Do Not Start With the Redhead Having a Hot Flash

The first thing that caught my eye was Senator McCain's assertion that a "$300,000 . . study whether . . yoga can be . . effective . .to reduce the severity of hot flashes in breast cancer survivors" is "waste."  Then, I find that the total for the100 stimulus projects that he and Senator Coburn describe as having "questionable goals," that are "being mismanaged or were poorly planned" and are even "costing jobs and hurting small businesses,"  is 1/2 of one percent of the Federal Stimulus package. 
Being a woman in her 50s with 20 + years of moderate to severe hot flashes has made me somewhat of an expert in what is, and is not effective in reducing them.  Your opinion of my expertise aside, I can assure you with some conviction that it significantly exceeds that of both Senators McCain and Coburn.  When I read that the Senators thought it wasteful to study yoga as an effective methodology to reduce the severity of hot flashes in breast cancer survivors, I thought perhaps the honorable gentlemen would have found the study less wasteful had studied reducing symptoms of discomfort for prostate cancer survivors. 
No matter, Senators.  You have my attention.
And I have a calculator.

• FLASH - Whether you agree or not with their conclusions of wastefulness, the totality of the programs in their 55 page report is one-half of one percent of the total Federal Stimulus package.
• FLASH - If I were running a business with gross revenues of $200,000, and wasted 1/2 of 1 percent of that money, that would be $1000, or $83 per month.  I do not actually have gross revenues of $200,000, but I do waste $20 per day, and consider myself a very non-wasteful person.
• FLASH - From another perspective, if Senators McCain and Coburn were to write a 55 page analysis for every $7 billion in the stimulus package, their report would be 9,428 pages long.   62-year-old Coburn may live to see the publishing of that report, but I don't believe it could be completed in the remaining lifetime of soon-to-be 74 year-old McCain.
• FLASH - This is a mid-term election year.  Voters may be polarized, angry, out of work and disappointed, but, by enlarge, can tell the difference between something of real importance and of a politically motivated attack.  There are plenty of relevant political issues that differentiate the parties.  This is not one of them.
• FLASH - Do not tell women that a study to minimize the discomfort after breast cancer surgery is wasteful.  We are more than 50% of the population and it may infuriate us.  Those of us over 40, actually having these symptoms (who choose not to take hormone replacement therapy because it has a statistically significant increase in instances of breast cancer) will not only not vote for you, but may actually become quite vocal and tell others what you have done.  You can't afford to lose have the voters.  THAT is a significant number.
• FLASH - Some of us have calculators.  And we know how to use them.

Why the European Bank Stress Test is Almost Meaningless

European banks just completed a "stress test" designed to indicate whether a bank could survive a further economic downturn.  The primary measurement in this test is whether the bank is adequately capitalized, another way of saying whether its assets can absorb losses that may occur in such a downturn. Therefore, the definition of capital assets, in this case "Tier 1 Capital," is critical.
The Test
Assume a cumulative two-year probability of a

1. Default rate of 15 percent on property and corporate loans, 
2. 10 percent loss on mortgages and 
3. Stringent "haircuts" (write-downs) on their sovereign debt 

would the bank retain a 6 percent core Tier 1 ratio?
 
Tier 1 Ratio Defined
Included in the European bank stress test's definition of Tier One capital is

1. Deferred tax assets.  These are primarily losses taken by a bank that are in excess of the amount that can be deducted in a particular year, and are carried forward to future years, which cannot absorb new losses
2. Hybrid bonds.  These are loans to the bank that are convertible to common stock, which, again, cannot absorb losses.
3. “Silent participation” stakes, which resemble sovereign debt rather than cash, which has been injected into banks. Nevertheless, it counts this towards its core Tier 1 capital.

Which Banks Would Have Failed Without Using These Items in Tier 1?
According to Reuters, almost all big European banks would have passed.  It's a different story for the
smaller state-owned banks. Germany’s landesbanks, for example, have an average core Tier 1 ratio of only 5.9 percent but a total Tier 1 average over 9 percent, according to KBW. Using a stricter definition of Tier 1 capital would probably mean taxpayers having to stump up much more in the event of an economic decline as described above.

What Was the Purpose Performing the Test Using Such Lax Standards?
Had core Tier 1 capital been applied without including deferred tax assets, hybrid bonds and sovereign debt, the number of banks that would not have passed the test would have been significant enough to cause panic and further economic downturn.

But, by concluding that  only 7 of 91 banks failed the stress test, most people will be reassured that a further European economic downturn won't result in widespread bank insolvency.

Don't bank on it.

The Case Against Goldman Sachs: Epilogue

Last April, I outlined the case against Goldman Sachs.  In that discussion, I posed the following questions:
1.  Should rating agencies rate securities on their own merit (not by considering who may or may not be investing in them)?
2.  Since ACA chose the securities in this investment from a list given to them by Goldman (from a Paulson list), was it a misstatement that ACA was "Portfolio Selection Agent?"
3.  Since banks and pension funds are defined as "sophisticated" investors, should they analyze the investments they are considering on their own merit (not by considering who may or may not be investing in them)?
Those questions have been answered by the Security and Exchange Commission in their settlement with Goldman.
In that settlement, the SEC found that Goldman omitted the material fact that Paulson & Co. was on the other side of the trade.  That finding assumes that ACA would have selected securities differently had it known that Paulson was taking a position against, rather than investing in the securities it was analyzing.  Stated slightly differently, that is analogous to saying that I would report findings on the financial health of Johnson and Johnson, the Washington Post, Moody's and Kraft Foods differently if I knew Warren Buffett was selling them than if he was buying them.  That doesn't say much for me as an analyst.  There's always someone selling when another is buying.  When must that be disclosed?  When the person is well respected?  Smart?  Well known?
The SEC additionally noted that material facts need by disclosed whether or not investors are "sophisticated" or not.  Again, that doesn't say much for banks and pension funds, which generally have staff analysts who review the financial health of potential investments.  Does the SEC feel that these analysts will conclude differently if someone they know is selling, rather than buying a security?  I taught Security Analysis and Advanced Security Analysis at UCLA, and focused upon balance sheets, cash flow statements and other fundamental measurements of financial health.  Not once did I recommend researching whether other people were buying or selling a stock when making a determination of its financial viability.
Put into perspective, the fine against Goldman was approximately three days' earnings, so even though it was the highest fine assessed so far by the SEC, it will not materially effect Goldman's earnings.
Further, Goldman admitted no wrongdoing in its acceptance of this agreement.  Consequently, those lining up to recoup losses from their investment will have a much higher burden of proof.
My assessment of this settlement is that of a business decision by Goldman to pay a fine rather than engage in a protracted battle with the SEC.  But the more meaningful message is this:  The SEC has little confidence in either analysts or rating agencies.
Should you?

Financial Regulatory Reform: A Mixed Bag

What's In It
Before you listen to pundits and talking heads, you may want to read a review by someone who's actually read the bill.  It's a mixed bag.  Some things are good.  Some things are not so good.
Let's take a look.
I.  What's In It
A.  Creates Consumer Protection Agency under the Federal Reserve Bank
B.  Increased capital requirements for financial institutions
C.  Creates a council to identify and address systemic risk
D.  Regulates most derivatives, asset-backed securities, hedge funds, mortgage brokers and payday lenders
E.  Streamlines bank supervision
F.  Provides shareholders with a non-binding vote on executive compensation
G.  New rules for credit rating agencies
II.  What It Says
A.  Consumer Protection Agency
The rationale for creating this agency was because "the economic crisis was driven by an across-the-board failure to protect consumers."  With this I disagree.  The economic crisis, in my judgment, was caused by

1. The belief that historic national upward trends in housing prices would continue, regardless of the effect of  increasing demand by those whose credit would not have previously qualified them for a home;
2. Granting a AAA rating securitized in part by these so-called sub-prime loans; and
3. Allowing those who made these loans to completely offload their risk to purchasers of securitized loans.

While I agree that the buyers of mortgage backed securities whose brokers assured safety needed protection from reliance on a AAA rating by rating agencies, the problem was rooted in the fact that the rating agencies did not do their job.  In other words, it was not lack of consumer protection, but a complete lack of competence by rating agencies, paid by the issuers of these securities, that resulted in brokers selling them and consumers buying them.  Further, borrowers who bought $500,000 houses with a $50,000 annual income did not need protection.  They needed to be honest about their ability to afford a home.
I am not saying some level of consumer protection in finance is inappropriate.  I am saying, however, that to say that a lack of consumer protection caused the financial crisis is an overstatement.  Had ratings agencies done their job, mortgage backed securities would have been unsaleable, and no crisis would have occurred.
B.   Increased Capital Requirements
Banks now need to put aside more money as a cushion against risk.  The more risk taken, the more money that must be put aside.  So far, so good.
In the current economy, banks, as most businesses know all too well, are reticent to lend money.  They got clobbered in the economic meltdown, and are now erring on the side of caution.  It's a good thing that banks are more cautious, but a bad thing that they're too cautious because without credit, business expansion is all but impossible.  So, the more money they must put aside for capital, the less they'll have to lend.  And that will delay economic expansion, including new hiring.  Are new capital requirement bad?  No.
But there will certainly be an effect, and that effect will be that businesses will find it hard to borrow.  And expand.  And hire.
Also, the largest banks will be required to fund a $50 billion fund dedicated liquidating to "too big to fail" banks which are insolvent.  Taxpayers will be on the hook only for working capital collateralized by bank assets, and will be first in line for repayment.
Again, on the surface, a good idea, but these funds will not be available for lending either, and will further exacerbate the difficulty in obtaining business financing.
C.  Financial Stability Oversight Council
A new council will be formed that will be responsible to identify and respond to emerging risks throughout the financial system.  As a last resort, they'll be able to break up any company, bank or not, that threatens US financial stability.
A good idea, but, as with anything, it will be as good as its members.  Chaired by the Treasury Secretary, it will also include regulators from the Federal Reserve Board, SEC, CFTC, OCC, FDIC, FHFA, the new Consumer Financial Protection Bureau.
D.  Regulates Derivatives, etc.
During the height of the mortgage boom, financial institutions collected fees for guaranteeing each others' mortgage portfolio.  As long as everybody was repaying their loans, that was fine.  When things went south, though, these so-called insurance promises were called in.  AIG, Bear Stearns and Lehman Brothers had issued lots and lots and lots of these promises, and you know what happened when the banks started experiencing mortgage losses.  Bear and Lehman went bankrupt, and taxpayers rescued AIG, which had made more promises than they could possibly repay.
Now, most derivatives will be traded on an exchange, so we'll all know about how many are issued and can theoretically stop problems based in making promises that can't be kept before they become too large. 
Banks must trade most derivatives in subsidiaries (which are not insured by FDIC, and therefore not available for taxpayer bailout), except interest-rate swaps, foreign exchange swaps and instruments deemed as “hedging for the bank’s own risk.”
As always, the devil is in the details.  FDIC, under this bill, will be on the hook for interest-rate swaps, foreign exchange swaps and "hedging for the bank's own risk."  We'll need to make sure somebody's watching these exceptions closely, or the taxpayers will find themselves on the hook for a hedge that the bank convinced regulators was "for its own risk."
Hedge funds are now officially investment advisers (making one wonder exactly what they were before).
The big (if boring) news is that there is now an Office of National Insurance under the Treasury Department.  Hopefully, this will be the first step in regulating insurance on a national, rather than State level, which will encourage more competition and - hey, that might even serendipitously bring down health insurance costs.
E.  Streamlined Bank Supervision
State chartered banks and thrifts under $50 billion will be regulated by the FDIC.
All nationally chartered banks and federal thrifts, and the holding companies of national banks and federal thrifts with assets below $50 billion will be regulated by the OCC.
Banks and thrift holding companies with assets of over $50 billion will be regulated by the Federal Reserve.
While technically, this will preserve the state banking system that governs most of our nation’s community banks, the reality is that small community banks are likely to put themselves up for sale now that they have 2000 pages of regulatory compliance to deal with.  I used to do that job, and speak from experience.  A community bank with 75 employees would need to dedicate 10% of its staff to compliance.  Not feasible.
F.  Provides Shareholders Non-Binding Vote on Executive Compensation
Non-binding is the operative word here.
G.  Credit Reporting Agencies
I blame the majority of the economic meltdown on credit reporting agencies.  Had they done their job, mortgage backed securities would have been rated as what they were - risky.  Few would have bought them.  Investment bankers would not have been able to sell their risk in extending loans to people who couldn't afford them, and would have stopped making those loans.
Now, there will be an Office of Credit Ratings at the SEC.  Yes, the same SEC that was responsible for overseeing Bernie Madoff. Analysts will now have to pass exams, compliance officers will be forbidden to perform sales, and the SEC can deregister an agency for providing bad ratings over time.
My reaction to this is probably about the same as yours.  Too little.  Too late.
III.  Brace Yourself
Bank loans will be harder to get.
Bank fees will go up.
Watch for the exceptions in this legislation to be the source of the next financial meltdown.
There will be another financial meltdown.
Fear and greed cannot be legislated out of the financial system, but this legislation is better than nothing.

The Saga of Property Tax Appeal: A Mini-Series

Some people want the government to run almost nothing because of its inability to do so without a mountain of red tape, layers of bureaucratic nightmares and regulations that are nearly unintelligible.  Here's one woman's journey through a property tax appeal, and why, at certain times, she found herself sympathetic to anarchists' point of view toward government.
Part I - A beautiful new home
While renting a sweet little cottage long enough to make certain that we were planting our roots in a neighborhood we would love, a serendipitous real estate meltdown occurred that brought the price for the home of our dreams within reach.  We found a buyer for our rental, and everybody was happy.  One of the best selling points for our dreamy new home was the seemingly low property taxes.  Emphasis on "seemingly."
Imagine our surprise when we received our property tax statement nine months later with a 40% tax increase.
Part II - Follow the yellow brick road
After numerous calls to the Assessor's Office, we found that the first step toward  rectifying this situation was an appearance in front of BOPTA (that's Board of Property Tax Appeals, for those of you who speak non-acronym-ish).  Okay, fine.
We assemble a plethora of data that includes the fact that the Assessor's Office January 1 RMV (Real Market Value) for this home was 8% higher than our independent appraiser determined 55 days later on the following February 24.  The basis for thier valuation was the Assessor's Office in-person appraisal on the previous November 24.  Among possible reasons for the miscalculation was the fact that the assessor determined that there was a 1120 sq. ft. fully finished basement, when the actual finished area was 336 feet.  But the burden of proof was ours.
Prior to scheduling the appearance before BOPTA, we spoke to the Assessor's Office (many times) and were pressured (many times) to allow another in-person appraisal.  We were reticent to do so, thinking that the inflated appraisal may get even worse, but did agree to let them see the basement, which was apparently the basis for the problem.  "No can do," said the Assessor's Office.  They are an "all or nothing" kind of group, and wanted to see everything or nothing at all.
With their repeated requests, were admissions that "we didn't have to" let them in.  Okay.  We would take our chances with BOPTA.
Part III - BOPTA
The Board of Property Tax Appeals is a group of three persons who listen to your case for about 15 minutes, and make a determination of whether your property taxes are too high.  We assembled our data (appraisal, arm's length sale, pictures of the basement, etc.) and made our case to three elderly, slightly confused people who clearly never bothered to review the information.  They shared the one copy we had mailed to the Board three months ago, had difficulty locating the Addenda ("Addendum III?  Let's see here," flip, flip, flip.  "Oh, okay, I found it," said the BOPTA triumvirate leader, with obvious pride). 
Some pertinent quotes included, "This appraisal of yours isn't very long," "How do we know when these pictures of the basement were taken?", and "Property values dropped precipitously after the first of the year."  No evidentiary weight was placed on the fact that the appraisal was complete, the date on which the pictures were taken was noted by the camera at the bottom of the picture and RMLS data showed that property values increased 14.8% from January 1 to February 28.  "Your fifteen minutes are up," they said after ignoring our responses.  "If you disagree with our findings, here's a booklet that shows you the next steps you can take."
Two weeks later, BOPTA informed us by letter that they lowered our Real Market Value by 3.7% and kept our taxes just the same.
Would we care to critique the experience?
Part IV - The Magistrate
Tearing the critique form into tiny pieces, we moved along to the next step.  This required a $75 filing fee, completion of new forms enumerating (again) the reason(s) that we disagreed with the Assessor's Office, and mailing a copy to the Assessor and the Magistrate.  Our booklet noted that the basis of taxation in our state is "complicated," and gave several cites proving that description to be one of the great understatements of history.
We dutifully mailed off our paperwork, and received, almost immediately, a response from the Assessor's Office.  They agreed that we owned the house at the given address, and that it was indeed residential property.  They disagreed that the taxes were incorrect, and the burden of proof was ours.
Part V - Measure 50
Our state, possibly in a drunken stupor, enacted a property tax measure in 1997 called Measure 50.  Briefly, it goes something like this.  All property will be assessed at 90% of its current value on the tax rolls as of 1997.  From that point forward, property taxes can increase 3% per year UNLESS there is an exception, such as, your house burns down or you fix it up.  The value of the exception is the value that the market places on improvements (or loss), and will be assessed in addition to the 3% annual increase.
You pay taxes on the MAV (Maximum Assessed Value), but that value is based on the RMV (Real Market Value) of the property.
Okay.  Well, we bought a house from people who bought it in 2007, fixed it up and sold it to us in early 2009.  The value of the improvements, then will be the difference between what they bought it for and what we paid, less the change in general property values in the area.  Easy enough.
Ha.
Part VI - The Case Management Hearing
Before you go to court, the Magistrate mandates a Case Management Hearing.  That means everybody gets on the phone and says what they think.  I wrote out our case ver batim in order that it was concise, to the point, and relevant.  Evidence was mailed (again) to both the Magistrate and the Assessor's Office.  Six months after our BOPTA appearance, the phone rang for said management hearing.
I told His Honor that we entered into an arm's length sales transaction to buy our house, for which an independent appraisal was effected on February 24.  The value of the home was clear, therefore, the value of the repairs was clear.  We pointed out the errors in the Assessor's Office appraisal.  We concluded by thanking all participants for their valuable time.
The Assessor's Office responded by saying that they needed to see the property.  We responded that they had seen the property, that our primary point of contention was the size of the finished basement and that we had been repeatedly told we were not obligated to let them in.
The Assessor's Office said, "Our appraiser never saw the interior.  He just walked around the house."
WHAT?  The burden of proof to refute some guy walking around the house and guessing how much it was worth - was MINE?
The Magistrate may have interpreted my shocked silence correctly, and said, "You need to let them in."
Jesus Tapdancing Christ.
Part VII - The Appraisal
The Assessor's Office appraisers came by at 9AM the day following our return from my step-son's wedding.  Groggy, but not unpleasantly, we let them in.  Yup, the basement isn't completely finished, they noted, as they measured the 336 sq. ft. we'd photographed, measured and presented last November.  They walked quickly through the house, measured nothing else, took a few notes, and left.
"We'll be in touch," they said.
Part VIII - The End
We had a detailed accounting of the expenditures made on the house from the previous owners, and applied the percentages of market value for each upgrade suggested by Century 21 on its website.  The market value of the repairs, according to these calculations, was $45,170.
When the appraiser called with his findings, he said, "Your exception value is $50,000."  "Really?" I responded.  "How did you determine that value?"
"We have a complex matrix . . ."  blah blah blah.  "The majority of the adjustment was the basement."
I refrained from saying, "The basement you didn't want to see last November?"
I paused, and instead said "I have a less complex matrix,  I applied the actual value of the repairs to the amount a national realty company suggests they are worth.  My value is $45,000."  Silence.
"We can't go any lower than $45,000," the appraiser snapped.
My thoughts then were inappropriate for writing here.  You could, however, describe them as "Expletives deleted."
We haggled about the square footage, and the real market value of the home, which they continued to think was 2.4% higher than the purchase price, but since it had nothing to do with the amount of taxes, I relented.  Close enough for government work, I guess.
"We'll send you a statement to sign, and will refund your overpayment,  Thank you for your cooperation," he ended.
"You're welcome," I responded, deleting more expletives.

The Ugly Truth About US Debt

Only your closest friends will stop you before you leave the house in an unflattering outfit.  Maybe it takes a grown woman without an agenda to tell you to truth about US debt.
Here's an unbiased look.  Please refrain from the temptation to shoot the messenger.
All links are to most current US government promulgated reports.
The Budget
We're spending $3.5 trillion dollars, and taking in $2.1 trillion in revenue.  The $1.4 trillion we're spending beyond our means is our annual deficit, and is added to all prior year deficits.  The total of all deficits as of last September 30 is $11.9 trillion.  That amount, now just over $13 trillion, is our national debt.
Expenses
Almost 40% ($1.35 trillion of our $3.5 trillion total annual expense) is Social Security, Medicare and Medicaid.
All the money we spend on national defense is is just over 15.5%, and rises to 22%, when including all other security programs.  Those two items are nearly 2/3 of what we spend.
The other third is non-security and other mandatory programs, like education, justice, commerce, state department and the like.
Income
Individual income taxes are just over 40% of all taxes.  Corporate taxes are almost 7%.
Social security, medicare and unemployment taxes are the biggest chunk - just over 42%.  By the way, if you think your social security taxes are put into the so-called "Social Security Trust Fund," think again.  There is no trust fund.  We spend that money.  But we promise to pay you back.  That promise is almost 40% of our annual expense.
Personalizing the Budget
I can see your eyes rolling back in your head.  No one can think in trillions.  So, let's put this budget in terms of your community.  To keep the numbers easy, we'll say that your community spends $100,000 per year, and expenses are split up just like our Federal budget.
$38,500 is put aside for old age benefits.  About 13% of your population is 65 and older.
$29,700 goes to education, agriculture, commerce, energy, justice, labor and the like..
$22,000 is for security.  You live in a dangerous area, and you've been attacked within the last decade.
$5,300 is interest on loans you've taken out to finance the amount you've spent above your revenues in the past.
$4,300 was invested in your local banks, which nearly stopped making loans due to their bad condition last year.  You've been repaid about half the amount you lent them so far.
Reviewing the Budget
Right off the bat, almost 40% of your budget is spent for old age benefits for 13% of your population. .
You may be able to cut a little here and there, but nothing is as anywhere near as significant as that expense.  Even if you cut your security budget in half, it wouldn't be as much of a benefit as cutting the old age benefit by just one-third.
But you know that this is a "sacred cow."  Just look at the civil unrest in Greece and Spain for an idea of what you can expect when you cut benefits that you've promised - even if you can't afford them.
The fact is, though, you can't continue to promise 40% of the budget to 13% of the population.  Someone, at some point, is going to have to tell your community the truth.
The Truth
Old age benefits began during the Great Depression.  At that time, US life expectancies were 60 years of age, and benefits were available at age 65.  Now, US life expectancies are 77.2, and benefits are still payable at age 65.  The age at which benefits are available has not moved, despite the increase in life expectancy of 27.2 years.
When old age benefits began, there were 42 workers per retiree.  In 1950, there were 16.  Now there are 3.3 workers per retiree.
Some Possible Solutions
1.  Age at which benefits are available must be increased in relation to the increase in our life expectancy.
2.  Those of us who have provided comfortably for our retirements must consider reduction, or even elimination of our benefits for the viability of the program.
3.  The option for a portion of benefits to be available for young workers to invest in capital markets.
4.  You decide.  Those of us who are parents and grandparents have the responsibility to make tough decisions in order to keep this program viable for the next generations.  Yes, we paid into the system.  Yes, a promise was made.  But we're paying out much more than we're taking in, and no expense is anywhere near that of Social Security, Medicare and Medicaid.  It's our responsibility.
We need to acknowledge the problem and fix it.
As always, I welcome your comments and suggestions.

Politicians + Banking Reform = Financial Disaster

Anyone who doesn't harbor some degree of animosity for the bankers who, through a combination of stupidity, short-sightedness and avarice, caused the global financial crisis is a better person than I am.  That said, financial reform should not be tantamount to financial dismemberment.  And there's a little known accounting rule winding its way through financial reform that may be just that.
My writer husband and I often discuss our finances.  He is a brilliant man, one whose brilliance is primarily that of adept observations and the facility with which he uses language to share them.  His writer friends, many of whom are dear to me, share a trait with him:  they hate math.
Consequently, when the business channel drones on about FASB's consideration of mark-to-market accounting for mortgages held by banks, his eyes glaze over like a weary parent listening to his two-year-old blathering unending baby talk.  I imagine many others do as well.
This bill, however, is important.  And I believe that a combination of me speaking English and you being smart will result in your understanding that this is a big deal, and something you should tell your Congressional representatives to stop.
Here goes.
Let's pretend you lend money in the form of buying a bond from the ABC company.  They pay you interest and agree to repay you on a certain date.  Let's say your bond is worth $10,000 (the amount you lend them), your interest rate is 3% and the bond is due (repayable to you in full) on June 1, 2013.  Unless ABC company files for bankruptcy protection before your loan is due, you can expect to be paid $150 twice each year (3% on $10,000), and the full amount you lent them, $10,000, in three years.
Now let's say interest rates go up this Summer.  Now companies like ABC have to pay 4% for borrowed money, 1% more than the amount they're paying you.  If you sell your bond to someone else after rates go up, it will now be worth less than the $10,000 you paid for it, because anyone can now get 4% for their money, and your bond only pays 3%.  If you mark your bond's value to the current market price (mark-to-market), your bond will be worth less after rates go up than it was what you bought it.
But, what if you don't sell it?  What if you hold your bond until June 1, 2013, collect your 3% per year, and get all your money back?
While you hold your bond from now until 2013, what is it worth?

• Is it worth what you could sell it for after rates go up?
• Is it worth what you know you'll receive what the bond is due?

With that in mind, let's pretend you're a bank.  You are now lending money to people to buy houses.  You don't sell your mortgages to investors.  You keep the loans, collect the payments and keep the interest your customers pay.  When rates go up, are these mortgages worth less?  When rates go down, are they worth more?
Yes, according to this new rule.  Why should you care?
If banks have no intention of selling their mortgages, then they probably will be very careful how they lend money.  Why?  If they keep the mortgages, they keep the risk that if borrowers don't pay them back, they'll take the loss.  They won't make crazy loans to people and sell them to investors.  That's good.
But, when rates go up (as they are sure to do), these loans will be worth less.  Then, the banks have to put more money aside for them, and will have less to loan to you.
Seems crazy, doesn't it?  Banks will be penalized for NOT selling their loans to investors, and you'll have a harder time getting a loan.
So, here's the English translation of what's going on.  FASB  (pronounced FAS-bee), is the Financial Accounting Standards Board.  They're considering marking-to-market (immediate sale to investors value, not repayment value) all mortgages that banks intend to keep.
FDIC Chair Ms. Bair is against it, as is former Chair Mr. Isaac.  So am I.  So should you, if you intend to borrow money from a bank who makes mortgages and doesn't sell them to investors.
Contact your Congressional Representatives if you agree, and tell them that you are against FASB Topic 220, 825 and 815.

Things Are (Sort of) Looking Up

In the midst of a stomach churning stock market correction, Dr. Nouriel Roubini predicts another 20% down.  Why I think he's wrong (and why I think the moniker "Dr. Doom" fits him well).
April Jobs Report
After losing over 8 million jobs, an upturn of 290,000 may not sound like much.  But, our April jobs report sends a strong signal that business recovery is gaining a firm foothold.  As businesses continue to expand, we are seeing signs of stability in the housing market, as well as signs that the US consumer is beginning to spend again.
Type of Recovery
Generally, after a deep recession, business recovery bounces back at the GDP rate of 5% or more for several quarters, releasing pent-up demand.  Not so this time, it appears.  With a slower job recovery similar to that after the deep recession in the early 1980s, and significant housing inventories from buyers who should never have been owners in the first place, economic indicators point to a sustained, but muted recovery of 3%+ for the remainder of this year into 2011.  More of a "U" shaped recovery than a "V" is likely under current conditions.
In addition, exports to Europe, where the declining value of the Euro to the Dollar make our goods more expensive, will dampen, but not eliminate US export growth.
Economic Indicators
This year started with a respectable 3.2% GDP growth in the first quarter.  Most strength was in manufacturing and consumer spending.  Business equipment spending was a moderate contributor. 
Challenges to growth are in business real estate, which was very overbuilt.  With the slowdown during the recession, it will be a while before businesses will grow into current vacancies. 
Other challenges remain in residential real estate, which, while stabilizing, is far from growing at normal levels, and exports, which we mentioned before, will be subdued in the European region because the dollar's strength will make them more expensive. 
In 2011, as the European situation stabilizes, improvements in exports will likely follow. 
Inflation
Subdued, for now, as residual effects of the recession, including high unemployment, keep demand low.  In the future, there are concerns that high levels of public debt will compete with private borrowing when the economy regains its footing.  Look to the current European problems to see how increasing rates for borrowing fuels higher costs both in government and the private sector, resulting in higher inflation.
That's down the road, but a grave concern nonetheless.
Business Income
One of the residual benefits of a recession is the cost cutting that businesses must do to retain profitability.  As consumer demand increases, these lean businesses will enjoy profits based more by sales than cost cutting. 
Stock Market
The so-called easy money has been made.  The brave investors who bought well run companies in March, 2009 have enjoyed a 70%+ gain.  Lately, prior to the recent correction, investor sentiment was very high (a bad sign), and price earnings ratios were nearly 14 times future earnings, slightly lower than the 15.8 long term average, but nowhere near the bargain prices in early 2009.  The recent correction provided a slightly better buying opportunity, but with a sub-par growth projection into 2011 and 70% gain from its lows, investors are understandably wary.
We're pointed in the right direction, to be sure.  Some caution is, however, warranted. 
A further 20% correction?  I'd have to be nicknamed Dr. Doom to say that.  And, I follow the data.  Not a nickname.

What If There Were a Sale (and Nobody Bought)

Do you remember looking back at the market low in March, 2009 and thinking, "I wish I had bought then"?  Here's another chance.
When I was in the business of investing other people's money, I often thought it ironic that I picked the only business where nobody wanted to buy when there was a sale.  Investor sentiment is a powerful thing, and, like the little girl with the little curl right in the middle of her forehead, when it's bad, it's horrid.  Fear paralyzes, and when the paralysis wears off, then the fear turns to greed - "I'd better buy soon or I'll miss the rest of the upturn."
It's not often that two corrections occur when memory is fresh.  But here it is.
Let's talk a little about why you may want to summon the courage to invest the money you won't be needing for the next five years.
I.  Safe isn't safe
If you thought you were very smart by keeping your money in cash over the last ten years, if history repeats itself, you will find the last decade an anomaly.  Generally, Certificates of Deposit, insured Money Market Accounts and the like are very good places to keep money that you need in the near future, and the very worst place to keep money you need for the long term.  Why?

• Inflation, the slow increase in prices over time; and
• Taxes.

Let's look at an example.  Right now, you can find money market accounts paying about 1% interest.  Inflation over the last twelve months is running just under 1% (.95%).  So, the increase in the cost of goods and services that you buy reduces your return to 1% - .95% = .05%.  Then, you also have to pay taxes on your interest income.
Federal and state tax rates for most people run about 20%.  20% of 1% is .20.  Subtract .20 from the .05% you had left after inflation, and you are left with negative .15%.  After inflation and taxes, your real return is negative.
For money you need in the near term, that's fine.  You can't risk the volatility of the stock or bond market with  short term money.  But, as you know, women live longer than men.  And most women don't like the idea of "old and poor."  So, we have to invest our money where it will earn more than inflation.
For that, you have two choices.  Real estate (investments, not your home) and stock and bonds.
Real estate requires a very large initial investment, so most women choose to invest in the capital markets.
II.  The two primary considerations
When you buy stocks and bonds, there are only two things you need to decide.  First, you need to know what to buy.  Second, you need to decide at what price to buy it.
The discussion of how to evaluate stock purchases is a primary focus in Financial Planning courses I taught at UCLA, and it required years of study.  But here are a few useful shortcuts.
If you are a value investor, you can buy Berkshire Hathaway Class B shares managed by Warren Buffett.  These shares trade at about $72 per share right now, down from $83.57 last March.
If you'd rather invest in the Standard and Poor 500 Index, including 500 US companies, you can buy it for about $1085 per share right now, down from about $1220 last April.
For risk purposes, many women

1. Subtract their age from 100
2. Invest that percentage of their long term money in stocks
3. Invest the rest in investment grade short term bonds.

So, there you are.  Stocks are on sale.  The sale's not as good as it was in March, 2008, but you have another chance.
Mary Buffett notes that women are good shoppers.
For the sake of our long term well-being, I hope she's right.

Vital Lessons Learned from the Market's Recent Freefall

Now "fat finger" and "high frequency" trades are part of the common vernacular.  Not much solace for those who lost money during the stomach churning drop.  What you must know to protect yourself from losing money, while the slow process of figuring out what happened occurs.
TYPES OF ORDERS
When you buy or sell stock, there are several ways that your order can be placed.  The first, and most common, is a "market" order.  When you place an order "at the market," you buy at the lowest price any seller asks, or sell at the lowest price any buyer bids. 
During the recent market free fall, however, prices fell precipitously.  Had you sold Proctor & Gamble "at the market" late in the day on May 6, you may have thought you were selling at about $61 per share, but were executed at $40.  That's because the selling was so intense and buyers were so few.  People in this predicament may have thought they were selling at a profit, but actually locked in serious losses.
So, lesson one is never sell "at the market."  Always enter a "limit" order" by checking the quote on the stock you want to sell, and entering it at the "bid" price.  That way, you'll be assured that your sale will be at that price (or better).
Some investors like to place "sell stop" orders.  These are orders that will automatically sell if the price falls to a given price.  Again, using the example of Proctor & Gamble, any such sell order for under $60 may have been executed at as low as $40, because the price of the stock fell so quickly.  Those who thought they were protecting their profits at $58 may have locked in losses at $40.
There are two lessons to be learned here.  If the investor absolutely wanted to place a "sell stop" order, if it is placed with a "limit" price of $58, the orders would have tried to execute when the price fell to $58, but if that price were not available because the price was falling so quickly, the order would not have been executed.  That investor would have likely been executed when the stock price bounced back later in the day.
Even still, after the execution when the price was on the way up, the investor would have sold at $58, and seen the price rise to $60 almost immediately.
The other alternative is not to place automatic orders at all.
This type of order was undoubtedly a part of the problem on May 6.  Why?  When many such orders are placed, more and more are executed as prices fall, causing more selling.  When there are few buyers, these type of orders just exacerbate the problem.
So, we never place a market order when selling stock.  We always place limit orders at the bid price.
We never place a "sell stop" order, without adding a "limit" price.  Perhaps we just don't place "sell stop" orders at all.
That's how we protect ourselves from unintended losses.  But there were some people who made money during the market drop.  What did they do?
Some were value investors.  These are investors who calculate the price at which they will buy a stock, and simply wait (sometimes for years) for the price they want.
Again, using the example of Proctor and Gamble, if an investor decided they wanted to buy this stock, but at a price no higher that $43 per share, she may have placed a buy order at that price that was "good until canceled."  That investor may well have had that order executed on May 6.
MARKET FREE FALL SOLUTIONS
One of the problems the market experienced is lack of uniformity.  Stocks that trade on the New York Stock Exchange have strict rules during market corrections.  Trading is suspended for a period of time.  We take a breath.  We look at information.  We make informed decisions that are not based in panic.
Unfortunately, there are automated exchanges that do not have such rules, and trades will sometimes be routed from the NYSE to these other exchanges during a panic sell.
There is virtually no argument against implementing uniform trading suspensions in all exchanges.  The problem is executing this uniformity.  The programming that is necessary to ensure that all exchanges operating under the same rules is complex, and cannot be written in a day.  It will take time, but it's a good idea and will undoubtedly be a reality before the end of the year.
Until then, remember:
1)  Sell only with limit orders;
2)  If you place sell stop orders, add a limit price;
3)  Consider not using sell stop orders at all; and
4)  If you're patient, place buy orders at the value that the earnings stream is worth.
If you want to know how to calculate the value of future earnings, buy Mary Buffett's book titled "Buffettology."  Or make sure your broker does.

Who's Most Guilty of Financial Malfeasance?

You may have heard Warren Buffett has said that he has no problem with the Goldman Sachs deal that has resulted in charges of client misrepresentation by the Security and Exchange Commission (and is being considered for criminal charges by the Justice Department).  As discussed in a previous article, I agree.  If not the banks, than who is most responsible for the financial meltdown?
1.  The Players  
The Quants
First, there were the "Quants," the quantitative analysts, fresh from Ivy League graduate schools, who prepared studies showing the extreme unlikelihood of all regions of the US housing market dropping in value at the same time.  As these were academically gifted young people with virtually no practical experience, I hesitate to lay blame here.
The Quants' Bosses
It started at JP Morgan.  The bosses, seasoned professionals, read the analysis, looked at the commercial banks' and thrifts' mortgage profits, and decided to get into the business.  The big question is, "Did they understand that the increase in demand that would result from broadening the real estate market would result in a crash?"  While the answer to this question is unknowable, there are two issues that may point to the truth.
The first, is the recent "Internet bubble."  Anyone could have seen that the amount of money that was invested in Internet stocks would have pushed their valuation to ridiculous levels.  Surely, an analogous investment in the real estate market would do the same.
The second, is the fact that the risk to increasing the number of real estate owners was mitigated by selling that risk to investors, instead of holding those investments on their books.
The Banks
Once JP Morgan entered the real estate business, it had to offer terms that would be more attractive to borrowers than commercial banks and thrifts.  So, underwriting standards were decreased.  So what if you didn't technically qualify for a mortgage?  A rising real estate market would allow you to sell your property at a profit, and a low "teaser" rate would result in low initial payments.  After five years, you'd be making more money at your job, wouldn't you?  Then you could afford the payments.
For banks and thrifts to compete, they, too, must lower their underwriting standards, or risk losing their loan portfolios to those banks that offered better refinancing opportunities.
So, we're off to the races.
The Borrowers 
The fact that borrowers were not required to prove their income did not force them to lie on applications.  Even if the borrowing terms were difficult to understand, people who earned $50,000 knew they could not afford a $500,000 house.
A lie is a lie.  Lies have consequences, and I am not in the camp that says, "Poor little borrowers didn't know what they were doing."
I don't think people are that stupid.
The Rating Agencies
Rating agencies are paid by the companies that generate the securities that they rate.  That is inherently insane.
If I have a security I want to sell to the general public and it's inherently risky, it is the job of the rating agencies to say "That is risky."
The problem is, if one agency declined to rate the security as "not risky," all the issuer had to do is take it to another and say, "Here's my fee.  See if you can rate this as 'not risky'."  And they did.
Packages of loans, geographically diversified in the US were sold to the general public as AAA - the same rating given to ultra-safe US Treasuries.  "Widows and orphans" could safely buy them.  Why?  Because, even if the underwriting standards were lax, there was good evidence provided by the Quants, verified by the Quants' Bosses (who paid big, fat fees for safe ratings), that a majority of the loans would be good, even if there were regional difficulties at times.
2.  Common Thread
If the Quants hadn't come up with the studies about the general safety of the US mortgage market, someone would have figured it out.  Maybe the Quants' bosses would have done it themselves, as they saw quarter after quarter of real estate lenders' profits.
Some percentage of borrowers have always lied on mortgage applications.  Underwriters catch some, but not all of them, but the number that squeak through the system were never significant.
But, this bubble could never have grown unless the issuers of laxly underwritten mortgages could have sold them to a "greater fool."  If they'd kept these mortgages on their books, the banks who lent the money would have had to acknowledge the losses.
That leaves the rating agencies.
3.  The Rating Agency Issue
There is no excuse for the ratings agencies giving AAA rating to risky securities.  Taking money to do so is effectively the same as taking a bribe.
Ratings agencies are charged with the responsibility of analyzing underlying securities and giving the public an easily understood way to know the level of risk they have.  This is the one place where, "I didn't know" isn't an excuse.  Maybe the Quants didn't know.  Maybe the Quants' Bosses didn't know.  Maybe the banks didn't know.
But the ratings agencies can't claim stupidity.  Rating securities is their reason for existing.  If they can't do that, they don't deserve to exist.
4.  Blame
Maybe the Quants should have known.  Probably the Quants bosses should have known.  Likely the banks should have know.  The borrowers should not have lied.  But, most definitely, the ratings agencies should have known.
So, the next time you hear that a security is rated AAA, what will you think?
It's time to hold the ratings agencies' feet to the fire.  Either rate securities by using generally accepted accounting principals or rename yourselves as, "Bribe Takers."
Perhaps a little something in this regard should be passed in Financial Regulatory Reform.  And, if it isn't, I wonder. 
Will it be because someone has been paid to ignore it?

The Case Against Goldman Sachs

There is no doubt that the sentiment toward big banks is negative.  Many resent that these banks were bailed out during the financial crisis, when the individual citizen who suffered as a result of irresponsible lending practices, misrepresentation of the safety of securities backed by those loans and resulting falling home prices, paid for the bail outs with their tax dollars.  When, added to that, historic profits are earned by those very banks, and enormous bonuses are paid to their employees, while ordinary citizens battle near double-digit unemployment, that anger is understandably exacerbated.
Few news reports give details of this charge, describing it as "complicated, difficult to explain, and hard to understand."  I disagree.  I think that, when explained properly, this is very understandable. 
It's easy to vilify Goldman for bad  behavior.  Let's take a look at this case, and decide for ourselves.
In plain English, Goldman is accused of selling derivative securities to their clients in April, 2007.  Derivative securities are securities that derive their price from another asset. The assets on which the price of these securities was derived, were residential mortgages, which were rated BBB-, the lowest "investment grade" rating available, by ACA Management, LLC, a company with experience rating securities like these. 
A Goldman employee, Fabrice Tourre, allegedly led ACA to believe that a hedge fund, Paulson & Co., Inc., was investing in these securities, when in fact, Paulson was investing in the other side of the transaction, i.e., a "short" position, or an interest in the securities losing value.  The securities that ACA approved as investment grade were chosen from a list that Paulson had chosen to invest against.
The approved securities were described as "Selected by ACA Management" and were marketed, not to individual investors, but to "sophisticated investors,” like banks and pension funds.
When explaining the difference between what must be disclosed to such sophisticated investors, former SEC lawyer Jacob Frenkel, explains,“Materiality is a lot like a continuum.  The amount of information that needs to be disclosed to institutional investors at the highest level, where they’re doing their own research and analysis, is less. Their criteria for the investment decisions tend to be far more sophisticated than the individual investor’s.”
So, the case is this.  A hedge fund wants to bet against sub-prime mortgages, and brings a list of the mortgages it feels will go down to Goldman.  Goldman takes the list to a rating agency, does not tell that rating agency that it received the list from a hedge fund that thinks the securities will go down, and gets an investment grade rating for most of those securities from that rating agency.  It sold those securities to banks and pension funds without telling them that a hedge fund was betting against them.  The banks and pension funds lost money.  So did Goldman, by the way.  They received $15 million for structuring this deal, but they lost $90 million investing in it.
The SEC alleges that Goldman should have told ACA and its investors that Paulson was investing on the other side.
Here are some questions that may help you decide how you feel:
1.  Should rating agencies rate securities on their own merit (not by considering who may or may not be investing in them)?
2.  Since ACA chose the securities in this investment from a list given to them by Goldman (from a Paulson list), was it a misstatement that ACA was "Portfolio Selection Agent?"
3.  Since banks and pension funds are defined as "sophisticated" investors, should they analyze the investments they are considering on their own merit (not by considering who may or may not be investing in them)?
I understand the anger many people feel toward investment bankers.  That said, I also feel that the analysis of securities, particularly by those who buy them on behalf of institutions or pension fund participants, should be based on analytical evaluation, not by "who else is buying this?"
I believe this to be a fundamentally weak case, and cannot help but notice that it was made public during the Financial Regulatory Reform debate.
For the record, I am in favor of Financial Regulatory Reform.  While this case may increase the likelihood of the passage of such reform, I find it largely without merit.
I welcome your comments.

An Issue of Trust

Who can you trust with your money? 
If you ask the individual investor, the answer is "no one."  Not after the likes of Bernard Madoff, Allen Sanford and, now, Goldman Sachs, the crown jewel of investment banks.  So, if you follow the thinking of the individual investor by measuring "Investor Sentiment," you would have drastically cut back in stock investments in December, 2008, and you would not have returned to the stock market yet. 
In other words, you would have sold near the market low.  No wonder Warren Buffett cautions, "Be greedy when others are fearful; be fearful when others are greedy."
I follow a proprietary investment model that measures twenty one economic indicators.  I've built this model over a period of over twenty years, and use it exclusively for two purposes:

1. It is my model, and I use only data from apolitical, independent sources for analysis.  That keeps me protected from data that may have been skewed by someone who has a vested interest in whether I choose to invest or not;
2. It removes all emotion from investment decisions.  If it says that I should be 70% invested, I'm 70% invested.  No panic.  No euphoria.  No need to trust anyone but me.

 When I invested money for other people, it was an invaluable tool.  If my clients wanted to sell low, I showed them that they were doing just that.  If they wanted to buy high, again, I showed them that was a less than stellar strategy.
Discussing each indicator, and how it relates to the overall decision was the subject of a semester's work in an advanced class at UCLA for professional financial planners who chose an emphasis in investment.  Mostly geeks.  I will, however, discuss one part of this analysis, Investor Sentiment, and tie that discussion to the general feeling of mistrust that is currently pervasive with the individual investor.
If you had followed Investor Sentiment as discussed above, you would have sold when the S and P 500 was at 888.61.  It is now at 1192.13.  As reflected above, you'd have sold low and, if you buy back in, it will undoubtedly be higher. 
If, on the other hand, you would have read Investor Sentiment as a negative indicator, i.e., you did the opposite of what it suggested, you would have enjoyed a 34% increase.   Hmmm.  I'm reminded of what my grandmother said when I based my plea to do something on, "Everybody else is doing it."  Her familiar response was, "If everybody jumped off a cliff, would you do it, too?"
So, now we have both Warren Buffett and my sweet little Meema advising us to think for ourselves, and even consider doing the opposite of what others are doing.  In the particular case of the last market correction, that would have been good advice.  But, does it hold true most of the time?
As it turns out, yes.  Investor Sentiment is the most predictive of all twenty one of my indicators, if you do the opposite of what it says to do.  And, I will add, that the stock market is nowhere near the bargain it was in March, 2008, when its cost (P/E)  was about its long term average of $15.82 for every dollar of S and P 500 earnings, but even though the market has come back 75% from its low (25% lower than its high), the individual investor is still not buying.
Back to trust.  Yes, Bernie Madoff is a thief.  Yes, Allen Sanford appears to have bilked thousands of investors out of their money, touting "safe" international CDs.  Yes, it looks like Goldman Sachs took both sides of the bet that the housing bubble would burst.  But does that mean you should keep your money in the bank?  Let's take a look at how that will work for you in the long term.
The best rate I could find for a two and one-half year insured CD was 2.1%.  To calculate your "real return," that is, your return after inflation and taxes, subtract from that 2.1% the current inflation rate, or 2.1%.  Now you're at zero, but you still have to pay taxes on your interest.  For most people,  your marginal tax rate is about 16%.  16% tax on 3% is .48.  So, tax of .48 plus inflation of 2.1 is 2.58.  2.1 - 2.58 = -.48  You're losing about 1/2% annually.
If you're a woman with $100,000 that must last you for 30 years, at that rate, this money will produce about $3100 per year.  On the other hand, if you were to invest in the stock market, using its long term average return of 9%, this money will produce about $9,700 per year.
We live longer.  Inflation hits us harder.  We can put our money in "safe" investments that are guaranteed to lose money over the long term, or we can listen to Warren Buffett and my sweet little Meema.
The choice is yours.

The Best Investor 2010 - First Quarter Results

Last January, I posed the question that buying shares in the S and P 500 may be just as effective as following professionals' stock market picks.  Some women who are participating in the Self-Invested Women Pilot Program are considering whether they are passive (people who buy an index, like the S and P 500) or active (people who buy individual stocks or types of stocks, like energy and health care) investors.  This may help you make that decision.
The S and P 500 Index
This index allows investors to buy 75% of the publicly traded companies in the US, many of which derive a significant part of their income outside the country.  While there are many indexes (Dow Jones Industrial, the Russell 2000, the Wilshire 5000), the S and P 500 is the index against which the vast majority of money managers measure their performance.
The Challenge
Last September, ten investment strategists gave their recommendations for which sectors of the market would outperform the total market in 2010 in Barron's magazine.  We chose six of these strategists, representing US Trust, Citigroup, JP Morgan, BlackRock, Deutsche Bank and Goldman Sachs.  We'll compare the S and P 500 index performance against the sectors recommended by each investment professional, assuming you were to invest equally in all sectors.
Fees
It requires no management fee to invest in an index like the S and P 500.  Investment advisers' fees range from 2% to 5%.  We'll use the lower figure, 2%, for this comparison, and deduct 1/2% every quarter from the recommendations by the advisers. 
Since there are trading costs for both individuals and money managers, we'll consider this a "wash."
Long Term Investing
We'll assume that we're in the stock market for long term investing, not short term "trading."  Therefore, one quarter's data is insufficient to make this decision.  We'll look at this performance all year, and discuss how relevant this little experiment is to your long term strategy.
First Quarter Performance
S and P 500
S and P 500 was up 6.04% in the first quarter this year.
US Trust
Technology + 10.45%
Materials + 6.89%
Energy + 5.04%
Industrials + 4.77%
Weighted Average performance +6.7875%, less 1/2% fee = +6.2875%
US Trust's recommendations beat the S and P 500 by about a quarter of one percent in the first quarter.
Citigroup
Materials + 6.89%
Financials - 3.68%
Software + 10.45%
Energy + 5.04%
Weighted Average performance + 4.675%, less 1/2% fee = +4.175%
Citigroup's recommendations lagged the S and P 500 by about 1.87% the first quarter.
JP Morgan
Energy + 5.04%
Industrials + 4.77%
Financials  - 3.68%
Technology + 10.45%
Materials + 6.89%
Weighted Average performance + 6.166%, less 1/2% fee = +5.666%.
JP Morgan's recommendations lagged the S and P 500 by about 3/8 of one percent in the first quarter.
BlackRock
Energy + 5.04%
Health Care + 8.53%
Weighted Average performance + 6.785%, less 1/2% fee = + 6.285%.
BlackRock beat the S and P 500 by just under 1/4 of one percent in the first quarter.
Deutsche Bank
Technology + 10.45%
Health Care + 8.53%
Energy + 5.04%
Industrials + 4.77%
Weighted Average performance + 7.1975%, less 1/2% fee = +6.6975%.
Deutsche Bank beat the S and P 500 by 3/4 of one percent in the first quarter.
Goldman Sachs
Energy + 5.04%
Materials + 6.89%
Financials - 3.68%
Technology + 10.45%
Weighted Average performance + 4.675%, less 1/2% fee = 4.175%.
Goldman Sachs lagged the S and P 500 by 1.865% in the first quarter.
Summary
So far this year, three underperformed the S and P 500 and three lagged behind its performance, with Deutsche Bank doing best, and Goldman worst.
Last year, only Deutsche Bank and JP Morgan beat the averages, and four lagged behind.
Another update after the second quarter.
We'd love to hear your thoughts.  Are you an active or passive investor - and why?

Taxation Without Torture

Taxes.  Just hearing the word makes most people cringe.  How a couple of easy steps can go a long way in making the process more bearable.

The first thing you need to know is that you don’t need to know how to prepare a tax return. You just need to know a couple of things that will make the amount of tax you pay as little as possible.

The second thing is that you don’t need to become an obsessive-compulsive record keeper. You can continue being a regular person, just one with a few more envelopes. You can live with that.

This discussion is not meant to replace your tax advisor, if you have one. Rather, it’s meant to give you the tools to reduce the fee she charges by keeping track of key expenses, and make sure you can manage the process – not do it yourself.

How Federal Taxes Work

The Internal Revenue Code (“IRC”) contains the rules for paying Federal taxes. It’s long, boring and has been patched together over many years and is now nearly unreadable, because it constantly refers you to lots of other places while you’re trying to read it. What’s important to know is that it contains Congress’ encouragement for you to do certain things, by reducing the taxes you pay if you do them.

Adjustments

Some tax incentives are called “above the line” adjustments. Above-the-line adjustments are more valuable than tax deductions because they come right off the top by reducing your income. Examples of above-the-line adjustments are contributions to retirement plans or health care savings accounts.  People in Congress really want you to fund your retirement plan, and have given you every financial reason in the world to do so. So, if you go no further than to learn that there is yet ANOTHER reason to invest for your future, do that. It will very likely make a difference in the amount of tax you pay, too.

If you lend money to municipalities by buying municipal bonds, you usually don’t have to pay tax on the interest you receive for that loan. If you lend money to the Federal government by buying Treasury bills, bonds or notes, you generally won’t pay state tax on the interest you receive for those loans.

Deductions

You’ve heard of tax deductions. Deductions are subtracted from your adjusted income. To see what the current standard deduction is, go to http://www.irs.gov/publications/p501/index.html Under “Publication 501 Contents,” go to “Standard Deduction,” and click “Standard Deduction Amount.” Scroll down to Table 7 to determine the amount of your standard deduction. You may have more deductions than that standard deduction amount. If you do, you will itemize their deductions, or provide a list that adds up to more than that standard deduction.

How do you know if you should itemize deductions?

Congress, through the tax code, encourages home ownership because it is seen as a stabilizing force in building communities, so both mortgage interest and property taxes are deductible. If you own a home, you will probably itemize deductions. You need to keep your property tax receipt, if these taxes aren’t part of your monthly mortgage payment . Otherwise, you’ll get a year-end statement with that amount from the bank that will also give you the total mortgage interest you paid, both of which are generally deductible.

Congress also encourages supporting charitable causes. So, if you contribute a significant amount to charity, it may make sense to itemize deductions.

And, with medical cost rising at an alarming rate, deductions are available for those, too - if they are more than a certain amount of your income .

So, if you have a lot of contributions to charities and/or medical expenses, it is a good idea to make envelopes called “Charity” and “Medical” and save all those receipts.

Like property tax, your state taxes are also deductible if you itemize your deductions.

If you work for someone else, and have lots of employee job expenses that were not reimbursed, you may be able deduct these, as well as education expenses that were directly related to your current job. Save those receipts in an envelope called “Employee Expenses.”

If you own your own or are starting your own business, you will probably file a “Schedule C.” This is the form that allows you to deduct business related expenses from your income. You are someone who definitely needs the help of a tax preparer – the sooner the better – particularly if yours is a home based business. While Schedule C itself does not appear to be a particularly complicated form, that is deceiving. Don’t do this yourself, but do save all business expenses.

Are there more? Yes, there are others. Lots of them. But, these are the big ones, and will give you a good start.

By organizing your deductions and knowing approximately how much you can deduct in each category you will have relatively organized information to give – and discuss with – your tax preparer.

Exemptions

These are also subtracted from your income. If you are single person, you are entitled to one exemption. A married couple filing a joint return receives two exemptions, and one more for each minor dependent child.

The amount of current Federal tax exemptions can be found at http://www.irs.gov/pub/irs-pdf/p501.pdf

Tax Calculation

In a nutshell, then the way taxes are figured is:

• Income minus

• Adjustments (like retirement contributions) equals

• Adjusted Gross Income minus

• Tax Deductions minus

• Total Exemptions equals

• Taxable Income which is multiplied by your tax rate.

Tax Rates

Your tax rate is determined by whether you are married. Single people pay a higher rate of taxes on their income than married people.

Your tax rate is also “graduated.” That means that your money is lumped into groups, and each group is taxed at a progressively higher rate. Then, they’re all added together, and that is the amount of tax you owe.

The lower the income, the lower your tax rate.

Tax brackets are useful for thinking about the rate you’ll pay on taxable investments, like dividends and interest.

Your average tax rate is different than your tax bracket. Here’s how to figure your average tax rate.

Amount of Tax Paid divided by Total Income

8,922.50 / 50,000 = 17.8%

Your goal in tax planning is to try to reduce your income as much as you can with above-the-line adjustments like retirement plan contributions, then reduce the tax you pay as much as you can by taking all the deductions that are available to you.

If you have a simple tax situation - a W-2 form, and interest from savings - you may prepare your own taxes. If you have a lot of any of the categories mentioned under “Deductions,” you may review whether it would benefit you to itemize.

Tax Preparers

At any point that you feel that preparing your taxes is overwhelming, get help. The kinds of people available to prepare your taxes are

Tax Preparer Attended tax preparation courses, usually sponsored by their employer firm, such as H&R Block, Jackson Hewitt, etc.

Enrolled Agents Extensive training in personal tax preparation

Accountant A person who has a Bachelors degree in Accounting

CPA Certified Public Accountant, a professional designation requiring experience, education and passing an examination.

Generally, an Enrolled Agent has more than adequate training for any tax preparation or tax planning question the majority of people will have. Some employees of national tax preparations firms are enrolled agents, but you’ll need to ask their qualifications. Questions you will want to pose to potential tax preparers are:

• What credentials do you have?

Again, an Enrolled Agent will have extensive personal tax preparation training.

• How long have you been preparing tax returns professionally?

You want at least five years of experience

• Describe your typical client.

You want a tax preparer who has experience with the tax issues that you have; e.g., similar income, profession, investments, etc.

• Does your fee include representing me if I’m audited?

You want representation if audited included, or for a small additional fee

If you keep your receipts organized and have a relatively simple tax situation, you may want to try preparing your taxes on your own. If so, software such as “TurboTax,” “TaxACT,” and others are helpful, but obviously will not include answering questions or representation in case of an audit.

Tax Planning

There are a few simple things that people who itemize deductions can do to decrease their taxes. These should be reviewed each year in mid-November.

• If you make State “estimated tax payments,” your last payment is due January 15 of the following calendar year. By making that payment before year end, it will be deductible.

• If you are considering any charitable contributions, make them prior to year end.

• If you own your home, consider making your January mortgage payment before year end, in order to deduct the interest from that payment.

• Schedule any doctor or dentist appointments before year end, especially in any year when you have high medical bills.

• If you’re planning to get married anyway, it’s better to do it in December than January to qualify for lower Married Filing Jointly tax rates.
Even if your spouse prepares your return (or oversees its preparation with a tax professiona, you are responsible for the tax return that you sign. Don’t sign it if you don’t understand it. Don’t be shy about asking questions.

In conclusion:

There is yet another reason that you should put as much money as you can into your retirement account and health care savings account.

There is yet another reason that you might consider buying a home (deductible mortgage interest and property taxes), if you don’t already have one.

If you just put all receipts for deductible expenses in separate envelopes - medical, contributions business and employee expenses every year - you’ll be way ahead of the game.

You know the basic concept for how taxes are calculated.

You know how to interview a tax preparer.

You won’t sign a tax return that you don’t understand, and won’t be shy about asking questions

Is Janet Yellen the Best Candidate for Vice Chair of the Fed?

San Francisco Federal Reserve Bank President Janet Yellin is Obama's nominee for Vice Chair of the Federal Reserve Bank.  Why this policy dove may be a perfect short term answer, and a long term disaster.
Mission
The primary role of the Fed is the pursuit of maximum employment and price stability.  Sounds simple.
It's anything but.
I.  Maximum Employment
To pursue the goal of full employment, the Fed must make business conditions favorable to hiring.  That means that businesses must be able to borrow easily, expand and hire employees to facilitate such growth.  As you know, banks must keep a certain amount of their deposits with their local branch of the Federal Reserve Bank in order to have sufficient liquidity to prevent panics that contributed to the Great Depression.  When short term interest rates are low, banks can more freely lend to businesses because they don't have to keep as close an eye on their cash reserves.  Money's cheap.
When rates rise, banks keep a tighter rein on lending by strengthening borrowing standards.  It's harder to get a loan, business expansion slows and jobs are harder to get.
Why not have a continuing policy of low interest rates?
II.  Price Stability
Price stability is another way of saying low inflation.  Inflation is the amount prices go up every year.  Anyone who lived through the 1970s remembers that prices rose much faster than wages.  Every year our same dollars bought less and less. 
When inflation takes hold, it's hard to stop.  People want more money to afford what they could afford last year.  If they get raises, however, their businesses have to raise prices to cover higher payroll costs, so costs rise.  A vicious circle ensues, where labor wants raises and businesses want higher prices.  What stops the circle?  A recession, when businesses lay off workers and can contain prices.  The higher inflation, the more prolonged the recession.
The problem is, during the recession, the Fed is pressured to lower interest rates to stimulate the economy.  But, r
Once inflation takes hold, it's very hard to stop.
A Dovish Policymaker
Janet Yellin is described as an inflation "dove."  That means that her decisions have been "growth and employment" oriented and less focused on containment of inflation.  You may think, that with unemployment rates hovering in the double-digits, this is just what we need.  Certainly, that political opinion would be currently popular.  But, would it be a good long term policy?
Deficits and Inflation
No reputable economist of whom I'm aware would not have advised deficit spending to stimulate the economy during the last recession.  It was a necessary evil that prevented the country from likely sinking into a Depression.  But historically, the relationship between deficit spending and inflation is problematic.
Generally, when government borrowing increases, the amount of funds that remains for businesses and individuals to borrow decreases, and the competition for these fewer dollars causes rates to increase. 
So-called inflation "doves," who generally advise keeping rates low, can accommodate both government and business lending only by printing more money for the government to buy its own debt, causing the money supply to expand and debt to contract.
Expanding the money supply is inflationary.  Instead of raising taxes to pay its debt, printing more money makes the dollar less valuable.  The cost of everything goes up when your dollar is worth less.
The Federal Reserve Board of Governors
At its last meeting, only one Fed governor, that of St. Louis, voted against keeping interest rates low.  The majority (11 members) voted to keep rates low because their perception that the risk of sinking back into recession was more significant than the threat of inflation.  Dr. Bernanke, current Fed chairman, is considered one of the premier scholars of the Great Depression.  One significant factor in its length is thought to be insufficient economic stimulus.  It is a mistake about which Bernanke argues eloquently, and apparently the majority of the board agrees.
With a propensity of more dovish members, however, it is of some concern that one who has been one of the most consistent would be considered as the Vice Chair.  Generally, upon the retirement or failure to reappoint the Chair, the Vice Chair is likely to assume this influential post.
At a time when deficit spending is so high, the national debt is ballooning and the nation only recently stepped back from the brink of Depression, is it wise to choose a member who is so dovish about inflation that she stated last February, "If it were possible to take interest rates into negative territory I would be voting for that."?
Perhaps a candidate with a more balanced approach to the Fed's dual mandate would be a more reasonable decision.

Examining Tea Party Allegations of Higher Taxes and Increasing Debt

The "Tea Party" movement alleges that the USA is moving toward socialism with higher taxes and increasing levels of public debt. 
I discussed where the US stands with respect to public debt in an article published last December.
Let's take a look at where the country actually stands with its taxation.  All data referenced in this discussion are compiled from the Organisation for Economic Co-operation and Development.
I.  Taxes as a Percentage of GDP
Taxes in the US, as measured as a percentage of Gross Domestic Product, were 25th lowest out of the 30 participating countries.  As of 2006, the latest year for which complete data are available, Denmark paid the highest at 49.1% of its GDP, the US paid 28%, and the lowest taxes were paid by Mexico, at 20.6% of GDP. 
II.  Top Marginal Taxes
As you know, the US has a "progressive tax." In this method of taxation, lower levels of income are taxed at lower levels, and higher levels of income are taxed at a progressively higher rate.  Most people pay Federal income tax as follows

• 10% on income up to $8,350
• 15% on income from $8,350 to $33,950
• 25% on income from $33,950 to $82,250
• 28% on income from $82,250 to $171,550
• 33% on income from $171,550 to $372,950
• 35% on income over $372,950

The average tax paid by a person earning $373,000 is 27%, as only $50 is taxed at 35%.
The USA ranks right in the middle (15th of 30 countries) for top marginal tax rates for employees, with Denmark again at the top (59.7%) and the Czech Republic with the lowest rate (15%).
III.  Corporate Tax Rates
As of 2009, the average corporate tax rate for the thirty countries in the OECD is 26.3%.  Two countries, Ireland and Iceland, have rates significantly lower than the average, 12.5% and 15%, respectively.  The remainder are between the Slovak Republic and Poland at 19% and Japan at 39.54%.  The US is second highest at 39.10%.

We rank 20th as a debtor nation.  We rank 25th in total taxes as a percentage of GDP.  We rank 15th in personal income taxes.  It is only in corporate taxes that the US ranks very high:  We are second in the world, after Japan.
It is a laudable goal to decrease deficit spending and lower the National Debt.  It is, however, important that we put the issue into perspective, and not overstate our current circumstances.

A Rose by Any Other Name

As our nation grinds to a halt under the failure of statesmanship, I refuse to take a side.  You may not characterize me with a word, when doing so will only give me the opportunity to give countless examples of when that word does not accurately describe my position. 
Democrat, Republican, Independent, Libertarian - or Capitalist
In my study of political structures, and which function best, I've concluded that capitalism is my preference.  I prefer that to Democrat, Republican, Independent, or Libertarian.  In societies where capitalism flourishes, there is likely

• Greater opportunity
• Tolerance of diversity
• Social mobility
• Commitment to fairness
• Dedication to democracy.

But, we must take care in how we define capitalism.  Unbridled free markets recently rocked global finance to its core, and financial reform is stalled in a gridlocked Congress over a year from barely skirting a depression.  Without requiring that capitalism be characterized as pursuit of a rising standard of living for the clear majority of citizens, it is reduced to a system that benefits the few.
Pursuit of a Rising Standard for All
With that definition in mind, it is interesting that the ratio of compensation of CEOs to workers was 30:1 in 1970 and 120:1 in 2000.  These data were provided by the Economic Policy Institute, a think tank dedicated to including the interests of low to middle income workers in economic policy.
The growth in CEO earnings virtually mirrors in the growth in the S and P 500 Index over that same period.  While workers are generally paid in the form of cash compensation, CEOs in non-financial firms earn over 70% of their compensation in the form of equity pay.  Therefore, the inequity appears to be based more in the performance of the price of their company stock options than any other factor.  If the CEO is ultimately responsible to her stockholders for the performance of the company, then this inequity is readily explained.
Further, during this period retirement savings changed from company-provided defined benefit pensions to  retirement programs where employees make contributions that are deducted from their income.  For example, a worker who contributes 15% of her $50,000 salary to a 401 (k) plan will show a taxable income of $42,500 after deducting the contribution.  Because the IRS limits the dollar amount of contributions, a $250,000 executive at that same firm would be limited to a $16,500 contribution.
The worker's salary in this example would be decreased by 15%, and the executive's by less than half that (6.6%), even though the executive contributed $9,000 more.  As you can see, workers contributing to these plans make their income appear proportionately less than CEOs.
Finally, because transfer (unemployment, welfare, disability and social security) payments are taxed, if at all, at a lesser percentage for lower income taxpayers, those amounts are not fully represented as income, based on tax return data.
A 2007 article by the Cato Institute demonstrates that many studies, including recent work from Paul Krugman, grossly overstate the disparity between CEO and worker income, and estimate, based on Congressional Budget Office figures, that the top 1% of earners in 2003 earn between 14:1 to 15:1 more than workers, up from about 9:1 in 1981.  
So, while the current climate is not one that shows capitalism in its finest light, we do appear to be in a rising tide that lifts most boats.  And, with that, I will add a codicil to my "Capitalist" title.
Barron's Byline Admission
One of my favorite economists is Gene Epstein, who is the Economics Editor of Barron's magazine.  I have often referenced his work when teaching Security Analysis at UCLA because of its data-orientation and lack of agenda.
Mr. Epstein recently gave a speech to young people that he was kind enough to share with me, wherein he described himself as a "bleeding heart capitalist."  It was at that moment that I adopted a party affiliation.
I am in favor of a system that is most likely to result in greater opportunity, tolerance of diversity, social mobility, commitment to fairness, and dedication to democracy.  I am, indeed, a capitalist.
But, I also demand that that system results in a rising standard of living for the clear majority of their citizens.  Rather than a "laissez faire" approach to free markets, I favor a properly regulated financial system that compels those who take extraordinary risk be subject to extraordinary loss - and be outside the realm of Federal insurance, either by mandate or by being "too big to fail."
I favor protection of the finest educational system in the world by protecting the free exchange of ideas in a meritocracy, encouraging participation with the world's greatest minds regardless of their country of birth, and funding their priceless contributions to our competitiveness in the global economy.
I, too, am a bleeding heart capitalist, and will support whichever political party that furthers these ideals.

The Case For (and Against) Raising Interest Rates

One of the Federal Reserve Bank's most powerful tools is raising short term interest rates.  Why they should (and why they shouldn't) do just that now.
Short Term Interest Rates
Didn't the Fed just raise rates?  Yes, they raised the Discount Rate by 50 basis points (1/2%).  The Discount Rate is the rate that the local branch of the Federal Reserve Bank charges for short term loans.  There are three types of loans available from the "Discount Window."
There is also the Fed Funds Rate, which is the rate banks lend money to each other at the local branch of the Federal Reserve Bank, in order to meet the reserve requirements they must set aside for liquidity purposes.  This rate, currently .25%, was set on December 16, 2008, during the recent financial crisis.
Extraordinary Measures
The Federal Reserve undertook several extraordinary measures to assist financial institutions during the recent the financial crisis. Besides providing loans to banks through the discount window lending programs referenced above, the Fed established other ways to provide liquidity to financial institutions, including:

• Term Auction Facility,
• Primary Dealer Credit Facility, 
• Term Securities Lending Facility,
• Commercial Paper Funding Facility,
• Money Market Investor Funding Facility,
• Term Asset Backed Loan Facility, and 
• Section 13(3) of the Federal Reserve Act loans to support specific institutions to avert their disorderly failures.

In short, the Fed became "the lender of last resort," after effectively lowering the Fed Funds rate to zero.
Now, by most measures, the liquidity crisis has been averted, and many of the programs listed above have been suspended.  Some economists feel that it is now time for the Fed to raise the Fed Funds rate and unwind other extraordinary credit facilities, and some feel that it should wait.  Here are the pros and cons.
Raise Rates Now
Those in favor of raising rates now generally feel that by raising rates gradually, the economy will avoid creating future excesses like inflation caused by holding rates artificially low.  This position represents the free market philosophy that the economy must move through the process of recovery without intervention by the Fed. 
Such economists see the 3% - 3.5% projected US growth in Gross Domestic Production this year partially due to previously provided economic stimulus, but more importantly through sustainable growth in global demand.  Acknowledging the problem of high unemployment rates, they think that potential problems created by guaranteeing low rates for the foreseeable future will create more serious economic excesses in rate sensitive sectors in the future.  In effect, this policy is seen as "postponing the inevitable," and proponents of this philosophy favor no economic intervention unless absolutely necessary.
Keep Rates Low
Those in favor of keeping short term rates near zero generally agree with the 3% - 3.5% projected US growth in Gross Domestic Production this year, but feel that reliance on growth in global demand is more precarious.  Citing recent concerns with the sustainability of the current recovery, including high rates of US unemployment  and sovereign debt risk abroad, proponents of this philosophy feel that Fed intervention will lessen the risk of slipping back into recession, and see that risk as more probable than creating inflation by keeping rates artificially low.
Weighing the Probabilities
Those who participate in this discussion often do so by labeling their opinion as "capitalist" or "progressive."  To do so is to grossly oversimplify the issue.  Whether rates should be raised or not lies simply in the measurement of future global demand.  Should demand be sufficient to sustain US growth, then interest rates should be raised, and the growth in production will result in new hiring that will eventually lower unemployment.  The amount of projected global growth in 2010 depends upon whose data you rely.
The World Bank projects 2.7% growth this year, slightly more pessimistic than the International Monetary Fund's projection of 3%.  The two organizations use different methods in calculating GDP, which partly accounts for the disparity.
For comparison purposes, global GDP growth was 5% in 2004, 4.5% in 2005, 5.1% in 2006, 5.2% in 2007, 3% in 2008, and -1.1% in 2009. 
Those in favor of raising interest rates feel that relying on growth from global demand projections in an admittedly sub-par year present less risk than the potential inflationary excesses that may be caused by keeping rates low.
Those in favor of keeping rates low feel that the probability of damaging a fragile recovery by raising rates are higher than causing future inflation by not doing so.
Clearly, choosing the wrong course of action may result in significant economic problems. 
What is your opinion, and why?