Photo by: whatmegsaid

When it comes to government policy it is rarely acceptable for politicians to do nothing.  Even if it’s only to give the appearance of doing something and instilling confidence, the government actually does have a role to play.   While there is certainly a case for stimulus and crisis management, too much government intervention can completely upset the whole purpose of free markets.  Even worse, the fear of government intervention can inject the same uncertainty in the market that it is supposed to help assuage.

The 2008 Crisis

In retrospect there is a lot of criticism about the TARP-the Troubled Asset Relief Program.^[1] Some politicians complain that the prices paid for the equities were too high.  This criticism is somewhat problematic, since the whole purpose of the TARP was to pay more than the market was willing to pay for distressed banks.^[2] Others claim that it was unnecessary, and that the market would have sorted things out itself.  These criticisms conveniently forget the abject panic that had beset the markets when the idea was put forth.  There was a tremendous amount of uncertainty as to whether the banking system was going to completely collapse and how the world would react.

With all its flaws the TARP may very well have injected some confidence into the market.  The same can be said of Obama’s sweeping stimulus.  Investors and businessmen knew that a large dose of spending was coming and had broad ideas about what it would include.  Economists may argue, but a case can be made for all these changes, particularly when they’re done quickly and in a sweeping fashion.

The Problem

The problem arises when the government becomes a first resort instead of a last resort.  When people expect the government, instead of natural forces, to correct all the ills of the market, uncertainty is sure to follow.  The government can’t do everything, so the economy becomes a guessing game of trying to determine which programs the government will implement.  Even worse it can become a hotbed of cronyism, where the supporters of those in power get bailouts and the rest watch despairingly.

History has taught us that central decision making and governments controlling markets invariably leads to this cronyism.  Free markets, for all their faults, do a better job than any single body of making sure capital is allocated to the best places.  While they are subject to the foibles of the human motivations driving them, they at least have the counterbalance of self-interest.  Even the best intentioned government programs are going to be naturally biased for their own perpetuation and the benefit of their supporters.

Take for example the shares of General Motors leading up the bankruptcy.  People were buying and selling these stocks in a guessing game to see if the company would get a bail out.  This isn’t really market discovery of price, but instead simply a form of gambling based on the speculators read of the government.  The decisions of the government are driving the price of things and that does not have a good historical record.

Conclusion

While many are apt to decry the government’s actions on the current economic crisis, in the face of massive uncertainty the government has a role to play.^[3] During crisis also tends to be when government is the least self-serving and the most just.  While they are tinkering with the market, the idea is to cushion the blow.  It’s important to remember however that you cannot avert the blow; your goal is simply to soften it.  The government can be helpful in a crisis; they just have to know when to stop.

Post from: Personal Finance And Investing

The Problem with Uncertainty

1. Wall Street Journal - Panel Steps Up Criticism of Treasury Over TARP
2. The Economist – Carping about the TARP
3. The Economist – Big government fights back

Photo by:  futureatlas.com

I am a fervent believer in free markets.  More specifically I believe that they, much like Democracy, are flawed but vastly superior to any alternative.  As various elements in the world decry the current financial crisis as an indictment of the flaws of capitalism, I wait patiently for them to suggest the proven alternative.  Despite this, I am left wondering if the financial sector is an exception to the wisdom of free markets.

Does Regulation Even Work?

If I’m defending free financial markets, my first piece of evidence is the Office of Federal Housing Enterprise Oversight.   This organization was 225 people as of 2006, tasked solely with regulating and overseeing Freddie Mac and Fannie Mae.^[1] With both of those organizations now being operated by the government after becoming tremendously over-leveraged, the efficacy of regulation is certainly in doubt.  If an organization of 225 people cannot regulate a large financial entity, what good does adding more regulation to the system do?

Is Financial Destruction Creative? 

One of the great arguments for free markets is the idea of creative destruction.  An oversimplification of the idea is that when you have an asset bubble burst its capital is reallocated more effectively.  In the end the death of these asset bubbles is good for your economy.^[2]  Hyman Minsky would argue that this is not equally true of a financial bubble.  He suggests that a financial boom and bust cycle differs from a normal market, in that the bursting of the bubble does not result in creative destruction, but instead simply a deflationary cycle.  Capital is actually destroyed instead of reallocated.^[3] This suggests that unbridled booms may not have the same benefits in the financial sector that they have in other markets.

Who’s Really At Risk?

We have empirical evidence to suggest that more politicians side with Minsky and believe that this deflationary cycle is something that must be avoided.  Namely they believe that they need to counter this deflationary cycle with government spending and bailouts.  If they support this idea then this inherently leads to an asymmetric risk profile.  During the booms, bankers and investors are rewarded handsomely because they’re allegedly taking a lot of risk, however during the bust, they are bailed out because society doesn’t want to deal with the “destructive destruction” that the bubble bursting brings.  They get rewarded for risk they aren’t actually taking.

What We Already Know

All of this sounds very theoretical and doesn’t necessarily suggest that if the government were to allow the banks to simply go bankrupt that it wouldn’t wind up being for the best.  However there is also empirical and practical evidence to suggest that some industries are inherently better served with some government interference. 

The most obvious example is FDIC insurance.  By putting the full faith and credit of the US government behind our banking institutions, we bring stability to the banking industry that was simply not there before.  Without this kind of insurance, people would literally have to analyze the balance sheets of banks to decide whether they wanted to keep their money there.  They’d also have to keep doing this due to fear of losing their life’s savings.  Ultimately this would deter many people from putting their money in banks at all.  This is not good for the flow of capital.

 A more glaring example is the insurance industry.  Imagine if insurance companies were not heavily regulated.  People could start insurance companies, charge unduly low premiums and when they didn’t pay off, they could simply declare bankruptcy and then insurance claims would go unpaid.  Once again it’s not necessarily good for the economy for insurance purchasers to have to do a tremendous amount of research before they can buy simple insurance.  Thus we regulate insurance companies to make sure that their claims will not go unpaid.  As AIG and the Credit Default Swap outcomes have shown us, insurance and banking are very closely related industries.

Utility Regulation

While all these arguments are compelling, it seems likely that the best outcome is somewhere in the middle.  Pro-regulation pundits are of course calling for blood and suggesting that the banking industry is out of control and needs tremendous reform.  One fears however that if the pendulum swings too far you will have the same kind of slow growth and poor allocation of capital that you see in other heavily regulated industries like utilities. 

While you don’t want to see the kind of insane risk, backed up by an asymmetric risk profile that we’ve all just witnessed, you also don’t want overly cautious banks.  In fact right now you’re seeing the pain of a “credit crunch” caused by banks that are afraid or unwilling to lend money.   Further diminishing banks’ willingness to lend doesn’t seem like a wise idea in the long term. 

Governments almost never run things efficiently, so you probably don’t want them taking too much control over our country’s capital allocation.  Central planning does not have a good track record for efficient capital flow.  While lawmakers are rarely reasoned, or contemplative, one can hope that this would be a case where they would invest the time in striking the right balance of regulation and market forces.

Post from: Personal Finance And Investing

Is the Financial Sector a Utility?

1. OFHEO 2006 Performance and Accountability Report
2. Joseph A. Schumpeter – Capitalism, Socialism and Democracy
3. The Economist – Minsky’s Moment

Photo by: Collin Anderson

Back in the era before I started falling asleep at night terrified by visions of inflation, I had a retirement plan.  Every month I would open a CD.  Eventually I would get to where I had a CD renewing every month, then every week, then every day.  Once the interest on those CDs paid my living expenses, I was done and could retire.  Of course my dreams of building a CD ladder were somewhat upended by the recession and  banking crisis.

What Is A CD Ladder?

A CD ladder is a way to get the improved returns CDs usually offer without the problems of diminished liquidity.  The idea is that you get CDs set up in such a way that the money you have invested in them matures periodically, maybe every month, giving you easy access to liquid funds while retaining better returns than a regular savings account.  This can be a good way to maximize returns on your cash.

How to Build a CD Ladder

A typical way to build a CD ladder is to build it all at once.  Let’s say you have $12,000 and you want to build a ladder where you have a one year CD renewing every month.  One way to approach the problem is to simply open a CD with one month, two month, etc. maturity dates, and then when the time comes to renew them, renew at a 12 month period.  Of course it can be hard to find a seven month CD, so you may have to go to plan B and build it over time.  My approach was simply to buy a 12 month CD every month until I had mine set up.  You do not have to use one year CDs of course.  You could use half as many six month CDs to get the same effects, although likely with inferior yields.

Some Hassles of CD Ladders

Part of the logic of my ladder was that I had chosen “good” banks with which to do business, and I could simply let the CDs auto-renew.  For a couple of years that worked fine.  While I didn’t always get the best rate at renewal time, it was close enough that I didn’t bother changing it.  The value of my time was higher than the difference in the interest.  Unfortunately, once interest rates plummeted, I began having to move them around frequently.  The amount of time it took to deal with all those CDs was absurd.  Many banks make it very difficult to get your money back unless you are aggressive.  The whole process was stressful and time-consuming.

To make matters worse, once the banking crisis hit, some banks started trying shenanigans like offering ridiculous rates on CDs (lower than their savings account rates) in the hopes that inattentive people would renew and they’d get free money.  I have had to be very diligent to make sure this doesn’t happen.  I have since decided that fewer CDs is better, since the cost of dealing with them is the same regardless of size.

Even when you don’t have craziness in the economy, banks still try to pull the wool over your eyes by offering “promotional” yields one year and then terrible yields the next.  So you either have to deal with the hassles of moving your money around, or get a terrible yield.

Bank Reviews

I have had some particularly bad experiences that I thought I might share, since it’s difficult to know which banks are good and bad.

GMAC Bank

GMAC bank has done the best as far as not changing interest rates too much, however, because of this, I don’t know how difficult it would be to get my money back from them.  They haven’t offered me an awful rate yet, so my money is still with them.

E-Trade Bank

E-Trade bank was fairly easy to get my money from, however I think that was aided by the fact I have a brokerage account with them, so I had more business to take away if they played any games.

Indymac Bank

I had one CD with Indymac.  Obviously I don’t have to warn anyone against using them since they’ve been seized by the FDIC and sold, but I had to spend a considerable amount of time making sure my CD wasn’t renewed when their interest rates dropped.

Amtrust Bank

I have saved the worst for last.  Part of my motivation in writing this article was to warn people who are considering dealing with this bank.  Although I had the most money with them and have dealt with them for the longest time, they have been simply awful since the banking crisis.  They dropped their interest rates on CDs to 1% and then 0.75%.  They have savings accounts that yield 1.5%, so clearly they don’t want my CD money.  They have sent out letters offering to let you “get out” of your CD without penalty, i.e. lose your interest rate.  Each time I’ve tried to keep a CD from renewing I’ve been told a different process was necessary-each more difficult and time-consuming than the last.

Like so many others in the banking industry, they seem to be focused on the short term only.  They are causing me stress and costing me time in an attempt to screw me out of a few dollars.  However, when times were good, and they may be again, I was a customer with a considerable amount of money invested there.  Do you imagine they’ll ever get my business again?

Summary

Here is some quick advice based on my experience with CD ladders:

• Shop around for good interest rates.  Bankrate.com has a good service for finding good yields.
• Favor fewer, larger CDs.  You will spend less time dealing with the logistics of managing the same amount of money.
• Get information on bank customer service in addition to their interest rates.  Your time is money, and you don’t want to spend a tremendous amount of time just to gain slightly higher yields.
• It can be easier to set up a ladder all at once than over time.  Once you have the CDs set up, they will renew, reminding you to take action each month.  If you set them up over time, you can forget one month and then have your schedule confused.

In all, I still hope to establish a ladder that will represent my retirement income.  But I’ve definitely changed my methodology.  I hope I’ve saved you some time on the learning curve as well.

Post from: Personal Finance And Investing

CD Ladders: Some Personal Experience

Photo by: epicharmus

As of this writing, the Citibank closed the previous day’s trading at $1.20 per share.  This gives them a market capitalization of just over $6 billion dollars.  Specifically, this means all the common stock of Citibank is worth $6 billion dollars.  In November, the US Government “injected” $20 billion and guaranteed $306 billion of Citibank’s assets.   Citibank has been “bailed out” repeatedly and has had a total of $45 billion of taxpayer money channeled to it.^[1] This leads to one simple question:

How is Citibank Solvent?

Of course the answer is, it isn’t.  But that leads to the question:  how is its common stock still worth $6 billion? 

Currently the governmnet is propping up a company to retain value for investors who should have been wiped out already.  Sure they have been diluted by government injections, but that seems a poor punishment for investing in an utterly insolvent company.

Nationalization

Many people like to jump up and down about the subject of nationalization, making the comment that we’re going to somehow become “socialist” if we take this approach.  This argument somehow overlooks the fact that the government already owns 36% of Citigroup.  We already own the banks, at least partially, and given what we guarantee we deserve to own them outright.   Additionally, the Federal Reserve’s regulatory oversight powers give it the authority to direct bank policy if necessary even without any equity stake.^[2]

It is not necessary that nationalization be permanent.   In fact it could be both temporary and brief.  It could serve as an orderly receivership process with the government acting as receiver in much the same manner as it did during the early 1990’s with the Resolution Trust Corporation that liquidated the assets of a hundreds of busted savings and loans.  They “clean up” the banks by selling off assets and cramming down debt holders and then reissue the stock (in some cases in lieu of old debt) and we all move on with solvent banks instead of insolvent ones.^[3]

Another argument made against this approach is that it will be bad for stocks, particularly bank stocks.  This argument is probably true, but seems irrelevant to me.  Maintaining stock market value is not the sole purpose of fiscal policy.  The true goal is to get the system “fixed” as quickly as possible, instead of trying to control the market, a proposition that is almost certainly doomed to fail.

Bond Holders

Many people have notably criticized the idea of nationalization.  The most common question is:  What happens to bond holders?  These banks have bonds to insurance companies and pension funds.  If that debt is wiped out, then we just have a new set of problems.  ((Washington Post – Nationalize the Banks!  We’re all Swedes Now))  This works under the assumption that you have to wipe them out, or wipe them out completely.  There are many approaches to this, including leaving them completely intact.  Morally it seems appropriate however that those who bought bonds from insolvent banks endure at least a small portion of the pain of restructuring them.

A Naïve Solution

Ultimately the idea of “cleaning up” these banks and reissuing their stock has a wide variety of pitfalls and details to be worked out.  On the plus side, it has the huge advantage that the right people are at least contributing to the solution.  Imagine this most simplified of solutions:

The government nationalizes the banks, spends $6 billion to improve their balance sheets, wipes out all the common stockholders and re-sells their shares at the exact same price they nationalized at.  You suddenly have a bank with $6 billion more in assets, which should certainly be worth more than the current institutions, particularly without the specter of nationalization hanging over their heads.  The government has spent essentially nothing and the only people footing the bill are common shareholders, who it only makes sense should be wiped out in the process.  Of course $6 billion is unlikely to be enough, so perhaps we make the bond holders pay a bit of the price too.  While it seems likely that the government might have to inject some taxpayer money, it also seems likely that a recapitalized bank could likely be resold to the public at a higher price than it currently enjoys. 

Obviously, this solution is naïve and there are tremendously more complex details.  But at a bare minimum it makes sense that those who invested in these doomed banks bear the brunt of the restructuring costs, versus taxpayers who had nothing to do with them.

Post from: Personal Finance And Investing

Handling the Bank Bailouts

1. NWAnews.com – Citigroup Deal 36% portion for U.S.
2. Federal Reserve – Section 5 Supervision and Regulation
3. Zacks.com – Banks: Winners and Losers