Wednesday, December 16, 2009

Extended Interview with Ben Bernanke

Extended Interview

I wouldn't want Ben to manage my personal finances.

The Psy-Fi Blog: A Sideways Look At … Retirement

The Psy-Fi Blog: A Sideways Look At … Retirement

Thursday, October 22, 2009

PE10 - S&P 500 1871 to Present -

The stock market sure isn't cheap when looking at earnings.

This chart is compliments of

Tuesday, September 29, 2009

Range Bound Market

This chart and article is from Tuttle Asset Management. Read on if you are interested.

Interestingly, the TSX, commodities, and other commodity based stock markets tended to do quite well during past US range bound markets.

Throughout the last century, not withstanding countless trials and tribulations, the United States of America has become the epitome of capitalism at home and abroad. Looking back over the last 100-years, the equity markets have correlated to the development of the United States as a leading global economic power. Only after consideration of our political, industrial, entrepreneurial and economic history, can one appreciate where we have come as a nation and decipher clues as to the potential future path. It would be a grave disservice to those who have paved the way to blatantly disregard our extensive history. Therefore, we have dedicated, as market historians in some respects, a section of our website to a continually evolving historical event and invention register.

History offers invaluable guidance for what may lie ahead. As Oliver Wendell Homes once said, “When I want to understand what is happening today and try to decide what will happen tomorrow; I look back because a page of history is worth a volume of logic.” The question we must ask ourselves is, “What can be learned from past market cycles that can be potentially applied to today’s market environment or perhaps how will tommorrow change as a function of yesterday`s history?"

1900-1909: Consumerism & Materialism
The turn of the century can be characterized as a time when many important inventions would come to the market, all which would have long run implications in the U.S. economy. During this period, Henry Ford invented the assembly line which allowed production of the first affordable car, the Model T, which would cost around $700-$900. Taking a casual Sunday drive became an American past time. In 1900 the Dow Jones Industrial Average (DJIA) stood at 70, and closed at 95 in 1910. Some considered this period to be one of the first eras of “consumerism and materialism.” A few of the major inventions at this time also included the air-conditioner, tractor, and color photography equipment. At this time, Wall Street was controlled by a few large bankers, most notably J.P. Morgan and Andrew Carnegie. The deals they put together amazed much of the Street. For example: When Morgan bought US Steel from Carnegie, he did it for a sum of $500 million which is equivalent to about $300 billion dollars today. Morgan continued financing larger deals including AT&T, Northern Securities, and International Harvestor. At this time, the markets were extremely volatile and witnessed two major panics occurred in 1903 and 1907.

1910-1919: The Dawn of the First World War
This period marked the rise of the U.S. as a world power. Not only did major inventions continue to change everyday life, but changes in the banking sectors and the creation of federal taxation would alter government and its people forever. In 1913, Congress passed the 16th amendment, which enacted the power to tax American incomes. In that same year, the Federal Reserve was founded to provide temporary relief during times of bank panics. In 1911, Standard Oil and American Tobacco controlled a better portion of the World’s oil and tobacco markets and were able to manipulate prices. Therefore, antitrust legislation was enacted and both companies were eventually dissolved. Just thirteen years after the Wright Brothers flew the Kitty Hawk in 1903, the Boeing Company introduced its first model, the Bi-Plane. In 1912, the Titanic sunk and took with it some of Wall Street’s most notable financiers.

By August 1914, all of the world’s financial markets were closed including the NYSE due to massive selling to return money to Europe in the wake of Archduke Francis Ferdinand’s execution and the oncoming World War. The New York Stock Exchange remained closed until December 12th, 1914. Although, the NYSE was closed, “curb trading” would begin to take place in September and the markets would return to their prewar level by the time they reopened. During the war, Wall Street had one of its worst years ever, 1917, where the DJIA slid below the 70 mark. Once the war ended, confidence was restored and the DJIA was able to close above 100 by 1919 for the third time ever.

1920-1929: The Roaring 20`s
The early 1920’s was certainly not the best time for the markets, highlighted by the fact the economy was in a recession until 1921. The DJIA entered the 1920’s coming off a high in 1919 and continued to fall again to the 70 level. After the recession subsided, the economy and the markets began to take off and thus began the “Roaring 20`s.” Many Americans were benefiting from new inventions and products that would make everyday life more enjoyable. One of the most notable inventions was the radio which fueled investor’s enthusiasm. By 1929, almost 10 million Americans had radios. Because of the 1919 ratification of the 18th amendment, it was illegal to manufacture, sell, and consume alcohol - therefore "speakeasies" became quite popular during the 1920’s. The cathode ray tube, a vital piece to the television, became a commercially viable product by 1922. It was also during this time that the mobsters such as Al Capone, who saw the market for illegal alcohol, would become infamous. This decade was also known as the “Age of Jazz,” a style of music became very popular in many speakeasies in the Northeast.
It was during the 1920’s that confidence of individuals was finally restored to the market and they began to place their money on Wall Street. Wall Street brokers, including Charlie Merrill, began advertising in newspapers and magazines. As the markets began to rise, word that quick money could be made in the stock market began to spread and more and more speculative money poured into the market. Many individuals began buying on margin, with very little money actually paid into the account. The DJIA ran to unprecedented levels (all the way to 350) up until the last quarter of 1929 when on October 24th the market collapsed. Over the 4th quarter alone, the DJIA quickly lost a 1/3 of its value, eventually falling all the way to 41. In the wake of the collapse, banks began to fail and many people began to file for bankruptcy, especially those who had brokerage accounts. The economy had entered a new era: the “Great Depression.”

1930-1939: Depression & Recovery
The early 1930’s would mark some of the worst times in the history of Wall Street. As the depression wore on, bank failures became more and more common. The largest bank failure in history occurred early in the depression taking $300 million in depositors funds with it. Unemployment in the U.S. would reach 25%. Some of the more positives changes to come from the depression were the founding of 3 acts: The Exchange Act of 1933, Securities Exchange Act of 1934, and the Glass-Steagall Act. The 1933 Act, sometimes called the “Truth in Securities Act,” required corporations to disclose information regarding the company’s businesses, finances, and management information to investors. The Exchange Act of 1934 was put in place to regulate the secondary markets, the trading and the exchanges. The Glass-Steagall Act was really two acts in one; it took the United States off the Gold Standard and created a separation of Bank and Brokerage. This led to the founding of many new investment banks including Morgan Stanley. Not only was unemployment high, but American families saw their incomes sink about 40%. In addition, a drought crippled many agricultural states - so even those not affected by the market were still crippled by the depression and the corresponding troubling times.
American life did see a few positive notes in these harsh times though; the country entered the “Golden Age of Radio,” and Technicolor film was invented and quickly became a standard. One creative inspiration to come out at this time was MGM`s “The Wizard of Oz.”

1940-1949: A Nation Unites
On December 7, 1941 the United States officially entered World War II when it was unexpectedly attacked by Japan at Pearl Harbor. The 1940’s are typically earmarked by WWII; an event that impacted many aspects of life and the U.S. Economy. Many American men poured into the armed services and as a result women had to fill their shoes in factories for the first time. To help finance the war effort, the U.S. treasury sold bonds in every denomination and even used sporting events to try to raise almost $60 billion needed to support the war effort. Across the nation rations were placed on everyday household items to help support the war effort. The DJIA held strong throughout the war effort and rose from 150 to 200 during the 5 years of the war. By putting itself into production mode to help advance the war effort, the U.S. was able to pull itself out of an inflationary environment. Once the war ended, industries again began to focus on consumers, many of which were ready to begin spending again in the post war, post ration environment. By 1946, the television began to be mass produced and the transistor was being invented. In 1949, the DJIA made a short term bottom before experiencing one of the largest bull markets ever that spanned 16 years and carried the DJIA from below 200 to just shy of 900.

1950-1959: Free Market Capitalism Shines
Despite fear that the U.S. economy would fall into a recession because the government was no longer funding a war, the Post WWII era showed economic resiliency under Republican President Eisenhower who took office in 1952, the first time since 1932 that a Republican occupied the White House. A Republican controlled government shined favorably on Wall Street as the DJIA almost tripled throughout the `50s. Unlike the bull market of the “Roaring Twenties,” this bull market was supported by strong fundamentals especially in defense and aerospace stocks. Mutual funds returned after a thirty year break and people began to trust brokers and the financial markets again.

Established industries such as automobiles flourished along with investment and development of new industries, namely aviation and electronics. Transistor electronics experienced a boom similar to the euphoria over radios thirty years prior. The seeds of globalization were planted when Toyota sold its first car in the U.S. in 1957. The real estate markets around the country also flourished as members of the military were given affordable mortgages. Policies that were enacted after WWII such as the Marshall Plan created new markets for numerous U.S. produced goods as they were sent to dismantled Europe after the war. In 1950, GDP stood at $300 million and increased to more than $500 million by 1960. Part of this rapid increase of GDP is attributed to the government’s continued investment in the military as the Cold War began against communism. With the advent of automobiles, AC, and federally funded interstates, people began moving away from cities to suburbs as well as Sun Belt states. Toward the end of the decade, the recreational sport of bowling became a craze across America as the automatic pinsetter was pioneered by Brunswick. Bowling alleys went up in these new suburban developments. The bowling craze had an impact on the stock market as recreational, building, and material stocks led the way.

1960-1969: Social Reform
“The sixties” will be remembered as an era marked by many radical changes in American society. Three dominant trends characterized this period: the human rights movement, civil rights movement, and anti-war protests against American involvement in Vietnam. At the start of the decade, John F. Kennedy was sworn into office and commanded our country through some very anxious times including the Cuban Missile Crisis. Martin Luther King Jr. led a non-violent protest for African-American rights, but radical spin-offs including the Black Panther party disrupted the peace. The volatile social climate also mirrored the ups and downs experienced on Wall Street. Corporations hoping to maintain high growth rates engaged in hostile takeovers of other companies. Often times these companies were unrelated and huge conglomerates were spawned.

The DJIA slowly climbed toward 1,000 but never reached that mark as investors began to scrutinize the true strength of these conglomerates. Also, during these times of social unrest and economic volatility, the U.S. government became more involved with the economy and social spending by enacting Medicare, food stamps, and revamping the educational system. President Lyndon Johnson increased government spending and arguably triggered domestic inflation toward the end of the 1960`s.

1970-1979: Inflation becomes a Household Name
Inflationary pressure began to accelerate in the 1970`s largely because of undisciplined government spending. However, this did not stop the DJIA from reaching the historic level of 1,000 in 1972. However, these gains would soon be erased. Social turmoil existed as abortion was legalized in a landmark Supreme Court Case. Economic growth was stifled, unemployment increased, and wage stagflation existed as the decade progressed. The resignation of President Nixon in 1974 also exacerbated the problem. The first oil crisis in 1973 caused the DJIA to lose over half its value. This added volatility to the marketplace proved to be beneficial for the maturation of the options and futures markets in Chicago. 1973 was the year when the Black-Scholes option pricing model was introduced, a model still utilized today. After the recession ended in 1974, an important reform occurred on Wall Street that helped the DJIA recoup its losses. For the first time, The New York Stock Exchange (NYSE) allowed for commissions to be negotiated and as a result, discount brokers thrived as small investors put their money to work in the market.

As the decade progressed, investor confidence in the markets fell given the risky social and political environment facing the United States. The U.S. trade balance became negative as cheaper imports from foreign competitors flooded U.S. markets. When President Jimmy Carter took office in 1978 the powerful westernized democracy of the United States was not in a solid state of affairs. Carter implemented voluntary wage and price guidelines to control inflation which failed miserably. During the Iran hostage crisis, oil had risen to $30 a barrel, about 15 times the cost in 1970. Inflation became cancerous and stagflation resulted. In 1979, Paul Volcker became head of the Federal Reserve and inflation was his primary concern. It would take Volcker two years to get inflation under control.

1980-1989: Reaganomics & "The Crash"
The 1980`s will always be touted as the era of “Reaganomics” and an end of the Cold War. When Ronald Reagan was elected in 1980, he saw the economy slump into a recession marred by high interest rates. The government had to bail out the Chrysler Corporation from bankruptcy by securing their debt. Reagan began to cut taxes based on his supply-side economic theory. His conservative policies de-emphasized the government’s role in social and economic policy while drastically reducing personal and corporate taxes to spur economic growth. To take advantage of Reagan’s new tax cuts, companies began issuing stock options again in the early 80s. Coincidentally, the rapid rise of stock options coincided with the Dow Jones Industrial Average’s 17 plus year climb toward over 11,000. Merger and acquisition activity continued at a fevered pace and investment bankers came under the spotlight. Junk bonds became popular among Wall Street’s elite. The rise in the financial markets along with decreased government spending on social welfare programs caused a great disparity among the rich and the poor. The number of new millionaires jumped as well as the number of homeless people living on the streets.
By the mid 1980`s, it was clear that confidence was high in American companies and Wall Street fell in love with companies such as Microsoft, Intel, and Compaq. This climb did not come without a scare as the stock market experienced its largest one day drop in history on October 19, 1987. After the widespread panic that hit the markets in late October of 1987, a presidential commission headed by the Treasury Secretary Jim Baker suggested that the markets adopt several changes. The most significant reform is “circuit breakers” which automatically cause the NYSE to shut down once certain precautionary levels are breached until the problems can be solved. The markets were still able to maintain an upward bias even as the savings and loans crisis unfolded in 1988. As the decade progressed, the Cold War intensified and the spending on this front along with tax cuts caused a substantial Federal deficit. The East Asian Tigers became an ever increasing important factor in World trade. Further, Japan’s economy was admired in the late 1980s under its tight economic policies but its torrid economic growth rate would soon stumble.

1990-2000: The Internet Revolution?
With George H.W. Bush as our commander and chief at the turn of the decade, the U.S. economy experienced a minor setback during Desert Storm and the breakup of the Soviet Union. Some people worried that defense stocks which had been the darlings of Wall Street throughout the Cold War would bring the market down after the Soviet breakup. But skepticism would be replaced with optimism as deregulatory legislation provided a spark to a wave of corporate spending. The U.S. stock market experienced a rapid boom which coincided with President Clinton’s two terms of service. Free market capitalism thrived as policies such as the World Trade Organization and the North American Free Trade Agreement (NAFTA) were enacted. Alan Greenspan, the head of the Federal Reserve, oversaw a robust economy with low inflation, low unemployment, and high productivity. The proliferation of personal computers and the World Wide Web significantly attributed to productivity levels. Telecommunication devices and logistic software revolutionized business processes. The stage was set for a technological boom as entrepreneurs and venture capitalists rushed to capitalize on the internet boom.

The Dow Jones Industrial Average (DJIA) closed above 11,000 for the first time ever on May 3, 1999 and proceeded to run higher until January. From its opening value at the start of the decade, the DJIA more than quadrupled from under 3,000 to over 11,000, but this was not without some troublesome events. On the other side of the world, the East Asian Tigers experienced a financial crisis in the latter part of the decade after years of spectacular economic expansion. Further, the financial markets almost came unraveled when Russia defaulted on its debt and the Federal Reserve had to call upon the private banking sector to bail out the hedge fund Long Term Capital Management (LTCM) from its leveraged positions. LTCM managed to lose $4.6 billion in less than four months. This disrupted the DJIA’s move upward in 1998.

2000-present: Freedom under Fire
The markets faced a turbulent time soon after the turn of the century as the “tech” bubble burst which sent the NASDAQ composite tumbling downward more than 80%. To complicate matters, the Presidential election in 2000 was hotly contested as George W. Bush edged out Al Gore after a recount in Florida. President Bush`s leadership role as Commander in Chief would soon be tested after terrorists destroyed the World Trade Centers, ultimately changing our lives forever. A new war was waged against terrorism by the Western World in an effort to protect democracy highlighted by Saddam Hussein’s removal from power in Iraq.

Aside from political and social turmoil, the financial markets were delivered a drastic blow as a wave of corporate scandals hit Wall Street. With consumer confidence waning, it was clear that the euphoria of the late ‘90s was a distant memory. However, beginning in late 2002, the markets bottomed and began an upward move on the heels of strong M&A activity, low interest rates, and a robust housing market. Earnings growth for S&P 500 companies averaged over 10% for the first 4 and ½ years of the bull market, but has been slowing recently. Numerous investor friendly activities also fueled great advances in the past few years. These activities included strong M&A activity, share buybacks and private equity deals. However recent concerns in the credit market have sparked a downturn in lending, real estate and high-risk hedge funds. This minor crash in the credit market dates back to the substantial reduction in interest rates put in place in 2001 after September 11 and the burst of the technology bubble. These record low rates allowed for unprecedented home and corporate financing. Now it appears the dust of this lending cycle has settled as witnessed by plummeting share prices of lending companies and headlines of financial giants crashing after heavily leveraged betting in the sub-prime mortgage market. But the question still remains if the “sub-prime” saga is the bolt of lightening that will end this latest bull market, or is it the bolt of lightening we don’t see that will derail the bulls.

Past Market “Booms”
Throughout modern day history, several noteworthy “booms” have occurred. Booms are created as a function of market euphoria over new technologies or social trends. They can vary in magnitude and influence over the broad markets. Often times, as with the `90s “Dot-Com Boom”, asset prices soar solely upon speculation, not earnings growth. During speculative “bubbles”, the old adage “buy low, sell high” becomes “buy higher, sell even higher.” The driving factor behind market “booms” often serves as a catalyst to lift the broad markets as investors seemingly can do no wrong and feel bolstered confidence.

After the excitement settles and rational thought returns to the marketplace, inflated asset prices correct and this correction can be quite violent depending upon the size of the upward move, or what ex-Federal Reserve Chairman Greenspan famously coined “irrational exuberance.”

Railroads – 1840`s
Computer time-sharing – 1960`s
Radios – 1920`s
Home computers & biotechnology – 1980`s
Transistor Electronics -1950`s
Internet – Late 1990`s
Bowling Boom – Late 1950`s
Real Estate - Early 2000`s

Reference: 100 Years of Wall Street by Charles R. Geisst

Monday, September 14, 2009

The Psy-Fi Blog: Index Tracking At The Omega Point

In meetings with clients I often stress the importance of when withdrawals will happen and the impact on returns.

The Psy-Fi Blog: Index Tracking At The Omega Point

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Tuesday, August 11, 2009

The Psy-Fi Blog: The End of the Age of Retirement

This article is extremely insightful. Few people will be able to retire and most governments will not be able to afford the benefits that they've promised.
The Psy-Fi Blog: The End of the Age of Retirement

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Friday, August 7, 2009

Canadians falling further behind in paying their bills

The Canadian Press

TORONTO -- As the recession causes the financial squeeze to get tighter, a credit monitoring company says Canadians are falling behind on their credit payments at "an ever-increasing rate."

Equifax Canada says the average national delinquency rate at the end of June rose to 1.56 per cent -- a jump of 24 per cent over the same time last year.

Equifax defines a delinquent bill as one that's at least 90 days overdue.

The company says the province with the highest delinquency rate is Nova Scotia at 2.09 per cent, while Saskatchewan has the lowest rate at 1.24 per cent.

It says rates of overdue bills are increasing fastest in Alberta and British Columbia at 32 per cent and 30 per cent respectively.

Equifax says among major Canadian cities, Toronto has the highest delinquency rate of 2.03 per cent.

Thursday, August 6, 2009

Personal Finance and Home Purchasing

Something that I haven't quite got my head around is how so many (thousands per month) people can seemingly 'afford' to purchase homes in the Vancouver area considering the prices at which local homes seem to be sold at. Greater Vancouver benchmark for all dwelling types is just about $520,000 as of June 2009.

Let's look at a sample first time home buyer.

Let's imagine John and Jenny want to get started on the property ladder after getting married last year. They have saved $10,000 over the past couple years and they have about $25,000 in their RRSP accounts which they intend to use toward a property purchase under the Home Buyer's Plan. Jenny's parents have offered to help them purchase their first home as well with an extra $20,000 'loan' to be used toward a down payment that may never need to be paid back. They don't have any credit card debt but are making payments of a combined $900 per month on two car loans which have 3 years left on them. Combined down payment = $55,000.

John makes $60,000 per year working in the technology field and his job prospects are very good given his education and work experience. Jenny works in sales and her income has averaged $50,000 per year over the past two years. Although she does okay at work, her job prospects are sketchy as the company she works for has seen business drop off considerably and has laid off a few people in the last few months. Gross Annual Income = $110,000. Net Monthly Cashflow = $6,000.

They are wondering what they are able to afford (apparently they don't have a budget) so they go talk to a mortgage broker about their situation. The mortgage broker punches some numbers into the computer and comes up with a preapproval amount of $430,000. John and Jenny are amazed, they wonder what they have done to make the bank love them so much! This pre-approval emboldens them.

They call up a realtor and begin looking at homes in the $400,000 to $500,000 price range. The realtor shows them several condos and a few townhouses which meet their criteria and they settle on a nice townhouse and make an offer for $450,000 which is accepted and the deal is drawn up.

John and Jenny put $45,000 down by using the parent's money and withdrawing from their RRSP accounts under the Home Buyer's Plan. They have paid CMHC and legal fees of $9,000 which gets added to their mortgage so they owe a total of $414,000 and they have decided to amortize over 35 years (they will be 65 when it is finally paid off if they stick to the original plan with the original rate) with a 5 year term and a rate of 4.5%. They will be making principal and interest payment of $1,950 per month, they have added life insurance to the mortgage ($50) and are paying property tax monthly with their mortgage payment ($200). They now get to pay strata fees of $200 per month as well.

Let's have a look at John and Jenny's monthly budget.

John and Jenny's total monthly obligations are:
Mortgage - $1,950
Life Insurance - $50
Taxes - $200
Strata - $200
Car Payments - $900
Food - $600
Fuel - $400
Home and Auto Insurance - $400
Telephone/Internet/Cable - $300
Clothing/Other/Misc - $300
Entertainment/Vacations - $500
RRSP contributions - $200
Total = $6,000

This couple can have a 'reasonable' lifestyle based on these numbers but let's look a little closer.
Let's test this for several common risks:

Death - The mortgage is life insured, the survivor would be financially okay so long as the life insurance remains in place.

Divorce - They are in bad financial shape if this happens. Neither one of the two could afford the townhouse if they split up and the townhouse would need to be sold quickly.

Children - They are in bad financial shape if they have kids. Not only would they have extra monthly expenses, which they don't have room for in the budget, they would also have less income for a period of time as it is typical for the mother to take some time off work after giving birth. Even if mom went back to work there are daycare costs, which are not small.

Job Loss - They are a financial disaster if one of the two loses employment of any extended period of time. They would be forced to make some significant life changes and likely sell the home.

Interest Rate Rise at Renewal - If interest rates rise by 100-200 basis points they would be extremely rough financial shape. Unless they had an increase in income, they would likely be forced to re-amortize the mortgage and/or make other lifestyle changes. If rates increased more than 200 basis points, they would not be able to maintain their current lifestyle in any shape or form.
1) 100 basis point rise to 5.5%, maintain original amortization, payments rise to $2180 / month
2) 200 basis point rise to 6.5%, maintain original amortization, payments rise to $2420 / month
3) 300 basis point rise to 7.5%, maintain original amortization, payments rise to $2670 / month

Time - This is the most insidious risk of all and the least recognized. As a financial planner, I see many people who have put themselves into this type of scenario and they manage to muddle through life, manage to pay off a modest home by retirement and save a very modest sum of money. They retire at 65 and have a fairly low standard of living since they have no real significant savings and no pensions. If none of the above risks occured and they both managed to work a full career, get regular raises, contribute to CPP, receive OAS and have some modest RRIF withdrawals, they would make it through life without severe financial hardship but as a debt slave. The bank would have made over $400,000 from them in interest payments and they would have never saved much. They would live month to month their entire life and financial freedom would be a mere dream as they play the lottery each week hoping their number is drawn.

The reality is that the risks noted above are very real and for John and Jenny's situation to work out they need everything to work perfect, with no hitches, glitches or problems. This seems unlikely to me. It would be far better for them financially to leave themselves more room in their monthly budget so that they could:
1) Live / survive with only one income
2) Maintain mortgage amortization if interest rates rise
3) Speed up mortgage pay down by making extra payments as they receive raises if things work out well.
4) Increase their personal savings to RRSP and/or TFSA to ensure they have money for the unexpected and for retirement.

There are only two ways for John and Jenny to make the above work in a sustainable manner:
1) Continue renting and saving aggressively
2) Buy a much cheaper home and aggressively pay down the mortgage

What are your thoughts? Do you know John and Jenny? I do.

Monday, July 27, 2009

Human frailty caused this crisis

By Richard Thaler and Cass Sunstein

Published: November 11 2008 19:46 Last updated: November 11 2008 19:46

Mea culpas are rare these days. In a debate with John Kerry in 2004, President George W. Bush fa­mously could not name a single mistake he had made in his first term. So it is both noteworthy and commend­able that Alan Greenspan, the former US Federal Reserve chairman, fessed up that he had
failed to anticipate the financial crisis.

“Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity (myself especially) are in a state of shocked disbelief,” he said. Mr Greenspan had faith that banks were prudent enough to make sure they were not lending money cheaply to people who could not pay it back. Yet that is what happened. As Mr Greenspan says of securities based on subprime mortgages: “To the most sophisticated investors in the world, they were wrongly viewed as a ‘steal’.”

Why did Mr Greenspan, along with the rest of the world’s regulators, fail to foresee that this could happen? We think their mistake was to neglect the role of human nature. To prevent future catastrophes, regulators should focus explicitly on how to provide safeguards against two all-too-human frailties explored by decades of work in behavioural economics: bounded rationality and limited self-control.

The standard (non-behavioural) econ­omic model has greatly influenced regulators. In that model, economic agents (econs for short) choose optimally, no matter how hard a problem they face. They play chess as well as they play tic-tac-toe. The problem with this approach is that the world is populated by humans, not econs. Humans are not stupid, but when things get complicated they flounder: they suffer from bounded rationality.

This brings us to an aspect of the financial crisis that has not received the attention it deserves: the financial world has become more complex in the past two decades. Not so long ago, most mortgages were of the 30-year fixed-rate variety. Shopping was simple: find the lowest monthly payment. Now they come in countless forms. Even experts have trouble comparing them and a low initial monthly payment can be a misleading guide to total costs (and risks). A main cause of the mortgage crisis is that borrowers did not understand the terms of their loans. Even those who tried to read the fine print felt their eyes glazing over, especially after their mortgage broker assured them that they had an amazing deal.

Yet growing complexity on the borrowers’ side was trivial compared with what was going on at the banks. Mortgages used to be held by the banks that initiated the loans. Now they are sliced into mortgage-backed securities, which include arcane derivative products.

Many economists have argued that even if individual consumers suffer from bounded rationality, markets will be set right by specialists who can figure out even the most complex problem. But, as Mr Greenspan now ­concedes, even these sophisticated investors got things badly wrong.
The second problem involves self-control. Econs do not suffer from self-control problems and so “temptation” is not a word that exists in the economists’ lexicon. As a result, regulators have not thought much about the problem. But when the dessert cart comes by, we humans often cave in. The next thing we know, we are fat. This crisis was fuelled by the seemingly irresistible temptation to refinance the mortgage rather than pay it off. Falling interest rates, rising home prices and aggressive mortgage brokers made re­financing (and second mortgages) seem like the apple in the Garden of Eden. When home prices fell and interest rates increased, the party ended.

Regulators therefore need to help people manage complexity and resist temptation. A potential response to complexity would be to require simplicity – for example, by allowing only the standard 30-year fixed-rate mortgages. This would be a big mistake. Eliminating complexity would stifle innovation. A TiVo is a more complicated product than a VCR, but it is also better.
A superior approach is to improve disclosure. One reason a TiVo is better than a VCR is that it is easier to use. Regulators can reduce the chances of a future meltdown by making it easier to understand financial products. Agg­ressive steps should be taken to imp­rove disclosure – for example, with mortgages, fine-print disclosure should be supplemented by machine-readable files enabling third-party websites to translate hidden details of the terms. Mandatory transparency for investment banks and hedge funds would also help.

The government and the market should try to deal with temptation. We hope that lenders will ask families to have done some saving in order to qualify to buy a home. Conscientious lenders could also nudge people to get off the refinancing merry-go-round, by suggesting that the term of the loan be shortened when a loan is refinanced. More ambitiously, private and public institutions could try to reintroduce an old social norm: try to pay off the mortgage sooner rather than later, and at the latest by the time you retire.

Greed and corruption helped create the crisis, but simple human frailty played a vital role. We will not be able to protect against future crises if we rail against greed and wrongdoers without looking in the mirror and understanding the potentially devastating effects of bounded rationality and limited self-control.

Richard Thaler is professor of behavioural science and economics at the Graduate School of Business, University of Chicago. Cass Sunstein is Felix Frankfurter professor of law at the Harvard Law School. They are the co-authors of ‘Nudge’ (Yale University Press)

Copyright The Financial Times Limited 2009

Wednesday, July 8, 2009

Saturday, July 4, 2009

First-timer home buyers like low rates | Vancouver, Canada |

This is an outrageous story of massive risk taking by a first time home buyer. I shudder to think what the consequences of these actions might be for them - bankruptcy, divorce, depression?

If this is representative of most first time buyers right now then this market is doomed.

First-timer home buyers like low rates | Vancouver, Canada |

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Friday, July 3, 2009

Bill Gross on the New Normal

Bill Gross, the “Bond King” is going to great lengths to get us to understand that the world is in a state of reversion to what he and El-Erian, his co-chief at PIMCO coined as the “New Normal” 3 months ago, in his latest missive - “Bon” or “Non” Appétit?.

Our economy which once feasted, no, binged, unable to stop itself, on debt and leverage, and on the basis that home and other asset prices would rise to the sky, is now fasting, cleansing itself of the fat that accumulated, and it is a long-term process that will take many years to complete.

Here are some of the highlights from the letter, which you may download here:
Gross re-iterates the “New Normal” - Its starting to sound a lot like “The Emperor’s New Clothes“:

Our economy’s lights, if not switched off in a rehash of the 1930s Depression, have certainly been dimmed in a 21st century version likely to be labeled the Great Recession. Much like John McSherry, U.S. and many global consumers gorged themselves on Big Macs of all varieties: burgers to be sure, but also McHouses, McHummers, and McFlatscreens, all financed with excessive amounts of McCredit created under the mistaken assumption that the asset prices securitizing them could never go down. What a colossal McStake that turned out to be. Now, however, with financial markets seemingly calmed and an inventory-based recovery in store for the balance of 2009, there is a developing optimism that we can go back to the lifestyle of yesteryear. PIMCO’s driving thesis however, if not a juxtaposition, is succinctly described as a “new normal” where growth is slower, profit margins are narrower, and asset returns are smaller than in decades past based upon the delevering and reregulating of the global economy, which in turn should substantially inhibit the “gorging” of goods and services that we grew used to in decades past.

Forecasts based on econometric models inevitably miss these secular/structural breaks in historical patterns because it is impossible to quantify human behavior, and long-term trends involving risk-taking and in turn derisking are decidedly human in their origin. Bell-shaped curves with Gaussian/random distributions fail to anticipate that human beings do not make decisions by chance or independently of each other, but in many cases in reaction to one another. Humanity’s personal and social computers appear to be programmed that way. And so, instead of “normal” distributions, economists and investors must learn to be on the lookout for “black swans,” and if not, then certainly “fat tails,” which differ from the measurement of natural phenomena accepted in science. “New normals,” flatter-shaped bell curves, and structural shifts in previously accepted standards become not only possible, but probable as human nature reacts to itself and its prior behavior. The efficient market hypothesis was always dead from the get-go, but academic tenure and Nobel prizes were food for the unwilling or perhaps unthinking.

Others are starting to wonder about the emperors new clothes, the “green shoots”:
I was impressed this weekend by an article in the Op-Ed section of The New York Times by staff writer Bob Herbert. “No Recovery in Sight” was the heading and his opening sentence asked, “How do you put together a consumer economy that works when the consumers are out of work?” That is really all one needs to ask when divining our economy’s future fortune. Unless an optimist can prescribe how to put Humpty Dumpty back together again and shuffle him/her back to work then there can be no return to an “old normal.” As unemployment approaches 10%, what is less well publicized is that the number of “underutilized” workers in the U.S. has increased dramatically from 15 to 30 million. Those without jobs, as well as those individuals who only work part-time and have become discouraged and stopped looking, total 30 MILLION people. The number is staggering. Commonsensically, one has to know that many or most of these are untrained for the demands of a green-oriented, goods-producing future economy. Imagine a welding rod in the hands of an investment banker or mortgage broker and you’ll understand the implications quicker than any economist using an econometric model.

Fifteen Words to describe the era that led us to our current economic crisis:
The supersizing of financial leverage and consumer spending in concert with the politicizing of deregulation describes in fifteen words our most recent brush with irrational behavior and inefficient markets. Greed will come again. But for now, the trend is the other way and it promises to persist for a generation at a minimum. The fact is that American consumers have suffered a collapse in wealth of at least $15 trillion since early 2007. Global estimates are less reliable, but certainly in multiples of that figure. And when potential spenders feel less rich by that much, the only model one can use to forecast the future is a commonsensical one that predicts higher savings, lower consumption, and an economic growth rate that staggers forward at a new normal closer to 2 as opposed to 3½%. There’s no magic in that number, and no model to back it up, just a lot of commonsense that says this is how people and economic societies behave when stressed and stretched to a near breaking point.

Where do we go from here:
Investors who stuffed themselves on a constant diet of asset appreciation for the past quarter-century will now be enclosed in a cage featuring government-mandated, consumer-oriented fasting. “Non Appétit,” not Bon Appétit, will become the apt description for the American consumer, and significant parts of the global economy, including the U.S. Because this is so, short-term policy rates will be kept low for longer than cyclical norms, and the outlook for risk assets - stocks, high yield bonds, and commercial and residential real estate will involve just that - risk. Investors should stress secure income offered by bonds and stable dividend-paying equities. Consumer Cuisinart consumption is a relic of the past.

Monday, June 8, 2009

Canadians not Saving Enough for Retirement

From the Globe and Mail:

"When the stock market was soaring and the economy was stronger, one hardly heard of any worries about private pensions. Many baby boomers were confidently facing retirement since they were thought to be healthier, better educated and wealthier than their parents' generation.

But now, with the collapse of the stock market as well as the economy, the boomers' easy coast into retirement has changed.Not surprisingly, a number of prominent organizations, including the C.D. Howe Institute, have recently concluded that Canadians are not saving enough for their retirement.

This basic conclusion is correct and seems even more relevant today because the economy is in recession and Canadians are losing their jobs.Simple economic theory, such as the life-cycle savings hypothesis (that individuals should put aside savings in their productive working years to maintain their standard of living in retirement), is useful in framing the policy choice for individuals, but it is not very practical with respect to telling them what they should do when everything goes wrong.

But how much should a Canadian actually save for retirement? The answer is: Who knows? We have no idea how long we'll live. Should we save enough to last until 75 or 95? If we save for a 95-year lifetime, the amount needed is obviously much greater.

One could save enough to buy an annuity at the time of retirement, an annuity that would provide an adequate income for life. But how much should we put aside to buy this annuity?

The amount of income an annuity will provide at retirement depends on the interest rates at the time the annuity is purchased and the income stream begins. Will one save enough to buy an annuity assuming the current level of interest rates? Canadian government bonds now yield from 2 per cent to just over 3 per cent. Or should one presume at the time of retirement that interest rates will be at the level they were in the early 1980s, when Canadian bonds yielded more than 16 per cent? If one assumes the high rate of interest, then the amount of saving needed for retirement would be a fraction of the amount needed with today's much lower rates.

All of these reasons demonstrate the inability of any person to know how much to save for retirement. So what's the public policy response? Do we need more registered retirement savings plan room? Do we need more defined-contribution pension plans? (A defined plan is one in which both the individual and employer contribute a set amount, with the individual investing those funds in some form until retirement.)

The problem with RRSPs and defined-contribution pension plans is that the amount needed for a set retirement income is always unknown. The additional problem is that the whole investment risk is carried by the individual saver. If the investment is successful, more funds are available at retirement; if it isn't, there's less to count on.For the baffled individual trying to plan for retirement income, private defined-benefit pension plans are very attractive, assuming the company that sponsors the plan remains solvent and the plan is adequately funded. (A defined-benefit plan is one that provides a set pension amount at the time of retirement usually based on both years of service and level of income. The costs to the individual and employer are based on those factors as well.)

There is also enormous cost savings and economic efficiency in very large defined-benefit pension plans such as the Canada Pension Plan when they are adequately funded.

The large pension plan knows how long we'll live because it deals in large numbers of people and uses averages for life expectancy. Thus, large defined-benefit plans can estimate fairly precisely the amount of savings one needs for the lifespan of the average pensioner in their plan. The large defined-benefit plan can also take a long-term view of interest rates and market returns, a perspective not often available to the individual investor. This again increases the economic efficiency of such plans as the CPP.

Three obvious public policy conclusions flow from this analysis:

Substantially increase the size of the CPP so it provides for a much larger proportion of income replacement on the retirement of Canadians. Many studies have recommended this idea. An increase in CPP contributions and coverage could be done over several years in a way that ensures the CPP remains fully funded.

Develop a system whereby companies and their employees can buy additional defined-benefit pension coverage from the CPP. These supplementary pensions would need to be fully funded and would be fully portable (as they are held in the CPP). An add-on plan to the CPP would provide companies and individuals with the economic efficiencies and the substantial cost savings that only a large plan can generate.Develop a strategy to get companies that have lost the incentive to provide defined-benefit plans back into the business of offering them. This will not be easy. Companies have moved away from such plans because of complex pension laws designed to protect workers, and their experience that such plans are costly and difficult to manage. In addition, employees are wary of such plans when they see large companies fail to fully fund their plans or go bankrupt with their pension plans underfunded.

A policy of both increasing the CPP and allowing companies and individuals to buy supplementary pensions from the CPP is one acceptable policy move. Another is a much closer monitoring of pension plans by regulators. A positive move in this direction would be the establishment of the proposed national pension guarantee system.Another feature of such a system would be to require underfunded pension plans to pay higher premiums for coverage. In other words, any company that requests relief from its required funding - that is, additional time to make up a pension deficiency - should pay an additional premium for such forbearance."

Doug Peters is former chief economist of the Toronto-Dominion Bank. Arthur Donner is a Toronto-based economic consultant.

Wednesday, May 27, 2009

CGA Study Finds Canadians Foolish With Money

Where Has the Money Gone: The State of Canadian Household Debt in a Stumbling Economy

Related Information
Media Release
Download Report
CGA-Canada shares its views on indebtedness of Canadian households (March 2009)[PDF — 98KB]

In the winter of 2008, the Certified General Accountants Association of Canada (CGA-Canada) embarked on a second consumer survey on the topic of household debt and consumption in Canada. A similar survey was commissioned by CGA-Canada in the spring of 2007. The purpose of this particular survey seeks to understand the extent to which the economic and financial crisis worsened financial positions of Canadians having already experienced some financial strains. As we have seen, the topic of household debt and consumption is timely, relevant and critical for Canadians to consider. We anticipate that this new report entitled Where Has the Money Gone: The State of Canadian Household Debt in a Stumbling Economy, will be of significant value to the Canadian public.

Key Report Highlights
Increasing debt load

Household debt is at an all-time high reaching $1.3 trillion in 2008 and the escalation of debt is primarily caused by consumption motives rather than asset accumulation.
The three main indicators of household indebtedness (debt-to-income, debt-to-assets and debt-to-net worth ratios) deteriorated significantly in the past two years and particularly during 2008.
Canadian households are financing consumption activity and fuelling gross domestic product growth with unearned money as families increasingly reach for credit to finance day-to-day living expenses.
The majority (58%) of survey respondents with rising debt said that day-to-day living expenses are the main cause for the increasing debt. This was higher than the 52% reported in 2007.
Lines of credit and credit cards account for the largest proportion of consumer debt, with 85% of indebted Canadians reporting that they have outstanding debt on a credit card.
A large proportion of Canadians acknowledged their debt as increasing. The proportion of respondents with rising debt went up from 35% in 2007 to 42% in 2008.
84% (vs. 81% in 2007) of Canadians are concerned that household debt is rising. 21% of Canadians who are in debt say they are in over their heads and can no longer manage their debt load.
Interestingly enough though, 79% of indebted Canadians are still confident that they can either manage their debt well or take on more debt load.
The majority of respondents (65%) felt that debt limits their ability to reach financial goals in at least one of the critical areas of retirement, education, leisure and travel, or financial security in unexpected circumstances.

Lack of savings
One third of Canadians do not commit any resources to savings and deteriorating economic conditions have not yet had the usual effect of encouraging increased savings.
Even with the temporary relief of a credit card or line of credit, one quarter of Canadians would not be able to handle an unforeseen expenditure of $5,000 and 1 in 10 would face difficulty in dealing with $500 unforeseen expense.
The majority (78%) of surveyed said they would not change their saving patterns in order to build or rebuild the financial cushion.
Economic factors
The Canadian economy has been recession free for 17 years before the events of 2008. The most recent recession took place over a 12 month period between April 1990 and March 1991.
Recent data on the job losses and bankruptcies leaves little doubt that the situation of the household sector has worsened.
Canadians, though, perceive their financial condition to be better than it is and many are not aware of how the economic downturn has impacted their financial situation.
Nearly one quarter (24%) of those surveyed did not think that a moderate decrease in housing or stock market, an increase in interest rates, cuts in salary, or reduced access to credit would noticeably affect their financial situation.

Vulnerable Canadian households
Certain socio-economic groups are particularly susceptible to increasing debt. The most vulnerable are the hardest hit – low income, households with children, young adults, the retired.
Canadian families in particular are struggling with increasing debt. Households with one or more children under the age of 18 reported debt as rising more often than those with no children, with 49% reporting their debt had substantially increased.
Respondents with lower income were much more likely to report increasing debt compared to the respondents in other income groups. And, those with low wealth continue to sink into debt and to experience further deteriorating in their net worth positions.
Debt-free households do exist of course and 88% of debt-free respondents lived in one or two-person households and were significantly less likely to have children under the age of 18.

Regional differences
There are regional differences for those carrying household debt.
As many as 56% of British Columbians told us their debt increased compared to the Canadian average of 42%.
Some 30% of residents in the Atlantic Provinces maintained an unchanged debt level compared to 23% of the total respondents who said their debt remained the same.
Debt-free respondents were more likely to be Ontario residents.


Balanced approach
The current level of indebtedness of Canadian households is a highly disturbing matter, particularly given the extent of the recent economic shocks (income shock, assets price shock and interest rate shock) and prospects for improving household financial security are low.
Although CGA-Canada recognizes the importance of consumer spending for business development and for economic growth, a balanced approach to spending, saving and paying down debt may be more of a desirable option than trying to promote consumer spending as a solution for the current economic downturn.
Canadians long-term financial goals should include accumulation of appreciable financial assets, building of a larger more diversified financial cushion and retirement investment. CGA-Canada urges Canadians to consider such savings vehicles as RRSPs and TSFAs.
CGA-Canada believes debt is rightfully a personal decision, however, it is crucial that Canadians be aware of potential risks of increasing individual household debt.
It is important to remember that risk tolerances of financial institutions should not be exercised as a substitute for the judgment of individuals who must discern between the good and bad of being in debt.

Financial literacy
Financial literacy remains an issue – Canadians frequently don’t understand the effect of carrying debt and the costs associated with servicing debt.
Households’ knowledge and skill to understand their own financial circumstances and the motivation to borrow, to spend and to save become crucial to marshalling households’ financial security and wellbeing.
Canadians need to take very seriously the issue of developing their financial capability, that is, improving their knowledge, skills and discipline when making financial decisions.
There is also an opportunity for government and the educational community to help Canadians improve their financial capability.
More needs to be done in educating the public on money management, spending, shopping habits, warning signs of financial difficulties and obtaining and using credit.

Thursday, May 14, 2009

Uncommon Sense from Charles Munger

Here is an article (hat tip to Calculated Risk) that I think is worth a good read.

Here is a couple of highlights:

As we look at the current situation, how much of theresponsibility would you lay at the feet of the accounting profession?
I would argue that a majority of the horrors we face would not have happened if the accounting profession developed and enforced better accounting. They are way too liberal in providing the kind of accounting the financial promoters want. They’ve sold out, and they do not even realize that they’ve sold out.

Would you give an example of a particular accounting practice you find problematic?
Take derivative trading with mark-to-market accounting, which degenerates into mark-to-model. Two firms make a big derivative trade and the accountants on both sides show a large
profit from the same trade.

And they can’t both be right. But both of them are following the rules.
Yes, and nobody is even bothered by the folly. It violates the most elemental principles of common sense. And the reasons they do it are: (1) there’s a demand for it from the financial
promoters, (2) fixing the system is hard work, and (3) they are afraid that a sensible fix might create new responsibilities that cause new litigation risks for accountants.

Link to Stanford Law.

Thursday, April 30, 2009

Swine Flu

The Swine Flu:

From the Washington Post.

Monday, April 13, 2009

The Debt Snowball Method

I have seen this work very effectively in several instances where I have done credit counselling for people.

From Wikipedia, the free encyclopedia

The debt-snowball method is a debt reduction strategy, whereby one who owes on more than one account pays off the accounts with the smaller balances first, proceeding to the larger ones later.

The debt-snowball method of debt repayment is a form of debt management that is most often applied to repaying revolving credit — such as credit cards. Under the method, extra cash is dedicated to paying debts with the smallest amount owed.

This method has gained more recognition recently due to the fact that it is the primary debt-reduction method taught by many financial and wealth experts. However, it has always existed, as people have a tendency to want to take care of smaller, easier-to-take-care-of things first.

The basic steps in the debt snowball method are as follows:

List all debts in ascending order from smallest balance to largest.

This is the method's most distinctive feature, in that the order is determined by amount owed, not the rate of interest charged. However, if two debts are very close in amount owed, then the debt with the higher interest rate would be moved above in the list.

Commit to pay the minimum payment on every debt.

Determine how much extra can be applied towards the smallest debt.

Pay the minimum payment plus the extra amount towards that smallest debt until it is paid off.
Note that some lenders will apply extra amounts towards the next payment; in order for the method to work the lenders need to be contacted and told that extra payments are to go directly toward principal reduction.

Once a debt is paid in full, add the old minimum payment (plus any extra amount available) from the first debt to the minimum payment on the second smallest debt, and apply the new sum to repaying the second smallest debt.

Repeat until all debts are paid in full.

In theory, by the time the final debts are reached, the extra amount paid toward the larger debts will grow quickly, similar to a snowball rolling downhill gathering more snow (thus the name).

The theory works as much on human psychology as it does on financial principles; by paying the smaller debts first, the individual, couple, or family sees fewer bills as more individual debts are paid off, thus giving ongoing positive feedback on their progress towards eliminating their debt.

A first home mortgage is not generally included in the debt snowball, but is instead paid off as part of one's larger financial plan. As an example, many financial plans pay off home mortgages in a later step, along with any other debt which is equal to or greater than half of one's annual take-home pay.

The issue of whether one should make retirement contributions during the debt reduction process is a matter of dispute among proponents of this method:

Some argue that all contributions are to be halted during the debt snowball, thus freeing up more money to pay down the debt snowball.

Others dispute this practice, citing the cost of compounding interest to be greater than the gains of paying off debt.

Some compromise by arguing that retirement contributions should be reduced to only the minimum amount that the employer will match with an employee, but not eliminated completely.

Many financial and wealth experts teach that this halting of retirement contributions should last no more than two years.

Simple Example
An example of the debt-snowball method in action is shown below.
A person has the following amounts of debt and additional funds available to pay debt (the debt is listed with the smallest balance first, as recommended by the method):
Credit Card A - $250 balance - $25/month minimum
Credit Card B - $500 balance - $26/month minimum
Car Payment - $2500 balance - $150/month minimum
Loan - $5000 balance - $200/month minimum

The person has an additional $100/month which can be devoted to repayment of debt.
Under the debt-snowball method, payments for the first two months would be made to debtors as follows:
Credit Card A - $125 ($25/month minimum + $100 additional available)
Credit Card B - $26/month minimum
Car Payment - $150/month minimum
Loan - $200/month minimum

After two months (presuming the person has not added to the balances, which would defeat the purpose of debt reduction), Credit Card A would be paid in full, and the remaining balances as follows:
Credit Card B - $448
Car Payment - $2200
Loan - $4600

The person would then take the $125 previously used to pay off Credit Card A and apply it as additional payment to the Credit Card B balance, which would make payments for the next three months as follows:
Credit Card B - $151 ($26/month minimum + $125 additional available)
Car Payment - $150/month minimum
Loan - $200/month minimum

After three months Credit Card B would be paid in full (the final payment would be $146), and the remaining balances would be as follows:
Car Payment - $1750
Loan - $4000

The person would then take the $151 previously used to pay off Credit Card B and apply it as additional payment to the car loan balance, which would make payments as follows:
Car Payment - $301 ($150/month minimum + $151 additional available)
Loan - $200/month minimum

It would take six months to pay the car loan (the final payment being $245), whereupon the person would then make payments of $501/month toward the loan (which would have a $2800 balance) for six months (with the last payment at $295).

Thus in 15 months the person has repaid four loans, with two of them being paid in a mere five months and three within one year.

The primary benefit of the smallest-balance plan is the psychological benefit of seeing results sooner. A secondary benefit of the smallest-balance plan is the reduction of total amount owed to lenders in a single month. This is a risk reduction in the event of a lost job or emergency.

People with more financial discipline can get ahead quicker by paying off the credit cards and loans with the higher interest rates first. This will minimize costs to become debt-free faster than the smallest-balance approach. Dave Ramsey, a proponent of the debt-snowball method, concedes that "the math" leans toward paying the highest interest debt first; however, based on his experience, Ramsey states that personal finance is "20 percent head knowledge and 80 percent behavior" and that people trying to reduce debt need "quick wins" in order to remain motivated toward debt reduction.

The Debt-Snowball method is only for those on high enough incomes to be able to meet all the minimum repayment requirements on their debts. This method could instead lead to problems for those who are struggling to meet these minimum payments demands. In this circumstance, an individual should not be advised to pay creditors differing amounts as this could count as non-equitable repayment, leading to problems (e.g. with going bankrupt, or with maintaining non-equitable repayments over longer periods).

Monday, March 30, 2009

Technical Analysis

Gallows humour has become a bit of the norm lately here at work.

Wednesday, March 4, 2009

Rolling 10 Year Returns

A friend sent me this chart and I thought I'd post it here for interest's sake.

The chart shows the rolling 10 year total return produced by the S&P500 from 1935 to 2009. Clearly there are very long cycles at play in the markets and we happen to be in the bottom of one of those cycles right now. If history is any indication of the future we can look forward to above average returns over the next 10 - 20 years.

We will see.

Friday, February 27, 2009

Beware of Terminal Paralysis

As the stock market indices are flirting with key charting levels and we are waiting for Mr Market to show his hand, it is useful to get an update on the outlook from Jeremy Grantham.
Grantham, chairman of Boston-based GMO, was a great skeptic between 1999 and October last year when he started propagating “hesitant and careful buying”. His latest thinking has just been reported in an interview with CNN Money as quoted below.

“Meanwhile, GMO chairman Jeremy Grantham is more upbeat - though he does expect more pain to precede any recovery.

“Looking back at historic bear markets, Grantham draws comparisons to 1974 and 1982, when the S&P 500 lost roughly half its value. Since he estimates the current S&P 500 fair value at 900, Grantham puts his worst-case bottom at a hair-raising 450.

“‘That’s fairly scary, but on the one hand we look at the massive stimulus, and then on the other we try to work out the fact that the global economy is in worse shape than it was in ‘74 or ‘82,’ says Grantham. ‘I’d say there are three-to-one odds that we go to a material new low. We should count on [the S&P 500] hitting 600 for a little while, and we should hope like mad it doesn’t get deep into the 500s.’

“Patience rules. Another looming threat is that the market may enter an extended period of drops and rebounds that flatten long-term returns and strand buy-and-hold investors for decades.

“Japan’s stalled stock market is one recent example, but the U.S. has had its shares of quagmires, too. Grantham likes to point out that investors who bought at market crests in 1929 and 1965 had to wait 19 years each time just to break even.

“Still, Grantham says buy-and-hold still makes sense for long-term investors when stocks are trading below fair value. He especially favors U.S. blue chips, and his fund is on a strict, slow schedule to invest as valuations dip even lower.

“‘If you don’t have a schedule for investing, you will not do it,” he says. “When the market goes down, it reinforces the hoarding of cash. By the bottom, you suffer what we called in 1974 terminal paralysis - you cannot pull the trigger. Almost everyone who avoids the great pain is very slow to get back.’

Source: Eugenia Levenson, CNN Money, February 25, 2009

Wednesday, February 25, 2009

Faber Blames Federal Reserve

From here.

Marc Faber the Swiss fund manager and Gloom Boom & Doom publisher blames the federal reserve's monetary policy for the global financial crisis.

Faber believes the additional printing of money across economies for financing such stimulus packages would lead to "higher and higher fiscal imbalances". In such a scenario, he expects precious metals such as gold and silver to outperform assets such as equities in 2009.
In a recent edition of The Wall Street Journal, Faber says: “The world has gone from the greatest synchronised economic boom in history to the first synchronised global bust since the Great Depression," due to monetary policy.

Our currently disastrous global economy may also be attributed to governments that ignored market signals and central bankers who believed in endless booms, Faber says.

"The Fed never truly implemented tight monetary policy [when it was needed]," he said. In January 2001, the Fed began cutting rates, from 6.5% to 1.75% as the year ended, and down to 1% in 2003, Faber points out. These were the wrong moves, Faber suggests, since the US economy began rebounding on its own in November 2001.

Right now, "the best policy response would be to do nothing and let the free market correct the excesses brought about by unforgivable [Fed] policy errors," Faber says.

The economic downturn and uncertainty in the global markets have focussed investors attention to gold as a unique asset class which can play a vital role in providing stability. Gold has risen at a much faster rate than equities and it is expected that this out-performance will continue for the next few years.

Addressing the gold to Dow Jones ratio at a recent Barron's Roundtable, Faber said: "One day the price of gold will be higher than the Dow Jones."

"The CRB, a broad index of commodities, fell for 20 years in nominal terms, from 1980 to 1999. It is now up 12% and is still inexpensive. The Dow and the S&P are up substantially from the 1980s or early 1990s. Everyone thinks fiscal and monetary measures will work to fix the financial system. I don't. They will be disastrous and fuel inflation. But the supply of oil, gas and copper is relatively limited compared to paper money you can print," Faber added.

If one considers that in 1932 and in 1980 the Dow Jones Industrial and the price of an ounce of gold were very close to parity, it is possible to envisage the same happening again during the current cycle.

Thursday, February 19, 2009

People are Going to Save, not Spend

The inevitable outcome.

Wednesday, February 18, 2009

Frontline - The FInancial Crisis

It seems that the video won't embed so here is the link:

Tuesday, February 17, 2009

Debt, debt, and more debt . . . .

From the Financial Post.

VICTORIA - Many Canadian households carry debt loads in the "danger zone," says the executive director of the Ottawa-based Vanier Institute of the Family.

Average household debt rose to more than $90,000 in 2008, Clarence Lochhead told a recent meeting of Victoria's Association of Family Serving Agencies. The Vanier Institute is a non-profit agency promoting the well-being of Canadian families.

The total debt-to-disposable income ratio rose to 140% last year, Mr. Lochhead said, referring to the Institute's report, The Current State of Canadian Family Finances.

Last year, the average household income was $65,200, up by 11.6% from 1990. In that same period, spending jumped by 24.4%, total debt went up more than six times faster than incomes, and annual savings shrank, he said.

The median (mid-point) real earnings of Canadians, when adjusted for inflation, show little increases between 1980 and 2005, he said. Meanwhile, many citizens are overloaded at work.
The reward: "We got credit. We got a lot of credit," he said in reference to interest rates dropping in the past several years.

"But there was a whole, I think, really big cultural shift too in the way we think about spending, the way we feel about money, the way we feel about availability of credit - the push to spend when you don't have money," he said.

When spending outpaces income, families end up close to the edge of their monthly budget. Mr. Lochhead said it can be financially painful if they hit a bump in the road, whether it is due to the fallout from today's recession or a personal reason.

It is not irrational behaviour to pull back on spending, Mr. Lochhead added. He said that not all debt is bad, but rising consumer debt as a percentage of annual income is "problematic."
Looking at the examples from past recessions, Mr. Lochhead said it could take a long time to recover from this recession.

He also had advice for governments that plan stimulus spending, "At the provincial level, why don't we do something about social assistance rates?" That money goes immediately back into the local economy, he said.

"Any analysis of spending at the lower income end will show you that every marginal dollar received will be spent and there is a very high probability that it will be spent locally."

When we are talking about infrastructure, Mr. Lochhead urged looking at more than roads and bridges. "Let's talk about providing supports that are going to help families."

Wednesday, February 4, 2009

Bill Gross - Economy Experiencing Wile E Coyote Moment

Bill Gross, Co-CEO, PIMCO, has published his latest (February) investment outlook, titled BEEP BEEP!

Here are some highlights:

PIMCO's thesis for several years has held that the levered global economy long ago morphed from a banking-dominated regime to one that hid behind securitized lending and structures resembling a shadow banking system. SIVs, hedge funds, CDOs and increasingly levered mortgage and investment banks fueled asset appreciation in all investment markets, which in turn propelled real economic growth and employment to unsustainable levels. But, with U.S. housing prices as its trigger, the delevering process did a Wile E. Coyote and headed over the cliff in mid-year 2007, dragging down almost all asset prices except government bonds. The real economy followed shortly thereafter, not just in the U.S., but globally, proving that linkages work on the down as well as the upside. To PIMCO, the remedy for this deflationary delevering and mini-depression is simple and almost axiomatic: stop the decline in asset prices. If that can be done, the real economy will level out as well. When home prices stop going down, newly created households will be more willing to take a chance on ownership as opposed to renting. If stock prices consolidate, recently burned investors will be more willing to invest, as opposed to stuffing their 401(k) mattresses with Treasury bills. Business investment, jobs, and profits should follow quickly behind.

The simplicity of the solution, however, is not easily achieved once deflationary momentum takes hold. Animal spirits, once dampened, are hard to reignite; fear of fear itself dominates greed. Under such circumstances, the benevolent hand of government is required and Keynes is reincarnated in an attempt to plug the dike via fiscal spending and imaginative monetary policies that support asset prices. PIMCO has recently been contracted to assist in several publically announced programs which have helped in that effort: the CPFF, which has benefitted commercial paper yields, and the Federal Reserve's purchase program for agency-backed mortgage loans, which has lowered 30-year mortgage rates to 4.5% and fostered the affordability of new and secondary housing prices. These two programs, in our opinion, have been the major policy successes to date – not because of our involvement – but because they have supported and increased asset prices whose decline has been the major deflationary thrust behind the real economy. Stop asset prices from going down and with a 12-month lag, unemployment will stop going up, and President Obama's targeted three million new jobs will have a fighting chance of being achieved.

Rather, asset prices securitizing commercial real estate and credit card receivables, as well as plain old-fashioned municipal bonds, must stop going down if the real economy has any chance to revive by 2010.

Example: CMBS or commercial real estate mortgage-backed securities are now priced to yield over 12% vs. 5% in recent years. As real estate financing comes due and rolls over in the next few years, it is imperative these yields return to mid-single digits if shopping centers, retail malls, and office buildings are to remain viable. How best to bring those yields down is debatable: another CPFF-like structure with self-insurance and contributed fees as its equity backstop? A generous portion of remaining TARP billions providing a reserve cushion for Federal Reserve funding? A good bank, bad (aggregator) bank structure? All three are being debated by policymakers and we should have clarity within a week's time. But one thing is certain: an economic recovery is dependent upon commercial real estate prices stabilizing and most retail stores staying open for business in the months and years ahead.

Read the complete newsletter here.

Monday, February 2, 2009

What are the 'experts' investing in right now?

Where are the investing world’s gliterati investing in today’s financial climate.’s Eleanor Laise, has written a timely article. Here is an organized run-down of all the participants’ investments:

Robert Arnott, Research Affiliates “I think this is a marvelous time to be investing,” says Rob Arnott, the 54-year-old chairman of Research Affiliates LLC, an investment-management firm in Newport Beach, Calif. “There are more interesting opportunities out there now than any of today’s investors have ever seen.” “Certain parts of the bond market are priced for a scenario that’s worse than the Great Depression.” One favored area is Treasury Inflation-Protected Securities, or TIPS, (Real Return Bonds in Canada) a type of Treasury bond whose principal is adjusted based on changes in the inflation rate. Ten-year Treasurys currently yield only about 0.9 percentage point more than 10-year TIPS, indicating that investors believe inflation will remain quite low in the coming years. Mr. Arnott says he boosted his TIPS allocation “in a very big way” in his personal taxable account toward the end of last year because he expects a substantial increase in inflation in the next three to five years. Mr. Arnott boosted his allocation to investment-grade corporate bonds in his personal taxable account late last year because the market had reached “irrationally high yields,” he says. Other experts say that emerging-markets stocks, which were hit especially hard last year, are starting to look tempting. If these shares take another dip, they could become “extremely interesting,” Mr. Arnott says.

John Bogle, Vanguard Funds - Tax Exempt Municipal Bonds“I earn my money and spend my money in dollars, and I don’t need to take currency risk.” Municipal bonds also look attractive to many longtime investors. Munis are typically exempt from federal and, in many cases, state and local income taxes. Many are now yielding substantially more than comparable Treasury bonds. In his taxable account, Mr. Bogle holds two muni-bond funds: Vanguard Limited-Term Tax-Exempt and Vanguard Intermediate-Term Tax-Exempt.

Burton Malkiel, Princeton University, author of bestseller, Random Walk Down Wall Street.He has boosted his allocation to highly rated tax-exempt bonds in his taxable account late last year, since yields available on some of these bonds were “unheard of.”

Jeremy Siegel, Wharton School of Finance, and senior advisor to Wisdomtree ETFs“Emerging-markets stocks have ‘gotten cheap enough to really give value now.’”He has recently raised his allocation for junk bonds.“Stocks and high-yield bonds will move together as the crisis passes,” rebounding from their depressed levels, the 63-year-old Mr. Siegel says.Mr. Siegel keeps one-quarter to one-third of his foreign-stock allocation in emerging markets, and “they’ve gotten cheap enough to really give value now,” he says. He has bought some more of these shares as they’ve declined in recent months.Mr. Siegel recently added some U.S. real estate investment trusts to his portfolio, which got “very cheap” after declining sharply last year, he says.

Muriel Siebert, Muriel Siebert & Co.She has recently been buying shares of companies like Pfizer Inc., Altria Group Inc., and General Electric Co. “I don’t mind buying a stock on the bottom and waiting,” says the 76-year-old Ms. Siebert. “But I do think when you get a market like this, you should be paid while you wait.” Pfizer and Altria yield roughly 8%, while GE yields over 9%.

David Dreman, Dreman Value Management LLCThe 72-year-old chairman and chief investment officer of Dreman Value Management LLC, says he has a roughly 70% stock allocation.Some battered stocks in the energy sector also look like bargains, Mr. Dreman says. He likes oil and gas exploration and production companies like Anadarko Petroleum Corp., Apache Corp., and Devon Energy Corp. If we don’t have a long world-wide recession — a scenario that Mr. Dreman thinks oil prices currently reflect — “we’ll see much higher prices for oil again,” he says.

Don Phillips, Managing Director, MorningstarInvests his entire individual retirement account in the Clipper Fund, a large-cap stock fund that lost about 50% last year. Early this year, he made the maximum IRA contribution to that fund, just as he has for the last 20 years. “It’s long-term money, and you have to look at it that way,” he says.

Jim Rogers, Rogers Jim Rogers, a 66-year-old veteran commodities investor, is putting new money into Chinese shares. He’s focusing on sectors of the economy that the Chinese are pushing to develop, such as agriculture, water, infrastructure and tourism. Mr. Rogers is putting some new money into commodities, particularly agricultural commodities. “We’re burning a lot of our food in fuel tanks right now,” he says.

Sunday, February 1, 2009

Timeless Money Wisdom

"The rich rules over the poor, and the borrower becomes the lender’s slave"
(Proverbs 22:7)

"Let the creditor seize all that he [the wicked] has; and let strangers plunder the product of his hand"(Psalm 109:11)

"The wicked borrows and does not pay back, but the righteous is gracious and gives"
(Psalm 37:21)

"But if anyone does not provide for his own, and especially for those of his household, he has denied the faith, and is worse than an unbeliever" (1 Timothy 5:8)

"A good man leaves an inheritance to his children’s children" (Proverbs 13:22)

"The wise man saves for the future, but the foolish man spends whatever he gets"
(Proverbs 21:20, LB)

"Steady plodding bring prosperity" (Proverbs 21:5, LB)

"[The wicked] caused the cry of the poor to come to Him, and that He might hear the cry of the afflicted [judgment result]" (Job 34:28)

"A poor man who oppresses the lowly is like a driving rain which leaves no food" (Proverbs 28:3)

"Like a roaring lion and a rushing bear is a wicked ruler over a poor people" (Proverbs 28:15)

"He who oppresses the poor to make much for himself or who gives to the rich, will only come to poverty" (Proverbs 22:16)

"The righteous is concerned for the rights of the poor, the wicked does not understand such concern"(Proverbs 29:7)

Monday, January 26, 2009

Jeremy Grantham Quarterly Letter

In October last year perennial bear Jeremy Grantham, chairman of Boston-based GMO, said: “We are reconciled to buying too soon, but we recognize that our fair value estimate of 975 on the S&P 500 is, from historical precedent, likely to overrun on the downside by 20% to 40%, giving a range of 585 to 780 on the S&P as a probable low.

“The world faces unavoidable declines in economic activity and profit margins, so this overrun is unlikely to be much less painful than average, although you never know your luck.”

Given Grantham’s forecast, it was with keen interest that I have been awaiting his latest quarterly newsletter entitled “Obama and the Teflon Men, and Other Short Stories. Part 1“. The following paragraphs are a summary of his investment recommendations from this report:
“The current disaster would have been easy to avoid by making a move against asset bubbles early in their lifecycle. It will, in contrast, be devilishly hard to get out of. But, we are deep in the pickle jar, and it seems likely that, in terms of economic pain, 2009 will be the worst year in the lives of the majority of Americans, Brits, and others. So break a leg, everyone!

“Slowly and carefully invest your cash reserves into global equities, preferring high quality US blue chips and emerging market equities. Imputed 7-year returns are moderately above normal and much above the average of the last 15 years. But be prepared for a decline to new lows this year or next, for that would be the most likely historical pattern, as markets love to overcorrect on the downside after major bubbles. 600 or below on the S&P 500 would be a more typical low than the 750 we reached for one day.

“In fixed income, risk finally seems to be attractively priced, in that most risk spreads seem attractively wide. Long government bond rates, though, seem much too low. They reflect the short-term fears of economic weakness and the need for low short-term rates. We would be short long government bonds in appropriate accounts.

“As for commodities, who knows? There were a few months where they looked like a high-confidence short, but now they are half-price or less, and are much lower confidence bets.
“In currencies, we know even less. It is easy to find currencies to dislike, and hard to find ones to like. There are no high-confidence bets, in our opinion.

“For the long term, research should be directed into portfolios that would resist both inflationary problems and potential dollar weakness. These are the two serious problems that we may have to face as a consequence of flooding the global financial system with government bailouts and government debt.”

Click here for the full report on Grantham’s views.