRA. STP and SPWRA have been hit hard lately, but investors like those. LDK is strong because they've had cash locked up for the next 2 years. These are all growth stocks keep in mind. A bud of mine played SOL for awhile. I played CSIQ, CSUN, and LDK before. I'm looking to hop back into LDK.
Oil Service Companies: HAL, and SLB. Hal I definitely like...Oil refinery is always a necessity, these stocks have been hit hard recently because of the falling oil price.
DJIA did hit a high of 9026.41 (touched it) and closed at 8934.81.
NASDAQ hit a high of 1583.81 (touched it) and closed at 1571.74.
S&P500 hit a high of 918.57 (touched it) and closed at 909.7.
WHAT THE MONKEY. I SAVED 2 pictures and was going to show you guys/gal how I came up with predictions. Guess I have to tell you how. You go to finance.yahoo.com And then there's an Asia tab. I like looking at HongKong and the Japanese index. Furthermore there are Futures for each of these 3 indeces up there (right column) at http://www.bloomberg.com/. Futures means, it predicts what is going to happen the next day.
I have saved the pictures if you guys want it. Anyways this link also provided some clues as well:
http://www.bloomberg.com/apps/news?pid=20601087&sid=a89EKb15mzdc&refer=home
Also, there was news that OPEC was going to cut supply and make the price per barrel go up. The cut will happen on the meeting date (dec. 18th) I think. THey think $70 per barrel is reasonable. That would raise it back to around $3 a gallon. So be happy while it's low yeah? And rising oil means rising solar stocks and oil refinery companies.
Solar: SOL, TSL, LDK, CSIQ, CSUN, AKNS, ESLR, STP, SPWRA. STP and SPWRA have been hit hard lately, but investors like those. LDK is strong because they've had cash locked up for the next 2 years. These are all growth stocks keep in mind. A bud of mine played SOL for awhile. I played CSIQ, CSUN, and LDK before. I'm looking to hop back into LDK.
Oil Service Companies: HAL, and SLB. Hal I definitely like...Oil refinery is always a necessity, these stocks have been hit hard recently because of the falling oil price.
Autobailout post-script
Well, it's pretty set in stone that the government will step in and give some money to the Big 3.
Summary of the Auto Rescue Bill
Here's a blog answering some questions about what's going to happen.
Five Questions on the Auto Bailout
WSJ also had an article about the bailout:
US, UAW might assume equity stake in automakers
Any questions or comments are welcome.
- Sean
Summary of the Auto Rescue Bill
Here's a blog answering some questions about what's going to happen.
Five Questions on the Auto Bailout
WSJ also had an article about the bailout:
US, UAW might assume equity stake in automakers
Any questions or comments are welcome.
- Sean
hello
hey guys,
thanks for letting me in. even though my knowledge of economics is limited, I look forward to contributing.
This is definitely a ballsy time to invest, but I'm sure it's also the time where there's the most money to be made.
Worse than Better
Hey guys,
Was looking at the LA Time and our newly elect Presdient stated in a press conference that the economy will continue to get worse before it gets better. This is a good and bad thing depending on where you stand in your stock choices. Today the economy is doing pretty well, but that means you can probably expect it to drop back down, especially after this news from the president. So, for you new buyers, maybe it's a good time to look into something eh?
Here is the link:
Have a great day.
P.S. Brian, nice call on the stock market today. Haha. Nice! Now tell me that GOOG will go up to $500 by the end of this week. Haha.
Sunday, December 7, 2008
Brian's BOLD Prediction
SO Brian right here, is going to take a bold step and predict the market tomorrow morning. I say: 100% guaranteed, that the market will open on the upside. Not only that, but I'm sure that Nasdaq will open higher than 1530, DJIA will open higher than 8750, and S&P 500 higher than 885.
Bolder predictions: DJIA will close above 9000 for the first time in a longgg time. Nasdaq will close above 1575, or shall I push it and say above 1600? S&P will close above 900.
I had a feeling that the bulls were back, but tomorrow will be a big statement showing that the bulls are back and the market has bottomed. I do regret not investing last week, because I was waiting to sell Citigroup and accumulate this week's paycheck. However, if I could've timed the market right, I could've used what money I had to make a trade, hold it till this week, sell, and then accumulate it. Speaking of Citigroup, I think it might break 9 tomorrow. Anyways, yeah can't regret right? Got to live in the present and keep looking forward. Anyways, everytime I think the market can't go down, it keeps going down. I'm hoping it can go down, so we all CAN invest at the bottom. As baby investors, we should hope for a bear market. : )
How did I make these predictions? Haha, techinical analysis, and a bit more. It'll be exciting. Tihs is the first time I'm putting my words on paper. We'll see how it goes. I'll come back and explain how I did this. Yes, Sean I know people always revise numbers, and putting down numbers is baloney, but I'm giving numbers NOW, and predicting where the market will end around. Let's see how I do ey? hahaha ahoy matey!
Bolder predictions: DJIA will close above 9000 for the first time in a longgg time. Nasdaq will close above 1575, or shall I push it and say above 1600? S&P will close above 900.
I had a feeling that the bulls were back, but tomorrow will be a big statement showing that the bulls are back and the market has bottomed. I do regret not investing last week, because I was waiting to sell Citigroup and accumulate this week's paycheck. However, if I could've timed the market right, I could've used what money I had to make a trade, hold it till this week, sell, and then accumulate it. Speaking of Citigroup, I think it might break 9 tomorrow. Anyways, yeah can't regret right? Got to live in the present and keep looking forward. Anyways, everytime I think the market can't go down, it keeps going down. I'm hoping it can go down, so we all CAN invest at the bottom. As baby investors, we should hope for a bear market. : )
How did I make these predictions? Haha, techinical analysis, and a bit more. It'll be exciting. Tihs is the first time I'm putting my words on paper. We'll see how it goes. I'll come back and explain how I did this. Yes, Sean I know people always revise numbers, and putting down numbers is baloney, but I'm giving numbers NOW, and predicting where the market will end around. Let's see how I do ey? hahaha ahoy matey!
Government Bailout
Hey all,
This post is somewhat of a follow-through on my previous post on the financial crisis. I hope people have read my previous post as it helps you to understand the origins of the financial crisis. This post will focus more on how the US government has responded to try and stymie a complete economic collapse. I understand that most of you will be bored out of your minds if I write an in-depth post because it will be super long. Thus, I will try to focus on the important details.
So, as you guys now know, the crisis originated from the housing market and the securitization of mortgages coupled with over-leverage (excess borrowing to make investments). (Please read my other post “financial fallout” if you don’t have a clue what I’m referring to). It’s important to understand that securitization and leverage are not a bad thing per se, as they help companies to spread risk and pursue viable investments, respectively. However, as I mentioned in the other post, it is when we take these measures to the extreme is when we expose ourselves to deep problems (As you guys all know, the idea of moderation applies to almost anything in life).
As the crisis unfolded, the US government responded in its customary slow fashion. Because they did not take serious action last year when the problem signs emerged, they have been forced to take unprecedented high-profile measures since. Here’s a synopsis of the major actions taken by the government:
Fannie Mae & Freddie Mac:
What they do: These are government sponsored enterprises (“GSEs”) that help fund mortgage loans by buying them from mortgage institutions. So, essentially, they give cash to a bank and in return they hold the mortgage loans and wait for all the payments to come in. In order to fund this operation, they package (securitize) the mortgage loans into MBS (Mortgage backed securities) that they sell in the secondary market.
What happened: As the housing market got worse, and prices continued to decline, the GSEs looked in trouble; Foreclosure and delinquency rates increased (less payments to Fannie Mae & Freddie Mac) so there was uncertainty about whether the GSEs could pay off the debt they owed their private investors. Private investors who bought MBS' from these two were guaranteed fixed payments from the entities. However, since these two companies were implicitly backed by the Government, nobody really knew if the government would step in to help pay off the debt that the GSEs owed. This concern and loss of confidence in the entities made their stock price go down drastically. Eventually, they were basically bankrupt.
Government Action: In early September, the Government rescued these two by placing them into what they call “conservatorship.” Basically, this means the government takes control of the operations of the firms, and most importantly, the US Treasury backs all the debt that the firms guarantee. Therefore, it reinstates the confidence that private investors have in the firms because it becomes an explicit rather than an implicit guarantee. The government had to bailout the GSEs because a lot of banks, foreign banks and other large influential firms were dependent on the GSEs. Had they gone bankrupt, it would have caused a huge ripple effect that would have put not only firms, but also countries in trouble.
Bear Stearns & JP Morgan:
What do these entities do: Bear Stearns and JP Morgan are investment banks – firms that sell investments such as stocks and bonds in the secondary market, as well as provide financial strategic consulting advice for mergers and acquisitions. Note: Some investment banks also do commercial banking (traditional bank function: take deposits, give out loans. Citigroup is an example). Investments banks such as Bear Sterns and JP Morgan form the storied quintessential Wall Street firms where bankers adorn $5,000 Armani suits and drive around Ferraris.
What Happened: Bear Stearns had a lot of losses related to its MBS' and eventually the losses were too significant for them to bear.
Government Action: The government felt that the collapse of Bear Stearns would be too catastrophic since it was interlinked with a lot of other big name firms. Therefore, the US government facilitated a deal whereby JP Morgan purchased Bear Stearns at 7% of its market value based on its closing stock price that day. Why sell Bear Stearns so cheap to JP Morgan? Well, the US government wanted to prevent other companies from wanting to follow Bear Stearns' path. That is, if companies knew they could sell themselves for a high price, they would give up on solving their investment problems.
Lehman Brothers:
What does this entity do: Lehman Brothers was an investment bank also.
What happened: Lehman Brothers had a lot of mortgage related investments that eventually bankrupted the company.
Government Action: The government decided not to help Lehman Brothers because they felt it wouldn’t have a drastic effect on the economy. As a result, Lehman filed for Chapter 11 bankruptcy resulting in the largest bankruptcy in US history.
The collapse of Lehman affected many companies as they invested money and lent money to Lehman. Many people believe that it was a big mistake that the US government did not step in to save Lehman. We won’t know for a while whether this is true or not. Since Lehman Brothers’ collapse, the US government has been a broker in making several merger and acquisition deals such as Bank of America’s purchase of Merrill Lynch, and Wells Fargo’s purchase of Wachovia. The banks that got acquired had a lot of mortgage write-downs related to their MBS' investments so their only choice was to sell the business.
Now, the only investment banks left on Wall Street are Goldman Sachs, and Morgan Stanley. Yet, it is not sure if their business model/structure will work in the future since a lot of their profits were derived from these credit derivatives. Both firms converted to commercial banks recently as this allows them to borrow short-term funds at the cheapest rate (the federal funds rate) from the Federal Reserve (“The Fed,” or the US Central Bank). In addition, Goldman Sachs’ desperation was further reinforced when it revealed its interest in pursuing online banking to get depository funds.
AIG:
What do this entity do: AIG is insurance company that offers traditional insurance but also decided to offer insurance in the credit derivatives market.
What Happened: AIG sold a lot of Credit Default Swaps (CDS'). CDS' if you remember are basically insurance contracts. As part of these contracts, the counterparty (insurance holder) can ask for more money (collateral) from the insurance provider (AIG in this case) if the insurance provider is downgraded (resulting from financial problems). This is exactly what happened in the case of AIG as a lot of the CDS holders asked for more money from AIG and eventually the company ran out of money. An analogous situation would be if everybody suddenly crashed their car and went to the insurance company. The company would not have enough money to cover everybody.
Government Action: The government bailed out AIG because too many people had these insurance contracts. AIG has to pay back the loan within 5 years with relatively low interest rate. The company is safe for now however.
Troubled Asset Relief Program (TARP):
This is the so-called $700 billion dollar bailout bill that Henry Paulson, US treasury secretary, and Ben Bernanke, the Fed chairman, vehemently endorsed. Initially, the money was supposed to be used to purchase “toxic assets” from the banks, basically all these risky investments that nobody wanted to buy. However, with strong opposition and outrage from the people, economists, and politicians, Henry Paulson and co. decided to make capital infusions (give banks money) into the banks. The banks that the government decided to sponsor, Goldman Sachs, Morgan Stanley, Citigroup, Wells Fargo, Bank of America, and JP Morgan are the biggest banks in the US. By giving them money, the government wanted to try and encourage banks to lend again - what the press has called “un-freezing the credit markets.” Economic indicators have shown that this process is occurring slowly but surely.
The government also ended up giving Citigroup, one of the investment banks, additional funds when the bank was in trouble. One week, investors suddenly lost confidence in Citigroup and there was basically a “run” on the bank as its stock price was plummeting. The government had no choice but to give Citigroup more money to stay alive.
The US treasury has spent about half of the $700 billion so far. Note: Had the government pursued the original plan, it would have been basically impossible to implement and would just be a drop in the bucket. The amount of these troubled assets are so large that $700 billion would not do much to shore up the banks’ balance sheets. The banks are hoping that these assets will be worth more when the housing market recovers.
Why bailout banks: Although the government would prefer not to interfere with what is happening in the markets, banks are so intertwined with the rest of the economy that they were left with no choice. Not only do they have countless investors that they owe money to, but they also are responsible for providing companies with short-term loans to cover costs. The majority of firms in the US are small firms that borrow money from banks to pay wages and operating costs to keep their businesses open. As the banks run into trouble and have less money, they refuse to lend money out to these small businesses because they need it for themselves. This causes a huge problem where businesses across the US have to go bankrupt as a result. Therefore, the US government has been trying to encourage the banks to lend out money to help business to continue.
Is their approach the best or correct way: Honestly, we do not know. What the government is doing now is not in any economics textbook. They’re basically doing everything on the fly so that’s not very reassuring. A prime example of the government’s uncertainty is the TARP and how its purpose changed. Originally, Henry Paulson and Ben Bernanke (Fed chief) said that buying the toxic assets is our only and best option. Yet, a couple weeks later they used the money not to buy the toxic assets but to give the banks capital. The truth is, Ben Bernanke and Henry Paulson do not fully grasp these mortgage securities (MBS', CDOs). The people who really understand how they work and the best way to deal with them are not the CEOs, or the people high in government, it’s the statisticians, geeks and mathematicians that are buried within the corporate firms.
It’s true that ex-ante, choosing Ben Bernanke and Henry Paulson to deal with this crisis would probably be our best option. However, in reality, things do not play out as we expect. Ben Bernanke is an expert on the Great Depression and he’s written many papers on how government could have prevented that crisis. Yet, he’s implemented all his solutions and the results are not what he expected. Henry Paulson used to be the CEO of Goldman Sachs, he understands the investment banks inside out. He should know how to get banks to lend and help the economy. Yet, despite all these problems, the economy is not as bad as everybody’s making it out to be. The Great Depression was MUCH MUCH worse.
The Big 3 Auto Companies (Ford, GM, Crystler):
I’m sure you guys have all heard about how the Big 3 have gone to Congress trying ask for money. What should Congress do? Well, in my opinion, the best option would be to let GM and Chrysler file for Chapter 11 Bankruptcy protection. However, I feel it is inevitable that the government will give them money sooner or later. If they do not grant it now, Obama will make sure they do. There’s a lot of politics at play here.
Fundamentally, the Big 3 are structurally unsound and they have a business model that does not work - too many brands, and too many SUVs and gas-guzzlers. They have a competitive disadvantage in that they are binded by the United Auto Workers (UAW) union in terms of pay scale, pension, and health costs. I feel that giving them money will only prolong the inevitable. In their plan to Congress they proposed certain measures to help cut costs by $4 billion a quarter, yet their costs are still in excess of $14 billion a quarter. You don’t need a PhD to figure out that the math does not work out. They have to file for bankruptcy so they can change those contracts and figure out a better business model. Also, the jobs that would be lost from their bankruptcy would be partially offset by the other carmakers in the industry.
What has happened globally?
Europe:
In Europe, there’s been a similar response to the US whereby a lot of banks, especially in the UK, have been given capital infusions. There has also been a fair number of bankruptcies. The European and US economy continue to be closely intertwined.
Asia:
Asia also has been greatly affected by what has been happening in the US. China’s growth rate has slowed considerably. They have mandated two economic stimulus packages to try and sustain an 8-9% growth rate.
What’s in store for the future?
Obama has done all the right things so far. He’s assembled an extremely skilled economic team comprised of both experienced economists and knowledgeable academics. (The team understands both bureaucracy and economics, because you need both to get things done in Washington). Yet, they have a tough task ahead of them and choosing the right team ex-ante does not guarantee results. Obama is planning a large stimulus plan coupled with several projects to increase jobs (he promised 2.5 million new jobs by 2011?): Obama's stimulus package
The government has also started to try and address the housing issues: US Eyes Plan To Life Home Sales. They’re lowering mortgage rates in an attempt to increase demand for houses and in turn, increasing house prices. There are still a lot of proposals floating around with respect to addressing the housing market. As we now know, stabilizing the housing market is a key to stabilizing the economy.
In the past, consumer spending was the driver of 60-70% of GDP. Now that consumer confidence is at an all-time low, consumer spending has been cut back drastically. Somehow Obama has to figure out how to get Americans to start spending their money again.
Also, exports are going to decrease substantially now because the dollar is strong (foreign investors are buying a lot of US treasuries, sold in US dollars and the closest thing to a risk-free asset, so there’s a high demand for US dollars => appreciating/strong dollar). But a shortcoming of this is that US goods are more expensive since a unit of foreign currency has less purchasing power now. This will hurt the US as well.
Well, that was a longer than expected post. I’m sorry for the lengthiness and don’t know if anybody’s going to read all of this. Haha.
- Sean
Sources:
http://knowledge.emory.edu/article.cfm?articleid=1178
http://en.wikipedia.org/wiki/Economic_crisis_of_2008
http://en.wikipedia.org/wiki/Global_financial_crisis_of_2008
http://en.wikipedia.org/wiki/Financial_crisis_of_2007-2008
http://www.nytimes.com/2008/03/16/business/16cnd-bear.html
http://online.wsj.com/article/SB122833771718976731.html?mod=article-outset-box
Good article if you want more technical in-depth reading on securitization:
http://economistsview.typepad.com/economistsview/2007/10/the-role-of-sec.html
This post is somewhat of a follow-through on my previous post on the financial crisis. I hope people have read my previous post as it helps you to understand the origins of the financial crisis. This post will focus more on how the US government has responded to try and stymie a complete economic collapse. I understand that most of you will be bored out of your minds if I write an in-depth post because it will be super long. Thus, I will try to focus on the important details.
So, as you guys now know, the crisis originated from the housing market and the securitization of mortgages coupled with over-leverage (excess borrowing to make investments). (Please read my other post “financial fallout” if you don’t have a clue what I’m referring to). It’s important to understand that securitization and leverage are not a bad thing per se, as they help companies to spread risk and pursue viable investments, respectively. However, as I mentioned in the other post, it is when we take these measures to the extreme is when we expose ourselves to deep problems (As you guys all know, the idea of moderation applies to almost anything in life).
As the crisis unfolded, the US government responded in its customary slow fashion. Because they did not take serious action last year when the problem signs emerged, they have been forced to take unprecedented high-profile measures since. Here’s a synopsis of the major actions taken by the government:
Fannie Mae & Freddie Mac:
What they do: These are government sponsored enterprises (“GSEs”) that help fund mortgage loans by buying them from mortgage institutions. So, essentially, they give cash to a bank and in return they hold the mortgage loans and wait for all the payments to come in. In order to fund this operation, they package (securitize) the mortgage loans into MBS (Mortgage backed securities) that they sell in the secondary market.
What happened: As the housing market got worse, and prices continued to decline, the GSEs looked in trouble; Foreclosure and delinquency rates increased (less payments to Fannie Mae & Freddie Mac) so there was uncertainty about whether the GSEs could pay off the debt they owed their private investors. Private investors who bought MBS' from these two were guaranteed fixed payments from the entities. However, since these two companies were implicitly backed by the Government, nobody really knew if the government would step in to help pay off the debt that the GSEs owed. This concern and loss of confidence in the entities made their stock price go down drastically. Eventually, they were basically bankrupt.
Government Action: In early September, the Government rescued these two by placing them into what they call “conservatorship.” Basically, this means the government takes control of the operations of the firms, and most importantly, the US Treasury backs all the debt that the firms guarantee. Therefore, it reinstates the confidence that private investors have in the firms because it becomes an explicit rather than an implicit guarantee. The government had to bailout the GSEs because a lot of banks, foreign banks and other large influential firms were dependent on the GSEs. Had they gone bankrupt, it would have caused a huge ripple effect that would have put not only firms, but also countries in trouble.
Bear Stearns & JP Morgan:
What do these entities do: Bear Stearns and JP Morgan are investment banks – firms that sell investments such as stocks and bonds in the secondary market, as well as provide financial strategic consulting advice for mergers and acquisitions. Note: Some investment banks also do commercial banking (traditional bank function: take deposits, give out loans. Citigroup is an example). Investments banks such as Bear Sterns and JP Morgan form the storied quintessential Wall Street firms where bankers adorn $5,000 Armani suits and drive around Ferraris.
What Happened: Bear Stearns had a lot of losses related to its MBS' and eventually the losses were too significant for them to bear.
Government Action: The government felt that the collapse of Bear Stearns would be too catastrophic since it was interlinked with a lot of other big name firms. Therefore, the US government facilitated a deal whereby JP Morgan purchased Bear Stearns at 7% of its market value based on its closing stock price that day. Why sell Bear Stearns so cheap to JP Morgan? Well, the US government wanted to prevent other companies from wanting to follow Bear Stearns' path. That is, if companies knew they could sell themselves for a high price, they would give up on solving their investment problems.
Lehman Brothers:
What does this entity do: Lehman Brothers was an investment bank also.
What happened: Lehman Brothers had a lot of mortgage related investments that eventually bankrupted the company.
Government Action: The government decided not to help Lehman Brothers because they felt it wouldn’t have a drastic effect on the economy. As a result, Lehman filed for Chapter 11 bankruptcy resulting in the largest bankruptcy in US history.
The collapse of Lehman affected many companies as they invested money and lent money to Lehman. Many people believe that it was a big mistake that the US government did not step in to save Lehman. We won’t know for a while whether this is true or not. Since Lehman Brothers’ collapse, the US government has been a broker in making several merger and acquisition deals such as Bank of America’s purchase of Merrill Lynch, and Wells Fargo’s purchase of Wachovia. The banks that got acquired had a lot of mortgage write-downs related to their MBS' investments so their only choice was to sell the business.
Now, the only investment banks left on Wall Street are Goldman Sachs, and Morgan Stanley. Yet, it is not sure if their business model/structure will work in the future since a lot of their profits were derived from these credit derivatives. Both firms converted to commercial banks recently as this allows them to borrow short-term funds at the cheapest rate (the federal funds rate) from the Federal Reserve (“The Fed,” or the US Central Bank). In addition, Goldman Sachs’ desperation was further reinforced when it revealed its interest in pursuing online banking to get depository funds.
AIG:
What do this entity do: AIG is insurance company that offers traditional insurance but also decided to offer insurance in the credit derivatives market.
What Happened: AIG sold a lot of Credit Default Swaps (CDS'). CDS' if you remember are basically insurance contracts. As part of these contracts, the counterparty (insurance holder) can ask for more money (collateral) from the insurance provider (AIG in this case) if the insurance provider is downgraded (resulting from financial problems). This is exactly what happened in the case of AIG as a lot of the CDS holders asked for more money from AIG and eventually the company ran out of money. An analogous situation would be if everybody suddenly crashed their car and went to the insurance company. The company would not have enough money to cover everybody.
Government Action: The government bailed out AIG because too many people had these insurance contracts. AIG has to pay back the loan within 5 years with relatively low interest rate. The company is safe for now however.
Troubled Asset Relief Program (TARP):
This is the so-called $700 billion dollar bailout bill that Henry Paulson, US treasury secretary, and Ben Bernanke, the Fed chairman, vehemently endorsed. Initially, the money was supposed to be used to purchase “toxic assets” from the banks, basically all these risky investments that nobody wanted to buy. However, with strong opposition and outrage from the people, economists, and politicians, Henry Paulson and co. decided to make capital infusions (give banks money) into the banks. The banks that the government decided to sponsor, Goldman Sachs, Morgan Stanley, Citigroup, Wells Fargo, Bank of America, and JP Morgan are the biggest banks in the US. By giving them money, the government wanted to try and encourage banks to lend again - what the press has called “un-freezing the credit markets.” Economic indicators have shown that this process is occurring slowly but surely.
The government also ended up giving Citigroup, one of the investment banks, additional funds when the bank was in trouble. One week, investors suddenly lost confidence in Citigroup and there was basically a “run” on the bank as its stock price was plummeting. The government had no choice but to give Citigroup more money to stay alive.
The US treasury has spent about half of the $700 billion so far. Note: Had the government pursued the original plan, it would have been basically impossible to implement and would just be a drop in the bucket. The amount of these troubled assets are so large that $700 billion would not do much to shore up the banks’ balance sheets. The banks are hoping that these assets will be worth more when the housing market recovers.
Why bailout banks: Although the government would prefer not to interfere with what is happening in the markets, banks are so intertwined with the rest of the economy that they were left with no choice. Not only do they have countless investors that they owe money to, but they also are responsible for providing companies with short-term loans to cover costs. The majority of firms in the US are small firms that borrow money from banks to pay wages and operating costs to keep their businesses open. As the banks run into trouble and have less money, they refuse to lend money out to these small businesses because they need it for themselves. This causes a huge problem where businesses across the US have to go bankrupt as a result. Therefore, the US government has been trying to encourage the banks to lend out money to help business to continue.
Is their approach the best or correct way: Honestly, we do not know. What the government is doing now is not in any economics textbook. They’re basically doing everything on the fly so that’s not very reassuring. A prime example of the government’s uncertainty is the TARP and how its purpose changed. Originally, Henry Paulson and Ben Bernanke (Fed chief) said that buying the toxic assets is our only and best option. Yet, a couple weeks later they used the money not to buy the toxic assets but to give the banks capital. The truth is, Ben Bernanke and Henry Paulson do not fully grasp these mortgage securities (MBS', CDOs). The people who really understand how they work and the best way to deal with them are not the CEOs, or the people high in government, it’s the statisticians, geeks and mathematicians that are buried within the corporate firms.
It’s true that ex-ante, choosing Ben Bernanke and Henry Paulson to deal with this crisis would probably be our best option. However, in reality, things do not play out as we expect. Ben Bernanke is an expert on the Great Depression and he’s written many papers on how government could have prevented that crisis. Yet, he’s implemented all his solutions and the results are not what he expected. Henry Paulson used to be the CEO of Goldman Sachs, he understands the investment banks inside out. He should know how to get banks to lend and help the economy. Yet, despite all these problems, the economy is not as bad as everybody’s making it out to be. The Great Depression was MUCH MUCH worse.
The Big 3 Auto Companies (Ford, GM, Crystler):
I’m sure you guys have all heard about how the Big 3 have gone to Congress trying ask for money. What should Congress do? Well, in my opinion, the best option would be to let GM and Chrysler file for Chapter 11 Bankruptcy protection. However, I feel it is inevitable that the government will give them money sooner or later. If they do not grant it now, Obama will make sure they do. There’s a lot of politics at play here.
Fundamentally, the Big 3 are structurally unsound and they have a business model that does not work - too many brands, and too many SUVs and gas-guzzlers. They have a competitive disadvantage in that they are binded by the United Auto Workers (UAW) union in terms of pay scale, pension, and health costs. I feel that giving them money will only prolong the inevitable. In their plan to Congress they proposed certain measures to help cut costs by $4 billion a quarter, yet their costs are still in excess of $14 billion a quarter. You don’t need a PhD to figure out that the math does not work out. They have to file for bankruptcy so they can change those contracts and figure out a better business model. Also, the jobs that would be lost from their bankruptcy would be partially offset by the other carmakers in the industry.
What has happened globally?
Europe:
In Europe, there’s been a similar response to the US whereby a lot of banks, especially in the UK, have been given capital infusions. There has also been a fair number of bankruptcies. The European and US economy continue to be closely intertwined.
Asia:
Asia also has been greatly affected by what has been happening in the US. China’s growth rate has slowed considerably. They have mandated two economic stimulus packages to try and sustain an 8-9% growth rate.
What’s in store for the future?
Obama has done all the right things so far. He’s assembled an extremely skilled economic team comprised of both experienced economists and knowledgeable academics. (The team understands both bureaucracy and economics, because you need both to get things done in Washington). Yet, they have a tough task ahead of them and choosing the right team ex-ante does not guarantee results. Obama is planning a large stimulus plan coupled with several projects to increase jobs (he promised 2.5 million new jobs by 2011?): Obama's stimulus package
The government has also started to try and address the housing issues: US Eyes Plan To Life Home Sales. They’re lowering mortgage rates in an attempt to increase demand for houses and in turn, increasing house prices. There are still a lot of proposals floating around with respect to addressing the housing market. As we now know, stabilizing the housing market is a key to stabilizing the economy.
In the past, consumer spending was the driver of 60-70% of GDP. Now that consumer confidence is at an all-time low, consumer spending has been cut back drastically. Somehow Obama has to figure out how to get Americans to start spending their money again.
Also, exports are going to decrease substantially now because the dollar is strong (foreign investors are buying a lot of US treasuries, sold in US dollars and the closest thing to a risk-free asset, so there’s a high demand for US dollars => appreciating/strong dollar). But a shortcoming of this is that US goods are more expensive since a unit of foreign currency has less purchasing power now. This will hurt the US as well.
Well, that was a longer than expected post. I’m sorry for the lengthiness and don’t know if anybody’s going to read all of this. Haha.
- Sean
Sources:
http://knowledge.emory.edu/article.cfm?articleid=1178
http://en.wikipedia.org/wiki/Economic_crisis_of_2008
http://en.wikipedia.org/wiki/Global_financial_crisis_of_2008
http://en.wikipedia.org/wiki/Financial_crisis_of_2007-2008
http://www.nytimes.com/2008/03/16/business/16cnd-bear.html
http://online.wsj.com/article/SB122833771718976731.html?mod=article-outset-box
Good article if you want more technical in-depth reading on securitization:
http://economistsview.typepad.com/economistsview/2007/10/the-role-of-sec.html
Saturday, December 6, 2008
KIVA
Well, after much thinking and researching. I think I'm going to be a part of KIVA. Looks great! It's cool because you can even start your own team or group and people can join it. So if we had one called like Compass '08 or something, we can join it and stuff. Just thought it was cool. Thanks again Dan.
Scottrade
Just to help up my good buddy, Brian-
Scottrade charges $7.00 dollars per purchase, and within the 6 years that I've used them they have never had their site down. So I don't think they are unreliable at all. (ahem, Brian) However, they do require that you do put a minimum of $500 in your account within the first 90 days of you opening an account. Transfering money doesn't cost anything either if you use Direct Money Deposit. I personally think it's a great place to start if you guys want something basic and cost effective. If you have any other questions, let me know.
...and Brian, imma slap you when i see you. Cappin' on my Broker like that. Psh! Haha.
Which Brokerage Should I Go To?
I got 3 for you all.
Charles Schwab (SCHW): I think commission per trade (sell or buy) runs anywhere from...hold on I just checked the site. WHAT $12.95 a trade and no trade miniumum (this means some brokerages want you to trade certain number of times a year because each trade is so cheap). IT USED to be $29.95. Here's the website: http://www.schwab.com/public/schwab/home/fees_commissions?cmsid=P-986345&lvl1=home&lvl2=fees_commissions
http://finance.yahoo.com/q?s=schw (stock quote for all you lazies : )
Scottrade: LAMEEE scottrade's website is down, I'll revise this later. (Thus less reliable)
E*Trade (ETFC): If you own more than $50,000 or trade more than 30 times a quarter, it is $6.99-$9.99 per trade here. Otherwise, it is $12.99. Here's the website: https://us.etrade.com/e/t/pricingandrates/commissions
http://finance.yahoo.com/q?s=etfc (stock quote for all you lazies : )
Wow, I can't believe Charles Schwab is so low now. I definitely recommend Charles Schwab because it has a smaller chance of going under than, E*Trade or Scottrade. Back during the dot-com bust, E*Trade almost went under.
WHAT I SUPER RECOMMEND ALL OF YOU IS TO START clicking on the past pages and reading the past blogs. They're ALLL pretty important, some are helpful for just the basics, stock quotes, and ground zeroes! And post how you feel too, prayer too. : )
Charles Schwab (SCHW): I think commission per trade (sell or buy) runs anywhere from...hold on I just checked the site. WHAT $12.95 a trade and no trade miniumum (this means some brokerages want you to trade certain number of times a year because each trade is so cheap). IT USED to be $29.95. Here's the website: http://www.schwab.com/public/schwab/home/fees_commissions?cmsid=P-986345&lvl1=home&lvl2=fees_commissions
http://finance.yahoo.com/q?s=schw (stock quote for all you lazies : )
Scottrade: LAMEEE scottrade's website is down, I'll revise this later. (Thus less reliable)
E*Trade (ETFC): If you own more than $50,000 or trade more than 30 times a quarter, it is $6.99-$9.99 per trade here. Otherwise, it is $12.99. Here's the website: https://us.etrade.com/e/t/pricingandrates/commissions
http://finance.yahoo.com/q?s=etfc (stock quote for all you lazies : )
Wow, I can't believe Charles Schwab is so low now. I definitely recommend Charles Schwab because it has a smaller chance of going under than, E*Trade or Scottrade. Back during the dot-com bust, E*Trade almost went under.
WHAT I SUPER RECOMMEND ALL OF YOU IS TO START clicking on the past pages and reading the past blogs. They're ALLL pretty important, some are helpful for just the basics, stock quotes, and ground zeroes! And post how you feel too, prayer too. : )
Friday, December 5, 2008
Microloans and Microentrepreneurs
I've recently been introduced to another opportunity to give to the poor and help underdeveloped communities... though with a small little twist-- you get your money back. The idea is that there are entrepreneurs in developing nations that are intelligent and hard working, but they don't have the capital nor the collatoral and credit history to obtain loans from local financial institutions to startup their own businesses. Even if these peopole are able to obtain local loans (often from loan sharks), the loaners often charge high interest rates putting families precariously into debt should unfortunate and unexpected circumstances arise.
The idea of a microloan is that "investors" loan small amounts of money (anywhere from $25-$1000) to individuals in developing nations who have been screened by "field partners"-- organizations in the local communities that work to help educate the people (in how to manage their finances and start a business), screen entrepreneurs and distribute/collect the money. Loans are paid back after a certain period of time (sometimes with a small interest) and the investor is able to loan the money again to another entrepreneur or withdraw the money.
After a quick google and wiki search-- I found 2 organizations that I was interested in both helping facilitate transactions between investors and entrepreneurs over the internet.
The first and probably most prominent organization is called Kiva which spearheaded the microloans movement on the internet in 2005. Kiva is very transparent in how it operates (it even provides short bios to all it's leaders) and is probably the most extensive of all the microloans organizations with entrepreneurs all over the world. There are about a thousand potential entrepreneurs on the website and you can read through all their biographies and see their pictures.
The other organization I looked into briefly is called "Rang De." This organization is much smaller, newer and based only in India. The point of interest that drew me to the organization was that they promised a return of 3.5% at the end of your social investment.
I haven't had an opportunity to invest myself in either of the organizations (though I plan to), however I read that involvement with the entrepreneurs doesn't just end after you hand over the money. Often there are newsletters from the entrepreneurs and updates on how their business is going and they are held accountable to how their money is being put to use.
This form of charitable giving is certainly very attractive in that it is very clear where every doller that is contributed is going and how it is helping lives. Not that I doubt the honesty and validaty of World Vision and where they put my money-- but through microloans I have a much more complete story of how I am contributing. Additionally, it's also neat that at the end of the partnership, you walk away not just with the knowledge that you've helped an individual and family, but the opportunity to do it again.
The idea of a microloan is that "investors" loan small amounts of money (anywhere from $25-$1000) to individuals in developing nations who have been screened by "field partners"-- organizations in the local communities that work to help educate the people (in how to manage their finances and start a business), screen entrepreneurs and distribute/collect the money. Loans are paid back after a certain period of time (sometimes with a small interest) and the investor is able to loan the money again to another entrepreneur or withdraw the money.
After a quick google and wiki search-- I found 2 organizations that I was interested in both helping facilitate transactions between investors and entrepreneurs over the internet.
The first and probably most prominent organization is called Kiva which spearheaded the microloans movement on the internet in 2005. Kiva is very transparent in how it operates (it even provides short bios to all it's leaders) and is probably the most extensive of all the microloans organizations with entrepreneurs all over the world. There are about a thousand potential entrepreneurs on the website and you can read through all their biographies and see their pictures.
The other organization I looked into briefly is called "Rang De." This organization is much smaller, newer and based only in India. The point of interest that drew me to the organization was that they promised a return of 3.5% at the end of your social investment.
I haven't had an opportunity to invest myself in either of the organizations (though I plan to), however I read that involvement with the entrepreneurs doesn't just end after you hand over the money. Often there are newsletters from the entrepreneurs and updates on how their business is going and they are held accountable to how their money is being put to use.
This form of charitable giving is certainly very attractive in that it is very clear where every doller that is contributed is going and how it is helping lives. Not that I doubt the honesty and validaty of World Vision and where they put my money-- but through microloans I have a much more complete story of how I am contributing. Additionally, it's also neat that at the end of the partnership, you walk away not just with the knowledge that you've helped an individual and family, but the opportunity to do it again.
Thursday, December 4, 2008
You guys too!
Just to remind you guys, if you guys have any concerns or requests, please let me know as well. However, don't expect too much, because Im no HTML genius. Also, at the same time, I don't want to make this Blog too much of a hassle to use. So finding that balance is key. So let me know as I continue to tweak this cyber world of ours. Thanks.
Ah yes, and I'm still working on the title page, im trying to give it a more personal touch. So don't mind the fact that it's huge and off centered. It will be fixed.
Blog reformatting
Thanks Alfred for making those changes. Hmm, we should try to find a way to also make it so that each post is categorized into its respective label. For instance, "investments," "stocks," "retirement," etc. Because right now, they're archived, but only by date and title.
By the way, here's how you create a label for your post:
By the way, here's how you create a label for your post:
- when you create a new post, in the bottom right hand corner, there's a box callled: "Labels for this post: e.g. scooters, vacation, fall." Within that box is where you put your labels.
- For those of you who have already made posts. Could you please go back and add labels to your posts so they'll be archived.
- To edit a post you can either go to blogger.com/blogspot.com and log in, which will show you all the blogs you're subscribed to and has tabs to edit your posts. If you click on "edit posts" it'll take you to the "Dashboard" where you view the most recent posts, other people's comments, drafts that people are writing, etc. Note: Only you can edit and delete your own posts.
Wednesday, December 3, 2008
Archives and Histories
I got your instant message Sean. Is something like this ok? That way we can refer back to old posts. Make sure you guys give them a title so we know where to look for future reference. Thanks!
Tuesday, December 2, 2008
Job Searching
Hey guys,
The economy is performing badly and companies are on a hiring freeze. The job market picture is getting worse and is not likely to improve in the near future. Here are some articles I found that may be useful in the job searching process:
Click here: For the Jobless, Websites Offer More Options
Click here: How To Handle a Low Job Offer You Can't Afford
Click here: "Where'd My Job Go?"
And remember, as brothers and sisters in Christ, we can continue to pray for each other and encourage one another. If you guys need prayer in this respect, please inform us and we would gladly help.
- Sean
The economy is performing badly and companies are on a hiring freeze. The job market picture is getting worse and is not likely to improve in the near future. Here are some articles I found that may be useful in the job searching process:
Click here: For the Jobless, Websites Offer More Options
Click here: How To Handle a Low Job Offer You Can't Afford
Click here: "Where'd My Job Go?"
And remember, as brothers and sisters in Christ, we can continue to pray for each other and encourage one another. If you guys need prayer in this respect, please inform us and we would gladly help.
- Sean
Investing in real estate a sure bet? Maybe not.
Everybody wants to buy a house eventually. While the time-frame to achieve this goal may differ for each and every one of us, we all hope to settle down one day. We may want to buy a house for social or economic reasons or both. Despite your motivation, it is imperative that we understand how real estate works as an investment and the returns it offers. When the time comes, it will be a significant decision that will most likely tie down most of your money; thus, we need to have a realistic and accurate understanding of how house prices will change.
Since the 1990s, house prices have increased at a staggering rate. As such, people have created this notion that owning a house is a tremendous investment -- many individuals even go so far as to say that real estate is the best investment out there. Is that really true?
I discovered an article released today (2 December, 2008) that discusses this very topic.
Click here: The Future for Home Prices
After reading that article, it seems as though ordinary people's perception of real estate contrasts with what credible economists believe. While the economists that made predictions in 1989 were incorrect about the trend of house prices in the last 20 years, we must concede that house prices were severely overpriced, leading to the real estate bubble that burst in 2005. Why it happened and what exactly transpired is another subject entirely. I won't go into that.
This post was written not to discourage you from buying a house. I am merely trying to provide you with the facts and discussions that will help you to make an informed decision when the time comes. There are many benefits to owning a house beyond its appreciation in value and I hope those are more important factors for you.
Comments and questions are welcome.
- Sean
P.S. It might not be a good idea to buy a house near the Hayward Fault in the near future btw.
Click here: America's 'most dangerous fault'
Since the 1990s, house prices have increased at a staggering rate. As such, people have created this notion that owning a house is a tremendous investment -- many individuals even go so far as to say that real estate is the best investment out there. Is that really true?
I discovered an article released today (2 December, 2008) that discusses this very topic.
Click here: The Future for Home Prices
After reading that article, it seems as though ordinary people's perception of real estate contrasts with what credible economists believe. While the economists that made predictions in 1989 were incorrect about the trend of house prices in the last 20 years, we must concede that house prices were severely overpriced, leading to the real estate bubble that burst in 2005. Why it happened and what exactly transpired is another subject entirely. I won't go into that.
This post was written not to discourage you from buying a house. I am merely trying to provide you with the facts and discussions that will help you to make an informed decision when the time comes. There are many benefits to owning a house beyond its appreciation in value and I hope those are more important factors for you.
Comments and questions are welcome.
- Sean
P.S. It might not be a good idea to buy a house near the Hayward Fault in the near future btw.
Click here: America's 'most dangerous fault'
Retirement Savings
So another question for you guys about personal finances:
401k or RothIRA or both?
Currently, I only have a 401k account because MIT matches up to 5% of my pretax income in contributions to my 401k account as part of my retirement benefits. What that means is that if my income is $100, and i put away 5% ($5) of that into my 401k then MIT will also give me another $5 (sort of like free money! yay!)-- I'm pretty sure most private companies match much more. Currently, I'm only contributing the minimum amount (5%) to earn the matching benefit from MIT.
I read somewhere that younger employees should be putting money away into their RothIRAs due to something about being taxed now (rather than later when we're in higher tax brackets). Take note that when you withdraw from your 401k, you will pay taxes on it according to the tax bracket you're currently in-- while with the RothIRA, you've already payed the taxes before you put it into your account. The other thing about the RothIRA is that you can only contribute a certain amount each year (I believe currently it's $6000)-- so the earlier you start contributing, the better.
Another question about the 401k-- how do you even begin to choose which investments you want to put your 401k contributions into? Thusfar I've just pretty arbitrarily chosen 2 "FID Diversified INTL" and "AIM MIDCAP CORE EQ A" whatever those are. I'm not even sure how to begin learning how to research them.
-------------------------------------------------------
As requested by Bcheng-- I'm adding my comment to the main post:
-------------------------------------------------
To say that the RothIRA is tax free is not exactly true.
The money that you contribute to your RothIRA is already taxed (income taxes) before you put it into the account. It's true that the earnings you make on the RothIRA are not taxed-- so when you withdraw it you get all of it.
Contributions towards your 401K are not taxed before they enter the account. In fact, your 401k contribution is completely deducted from your taxable income.
In essence-- if you were to put the same percentage money into both your 401k and RothIRA-- your principal for the 401K would be higher. However, you will be taxed on the withdrawings of your 401k.
In the end, since we will be moving into higher tax brackets before retirement-- paying the taxes on the RothIRA now would be the best idea. For older folks who don't anticipate moving up in tax brackets-- it'd be better for them to contribute to their 401k since their principal would be higher.
401k or RothIRA or both?
Currently, I only have a 401k account because MIT matches up to 5% of my pretax income in contributions to my 401k account as part of my retirement benefits. What that means is that if my income is $100, and i put away 5% ($5) of that into my 401k then MIT will also give me another $5 (sort of like free money! yay!)-- I'm pretty sure most private companies match much more. Currently, I'm only contributing the minimum amount (5%) to earn the matching benefit from MIT.
I read somewhere that younger employees should be putting money away into their RothIRAs due to something about being taxed now (rather than later when we're in higher tax brackets). Take note that when you withdraw from your 401k, you will pay taxes on it according to the tax bracket you're currently in-- while with the RothIRA, you've already payed the taxes before you put it into your account. The other thing about the RothIRA is that you can only contribute a certain amount each year (I believe currently it's $6000)-- so the earlier you start contributing, the better.
Another question about the 401k-- how do you even begin to choose which investments you want to put your 401k contributions into? Thusfar I've just pretty arbitrarily chosen 2 "FID Diversified INTL" and "AIM MIDCAP CORE EQ A" whatever those are. I'm not even sure how to begin learning how to research them.
-------------------------------------------------------
As requested by Bcheng-- I'm adding my comment to the main post:
-------------------------------------------------
To say that the RothIRA is tax free is not exactly true.
The money that you contribute to your RothIRA is already taxed (income taxes) before you put it into the account. It's true that the earnings you make on the RothIRA are not taxed-- so when you withdraw it you get all of it.
Contributions towards your 401K are not taxed before they enter the account. In fact, your 401k contribution is completely deducted from your taxable income.
In essence-- if you were to put the same percentage money into both your 401k and RothIRA-- your principal for the 401K would be higher. However, you will be taxed on the withdrawings of your 401k.
In the end, since we will be moving into higher tax brackets before retirement-- paying the taxes on the RothIRA now would be the best idea. For older folks who don't anticipate moving up in tax brackets-- it'd be better for them to contribute to their 401k since their principal would be higher.
Response to Dan
Hey Dan,
First of all, when it comes to responding to posts, I don't know what would be easier: Responding with an entirely new post? Or Responding in the comments section? I'll post in both and see which one is more convient. Cause if we all respond with an new post it would end up pushing your original post out of sight. Anyways...
I have my checking and savings account with BofA. However, I decided to open JUST a savings a account with Capital One Online Banking. There is no extra fee, it's very easy to sign up, and their interest rate starts at 2.79%, I believe, and goes up with the amount of money saved. I believe at $5k saved it jumps to 3.99%. It's pretty decent and you can automatically transfer funds, free of charge, between your current bank and Capital One. I'd check it out just to see if it's something for you. They will give you the breakdown of the interest rates and such as well before you sign up.
It's been working well for me so far, and whenever I need cash I just transfer it back to my regular checking account. Those are my two cents. Hope it helps. And stay warm in Boston. Cheers.
Where's your money?
So now that I'm earning a paycheck (whatever a pittance it might be) I'm looking around for somewhere to keep my money. In the past, I've just had a Wamu (Washington Mutual) account however the interest rate for their checking and savings accounts are extremely low-- 0% and 0.08% respectively. I've never had enough money in my accounts combined (usually less than $1000) for the interest rate to really matter-- however the readily available ATMs and free checks from Wamu were definitely beneficial through college.
Now that I'm in Boston however, Wamu doesn't have any branches out here so I have no ATMs (I usually obtain cash by getting cash back at grocery stores or else paying for people meals with my card and having them pay me back in cash). I also anticipate having a significantly greater amount of money that the interest rate begins matter. I've looked into a couple different banks including Citibank, HSBC and IgoBanking. Each bank offers at least 3% interest rate on their online savings accounts-- and sometimes for their checking accounts. Citi would have been ideal for me because they have many ATMs available here in Boston. If I applied with HSBC and IgoBanking though, I would have had to do most of my banking online (although I've basically been doing that presently anyhow).
The challenge I face now however is that as a new graduate with little established credit, working at a new job and the fact that I don't have any loans out, don't pay utilities nor phone bills (our house doesn't even have a land line) I'm having a lot of trouble even just opening an account. I tried applying at Citi, and jumped through all their initial hoops in proving my residence with a paper statement from Wamu (which set me back $5 because I had to request one from wamu since they don't send me paper statements usually and Citi didn't accept a printed copy of the online statement) and all the other basic stuff. However, now they want a letter from my employer, utility and phone bills (which I don't have) and multiple pay stubs from the last 60 days (except I'm paid on a monthly basis-- not biweekly so I only have 2). They also keep asking for my land line number (not cell phone) which we don't have. I've called Citi and waited many minutes to talk to heavily accented phone representatives who don't seem to understand how I can't have a land line and utilities bills. In essence I'm completely fed up with the process and exploring other options.
I may end up opening a checking account at the local Citibank in person and opening a savings account at another institution (does anyone know if it'll be an issue transferring funds from one bank to another?). I'm also now considering just opening an account at the MIT Credit Union since it'd be much simpler since I'm already an employee here-- however the interest rate is not as nice as the online accounts (around 1% rather than 3%).
So my question to you guys-- What banks do you guys have accounts in? Have you had any similar challenges opening an account (like the ones I currently face)? Do you have various accounts (perhaps at various banks) for various functions (Emergency stash, short term investments, online accounts, money market account, CDs)? What sort of interest rates do you get? What was the decision process for you to open an account at that bank?
Now that I'm in Boston however, Wamu doesn't have any branches out here so I have no ATMs (I usually obtain cash by getting cash back at grocery stores or else paying for people meals with my card and having them pay me back in cash). I also anticipate having a significantly greater amount of money that the interest rate begins matter. I've looked into a couple different banks including Citibank, HSBC and IgoBanking. Each bank offers at least 3% interest rate on their online savings accounts-- and sometimes for their checking accounts. Citi would have been ideal for me because they have many ATMs available here in Boston. If I applied with HSBC and IgoBanking though, I would have had to do most of my banking online (although I've basically been doing that presently anyhow).
The challenge I face now however is that as a new graduate with little established credit, working at a new job and the fact that I don't have any loans out, don't pay utilities nor phone bills (our house doesn't even have a land line) I'm having a lot of trouble even just opening an account. I tried applying at Citi, and jumped through all their initial hoops in proving my residence with a paper statement from Wamu (which set me back $5 because I had to request one from wamu since they don't send me paper statements usually and Citi didn't accept a printed copy of the online statement) and all the other basic stuff. However, now they want a letter from my employer, utility and phone bills (which I don't have) and multiple pay stubs from the last 60 days (except I'm paid on a monthly basis-- not biweekly so I only have 2). They also keep asking for my land line number (not cell phone) which we don't have. I've called Citi and waited many minutes to talk to heavily accented phone representatives who don't seem to understand how I can't have a land line and utilities bills. In essence I'm completely fed up with the process and exploring other options.
I may end up opening a checking account at the local Citibank in person and opening a savings account at another institution (does anyone know if it'll be an issue transferring funds from one bank to another?). I'm also now considering just opening an account at the MIT Credit Union since it'd be much simpler since I'm already an employee here-- however the interest rate is not as nice as the online accounts (around 1% rather than 3%).
So my question to you guys-- What banks do you guys have accounts in? Have you had any similar challenges opening an account (like the ones I currently face)? Do you have various accounts (perhaps at various banks) for various functions (Emergency stash, short term investments, online accounts, money market account, CDs)? What sort of interest rates do you get? What was the decision process for you to open an account at that bank?
Monday, December 1, 2008
DROPPED! But no worries...
OH crazy babies!!
Whole stock Market dropped today. But no worries, now is a good time to see if there is anything you want to buy. As for those of us who are losing money, NO WORRIES! Things will turn out ok. I know you guys know that already, but yea, just a reminder. Thanks again Sean for the information. It's a nice crash course.
And to all you new authors. You can post stuff whenever you want. Don't just sit there, ok? Haha. Cheers.
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