Don’t Feed the Alligators

A Personal Finance Blog from a Small-Scale Landlord’s Perspective

Archive for September, 2008

Bernanke, Bush, Greenspan

Creative Commons License photo figure credit: azrainman

Editor’s Note: Introducing guest poster Matt.  Matt and I have been close friends since our first days of college — we and our wives were in each others’ weddings.  Matt has been a bond market professional for the last ten years, and I strongly value his insight into the current economic/political crisis.  Despite the expected settlement by Congress, the American public still needs to understand and ultimately accept it.  I’ve gone back and forth on this all week, and Matt’s assessment below has certainly swayed me back the other way.

I would like to share some insights on the pending economic bailout package and perhaps clear up some confusion that seems to be circulating through political sound bites and media commentary.  To be clear upfront, as I’ve dedicated my career to them, I am a strong proponent of capital markets and believe in the model.  Also worth noting, I have never been in a role to participate directly in any mortgage lending or borrowing that is relevant to the issue at hand.

Despite my strong belief in free markets and my opposition to an RTC-like (Resolution Trust Corp as in the early 1990s Savings and Loan bailout) solution to this problem from the beginning, the recent bankruptcy of Lehman Brothers has pushed us to the breaking point and we now have no option but to pass this plan in one form or another.  This is not particularly evident by looking at the the widely tracked equity markets, but is painfully clear in the bond markets.  This is where all individuals, institutions and corporations secure loans and therefore, the economy cannot function without liquid and orderly money markets (short-term lending in the bond market).  The recent acceleration of this crisis of confidence occurred when Lehman Brothers filed for bankruptcy (as a result of a perceived weakening of financial strength leading to the loss of funding availability, the same effect that brought down Bear Stearns) and general creditors (people and institutions that loaned money to Lehman) will likely lose all of their principal.  This did not happen with Bear Stearns, Fannie Mae, Freddie Mac or AIG where only the common shareholder was wiped out.  Money markets were no longer safe and cash fled to safe haven FDIC insured bank accounts and US Treasury Bills, which briefly traded at slightly negative yields last week.  This means investors were willing to PAY the government a small amount of interest to LEND it money for one month and know their principal was safe!  The SEC ban on short-selling prevented traders from attacking the next weakest link via the equity market, but with many people unwilling to lend to banks, short-term interest rates surged and liquidity dried up.  Direct borrowing from the Fed, the lender of last resort, has exploded, and the Fed’s almost one trillion dollar balance sheet has been mostly used at this point for collateralized short-term lending to financial institutions around the world.  This is unsustainable and is a result of the inability of banks to fully fund themselves through the capital markets.  It is the combination of lack of funding, reduced equity and being saddled with illiquid assets that is preventing banks from extending credit, and the negative feedback loop that exists between these factors will ensure that the problem gets worse until something is done to turn the tide.

One important point is that this is a bailout of the economy as a whole and not just of the financial industry.  Most people do not realize how close we are to doing irreparable damage to the capital markets and how important that is to everyone in this country.  This crisis will now become worse at an accelerated pace and we haven’t seen anything yet if we continue down the current path.  This plan is the only way to restore confidence to the US banking system.

What are the reasons not to go ahead with the plan in some form?

1) Let’s not bail out a bunch of rich Wall Street people.

This is silly because they have already lost billions of dollars and over 120,000 jobs and are only one piece of the puzzle. It is an inaccurate simplification to only blame investment banks for this problem. Everyone from homeowners/spec buyers to mortgage brokers to foreign bondholders to the US government (a big part of it actually) share the blame and they have and will be punished in one way or another.

2) The taxpayer shouldn’t have to pay for this mess.

This needs to be clarified because the media is misrepresenting the facts in many ways.  The taxpayer may very well have to pay something in the end, but here are the important points:

a) The government is not “writing checks”, it is making loans and investments.  This goes for the AIG bailout as well.  Nobody “spent” $85 billion on that deal.  The government will receive LIBOR + 8.5% (London Interbank Offered Rate), which is currently more than 12% interest, on that loan and will own most of the equity upside of the future of the company.  Could it lose money?  Yes.  But it could also make a lot.

b) The government is not using taxpayer money to make these loans.  Think of the government as a giant hedge fund.  It borrows money and makes investments.  It will issue $700 billion of US treasury notes and bills and use the proceeds to buy the distressed assets.  The interest rates on the assets far exceeds the interest rates on the US govt debt so it will net receive income. As time passes, depending on default and recovery rates on the underlying mortgages, it will make or lose money on the assets, and losses, if any, may or may not be covered by the positive interest rate differential that the government will earn.  In the end, the taxpayer is on the hook for the losses, if any, and will receive the gains, if any.  Either way, the gains or losses are unlikely to be anywhere near $700 billion.  One other interesting point is that as soon as the government buys the assets, they will immediately become more valuable and private capital will most likely flow into the system again.  For example, Warren Buffet just put $5 billion into Goldman Sachs.  Would he have done that if he didn’t believe this plan would be passed?  Not a chance.
3) If we start with $700 billion, what if we need three times that much, and are we going down a dangerous road where we keep throwing good money after bad?

This is a concern and only time will tell.  It might need to expand at some point, and may or may not be approved in that event, but my feeling is the initial size will be sufficient.

This plan has more hair on it than the similar RTC-type plans in the past, but there is precedent for this.  Again, I don’t like that it has come to this, but unfortunately we have no choice.  The US economy, already effectively in recession in my opinion even though GDP growth has yet to go negative, will continue to weaken in the coming months.  However, with the passage of this bill, we have a chance to repair the banking system and enable the Fed to inject credit into the economy in levered form as it always does at this point in the cycle (i.e. the Fed cheapens lending and reduces incentive to save –> banks borrow –> banks lend ten times as much also at cheaper rates –> economic activity ultimately picks up).  Without the bill, we risk a serious disaster in the financial system and a dysfunctional banking sector will prevent the economy from operating properly.  Unemployment will rise significantly, many businesses will fail, asset prices will continue to deflate, possibly at a faster rate, capital will retrench and we risk a deflationary environment, a depression or a Japan-like scenario (also generated by collapsing asset prices and the unwillingness to write down and remove bad loans from bank balance sheets).  I think we can work out of this mess, but it’s time to take out the big bat and shock the system.  Too bad politics are involved.

Hotel Pool

photo figure credit: ScrapperMom

Michelle asks:

"How was the vacation?"

In a word: Fantastic!  We got to meet the newest member of our extended family (on that side, anyway…) who is already one and half!  We got to catch up with family that we haven’t seen in over 2 years.  We got to know new wives, girlfriends, and old friends a lot better.  Thanks to all of them for taking the time out of their busy schedules, providing places to stay, cooking dinner, etc.  This picture is the pool at the hotel in Orlando, which the kids loved.

As a follow up to my original post on this topic, I thought I would offer a post-trip analysis on how we did financially. It’s important to note that while we put nearly everything below on our rewards credit card, it will all be paid off by the end of the month because we had already set aside the funding for this trip.

I’ll start with the area in which I feel we did the worst from a frugal perspective: Dining out.  In total we purchased 9 meals out and they totaled $378.  This breaks down to $42 per family-meal, or $17 per person per meal if we count dear daughter #1 as a half person who shared what we ate most of the time.  Given that we ate a total of 22 meals, 9 represents only 40%.  We easily could have converted a couple of dinners out into dinners at home, but then again, we were on vacation…  We did manage to convert a couple of these meals into lunches the next day since the portions were often too big! I should also point out that this total included drinks with meals as well, which as you know can get pretty expensive.  During one meal we paid close to $9 for an 8 ounce rum and coke!

Relating to dining, our grocery bill came in at $141.  As described in the initial article, we had a lot of opportunity to prepare meals, especially breakfasts and lunches.  If you put all of our food spending together, the per person per meal average comes down to $9.50.  The grocery bill includes a 12 pack of beer that we brought to a party, as well as a lot of bottled water that we wouldn’t normally buy at home, but the local water was terrible!

In the category of transportation, we got a great deal on airline tickets: we purchased 3 seats for $597 on JetBlue.  The in-flight entertainment, especially Animal Planet and the XM station for Radio Disney went a long way to keeping our 21 month old busy on the flight each way.  In total, we spent $378 (Yes, exactly the same as on dining out!) on the rental of a mini-van and the fuel we needed for a week.  We drove the van over 500 miles since we went down to Disney, and much of the time the van was nearly at capacity with 4 adults and 2 toddlers in car seats.

Our short jaunt to Disney cost us both on the ticket side and on lodging.  We somehow thought that we still had tickets that we could use at Disney, which would have given us “free” entry to the park.  Unfortunately this was not the case, and we ended up having to buy 2 adult, single day passes for a total of $160.  Yes, that hurt.  The Magic Kingdom is a great place, but honestly I think it’s looking a bit dated, and I’ve been to a number of better parks in recent years that cost a lot less than this.  But it’s the American Way to take your kids to Disney, right?  The lodging for one night was not bad at $90.  This was our share of the split on the condo that we shared with my cousin and his family.

We spent a total of $23 on items that didn’t fit into any of these other categories.  This included a Christmas ornament from Disney, and a couple of magazines at the airport.  We successfully resisted the urge to spend $17 on a fan-assisted squirt bottle in Disney on a 93 degree, scorching hot day.  We also avoiding having to purchase every cute stuffed animal that DD#1 got her hands on.

Last, and far from least, we spent $720 at the Dog Kennel.  As outlined in this article, our dogs are expensive.  It definitely hurts to have to budget 30% of every trip we take to kenneling the dogs, and it’s the first thing that pops into my head whenever we consider a trip.  We spent a few years trying to find the right mix of costs for kenneling.  In this business, the saying is true: You get what you pay for.  We were horrified upon retrieving our dogs from a budget kennel on one trip, and they didn’t want to come home when we tried to get them from a super-expensive kennel.  Eventually we found a “just right” kennel that treats them well — but not too well.  This is certainly an area that will factor into any future pet decisions.  It’s a good argument against having two pets.

In total, we spent $2487.  This is a lot less than ScrapperMom and I spent on a lavish Quebec trip a number of years ago, but more than we have spent on a vacation in some time.  Was it worth it?  It’s hard to put a price-tag on the experiences that we had.  If pressed, however, I would have to say that the cost was worth it since it meshes with our values: notice that we have only a couple of magazines and a Christmas ornament to show for this expenditure.  We don’t place a high value on “stuff”, but rather experiences and time spent with family and friends.  You can’t put a price on that.  This trip would have been a lot less fun if we just went to Florida by ourselves…

We’re already looking forward to a mini-vacation in November as we travel to New Jersey to celebrate a wedding!

09.24.2008
Neutron Star

Creative Commons License photo figure credit: pingnews.com

$1,000,000,000,000

The term $1 Trillion has been in the news a lot lately, but rarely have I actually seen it written out.  That’s a lot of zeros!  To look at it another way, it is :

$1,000,000 X $1,000,000

One Million Dollars times One Million Dollars equals One Trillion Dollars.

If you had a trillion dollars and wanted to count it, and could count at a rate of one dollar per second, it would take over 31,000 YEARS to finish!  (Apparently, aside from the lifespan issue, you couldn’t actually count this high this fast anyway, because some numbers would take longer than 1 second to say, like nine hundred and ninety-nine billion, nine hundred and ninety-nine thousand, nine hundred and ninety-nine.)

A stack of $1 Trillion dollar bills would wrap around the earth at the equator two and half times.

Those same dollar bills laid end to end will reach further than the sun — at it’s farthest approach.

Do you think $1 Trillion is a lot of money?  I do.

Hope your great-grandkids don’t mind paying taxes…

What do you think about the proposed bailout out of the financial industry? Let’s hear your thoughts in the comments section below!

Rushing to get it all done

Creative Commons License photo figure credit: booleansplit

In the original post on this subject, I outlined the almost comical amount of difficulties I faced in trying to move approximately $44,000 out of our Money Market fund at Vanguard and into our checking account so that we could pay the balance on our Chase Freedom card.  You may also recall that the reason why our balance was so high is that we were exploiting a 0% interest rate on purchases for one year — otherwise known as a form of arbitrage.

Picking up where I left off, the plot gets thicker before finally thinning out for good:

The good news is that the payment from the Vanguard check arrived at EverBank on September 8th.  The bad news is that I didn’t even consider the fact that it could take days before the check cleared.  Because of the very large amount of the check, the bank cleared it in increments: I got a $100 credit on day 1, a $5000 credit on day 4, and the total was credited on day 7.  Each day, starting on September 10th, I had to move my online bill payment from that day to the day after the final schedule payment in hopes that the check would clear the next day.

After doing this for 3 days straight, I discovered that the Chase website has an option for making payments online.  This option requires you to enter your bank’s routing number and the account number from a check.  “Great!”, I thought.  But there must be a catch to this also.  I emailed customer service and asked what the fee was for this, what the maximum amount I could pay at any time was, and how long it took to post to my account.  I was told that there was no fee, the only limit to the amount I could pay was the total of my credit card balance (in other words, I could not overpay my account), and that the payment posted on the same day as long as it was made before 4pm.

At this point, I canceled all of the scheduled billpay payments and went about setting up the payment on the Chase website.  Wouldn’t you know that I discovered another catch?  The website, contrary to the information from customer service, limited me to a payment of $25,000.  Additionally, I could not set up another payment until 3 days after the first payment.  Luckily, I still had time.  The first payment was set up for the 13th of September and the second payment was set up for the 16th.  Both payments executed properly, and I met the September 17th deadline to get the entire balance paid off by the due date.

Whew!  In total, I paid a lot for this in stress, as well as the $20.71 FedEx overnight fee to get the check from Vanguard as soon as possible.

Lessons learned and next actions:

  • We are going to fill out the form that would have allowed us to transfer the money directly from Vanguard to EverBank.
  • Never trust what a customer service person tells you — even if you get it in writing.
  • Plan ahead!
Dominoes

Creative Commons License photo figure credit: JL2003

ScrapperMom and I are back from vacation and have been trying to get back into the swing of our routine.  Our almost 21 month old is nearly back on her sleep schedule, which is always a good thing.

Obviously this has been a crazy couple of weeks for anyone who has money, which is mostly everyone — near as I can tell.  I remember where I was for some monumental events in American History over the last 25 years or so (since about the time I understood what news was…), and I have to wonder whether I’ll look back and remember driving out of Disney World the day that I found out the Bank of America bought Merrill Lynch and set off a 500 point market drop.  Will this ultimately end up being the straw that broke the camel’s back?  I wondered at that moment whether we should not have put the money we spent on the vacation into an emergency fund instead, and whether or when we would next be able to take such a vacation…

On that upbeat note, here’s a few articles that caught my eye over the last couple of weeks:

Five Cent Nickel gives us a bit of investing perspective here, with my additions in italics:

  • The Dow finished the week down just 34 points after dropping nearly 1000 points over the course of the week
  • In the past month, the Dow is up 40 points
  • Over the past 5 years, the Dow is up 18%
  • Over the past 10 years, the Dow is up 44%

Sure, the Dow isn’t gaining 7%-10% per year as it has historically, but it’s still rising steadily.

J.D. at Get Rich Slowly has some great advice for the vast majority of investors here:

  • Don’t panic.
  • Tune out the media.
  • Remember your goals.
  • Focus on the fundamentals.
  • Know your risk tolerance.
  • Educate yourself.

David at My Two Dollars has a great article on why we need healthcare reform ASAP.  I agree with David, as is evident in the spirited discussion that follows.  I believe that the single best way to increase freedom in the United States is to take away the fear of having the money to pay for medical care.  Not everybody “deserves” a flat screen TV, SUV, dinners out, etc., but as humans, we all deserve health care.  (And since the government can afford a $1 Trillion bailout of the financial industry, surely it can also afford healthcare for the people of the wealthiest country on the planet.)

J.D. has another interesting article about saving money by avoiding advertising.  Look for a similar article on this at this site soon…

Lastly, David has a nice quote from Paul Mccartney.  You can click here to read it.