Payback Time for Banks

By John F. Wasik (Reuters)

It’s time for banks to pay back their debt to the rest of us

The deficit dance has been a convenient distraction for big U.S. banks. They’ve not only escaped new taxes for now, but they also are relishing their taxpayer bailout by earning robust profits.

Except for Bank of America, the major U.S. banks are doing just fine, thank you. Yet for all of the abundant generosity and forgiveness of the American people, have banks lent out enough money to Americans to make a difference to the economy at large?

No. Banks are lending less to consumers than they did in 2007, the year before the full-blown financial meltdown, according to recent Federal Reserve Consumer Credit tallies.

Outstanding consumer credit was $2.5 trillion in 2007 compared to $2.4 trillion through May of this year. Revolving credit was down fivemo percent in the first quarter of this year. Total consumer lending was down about $100 billion in 2010 and 2009 alone from 2007 levels.

The net effect was less money flowing to consumers, who are the engine of the U.S. economy. Even if you wanted to build that addition to your home or buy a foreclosed home, good luck getting a large loan from a bank — unless you have perfect credit ratings.

Banks’ bowstring-tight standards for mortgages and home-equity loans triggered the lending squeeze. The Fed’s July 13 Monetary Policy report told the story:

“Mortgage originations trailed off with the end of the refinancing wave that occurred last fall, when interest rates declined … Bank lending through home equity lines also remained extraordinarily weak, reflecting in part tight lending standards amid declines in home prices that cut further into home equity. Both credit card and other consumer loans from banks contracted, on balance, over the first half of the year.”

For taxpayers, the bailout begun in 2008 worked as a mega-banking stimulus unrivaled in history. The largest banks were saved and became bigger. Their trading profits and brokerage operations were protected. Then they were able to pour their taxpayer-enabled profits into lobbying against the needed financial reforms of the Dodd-Frank law. Undaunted, banks are still free to lend out money to credit card holders for 14 percent or more.

In the economy at large, though, layoffs continue, the housing market is still in intensive care and the Federal Reserve’s stimulus plan is a bust.

Despite their soaring profits, megabanks still owe U.S. taxpayers money from the bailout. A new study of released by the Center for Media and Democracy shows that $1.5 trillion of the $4.8 trillion in federal bailout loans are still outstanding.

An even bigger boondoggle is the government’s effective nationalization of the U.S. home mortgage market. Through the purchase of mortgage backed securities and debt from government-seized Fannie Mae and Freddie Mac, the Fed has supported the moribund housing market.

The Obama Administration has yet to put forward a plan to resolve its ownership and continued funding of Fannie and Freddie, two fiscal black holes. Meanwhile, homeowners are still getting foreclosed upon with no end in sight.

“The Federal Reserve and the Treasury have spent $1.6 trillion in a bank-shot to save the housing market by using the same financial companies that got us into this mess,” said Conor Kenny, lead author of the Center study. “That’s more than 800 times what they’ve spent directly to keep homeowners in their houses, and the banks have only made money off the whole thing.”

For American taxpayers, the social return on the bailout has been dismal. Bank foreclosures have resumed their rise. So-called “robo-signing” abuses in home purchases where mortgages are fudged to the benefit of banks also continue. And jobless claims are rising.

It’s time for banks to pay back their debt in a profound way. Yet first, an attitude adjustment is in order: Financial speculation in bank profits should be taxed to pay for education and health care. This trading tax will also reduce the federal deficit over time.

A “Robin Hood” tax like this would even the social capitalism balance sheet. Such a plan is afoot in the U.K. and it should be on the table in any larger discussion

Debt Ceiling Sellout

3 more gloomy bargains: How much the debt deal will cost you

By John F. Wasik (Reuters)

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No matter what plan Washington concocts to reduce the deficit, it’s going to cost you something. “Shared sacrifice” is in vogue, but your pain will be bigger if you’re unfortunate enough to earn wages or need social benefits.

Most conservative deficit-reduction plans shred the social safety net and cherished personal write-offs in unprecedented ways. The core elements of each proposal will pare middle-class tax breaks, Medicare and Social Security.

As Yogi Berra once said, “it’s déjà vu all over again.” The $3.7 trillion Senate “Gang of Six” plan and related iterations bear a striking resemblance to a “Moment of Truth” deficit commission report issued, and mostly ignored, late last year and pieces of a Heritage Foundation plan ironically entitled “Saving the American Dream.”

No plan will preserve or protect the American Dream as we’ve come to know it. And the powers that be don’t seem to be rattled by the potential chaos if an agreement on raising the federal debt ceiling by Aug. 2 doesn’t happen. Markets may collapse, benefits will be delayed and salaries won’t get paid if the U.S. can’t issue more debt, but the Beltway bickering goes on.

Instead, we have this power play in the form of Byzantine musical chairs. One sure loser is already ordained, though: Middle America. Let’s look at where the deficit commission, Senate and Heritage plans intersect:

“Broaden the tax base”
This is one of the most Orwellian prevarications since the coining of the “death tax.” (Have you ever met a dead person who paid a tax?) When conservative policymakers say this, they don’t mean raising taxes, they mean lowering tax rates and eliminating “tax expenditures,” like deductions for individuals.

The Senate “Gang” plan proposes three tax brackets ranging from eight to 29 percent. Currently the highest personal tax rate is 35 percent. The Senate plan would also cut the hated $1.7 trillion alternative minimum tax. At first blush, both moves will reduce revenue flowing into the Treasury and balloon the deficit. How would the Senate make up the shortfall, considering that it also cuts corporate tax rates from 35 percent to as low as 23 percent? They say: “Reform, not eliminate, tax expenditures for health, charitable giving and homeownership.” Bottom line: Your after-tax cost for healthcare and mortgages may be higher. Although limiting the mortgage interest deduction to one home and capping it isn’t a bad idea, this is not a “broadening” of the tax base. Middle class workers will pay more — unless the cost of healthcare and homeownership mysteriously drop.

“Enacting a $500 billion down payment … ”
One of the key elements of this Senate concept carves up Social Security. Instead of the current formula for cost-of-living adjustments, the Senate (and deficit commission) would substitute a “chained” Consumer Price Index. Through economic legerdemain, this new index would shave an estimated 0.25 percent annually from the current cost-of-living payments. That means a lower Social Security payment!

What about bringing more government workers into the system, immigration reform or simply raising the cap on earnings subject to Social Security and Medicare taxes? None of this is mentioned. After all, to “broaden” the tax base — at least in this perverse definition — “reformers” will reduce benefits. Note: There was no COLA paid in January due to low inflation, even though for millions of retired folks the cost of medicine, food and energy rose. The takeaway here is that “entitlement reform” means cutting benefits and raising your out-of-pocket costs for Medicare and Social Security.

“Repeal the CLASS Act”
The Senate document doesn’t even bother to explain what this is, but I will. The CLASS Act was one of the better ideas to emerge from Washington in recent years. It would have given workers the option to buy lower-cost long-term care insurance through their workplace. If you’ve seen a nursing home bill lately, you know that decent care costs more than $70,000 a year. It’s estimated that 70 percent of Americans over 65 will need long-term care at some point. Right now, either families or the Medicaid program absorbs these exorbitant costs — and Medicaid funding has one of the biggest bulls eyes on it. So middle-class and lower-class families will pay more.

There is some good news in all of this. If you’re a hedge fund, private equity manager, bank, corporate treasurer or securities investor, you’ll be just fine. No one has suggested raising taxes on capital gains, trading profits, derivatives, dividends or “carried interest.” Apparently not everyone will be asked to sacrifice when the tax base is broadened.

Can Your Protect Your Savings in the Event of a US Debt Default?

Debt ceiling & dumber: No safe haven for your money?

By John F. Wasik (Reuters)

Washington is now acting out a scene from Tennessee Williams’ classic play Glass Menagerie. The ever-fragile players are about to shatter .

Yet this is not the time to turn a farce into a tragedy. A default on U.S. debt will make the 2008 debacle look like a Simpson’s episode. Interest rates will soar through the roof. Everything from mortgage rates to adjustable credit card financing will skyrocket. Payrolls may be imperiled along with Social Security and Medicare payments. Think economic crash and burn — in a big way.

If the credit rating of U.S. debt is downgraded from AAA, that will automatically signal to the global bond market that investors should demand higher yields for taking more risk. Standard & Poor’s has put the U.S. on its ominous “CreditWatch” status and will downgrade unless a debt deal is struck soon.

Money moves exponentially faster than politics these days. If bond managers get even a whiff of actual default, they will move their funds out of U.S. Treasuries at the speed of light. That tsunami may devalue anything measured in dollars, including U.S. stocks; corporations would then fire even more people and halt capital investment. Unemployment would hit Depression-era levels. Americans would wistfully recall the days of nine percent joblessness.

More importantly, a debt default will be a smack-down to the credibility of the U.S. as an issuer of the highest-quality bonds. It will also clobber the liquidity of anyone who holds U.S. paper, from Chinese banks to Europeans hoping to escape debt debacles in Greece, Ireland, Portugal, Spain and Italy. Trillions could flow out of Treasuries into countries perceived as fiscally sound.

Here’s PIMCO’s Bill Gross, the biggest bond fund manager by assets, writing in the Washington Post: “Global investment managers have global choices these days, and a solvent Germany or Canada is just a wire transfer away for trillions of potential investment dollars looking for a safer haven.”

Gross said several weeks ago that he sold U.S. Treasuries from his PIMCO portfolio. “The debt ceiling must be raised and not be held hostage by budget negotiations,” Gross concludes. “Don’t mess with the debt ceiling, Washington. Bond and currency vigilantes will make you pay.”

Both parties have now entered the “break it, you own it” phase of their bickering. Who do you pay first in the event of a default? The military? Air-traffic controllers? Who gets burned? Social Security recipients? National Park visitors?

How do you avoid getting walloped? If the White House and Republicans can’t agree on a plan to avoid default, it would be silly to retreat into gold or other precious metals. You can’t use bullion to buy food, medicine or pay utilities.

Worst-case scenario: To protect yourself against interest rates ballooning, you could short Treasury bonds. This is incredibly speculative — and risky.

One approach is to buy leveraged exchange-traded funds such as the ProShares Ultrashort 20+ US Treasury ETF. This fund promises a return 200 percent of the inverse performance of a 20-year U.S. Treasury-bond index. So if interest rates soar, you can make a lot of money, or just offset the losses in every other part of your portfolio.

Of course, this is a money-loser if politicos come to their senses and interest rates don’t climb dramatically. A lower-risk approach may be to hold onto a high-quality money-market fund that mostly holds corporate debt. Cash would be king — as long as it didn’t involve defaulted U.S. debt. In truth, though, no one really knows what will happen or what the safe havens will be.

There are other ways of defusing this mindless political kabuki: Take Social Security and Medicare off the table for now. Discuss them separately in a series of expert town hall forums over the next year. Besides, these programs should never have been held hostage in the perfunctory debt-ceiling passage. They are largely self-funded by payroll taxes and merit separate treatment.

The American people, who overwhelmingly support social insurance benefits, deserve an intelligent dialogue on whether all or part of these programs should be cut or privatized under the Republican template. When I talked to a packed room of fiscally conservative older Americans Wednesday night on whether they wanted to see Medicare or Social Security privatized, not one raised a hand.

Wiser heads may prevail, although it’s ironic that shorting Treasuries is not only an uber-cautionary strategy, but a portfolio position held by a key player in the debt talks — Rep. Eric Cantor (R-Va.), the House Majority Leader, at least in his 2010 financial disclosure statement.

Is Cantor merely trying to speculate on inflation returning, which countless pundits have been forecasting for years? Or maybe, since he’s at the center of this maelstrom, he’s cynically hedging his bets.

We’re not playing checkers here. The pieces can break in a disastrous way.

Check your insurance!

8 home issues your insurer doesn’t cover

By John F. Wasik (Reuters)

You won’t believe this, but my house was hit by lightning — twice.

I know this isn’t supposed to happen. Fortunately nobody was hurt and the house didn’t burn down. Yet I think a deity (maybe Thor or Zeus) was reminding me to check my insurance coverage and install lightning rods.

Checking your homeowner’s insurance is a matter of seeing 1) what they won’t cover and 2) your out-of-pocket expenses, based on your deductibles.

Since I carry a $1,000 deductible on my homeowner’s policy, which reduces my premium, I know anything under that threshold is on me.

It could have been worse. In the case of my dual lightning strikes, I only had to pay to replace (2) circuit boards from my garage-door opener, a sump pump and computer board in my stove. Those expenses totaled about $900. The garage-door opener repair service generously offered to send in a claim directly to my insurer, which was helpful, but it still wouldn’t exceed the threshold of my deductible.

I discovered in researching this subject that even if my lightning-related expenses had exceeded $1,000, my insurer may not have reimbursed me anyway since power-surge damages typically aren’t covered. I had bought a cheap surge protector to protect my garage door opener, which didn’t do much good against a million volts. (I noticed in the hardware store, though, that more expensive surge strips carried insurance in case any appliance got fried, so that was some reassurance).

Since I live in the Midwest, I’m most concerned with water and wind damage. In the winter, we get these gremlins called ice dams that back up on frozen gutters and leak into the house. Roof vents have also leaked in the past, which have caused extensive ceiling damage upstairs. Insurance covered that.

What gets tricky is that insurance rarely pays for water that accumulates from burst pipes, broken sump pumps or sewers. Tornadoes and hurricanes? Sure, but not minor floods and seepage.

Here are some other problem areas when it comes to homeowner’s insurance:

Roof damage
As I mentioned above, big storm damage is generally covered. If you’re hit by a hailstorm, then claim payment depends on the size of the hail and what it did to your roof and vehicles.

Termites and rodents
It’s amazing how much damage a critter can do, but insurance generally doesn’t cover pest destruction. Exterminators aren’t covered, either. You’ll need a trapper for skunks and other varmints.

Home office equipment
Most home policies don’t cover computers, copiers and fax machines, especially when it involves power surges. You may need a separate rider or business equipment policy. Surge protectors and uninterrupted power systems usually protect your key equipment.

Liability
What if someone is injured on your property and they sue you? Most policies have liability protection, but check on the limits. Generally $1 million is common, but you can always buy more coverage.

Flooding
As I mentioned above, this is generally not covered. If you live on a flood plain, buy low-cost government flood insurance separately.

Normal wear and tear
Don’t expect your insurer to pay to replace a 20-year-old roof that hasn’t been damaged by a storm, old siding or other items that just wear out.

Mold
Since this became a huge problem a few years ago, many insurers stopped covering this and added exemptions, except in rare cases. Check your policy “endorsements” to see if your insurer covers this. In insurance jargon, an endorsement or “rider” is a clause insurers add to your policy that says they will or won’t cover a certain kind of claim.

Earthquakes
Like flooding, this may require a special policy or coverage, depending upon where you live.

Keep in mind that, depending upon how much you want to spend, you can always buy more insurance. You can even get coverage to protect against identity theft. Generally, though, you can save the most amount of money by keeping deductibles high, which lowers premiums.

No matter what kind of policy you get, make sure you have inflation protection and replacement cost coverage. Even though the value of the contents of your home or apartment may have declined, the cost of replacing them hasn’t.

College Costs too Much

Is college worth the investment?

By John F. Wasik (Reuters)

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Is a college education worth it? In the free market of ideas, maybe. In a labor market that can’t be sustained by wage growth or job creation, probably not. Another bubble may be bursting.

The college degree payback may be long and may not materialize for decades. A six-figure education may not be a guarantee to higher real wages in the near future and it may not be worth going into debt to finance it.

I’m not alone in this sentiment. A widespread public skepticism is fueled by poor short-term job prospects. It’s not surprising that 57 percent of those surveyed by the Pew Research Center said that higher education doesn’t provide a good value and 75 percent said it’s just too expensive for most people.

As young people attempt to enter the workforce and face an unemployment rate twice that of the majority of the general population, you have to take pause and examine what’s happened to create this bleak situation.

After World War Two, employment was plentiful. People who wanted a decent job in manufacturing or the white-collar sector could find one and stay there for 30 years. About one-third of private-sector workers were guaranteed union benefits, healthcare (even in retirement) and defined-benefit pensions. Productivity was on the rise and consumers drove the economy because they had plenty of disposable income and little debt.

That era, called the “Great Prosperity” by former Labor Secretary Robert Reich, ended in roughly 1977. Over the past 30 years, collective bargaining, decent manufacturing jobs and guaranteed benefits began to disappear. I remember that time because I was just getting out of college in the middle of a nasty recession and took a low-paying job myself.

Because high-paying manufacturing jobs were offshored over the past generation, workforce preparation increasingly focused on services and the white-collar sector. While office-oriented employers mostly demanded workers have college degrees, there were no extra payments for overtime. Guaranteed pensions were thrown into the maw of the stock and bond markets in the form of 401(k)s. Healthcare was also eroded.

Real wages, that is, what you earned after you subtracted inflation and taxes, entered a freefall in the past two decades. “Rather than be out of work, most Americans quietly settled for lower real wages,” Reich recently told Congress, “or wages that have risen more slowly than the overall growth of the economy per person.”

That brings us back to the value of a college degree. If the price of college had tracked real wages, net job growth or just inflation, then college tuition should have fallen dramatically in recent years relative to the outgoing economic tide of the middle class.

Yet the depletion of household wealth and earnings in recent years has made the gap between college bills and incomes even wider. While consumer inflation has soared some 107 percent since 1986 (through late 2010), college tuition has ballooned 467 percent.

Why the huge disparity between consumer prices and higher education bills?

Colleges benefited from a huge influx of students — the children of baby boomers — so they didn’t see their enrollment numbers decline significantly. The opposite was true; leading them to believe that there was a robust demand for their services. Universities kept investing in bricks and mortar and hiring professors while raising their prices to pay for it all. At the same time, states dialed back on their funding for public universities.

Then the catastrophic meltdown of 2008 skewered the economics of paying for college. Those who lost home equity had less collateral for home-equity loans or cash-outs. Bond returns were dismal and stocks had a bum decade.

Responding to this massive wealth evaporation, roughly about the time the U.S. housing market (and then stock market) collapsed, private non-profit colleges started a wave of tuition discounting, according to the National Association of College and University Business Officers.

Discounting reached an all-time high of 42 percent last year, the group reported, with 88 percent of freshmen receiving institutional grants. I expect this trend to continue as more and more families pull out of four-year colleges.
In the interim, if more students attend community colleges, eschew loans and encourage their children to take advanced-placement courses in high school — and demand tuition discounts — the paradigm will continue to shift and prices for bachelor’s degrees will fall across the board.

When the bubble bursts, though, it won’t be for the expectations that Americans have for their children after college. After all, even the Pew study shows that college graduates will likely have a $20,000 annual earning advantage over high-school grads.

A college education is a value relative to future earnings, vocational success and its ability to lift you above the economic burdens of underemployment and stagnant earnings. Right now, that equation just doesn’t measure up for most families.

Warnings on structured products

I wrote about these products in a Demos/Nation Institute study and pieces in Morningstar.com, The New York Times and AARP Magazine.

While the SEC and FINRA are now issuing warnings about these products, they stopped short of saying there would be future or ongoing probes. Tell the agencies you want a full investigation.

Here's the SEC notice:

SEC, FINRA Warn Retail Investors About Investing in Structured Notes with Principal Protection

FOR IMMEDIATE RELEASE
2011-118

Washington, D.C., June 2, 2011 — The Securities and Exchange Commission’s Office of Investor Education and Advocacy and the Financial Industry Regulatory Authority (FINRA) have issued an investor alert called Structured Notes with Principal Protection: Note the Terms of Your Investment to educate investors about the risks of structured notes with principal protection, and to help them understand how these complex financial products work. The retail market for these notes has grown in recent years, and while these structured products have reassuring names, they are not risk-free.

Structured notes with principal protection typically combine a zero-coupon bond – which pays no interest until the bond matures — with an option or other derivative product whose payoff is linked to an underlying asset, index or benchmark. The underlying asset, index or benchmark can vary widely, from commonly cited market benchmarks to currencies, commodities and spreads between interest rates. The investor is entitled to participate in a return that is linked to a specified change in the value of the underlying asset. However, investors should know that these notes might be structured in a way such that their upside exposure to the underlying asset, index or benchmark is limited or capped.

Investors who hold these notes until maturity will typically get back at least some of their investment, even if the underlying asset, index or benchmark declines. But protection levels vary, with some of these products guaranteeing as little as 10 percent — and any guarantee is only as good as the financial strength of the company that makes that promise.

“Structured notes with principal protection contain risks that may surprise many investors and can have payout structures that are difficult to understand,” said Lori J. Schock, Director of the SEC’s Office of Investor Education and Advocacy. “This alert is a ‘must read’ for investors considering these products, especially those with the mistaken belief that these investments offer complete downside protection.”

“The current low interest rate environment might make the potentially higher yields offered by structured notes with principal protection enticing to investors,” said FINRA Senior Vice President for Investor Education John Gannon. “But retail investors should realize that chasing a higher yield by investing in these products could mean winding up with an expensive, risky, complex and illiquid investment.”

FINRA and the SEC’s Office of Investor Education and Advocacy are advising investors that structured notes with principal protection can have complicated pay-out structures that can make it hard to accurately assess their risk and potential for growth. Additionally, investors considering these notes should be aware that they could tie up their principal for upwards of a decade with the possibility of no profit on their initial investment. Structured Notes with Principal Protection: Note the Terms of Your Investment also includes a list of questions investors should ask before investing in these products.

For additional information regarding the SEC and FINRA’s educational outreach and program, please visit www.investor.gov or www.sec.gov/investor or www.finra.org.

Family finances for a fairytale romance

By John F. Wasik (Reuters)

When the honeymoon’s over, the hard work begins. Talking about money isn’t romantic, but it’s a great ongoing topic that may ensure a long marriage.

While I don’t think Kate and Will will need any of my humble yeoman’s advice, discussing money issues on a regular basis is a good relationship builder. Here are five ways to steer clear of fiscal disharmony:

Put it all out on the table. The kitchen or dining room table is a great place to discuss expenses, bills, income and goals. Make a point of setting aside some time every month. Surveys show that money problems are among the leading cause of divorce. Is one or both partner a debtaholic? Get help and get a “debt score” to see if you have a problem. Clean the table first, both physically and metaphorically.

A home is where the heart is. But it’s often a bad investment, except for maybe Windsor Castle and Buckingham Palace, which are not only taxpayer-maintained but indirectly income producing. Most of us commoners, though, have to fix our own roofs, heat/cool our manor homes and suffer through one of the worst housing recessions in history. Owning a home is an emotional experience, yet don’t forget to tally up what it will cost you over time in taxes, maintenance, insurance and financing. The math may not add up, even with tax breaks. Renting is no sin.

Teach your kids about money. You can do this in so many fun ways. Give them piggy banks. Have them save their birthday and special-event money from grandparents. Give them an allowance. Set up a savings account and have them watch the balance grow. Assign them chores and pay them. Help them save at least half of what they earn. Charming guides for little ones include “Money Mama and the Three Pigs” by Lori Mackey and “The Great Piggy Bank Adventure“. Since kids get most of their ideas on money from their parents, start them off saving and realizing the fruits of their young labor.

Choose college prudently. Although I think the future heirs of England may just sneak into the Oxbridge system, for the rest of us, keeping our children out of debt after college is essential for a lower-stress adulthood. Spending the greatest amount of money on the biggest name-brand school isn’t always a wise choice. Community colleges are still the best bargain in higher education and save an average $3,000 a year (or more) over public universities. They offer virtually the same first- and second-year courses close to home. Before they even get into middle school, set up a 529 college saving plan for them. You can withdraw the money tax-free for education. Utilize the internet to find the best programs and available scholarships. Find the best cities for their higher education through the College Destinations Index.

Keep talking and saving. Life is an ocean that’s ever changing. There will be turbulent times of stress and illness. And old age is no parade with white horses. While the British mostly seem content now to take care of our fairytale couple well into their old age, the rest of us need to think about out-of-pocket medical expenses and long-term care. That ultimately means more savings. Do it automatically by auto-debiting money from your checking account into your money-market fund. Keep an emergency kitty. Consider long-term care insurance.

Most importantly, don’t forget to laugh after you put your money goals on auto-pilot. Most of us will never be dukes and duchesses of Cambridge or barons of Carrickfergus or be members of a moldy, unnecessary and taxpayer-funded monarchy. Still, we can live our lives productively in our own little palaces.

The key is ensuring that our castles and everything in them can be paid for without sacrificing our happiness. Oh, and Willie, don’t leave your royal hosiery lying about. Even a baron’s stinky socks can be an annoyance. In relationships, as in money, everything adds up over time.