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” COMPOUND YOUR GAINS, NOT LOSSES,’ by Walecia Konrad in Money Magazine. ‘Market sell-offs are bad enough. By fixing these common investing mistakes, you’ll make sure difficult times aren’t made worse.’ GOOD ORDERLY DIRECTION (G._. D.)!!!!

In Uncategorized on April 28, 2009 at 10:59

Compound your gains, not losses

Market sell-offs are bad enough. By fixing these common investing mistakes, you’ll make sure difficult times aren’t made worse.


(Money Magazine) — Hoyt Cory doesn’t know quite what hit him. The 61-year-old holistic wellness practitioner in Sonora, Calif. expected steep losses in his $890,000 retirement funds, given the market crash. But when he added up the damage at the end of last year and saw that he had only $542,000 left in his stock and bond portfolio – nearly a 40% decline – the former corporate training and development consultant couldn’t believe it.


“I thought I did everything right,” says Cory, who is about to get married. “I read up on this stuff, I diversified, I even got help from a financial adviser. I just didn’t see the writing on the wall.”


There are plenty of people who share Cory’s disbelief – and pain. The typical long-term 401(k) investor ages 45 to 64 lost about 20% in 2008, according to the Employee Benefit Research Institute. If, like Cory, you suffered steeper losses than that, it’s probably a sign that you had problems in your portfolio. That means you got pounded twice – first by the crash and then by your missteps.


While you can’t do much about the market, you can correct your errors


Mistake no. 1: You invested too aggressively for your age


The very young can invest almost all of their money in equities, since they have time to make up for losses. But the same isn’t true for boomers. Yet an alarming number of workers nearing retirement are too heavily weighted in stocks.


Among 401(k) savers 56 to 65, nearly two in five recently had 80% or more of their retirement assets in equities, according to EBRI research director Jack VanDerhei. Cory was one of them, though he didn’t realize it at the time.


While virtually all assets (stocks, corporate bonds, real estate and so forth) were hit hard by this downturn, a higher fixed-income allocation would still have prevented Cory from losing so much, notes Plymouth, Mass. financial planner William Driscoll.


For instance, had Cory invested 65% of his money in an S&P 500 stock index fund and 35% in a diversified bond index fund, he would have lost 22% last year. That still would have hurt, but it’d be better than his actual 39% decline.


Solution: Sit down and figure out your proper allocation. Take into account your financial standing, expected retirement date and tolerance for risk. Based on these factors, Colorado Springs financial planner Allan Roth recommends that Cory put 65% of his portfolio in equities – not the nearly 85% he currently has – with the rest in bonds and cash.


To figure out the best strategy for you, check out the asset-allocation tool ( Even if you work with a financial planner, run the calculation. If your adviser recommends a different strategy, ask why.


Mistake no. 2: You forgot to keep your plan in check


It’s tempting to let your portfolio run unfettered when stocks are rollicking. But failing to routinely monitor your investments will make you more vulnerable to market crashes.


Take Cory. It was never his intent to have nearly 85% of his retirement funds in stocks. When he was in his mid-fifties, an adviser recommended that he be 75% in equities. Cory took the advice. But he never reset his portfolio to that initial mix of stocks and bonds. Since his equities grew faster than his bonds between 2003 and 2007, his 75%-stock strategy morphed into a more aggressive plan on its own.


Solution: Reset your mix to your desired allocation at least once a year. In a rising stock market, rebalancing forces you to take some profits. It also ensures that your portfolio won’t be too aggressive when the next bear strikes. Conversely, when equities are falling, rebalancing forces you to buy shares when prices are low. And it ensures that your portfolio won’t be too conservative when the next bull rolls around.


What’s the best way to rebalance? Driscoll suggests that Cory set triggers. If his stock weighting changes by more than five percentage points in either direction – in other words, if his 65%-stock allocation shrinks to less than 60% or grows to more than 70% – rebalance then and there. An easier solution: Pick a date on the calendar and just rebalance annually.


Mistake no. 3: You picked some real dogs


Sometimes it’s not your overall strategy that’s flawed. It’s the individual funds you picked to implement your plan.


Yet investors often struggle psychologically with the idea of selling their underperformers. Part of the problem is that many investors “feel the pain of taking a loss twice as much as the pleasure of realizing gains,” says Michael Pompian, author of “Behavioral Finance and Wealth Management.”


It could also be the fear of triggering long-term capital-gains taxes. That’s not as big a concern now, with 52% of U.S. stock funds down over the past 10 years and 91% underwater for the past five. Yet with so many funds down, it’s also hard to figure out which funds are the true losers.


Solution: Separate your real laggards from funds that are simply down – and take this opportunity to sell. Start by comparing apples with apples. “If the stock portion of your portfolio did worse than the S&P 500’s (.SPX
) 37% plunge, that’s telling you something,” says Daniel Moisand, an adviser in Melbourne, Fla.


Then dig deeper. Check how each of your funds has done over the past year and the past five years compared with peers that invest in a similar style. So if you own a large-cap growth fund, see how it ranks against other large-growth portfolios. It doesn’t have to be the absolute best, but make sure it’s at least close to average. To look up average performance figures for all fund categories, visit, click on the Markets tab and then scroll down to Fund Categories.


After looking over his portfolio, Cory found that many of his funds were under-performing – and that he was losing too much to fees and commissions. So he is simplifying his strategy by replacing his dogs with low-cost index funds.


That may not be the approach you ultimately select. But whatever you do, don’t wait too long to fix your portfolio. Who knows if the next rebound – or sell-off – is just around the corner?



In Uncategorized on April 27, 2009 at 20:00

Hard times call for hard money choices BY BEN MATTLIN, BANKRATE — 04/24/09 Financial advisers typically recommend setting aside at least three months’ worth of living expenses in a safe, liquid account in case of prolonged unemployment, sudden medical emergency or other unforeseen financial demands. This is called your “financial cushion.” Yet in today’s economic climate, is it really practical? With the proverbial “rainy day” now closer than ever, you may be tempted to dip into your savings, not add to them. So under what circumstances is it OK to spend your reserves? Are there better sources of ready cash to keep you afloat? Saving during recession “Don’t expect to maintain your current standard of living,” says David Hefty, CEO and co-founder of Cornerstone Wealth Management in Auburn, Ind. “If you have children, use this as an opportunity to teach them about sacrifice … Use this horrible economic downturn as a positive and don’t be a victim.” To be sure, there’s no single, simple formula for not becoming a victim. What’s right for one person might not be right for another. “There’s no cookie-cutter or off-the-shelf answer to the question of what to do about your nest egg in hard times,” says Rob Barmen, executive vice president at BPU Investment Management, a financial advisory firm in Pittsburgh. “It really depends on your situation.” Ironically, despite these recessionary times, Americans are suddenly managing to put away more money, not less. In early March, the U.S. Commerce Department announced that personal savings as a percentage of disposable personal income surged to 5 percent in January this year, the highest level since March 1995. “Consumers are fearful right now,” says Michael M. Eisenberg, a certified public accountant and personal financial specialist in Los Angeles. “If they have a job, they’re afraid they might lose it. In a way, that’s the silver lining of this crisis. It’s showing people they can and must save.” Spending during recession Naturally, there are times when you can’t save. There may be times when you’re tempted to spend your savings. That’s fine, if you’re prudent. Job losses or urgent medical needs and other emergencies are valid grounds for withdrawing from a rainy-day fund, Eisenberg says, but a sale at Bloomingdale’s doesn’t count. “The emergency fund is there to get you through unanticipated crises,” Eisenberg says. “You can tap into it for spontaneous, one-time events, such as an urgent car repair or, if you’ve just lost your job, to make your next property-tax payment, that kind of stuff.” At other times, though, it can be better to borrow money than spend your savings. Interest rates are enticingly low at the moment, except on credit cards. If you can borrow at a lower rate than you earn from your savings, it might be a wiser option. However, if owing money keeps you awake at night, it’s probably not a smart move. When to borrow If you have to borrow money, a home-equity loan is often the best choice. The interest payments are tax-deductible. “If you need to make repairs to your house, for example, this is an appropriate source of funds,” Eisenberg says. “If your kids are in college and they have a semester or two to go, and you want them to finish that education, I can see using a home-equity loan. Not for all four years of college; that doesn’t make sense, but for short-term, major expenditures. Don’t use it for vacations or buying sprees.” But home-equity loans can be hard to get in the credit crunch, and they’re almost impossible to find if you’re unemployed. What’s more, property values have plummeted, and you don’t want to tap the diminishing equity in your home if you don’t have to. If you sell your home later, before paying off the loan, you’ll pocket less of the proceeds because a larger chunk is going to your lender. Some financial advisers prefer other options. For one, see if your life insurance policy has a cash value. Many “whole” or “universal” life policies, as opposed to “term” life insurance, invest a portion of your premium payments in a separate tax-deferred account. It builds value over time so that some benefits can be paid out before your death as well as after, says Stacy Francis, a financial planner in New York. “It’s your money, it’s in cash and there are usually no penalties for tapping into it,” Francis says. But there are two caveats about tapping life insurance: 1. Any cash you withdraw will reduce your after-death payout to heirs. It’s not always a dollar-for-dollar formula, either. In some cases, you could be reducing your death benefit by more than the amount you withdraw. Policies vary, so check with your provider before taking out funds. 2. Don’t access the cash value of your life insurance by taking out a loan against it. Often policies offer loans at a lower rate of interest than banks with the cash value of your policy serving as collateral. Nevertheless, you are paying interest, which makes anything you purchase with the funds that much more costly. In some cases, the loan plus interest can be deducted from your death benefit rather than paid back in your lifetime. This may seem tempting, but again, it diminishes what you leave your heirs, says Eleanor Blayney, a consumer advocate at the Certified Financial Planner Board of Standards in Washington, D.C. Asking loved ones Another choice is to ask friends or family for money. Doubtless this will entail emotional strings, yet that’s no reason to avoid it. “I certainly would hope my child would come to me before doing something foolish,” Blayney says. If you’re going to borrow from an individual, draw up formal loan papers to clarify terms and clear up potential misunderstandings. Often, family members prefer to give the money as a gift with no promise of repayment. Parents or grandparents may enjoy doling out inheritance money while they’re still alive. In so doing, they can avoid estate taxes while seeing how their heirs use it, says Bill Schultheis, investment adviser and principal at Soundmark Wealth Management in Kirkland, Wash. In 2009, individual benefactors can give up to $13,000 a year as a gift — married couples, twice that — without a penalty. Larger gifts could incur gift taxes. Money to avoid In desperate times, smart people can make stupid choices. Here are several warnings about sources of ready cash to avoid: – Do not dip into your retirement accounts. If you do, you’ll face taxes that would otherwise be deferred until retirement and substantial penalties for early withdrawal. Plus, you will need that money when you get older. “401(k)’s and IRAs give you creditor protection,” Blayney says. “So if you’re on your way to bankruptcy, remember that those assets are protected.” – Avoid payday-advance or tax-refund anticipation loans. They carry very high interest rates for money that’s yours anyway. – Don’t be tempted by a reverse mortgage unless you’re a senior citizen who has paid off most of your mortgage and you want to remain in your home and have no heirs to leave it to. The extra cash is generally not taxable, but look out for high hidden fees. However you do it, taking charge of your financial situation can be as comforting as it is necessary. Still, for some, the best comfort may be recognizing that tough times don’t last forever.

‘WHICH IS COMING DOWN THE PIKE? INFLATION OR DEFLATION.”, you better know which to prepare for. Quarterly review & Outlook from Outside the Box, by John Mauldin. GREAT READ. STUDY. Stay informed.

In Uncategorized on April 21, 2009 at 13:57

Quarterly Review and Outlook 
First Quarter 2009


Over the next decade, the critical element in any investment portfolio will be the correct call regarding inflation or its antipode, deflation. Despite near term deflation risks, the overwhelming consensus view is that “sooner or later” inflation will inevitably return, probably with great momentum. This inflationist view of the world seems to rely on two general propositions. First, the unprecedented increases in the Fed’s balance sheet are, by definition, inflationary. The Fed has to print money to restore health to the economy, but ultimately this process will result in a substantially higher general price level. Second, an unparalleled surge in federal government spending and massive deficits will stimulate economic activity. This will serve to reinforce the reflationary efforts of the Fed and lead to inflation.

These propositions are intuitively attractive. However, they are beguiling and do not stand the test of history or economic theory. As a consequence, betting on inflation as a portfolio strategy will be as bad a bet in the next decade as it has been over the disinflationary period of the past twenty years when Treasury bonds produced a higher total return than common stocks. This is a reminder that both stock and Treasury bond returns are sensitive to inflation, albeit with inverse results.

If inflation and interest rates were to rise in this recession, or in the early stages of a recovery, the expansion would be cut short and the economy would either remain in, or relapse into recession. In late stages of economic downturns, substantial amounts of unutilized labor and other resources exist. Thus, both factory utilization and unemployment rates lag other economic indicators. For instance, reflecting this severe recession, unused labor and other productive resources have increased sharply. The yearly percentage decline in household employment is the largest since current data series began in 1949. In March the unemployment rate stood at 8.5%, up from a cyclical low of 4.4%. This is the highest level since the early 1980s. The labor department’s broader U6 unemployment rate includes those less active in the labor markets and working part time because full time work is not available. The U6 rate of 15.6% in March was the highest in the 15 year history of the series and up from its cyclical low of 7.9%. The operating rate for all industries and manufacturing both fell to their lowest levels on record in March. Manufacturing capacity was around 15% below the sixty year average (Chart 1). Given these conditions, let’s assume for the moment that inflation rises immediately. With unemployment widespread, wages would seriously lag inflation. Thus, real household income would decline and truncate any potential gain in consumer spending.

Manufacturing Capacity Utilization - Monthly

A technically superior and more complete method of capturing the concept of excess labor and capacity is the Aggregate Supply and Demand Curve (Chart 2). Inflation will not commence until the Aggregate Demand (AD) Curve shifts outward sufficiently to reach the part of the Aggregate Supply (AS) curve that is upward sloping. The AS curve is perfectly elastic or horizontal when substantial excess capacity exists. Excess capacity causes firms to cut staff, wages and other costs. Since wage and benefit costs comprise about 70% of the cost of production, the AS curve will shift outward, meaning that prices will be lower at every level of AD. Therefore, multiple outward shifts in the Aggregate Demand curve will be required before the economy encounters an upward sloping Aggregate Supply Curve thus creating higher price levels. In our opinion such a process will take well over a decade.

An Illustration of the Aggregate Supply Curve during a Period of Substantial Unutilized Resources

Record Expansion of the Fed’s Balance Sheet and M2

In the past year, the Fed’s balance sheet, as measured by the monetary base, has nearly doubled from $826 billion last March to $1.64 trillion, and potentially larger increases are indicated for the future. The increases already posted are far above the range of historical experience. Many observers believe that this is the equivalent to printing money, and that it is only a matter of time until significant inflation erupts. They recall Milton Friedman’s famous quote that “inflation is always and everywhere a monetary phenomenon.”

These gigantic increases in the monetary base (or the Fed’s balance sheet) and M2, however, have not led to the creation of fresh credit or economic growth. The reason is that M2 is not determined by the monetary base alone, and GDP is not solely determined by M2. M2 is also determined by factors the Fed does not control. These include the public’s preference for checking accounts versus their preference for holding currency or time and saving deposits and the bank’s needs for excess reserves. These factors, beyond the Fed’s control, determine what is known as the money multiplier. M2 is equal to the base times the money multiplier. Over the past year total reserves, now 50% of the monetary base, increased by about $736 billion, but excess reserves went up by nearly as much, or about $722 billion, causing the money multiplier to fall (Chart 3). Thus, only $14 billion, or a paltry 1.9% of the massive increase of total reserves, was available to make loans and investments. Not surprisingly, from December to March, bank loans fell 5.4% annualized. Moreover, in the three months ended March, bank credit plus commercial paper posted a record decline.

M2 Money Multiplier and Excess Reserves - monthly

If this all sounds complicated you are right, it is. The bottom line, however, is that it is totally incorrect to assume that the massive expansion in reserves created by the Fed is inflationary. Economic activity cannot move forward unless credit expansion follows reserves expansion. That is not happening. Too much and poorly financed debt has rendered monetary policy ineffective.

What about the M2 Surge?

M2 has increased by over a 14% annual rate over the past six months, which is in the vicinity of past record growth rates. Liquidity creation or destruction, in the broadest sense, has two components. The first is influenced by the Fed and its allies in the banking system, and the second is outside the banking system in what is often referred to as the shadow banking system. The equation of exchange (GDP equals M2 multiplied by the velocity of money or V) captures this relationship. The statement that all the Fed has to do is print money in order to restore prosperity is not substantiated by history or theory. An increase in the stock of money will only lead to a higher GDP if V, or velocity, is stable. V should be thought of conceptually rather than mechanically. If the stock of money is $1 trillion and total spending is $2 trillion, then V is 2. If spending rises to $3 trillion and M2 is unchanged, velocity then jumps to 3. While V cannot be observed without utilizing GDP and M, this does not mean that the properties of V cannot be understood and analyzed.

The historical record indicates that V may be likened to a symbiotic relationship of two variables. One is financial innovation and the other is the degree of leverage in the economy. Financial innovation and greater leverage go hand in hand, and during those times velocity is generally above its long-term average of 1.67 (Chart 4). Velocity was generally below this average when there was a reversal of failed financial innovation and deleveraging occurred. When innovation and increased leveraging transpired early in the 20th century, velocity was generally above the long-term average. After 1928 velocity collapsed, and remained below the average until the early 1950s as the economy deleveraged. From the early 1950s through 1980 velocity was relatively stable and never far from 1.67 since leverage was generally stable in an environment of tight financial regulation. Since 1980, velocity was well above 1.67, reflecting rapid financial innovation and substantially greater leverage. With those innovations having failed miserably, and with the burdensome side of leverage (i.e. falling asset prices and income streams, but debt remaining) so apparent, velocity is likely to fall well below 1.67 in the years to come, compared with a still high 1.77 in the fourth quarter of 2008. Thus, as the shadow banking system continues to collapse, velocity should move well below its mean, greatly impairing the efficacy of monetary policy. This means that M2 growth will not necessarily be transferred into higher GDP. For example, in Q4 of 2008 annualized GDP fell 5.8% while M2 expanded by 15.7%. The same pattern appears likely in Q1 of this year.

Velocity of Money 1900-2008

The highly ingenious monetary policy devices developed by the Bernanke Fed may prevent the calamitous events associated with the debt deflation of the Great Depression, but they do not restore the economy to health quickly or easily. The problem for the Fed is that it does not control velocity or the money created outside the banking system.

Washington policy makers are now moving to increase regulation of the banks and nonbank entities as well. This is seen as necessary as a result of the excessive and unwise innovations of the past ten or more years. Thus, the lesson of history offers a perverse twist to the conventional wisdom. Regulation should be the tightest when leverage is increasing rapidly, but lax in the face of deleveraging.

Are Massive Budget Deficits Inflationary?

Based on the calculations of the Congressional Budget Office, U.S. Government Debt will jump to almost 72% of GDP in just four fiscal years. As such, this debt ratio would advance to the highest level since 1950 (Chart 5). The conventional wisdom is that this will restore prosperity and higher inflation will return. Contrarily, the historical record indicates that massive increases in government debt will weaken the private economy, thereby hindering rather than speeding an economic recovery. This does not mean that a recovery will not occur, but time rather than government action will be the curative factor.

Gross Federal Debt Held by Public as a % of GDP

By weakening the private economy, government borrowing is not an inflationary threat. Much light on this matter can be shed by examining Japan from 1988 to the 2008 and the U.S. from 1929 to 1941. In the case of Japan government debt to GDP ratio surged from 50% to almost 170%. So, if large increases in government debt were the key to economic prosperity, Japan would be in the greatest boom of all time. Instead, their economy is in shambles. After two decades of repeated disappointments, Japan is in the midst of its worst recession since the end of World War II. In the fourth quarter, their GDP declined almost twice as fast as that of the U.S. or the EU. The huge increase in Japanese government debt was created when it provided funds to salvage failing banks, insurance and other companies, plus transitory tax relief and make-work projects.

In 2008, after two decades of massive debt increases, the Nikkei 225 average was 77% lower than in 1989, and the yield on long Japanese Government Bonds was less than 1.5% (Chart 6). As the Government Debt to GDP ratio surged, interest rates and stock prices fell, reflecting the negative consequences of the transfer of financial resources from the private to the public sector (Chart 7). Thus, the fiscal largesse did not restore Japan to prosperity. The deprivation of private sector funds suggested that these policy actions served to impede, rather than facilitate, economic activity.

Japan: Gevernment Debt as a % of GDP and Nikkei Stock Average

Japan: Government Debt as a % of GDP and Long Term Government Rates

This recent Japanese experience mirrors U.S. history from 1929 to 1941 when the ratio of U.S. government debt to GDP almost tripled from 16% to near 50%. As the U.S. debt ratio rose, long Treasury yields moved lower, indicating that the private sector was hurt, not helped, by the government’s efforts. The yearly low in long Treasury yields occurred at 1.95% in 1941, the last year before full WWII mobilization. In 1941, the S&P 500, despite some massive rallies in the 1930s, was 62% lower than in 1929, and had been falling since 1936. Thus, two distinct periods separated by country and considerable time indicate that stock prices respond unfavorably to massive government deficit spending and bond yields decline.

The U.S. economy finally recovered during WWII. Some attribute this recovery to a further increase in Federal debt which peaked at almost 109% of GDP. However, the dynamics during the War were much different than from those of 1929 through 1941 and today. The U.S. ran huge trade surpluses as we supplied military and other goods to allies, which served to lift the U.S. economy through a massive multiplier effect. Additionally, 10% of our population, or 12 million persons, were moved into military services. This is equivalent to 30 million people today. Also, mandatory rationing of goods was instituted and people were essentially forced to use an unprecedented portion of their income to buy U.S. bonds or other saving instruments. This unparalleled saving permitted the U.S. economy to recover from the massive debt acquired prior to 1929.




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Bonds Still an Exceptional Value

Since the 1870s, three extended deflations have occurred–two in the U.S. from 1874-94 and from 1928 to 1941, and one in Japan from 1988 to 2008. All these deflations occurred in the aftermath of an extended period of “extreme over indebtedness,” a term originally used by Irving Fisher in his famous 1933 article, “The Debt-Deflation Theory of Great Depressions.” Fisher argued that debt deflation controlled all, or nearly all, other economic variables. Although not mentioned by Fisher, the historical record indicates that the risk premium (the difference between the total return on stocks and Treasury bonds) is also apparently controlled by such circumstances. Since 1802, U.S. stocks returned 2.5% per annum more than Treasury bonds, but in deflations the risk premium was negative. In the U.S. from 1874-94 and 1928-41, Treasury bonds returned 0.9% and 7% per annum, respectively, more than common stocks. In Japan’s recession from 1988-2008, Treasury bond returns exceeded those on common stocks by an even greater 8.4%. Thus, historically, risk taking has not been rewarded in deflation. The premier investment asset has been the long government bond (Table 1).

Risk Premium During Debt Deflations

This table also speaks to the impact of massive government deficit spending on stock and bond returns. In the U.S. from 1874-94, no significant fiscal policy response occurred. The negative consequences of the extreme over indebtedness were allowed to simply burn out over time. Discretionary monetary policy did not exist then since the U.S. was on the Gold Standard. The risk premium was not nearly as negative in the late 19th century as it was in the U.S. from 1928-41 and in Japan from 1988-2008 when the government debt to GDP ratio more than tripled in both cases. In the U.S. 1874-94, at least stocks had a positive return of 4.4%. In the U.S. 1928-41 and in Japan in the past twenty years, stocks posted compound annual returns of negative 2.4% and 2.3%, respectively. Therefore on a historical basis, U.S. Treasury bonds should maintain its position as the premier asset class as the U.S. economy struggles with declining asset prices, overindebtedness, declining income flows and slow growth.

Van R. Hoisington 
Lacy H. Hunt, Ph.D.

‘ FINANCIAL INNOVATION FOR BEGINNERS ‘, baselinescenario .com, trying to explain where new banking & financial instrument regulations may be headed. Trying to sort things out before deciding what & where to reign things in. Going to be one long process. Meanwhile still lots of trouble in River City in my outlook.

In Uncategorized on April 19, 2009 at 10:02

The Baseline Scenario Financial Innovation for Beginners Posted: 18 Apr 2009 04:26 PM PDT (For a complete list of Beginners articles, see Financial Crisis for Beginners.) Kevin Drum pointed me to Ryan Avent’s insightful review of Ben Bernanke’s recent speech on financial innovation. (How’s that for the Internets in action?) Bernanke’s brief was simple: to defend financial innovation in general while acknowledging that at the margin it can be counterproductive and may need to be more closely regulated. “I don’t think anyone wants to go back to the 1970s,” he said in a line that was clearly supposed to make his point. Unfortunately for Bernanke, Avent was listening closely. His rejoinder: neither could Bernanke point to a truly helpful piece of financial innovation developed after that decade. His examples of successful financial products? Credit cards, for one, which date from the 1950s. Policies facilitating the flow of credit to lower income borrowers was another, for which he credited the Community Reinvestment Act of 1977. And, of course, securitization and the secondary mortgage markets developed by Fannie Mae and Freddie Mac in…the 1970s. With one exception: Tasked with defending deregulation as a source of financial innovation, Bernanke reached for subprime lending. This helped at least partially crystallize some thoughts I have had floating around about financial innovation for a while. Where I come from (career-wise at least), innovation meant that you invented something that people wanted, or you figured out a cheaper way to make something that people wanted, or you figured out a way to improve something that people wanted. Think of the iPod, or floss with a thin coating that makes it slide between your teeth more easily, or those little plastic things that keep the tips of your shoelaces together. These are things that make our lives, in aggregate, unequivocally better. Financial innovation, however, comes in two forms. There are financial innovations that make our lives easier. One is the automated teller machine (ATM). ATMs are great. They mean that you don’t have to wait in line at bank teller windows or rearrange your schedule to go to the bank when it is open, and most importantly you can get cash at any hour if you need it . . . almost anywhere in the world. I would pay real cash money to use ATMs if I had to (and occasionally I do, if it’s not at my bank). Another example is the debit card, which saves me the trouble of dealing with cash altogether. There are corporate versions of these innovations, like corporate purchasing cards, which help automate the process by which employees buy stuff for their companies and get reimbursed for it. These types of innovations increase the quality of service and reduce costs – it’s hard to argue with that. The other kind of financial innovation has to do with extending access to credit. Here I think it’s less clear that innovation is unequivocally good. It is certainly possible for a society to be below the optimal level of access to credit. Consider the idyllic banking paradise that gets mentioned a lot these days, in which people deposited their savings with local banks which, in turn, lent money out to trustworthy local homebuyers and held onto those mortgages to maturity. The good thing about this model is it encouraged responsible underwriting. The bad thing is that it isn’t very good at moving capital (money) from one part of the country to the other. Imagine in Iowa no one needs a mortgage, so the banks have no place to lend and can only pay their depositors 0.1% interest. In Florida lots of people need mortgages, so the banks offer 4% on savings accounts, but they still can’t attract enough cash and people who would buy houses can’t. (Or, alternatively, people who would take out loans to expand their businesses can’t.) Securitization is one innovation that helped overcome this problem and increased access to credit, and I think securitization on balance is a good thing. But it’s not in the same category as the iPod, or better floss, or better shoelaces, which are things that make people’s lives better directly. Securitization is something that increases access to credit, which may or may not be good, depending on the context. The effect of securitization should be to moderate differences in interest rates – mortgage rates can come down as money moves into Florida, but they may go up as money leaves Iowa – and perhaps to lower them overall by making more money available to the market as a whole. If we were in a situation where too few people were getting mortgages, this is a good thing. But it is also possible for too many people to be getting mortgages, as we now know. Something similar happened with venture capital and startups over the last fifteen years. After the IPO rush of the late 1990s, billions of dollars of new money piled into the VC industry; that money flowed to thousands of companies that should never have gotten funded, resulting in lost money for investors and lost time and effort for thousands of generally bright and well-meaning entrepreneurs. Even credit cards – which I think most people would say are on balance a good thing, and which I personally use multiple times almost every day – can sometimes be a bad thing: they can prompt people to make unwise purchases they might otherwise not have made, with negative consequences for themselves. In short, financial innovations whose sole function is to increase access to credit do not in and of themselves make the world a better place. They can help by providing the credit that people need to make the world a better place, but they can also make it possible for people to do irrational and economically destructive things. So when people say that innovation is the source of all progress, that may be true – but not all types of innovation are equal.

” GREEN SHOOTS & GLIMMERS,’ by Paul Krugman, the Times. Four reasons to be cautious about the economic outlook. ‘DON’T COUNT YOUR RECOVERIES UNTIL IT’S HATCHED.’ Be cautious, stay focused, disciplined, at the ready.

In Uncategorized on April 17, 2009 at 18:45

Green Shoots and Glimmers

Published: April 16, 2009

Ben Bernanke, the Federal Reserve chairman, sees “green shoots.” President Obama sees “glimmers of hope.” And the stock market has been on a tear.

Fred R. Conrad/The New York Times

Paul Krugman

So is it time to sound the all clear? Here are four reasons to be cautious about the economic outlook.

1. Things are still getting worse.Industrial production just hit a 10-year low. Housing starts remain incredibly weak. Foreclosures, which dipped as mortgage companies waited for details of the Obama administration’s housing plans, are surging again.

The most you can say is that there are scattered signs that things are getting worse more slowly — that the economy isn’t plunging quite as fast as it was. And I do mean scattered: the latest edition of the Beige Book, the Fed’s periodic survey of business conditions, reports that “five of the twelve Districts noted a moderation in the pace of decline.” Whoopee.

2. Some of the good news isn’t convincing. The biggest positive news in recent days has come from banks, which have been announcing surprisingly good earnings. But some of those earnings reports look a little … funny.

Wells Fargo, for example, announced its best quarterly earnings ever. But a bank’s reported earnings aren’t a hard number, like sales; for example, they depend a lot on the amount the bank sets aside to cover expected future losses on its loans. And some analysts expressed considerable doubt about Wells Fargo’s assumptions, as well as other accounting issues.

Meanwhile, Goldman Sachs announced a huge jump in profits from fourth-quarter 2008 to first-quarter 2009. But as analysts quickly noticed, Goldman changed its definition of “quarter” (in response to a change in its legal status), so that — I kid you not — the month of December, which happened to be a bad one for the bank, disappeared from this comparison.

I don’t want to go overboard here. Maybe the banks really have swung from deep losses to hefty profits in record time. But skepticism comes naturally in this age of Madoff.

Oh, and for those expecting the Treasury Department’s “stress tests” to make everything clear: the White House spokesman, Robert Gibbs, says that “you will see in a systematic and coordinated way the transparency of determining and showing to all involved some of the results of these stress tests.” No, I don’t know what that means, either.

3. There may be other shoes yet to drop. Even in the Great Depression, things didn’t head straight down. There was, in particular, a pause in the plunge about a year and a half in — roughly where we are now. But then came a series of bank failures on both sides of the Atlantic, combined with some disastrous policy moves as countries tried to defend the dying gold standard, and the world economy fell off another cliff.

Can this happen again? Well, commercial real estate is coming apart at the seams, credit card losses are surging and nobody knows yet just how bad things will get in Japan or Eastern Europe. We probably won’t repeat the disaster of 1931, but it’s far from certain that the worst is over.

4. Even when it’s over, it won’t be over. The 2001 recession officially lasted only eight months, ending in November of that year. But unemployment kept rising for another year and a half. The same thing happened after the 1990-91 recession. And there’s every reason to believe that it will happen this time too. Don’t be surprised if unemployment keeps rising right through 2010.

Why? “V-shaped” recoveries, in which employment comes roaring back, take place only when there’s a lot of pent-up demand. In 1982, for example, housing was crushed by high interest rates, so when the Fed eased up, home sales surged. That’s not what’s going on this time: today, the economy is depressed, loosely speaking, because we ran up too much debt and built too many shopping malls, and nobody is in the mood for a new burst of spending.

Employment will eventually recover — it always does. But it probably won’t happen fast.

So now that I’ve got everyone depressed, what’s the answer? Persistence.

History shows that one of the great policy dangers, in the face of a severe economic slump, is premature optimism. F.D.R. responded to signs of recovery by cutting the Works Progress Administration in half and raising taxes; the Great Depression promptly returned in full force. Japan slackened its efforts halfway through its lost decade, ensuring another five years of stagnation.

The Obama administration’s economists understand this. They say all the right things about staying the course. But there’s a real risk that all the talk of green shoots and glimmers will breed a dangerous complacency.

So here’s my advice, to the public and policy makers alike: Don’t count your recoveries before they’re hatched.

‘ THREE WAYS INVESTORS CAN NAVIGATE THIS MARKET,’ by Will Swarts, Smartmoney, 04-13-09. Good primer to study if you think this might be a good time to buy or think about it. You gotta stay informed, hip, at the ready, prepared. AND THEN YOU DECIDE WHEN TO PULL THE TRIGGER.

In Uncategorized on April 17, 2009 at 18:12

This week the heart of the first quarter earnings season starts to report its numbers. While the results during the next few weeks are widely expected to be dismal — at the conclusion it should be the seventh consecutive quarter of negative earnings growth — many investors are looking for signs in the corporate releases that show this 12-week period represents the low point in the economic downturn. The thinking goes that once it’s in the rear view mirror, the stock market will hopefully resume an upward trajectory. Investors have already seen glimpses of that. The Dow Jones Industrial Average (.DJI Loading… ) gained 22% during a four week period that started at the March 9 bottom of 6547 and cooled off shortly before Alcoa (AA Loading… ) announced its results last week, traditionally the start of earnings reporting. Along the way there have been streaks of triple-digit trading days that made headlines but not a lot of money for most long-term investors. The end result of that volatility adds up to little in a stock market that seems like it can’t sustain a rally — at least for now. For long-term investors, big swings don’t equal big gains, especially when fast-money hedge funds drive the action, profiting from moves on volatile stocks with prices that bear no relationship to their earnings fundamentals. Nevertheless, fund managers are making changes to their portfolios in this tricky environment, whether it’s to play certain broad trends, profit a little on the margins of a long-term strategy or because they are setting themselves up for what they believe will be a rebound later this year and in 2010. These are three different approaches, and you can easily follow them, too, even if your investment horizon is ten years out not ten minutes. The day-to-day volatility will certainly continue this week as the banking sector releases its results. Even a change in mark-to-market accounting rules won’t prevent these firms from posting miserable results. The inevitable knee jerk reaction will be to sell. Indeed, J.P. Morgan (JPM Loading… ) equity strategist Thomas Lee believes trading activity without solid fundamentals will keep the benchmark S&P 500 stock index (.SPX Loading… ) between 750 and 1100 until the housing and financial sectors bottom out and stabilize. “We still think a final low is ahead of us,” he wrote recently. Charlie Mercer, manager of the Aston/Veredus Select Growth Fund (AVSGX | Get Prospectus Loading… ), points out that throughout 2008, the market has endured 28 one-day swings of 4% or more. Between 1945 and 2007, he says, the S&P had 49. That’s “the type of volatility we see in frontier and emerging markets,” he says. “Not the biggest, most developed market in the world.” “That creates a different environment, and what you do depends on your appetite not so much for risk taking, but more about your desire to trade in a trader’s market,” he says. That’s not for everyone, particularly small investors who can’t be as nimble as professional traders. “The volatility bubble won’t last forever, and being long in it at this stage of the game is a very risky bet.” We asked Mercer and two other managers with long term perspectives how they were playing this market. Of course, we got three different answers. Mercer remains cautious about earnings, but he does see positive signs in how some sectors are performing. “Earnings are not good,” he says, adding that conventional wisdom predicts nine consecutive quarters of negative growth will come to an end in the third quarter of 2009. “But there are some sectors where estimates have simply been too low.” Technology has traditionally done well coming out of downturns as investors flock to stocks that have big growth potentials. That trend is playing out in a big way in 2009. Through last week, Lipper says the average technology fund returned 9.2% in 2009 vs. a 7% loss for S&P 500 index funds. Mercer says semiconductor stocks like Qualcomm (QCOM Loading… ), Broadcom (BRCM Loading… ) and Intel (INTC Loading… ) have been oversold. He’s also looking at low-end dining chains like Darden Restaurants (DRI Loading… ), Chipotle Mexican Grill (CMGB Loading… ) and Panera Bread (PNRA) as a way to play the cash-strapped consumer angle. These stocks have outperformed this year albeit against extremely low expectations. “The market is priced for near Armageddon,” he says. “People simply got too negative with those industries.” One option for long-term investors is to develop a keen short game, says David James, portfolio manager and senior vice president at James Advantage Funds, a mutual fund company based outside of Dayton, Ohio. James says investors should lower their overall stock allocation but shoulder a bit more risk with small sums of cash. “It’s more of a counterpuncher situation,” he says. “Remember not to fall in love with your stocks – you’re looking to buy them and hold them for a period of time, and enjoy a portion of the rally.” James Balanced: Golden Rainbow (GLRBX | Get Prospectus), the firm’s $533 million flagship fund, currently splits its assets between bonds (42%), stocks (33%) and a large cash position. Top equity holdings as of its last filing date include Hess (HES Loading… ), IBM (IBM Loading… ) and Western Digital (WDC Loading… ). The fund holds the top spot in its Morningstar peer group over the last decade and only lost 5.5% last year. Or, investors could look at these short-term blips as just that — temporary fluctuations that shouldn’t influence a long-term strategy. That’s an idea Adriana Posada recommends. Posada, who manages the American Beacon Large Cap fund (AADEX | Get Prospectus Loading… ), says it’s better to think years ahead, not get caught up in the moment. Her fund, whose major holdings include IBM, Verizon Communications (VZ Loading… ) and Wyeth (WYE Loading… ) (which proved to be a wise name to stay with – the pharmaceuctical company was bought out by rival Pfizer (PFE Loading… ) at a 32% premium at the end of March), has very little turnover despite current market turmoil. “If you have to take a beating, that’s what you do,” she says. “We think that a lot of the retrenchment is not permanent, not due to fundamentals. These companies are not broken. As long as they can have internal or alternative sources of short-term funding they can survive.”


In Uncategorized on April 15, 2009 at 17:23

12 Smart Steps to Prepare for An Uncertain Financial Future 

By Al Herter 

Notice: These smart steps can alter your life and your future outcomes—especially by following them again and again, which will put some traction in your action. 

  1. Think simple living. Quakers as the standard. Want what you have. Do what you can. Be who you are. Count your blessings.
  2. For a month, keep track of every penny you spend in a small notebook (but don’t go out and buy one). Review each bill you pay or have paid. Need all those cable channels? The lattes? The smokes? The cleaners? The maid twice a week.
  3. Mend clothes, darn socks, turn off lights, re-heat leftovers. Think small, cheap, and affordable.


  1. Sell anything you don’t use, want, need, or are just storing for posterity, for the children, or for a rainy day. Get onto Craigslist and sell all that extra stuff you have and don’t use. It declutters and puts money in your pocket.


  1. Look for other revenue centers that you can profit from, such as rent out a small room as an office for someone who will use it; or rent out the garage or even the basement for storage.


  1. Explore how you can rent or exchange apartments rather than use hotels.


  1. Health is number one on my list. Eat better. Eat less. Take yoga, walks, bike rides.


  1. Plant a veggie garden. It saves money and is better for you—and may even be something you can sell to others and/or barter with them. You do tomatoes, and the neighbors do corn/beans/squash. You share the tools, knowledge and harvest. Not only will your garden grow, but so will your neighborly community.


    Start to get the drift that the landscape has changed dramatically? 

  1. Cook and entertain at home. Invite others over for potlucks. They’re cheaper, easier nicer and more fun!


  1. Walk, use public transit, use your bike, car pool, or any combination thereof (but not all at once, of course).


  1. Be preventative with your health through diet, exercise and relax. When necessary, use generic drugs.


  1. Breathe, relax and enjoy life! You’ve only got this very moment to live it to the fullest—and that’s one thing that is for certain!

DEMOCRATS ABROAD FRANCE SPONSORS ‘AN EVENING WITH AL HERTER.’ April 21st, starting at 18h30, at the American Church, 2nd flr. Thurber Room. 15E each/10E members of Young Democrats Abroad France. RSVP Necessary. Plus comments from talk last Sept. 19th in Paris for the benefit of Handicap International.

In Uncategorized on April 13, 2009 at 18:04
An Evening With Al Herter
Tuesday, April 21, 2009 – 6:30pm

The ‘hippie philanthropist’,
the man who does both well and good,
the Progressive’s answer to the smart-money guy

will speak for Democrats Abroad France

Tuesday, April 21 at 6:30 PM
At the American Church in Paris
65 Quai d’Orsay, 75007 Paris


Come hear the wit and wisdom of Al Herter, a self-made millionaire
and successful private investor, and learn how his years of investment
experience can work for you. Get his take on where his money is today
and why, and how he sees this financial meltdown working out.

Al has nothing to sell. But he does like to help people. He has
spoken with great success here in Paris annually since 2005: for
W.I.C.E., Young Democrats Abroad at the QLIC Cafe last September when
800E were raised for Handicap International. Al will take questions
from the audience and respond to suggested topics.

Al Herter is a native New Yorker with academic degrees from Cornell
(economics) and New York University (public finance). A private
investor for 40 years, he has always worked for non-profits and public
agencies. He retired at age 37 to become a Mr. Mom to his three very
young sons. A resident of Paris, Manhattan and San Francisco. he
describes himself as a ‘Hippie Philanthropist’ trying to make a
difference in other peoples lives. He has deep Scottish roots, which
are a good place to start as an investor. See his website: (Al’s March 2006 warning about the coming financial meltdown and bursting house bubble is posted in ‘Archives, Dec. 2008’!)
15 euros (10 euros for Young Dems) at the door, to benefit DAF
Limited seating, you must RSVP.

Click here to rsvp:
Barbara Tucker


” It was the perfect discussion for the moment!”

” I really appreciated Al’s very inspiring talk. What was most inspiring was
the man himself and how he thinks, very different to what I imagined. ”

” it was not only interesting and helpful but very enjoyable as well (and
for a good cause to boot, what more can one ask for).”

” I really enjoyed the evening!”

” Apart from it being very informative, I found Al to be really inspiring.
I loved his honest and straightforward manner.”

” Thanks for introducing us to Al Herter and for organizing the entire
evening. I was impressed. We were pretty wired after his talk. I enjoyed his
presentation, his style and message.”

“It was a great evening and helped unblock stuff for me. Al is terrific.”

‘INFLATION PROSPECTS IN AN EMERGING MARKET, LIKE THE U.S.’ from www. baselinescenario. com. Simon Johnson is brilliant. Former chief economist at I.M.F, now prof. at M.I.T. A MUST READ FOLKS!

In Uncategorized on April 7, 2009 at 11:23

Inflation Prospects In An Emerging Market, Like The U.S. Posted: 06 Apr 2009 02:57 AM PDT There are two ways to think about inflation in today’s economy. The first, suggested by conventional macroeconomic frameworks for the US, is that, with rising unemployment and actual output sinking further below “potential” output, inflation will stay low – and we could actually experience the dangers of falling wages and prices (think what happens to mortgage defaults in that scenario). This is the view, for example, expressed by Fed Vice Chair Don Kohn last week, and the Obama Administration seems to be on exactly the same page – talking already about a further very large fiscal stimulus. Some people in this camp do see a danger of inflation, down the road, as the economy recovers – and resumes its potential level (or growth rate). As a result, many of them stress that the Fed will need to start “withdrawing” its support for credit and raising interest rates as soon as the economy turns the corner. One informed insider’s reaction to our piece on Ben Bernanke in the Washington Post on Sunday was that we were too easy on Bernanke for failing to tighten monetary conditions as the economy began to recover after the last big easing earlier this decade (specifically, our correspondent argues that Bernanke provided the intellectual underpinnings for what Greenspan wanted to do.) In today’s post-G20 summit situation, some of my former IMF colleagues are worried that further monetary easing around the world will create inflationary pressure in middle-income emerging markets, where inflation is often harder to control than in richer “industrial countries.” But if you think the broader political and economic dynamics of the United States have become more like those of emerging markets, e.g., the concentrated power of the financial elite and their ability to access corporate welfare, doesn’t that also have potential implications for inflation? In discussions of emerging markets, you rarely hear discussion of “potential output.” This is a slippery concept even for the United States, with origins in the idea of running factories at “full capacity” but also reflecting the traditional bargaining power of labor – macroeconomists argue about the exact reasoning but most agree it’s a magical place where inflation is stable. If output (or growth) is too high relative to potential, inflation rises and, depending on where you are relatively to some sort of inflation goal, the central bank needs to tighten monetary policy in order to bring it down. Emerging markets traditionally experience big movements in relative prices (e.g., entire sectors collapse), big ups and downs in credit (i.e., regular banking crises and recoveries), and waves of government bad behavior (think expropriation of people’s pensions or other assets). Potential output simply isn’t stable, or perhaps even measurable, in situations with a lot of investment (in good times) and much disinvestment or scrapping of capital (when times turn sour). So what determines inflation in emerging markets? This is simple, but also very hard to manage: the balance of supply and demand for money. The government issues money through its financing of budget deficits and various credit-support operations; this obviously tends to push up inflation (i.e., more money tends to reduce the value of money outstanding). People’s demand for money depends on what they expect in terms of inflation, and this is often affected by what the exchange rate is doing – a depreciating currency both raises the prices of imports directly and moves people’s inflation expectations upwards. In the background, of course, a growing economy has an increasing demand for money, so the economy can handle – and perhaps even needs – money issue. In practice, policymakers watch the inflation rate like a hawk and move rates up or down accordingly – but subject to the political pressures coming from higher or lower growth, perhaps relative to their perception of “trend” but without reference to any kind of “potential” concept. What kind of economy is the US today? The financial sector has taken a huge hit and is almost certainly going to contract. The credit system remains disrupted and levels of investment are almost certainly down across the board. Many firms, nonprofits, and consumers overexpanded relative to what they now see as their more permanent prospects, so there is a big move to “repair balance sheets” (pay down debt; invest less). Potential output, if that is still a meaningful concept for the US, must be falling; and potential growth (based on some idea of where productivity can go) must also be down. Even more important in the short-run, inflation expectations are on the move. There are different ways to think about this (naturally elusive) concept, but take a look at the latest data from the inflation swap market (we’ll do an explainer on this; for now, just look at how expectations have rebounded already from their low at the end of last year; if you want technicalities on this market, try the beginning of this document). If you prefer to focus on the implied inflation expectation in indexed 10 year US Treasury bonds this stood at 1.4 percent on Friday and shows a similar rebound over the past few months. (For some reason, my official colleagues prefer bonds; my financial market friends prefer swaps.) As we explained in our Washington Post article yesterday, we strongly support what Ben Bernanke is doing – there is a lot of uncertainty and the alternatives are much worse. But we don’t accept the premise that the Fed’s actions today cannot cause inflation quite soon. Arguing more about this, here and elsewhere, should help us think about how to manage the consequences and minimize the costs. Excessive inflation is a typical outcome in oligarchic situations when a weak (or pliant) government is unable to force the most powerful to take their losses – high inflation is, in many ways, an inefficient and regressive tax but it’s also often a transfer from poor to rich.