Blog – Page 275

I can't make change, all I have are quadrillions

Control Hoard Your Cash

Cash is a bad investment, right? Not as bad as penny stocks, perhaps, or California muni bonds, but certainly not much better.

Besides, can you even call holding cash “investing”? Does it fit the definition of using money to generate potential profitable returns?

It can, when deflation happens.

Simply spend enough time on this planet, and you’ll be conditioned to believe that prices and wages inevitably rise- and that what a dollar bought a year ago, it’ll buy slightly less of today.

2010 is an outlying economic year for many reasons, not the least of which is the possibility/certainty of deflation.

Well, that and the gargantuan government spending. Our apologies if we used the word “gargantuan” in a recent post: we’re running out of adjectives that denote bigness. According to the economists at the Bureau of Labor Statistics (which spends an average of $2 per taxpayer per year), the consumer price index fell .1% last month, .2% in May, and .1% in April. Those numbers look miniscule, don’t they? Harmless, even. But keeping in mind that the numbers are several, and that they determine a trend, it might be time to start worrying. It’s hard to draw too many conclusions when the BLS only ratiocinates to one decimal place, but cumulatively, the above numbers tell us that prices have fallen somewhere between 2.5% and 5.4% in a mere 3 months.

Great news for spenders. Rotten news for savers. If that 3-month average were to maintain itself for a year, we’d be looking at a 20% decline in prices.

So what’s the downside to this? You’re complaining about lower prices? God, you really are a killjoy. You probably complain about how sweaty things get during sex, too.

It’s not that simple. Prices and wages usually move in lockstep.

So things are neither better nor worse than usual, then.

Not quite. Say you have a long-term obligation, like a 30-year fixed mortgage. One of the features people like about mortgages that last so long is that by the time you get to the end of the term, the payments will be tiny. They’ll be as large in nominal terms as they are today – fixed rate means if you pay $1000 a month in Year 1, you’ll pay $1000 in Year 30.

Go back to 2005, when annual inflation was close to 4.0%. That’s pretty close to the historical average, maybe a little higher. Say your monthly payment was $1000. If prices rose at 4% throughout the term of your loan, the final payment would be the equivalent of only $321 in constant dollars.

When deflation happens, those payments get progressively harder to make, not easier. During deflation, it’s great to be owed money, less great to owe it. Extended deflation makes banking less viable as an industry. If prices are dropping 20% annually, bank rates have to lower accordingly. That 1-year CD that pays barely 1% in nominal terms thus pays 21% in real terms. Banks aren’t in the habit of throwing money away, which means they’ll stop offering anything other than super-risky loans. If you can keep money in an ammo box buried in your backyard, and enjoy a real rate of return of 20%, banks outlive their usefulness.

A little inflation isn’t all that bad. You could almost argue that it’s crucial for a healthy economy, in that it gives people an incentive to lend and borrow (the latter in hopes of larger returns, the former with the comfort of guaranteed returns.) Deflation isn’t exactly a sign of a robust economy. Again, it usually means wages are decreasing on average, which upon further examination often means that wages are staying the same, just the number of people employed is decreasing, thus lowering the mean. The latest sustained period of deflation in this country’s history was from 1930 to 1933. Go ask your great-grandparents how much fun it was to escape the Great Plains while John Steinbeck wrote books about them and Woody Guthrie sang songs about their plight.

Thanks for the history lesson. How does this help me now?

Get out of that dying industry that you work in, where your shaky paycheck is sustained at the whim of your employer.
If you’re at the point where you’re looking at passive income to supplement or outperform your active income, a) nice going and b) don’t get locked into modest rates. Instead of a conservative money-market account, see what your bank is offering in terms of certificates of deposit. Don’t be shy about shopping around, either: there’s no rule that says you have to keep all your accounts at the same bank. In fact, almost no rich people do. Use the CD ladder technique, which manages to get your entire investment to pay long-term returns even though you’re only in it for the short term.

You want more details on that? You can wait for it to find its way into the rotation as our weekly free book excerpt, but by then the economy could be riding a hyperinflationary thermal for all we know. Or you can one-click your way here.

**This post was featured in Canajun Finances’ Best of Money Carnival #61.**

**This post is featured in the Carnival of Personal Finance #267**

This is Tony Hayward, a man who combines the ruthlessness of Mao Zedong with the sheer genocidal glee of Hitler. Add the economic scorched-earth policy of General Ne Win, and a dash of Saddam Hussein’s disdain for the environment, and in the BP chairman we have a thoroughly contemporary supervillain. In some circles, he’s almost as hated as George W. Bush.

BP has lost $102.7 billion in 10 weeks. That’s the GDP of Poland, the country with the 18^th-largest economy in the world. All because Hayward wouldn’t ensure that the series of valves used to prevent a blowout on the Deepwater Horizon rig included a trigger with a “deadman’s switch” that only stays inactive when the rig is manned. It would have cost an extra $500,000. The law didn’t require a deadman’s switch on Deepwater Horizon, and still doesn’t, but surely someone as diabolical as Tony Hayward should be able to predict the future. The populist wisdom is that Hayward ought to be keelhauled for the unspeakable atrocities he’s committed in the lubeless anal rape of Mother Gaia.

This is Franklin Delano Raines, former chairman of Fannie Mae.

(This always needs to come with an explanation, because so few people understand what this famed but mysterious entity does. Same with Freddie Mac. This particular explanation involves only Fannie Mae, but the two are close to interchangeable.)

You get a mortgage through a standard lender. But that lender can only lend out so much, relative to its assets. So the lender sells the rights to your loan to Fannie Mae, then takes that money and can loan it out. Multiply that by all the lenders in the nation, and Fannie Mae is essentially a bank with limitless funds. The argument for Fannie Mae’s existence is that it gives more people a chance to own homes, leaving open the question of why this is so important that it needs to be achieved artificially.

Now Fannie Mae has all these loans on hand – yours, and millions of others. Fannie Mae then packages the loans and sells them to investors. It promises the investors a decent return, and…

WAIT. How can Fannie Mae promise any kind of return? That’s not how investments work.

Private investments, no. But Fannie Mae is a government entity.

No it isn’t. Its own website says it’s a private corporation.
Yes, and the Hell’s Angels are a motorcycle club that gives toys to kids every Christmas.

You’d have to agree that if, say, a bunch of people default on the underlying mortgages, Fannie Mae would have to lower its returns. Except Fannie Mae has access to something that Microsoft, Geico and Cargill don’t: your tax dollars.

If Fannie Mae isn’t a government organization, then why doesn’t it pay state or local taxes? Why is it exempt from Securities & Exchange Commission regulations? Why did it enjoy a AAA credit rating when its debt-to-equity ratio would suggest a D rating?

For the first 30 years (1938-68), Fannie Mae was blatantly and officially a government operation. The only reason it switched to a “private” corporation was to keep its dismal numbers off the federal balance sheet. From that point on, you know the story: Fannie Mae leaned on lenders to hand out mortgages to people who didn’t earn enough money to justify the payments. (Thanks to 1977’s Community Reinvestment Act, an attempt to circumvent classical economics.) Thus Fannie Mae’s returns to investors should have decreased, but didn’t. And why not? After all, ultimately it was someone else who had to pick up the check.

There’s a reason why Fannie Mae goes through chairmen like the Oakland Raiders go through head coaches.

The worse the economy gets, the more harm Fannie Mae and Freddie Mac’s unassailability does to the economy. People can’t pay their mortgages, Fannie Mae and Freddie Mac continue to sell investments, and the implicit government backing becomes explicit, with no end in sight.

BP produces something tangible: without what they offer, our cars would be nothing more than stationary status symbols. Trucks move freight, and need gas to do so. The importance of BP’s role in the economy is obvious. Fannie Mae and Freddie Mac? Not even close. Their very purpose is to thwart economic movement, under the guise of democratizing the way people buy homes. But selling homes, like anything else, has nothing to do with how many people would enjoy the product and everything to do with whether they can afford it.

The cleanup estimates for Deepwater Horizon have ranged from $3 billion (BP’s own, presumably conservative estimate) to $20 billion (the amount the White House “suggested” BP fork over) to $63 billion (a recent estimate by a Raymond James analyst.) Let’s go with $20 billion, which is not just the median but close enough to the geometric mean. This will be paid exclusively by BP’s owners: its shareholders. Which primarily means the pension fund holders throughout the United Kingdom who watch every drop in BP’s stock price (it’s down 57% since the accident) with trepidation. American taxpayers won’t be out a nickel. (Check that. Obviously the oil leak impacts a lot of people economically, just like other unrelated events impact those same people both positively and negatively – just not in their capacity as taxpayers.)

Now, let’s contrast the havoc BP hath wrought with the similar numbers for Fannie Mae and Freddie Mac.

On October 4, 2007, Fannie Mae traded at 67.39. Within 11 months it had fallen to 33¢, a penny or two from where it remains. That’s a loss of $79 billion.

On June 9, 2008, Freddie Mac stock traded at 41. Within 9 months, it sank to where Fannie Mae is today. A mere $26.5 billion loss.

That’s $105 billion evaporated. The companies’ corpses are now the property of…well, you and me, whether you like it or not. We’ve already given Fannie Mae and Freddie Mac $145 billion from a line of “unlimited” government credit, although presumably it’s limited by how much you and I can earn.

The Congressional Budget Office, which has an interest in keeping government numbers as conservative as BP keeps its, estimates that ultimately Fannie Mae and Freddie Mac will cost us $389 billion. Barclays Capital says $500 billion ($1500 per capita.) Other estimates are twice that.

Janet Jackson exposes a nipple, Mark McGwire injects dianabol, an idiot woman conjures up a story about the accelerator and the brake in her Lexus switching places, and Congress can’t wait to publicize the hearings. Yet an entity created by Congress does what government entities do – destroy wealth, but profoundly in this case – and the quiet is deafening.

That quiet is also tampered by the obfuscation of institutionalization. The people who ran, and run, Fannie Mae and Freddie Mac took our money and torched it. They have names.