Our Race to Retirement: First Month

Financial Fluency: My first Month

BLOGGER: DEBORAH HEISER

Click this link to read the first article: Our Race to Retirement

Click this link to read the second article:  Our Race to Retirement: The Preparation Begins

A bit more than a month has passed since Jackie, Judy and I purchased our first stocks.  Here’s how it happened.  We took a financial fluency course and were inspired to compete (using 1,000) to see who could do the best at picking stocks.

Jackie, Judy and I each set up accounts for 1,000.  Here’s how we’ve done so far…

Debbie:

To start, I decided to use an old retirement account that had been doing poorly for many years (and I mean poorly – when I got it way more than 10 years ago, it had 5,000 in it.  Since that time, it has dipped to less than 1,000).  I wondered if I’d end up owing money on it and figured I couldn’t possibly do worse than the professionals who had managed it.

• I activated the account online and added some money to bring it up to 1000.
• Next, I started reading the Wall Street Journal and my usual news sources each morning.

Then I looked around at what I like personally, and what I use personally on a regular basis. I continued to read the papers and online news: NY Times, CNN, WSJ,  and I added something new.  I looked at what I tend to purchase, what I like, and what I notice others doing and buying.  Since I don’t’ eat out all that often, I didn’t feel comfortable buying fast food or restaurant/coffee shop stocks.  I also don’t have major brand loyalty when it comes to major stores for shopping.  I’ll go anywhere for the basics.  So, that left me with my annual gift that I get from my husband.  A handbag.  If there is a major holiday or birthday, I’m sure to get a handbag.  And, it is from Coach.  Although this didn’t start based on brand loyalty (he couldn’t find the store he was originally looking for and stopped in at a Coach store and bought the bag in the window).  I liked the bag, so rather than try something new, this bag purchase has become a tradition.  I looked around and noticed a lot of other women toting Coach bags and accessories: on the subway, in the grocery store, on the street, and in airports.  They are everywhere!  So, I made my first purchase of nearly 500.00 (I found out you don’t get much for 500.00) and left the rest of the money in the account to see how I did with my first pick.

• Then I watched as it did GREAT – it climbed, climbed and climbed.  I was feeling pretty good, so I threw caution to the wind, and went against my original idea of waiting 6 months to see who I did on my first stock and bought my second stock.  Hewlett Packard.

This was because I’ve always had HP printers, and everyone I know for the most part has HP printers.  I realized this isn’t a good reason to pick a stock, but it worked for Coach, so why not.  Anyway, it did well for a day or two and I felt like a stock picking winner.  Then…the decline.  Day after day, decline in both stocks.  In fact, I kept reading the news and came to find out even Coach CEO and EVPs sold massive amounts of their personal stocks in the company.  So, I am not considering myself a stock picking maven.

I did notice, though, the market has bounced back up and my stocks are about even with where they were when I purchased them.  I’m going to just sit back and wait to see how they do.  I’m not planning to impulsively sell them or do anything for now.

• So, end result, I’m down right now, from my original 1000.00, but not far down.  I’m doing better than the account was doing before I started, but let’s see how it all works out in the long run.

Judy:

Judy has a bit more knowledge than me (she is the smart one) and she bought her stocks when they got to a price per share she was comfortable with .  In her words “I placed orders on all these stocks.  I did a little research, saw the previous days lows and highs, and picked a figure a little higher than the low.  Wouldn’t you know, the stocks kept climbing from that day on!  It took a few days/weeks to secure my stocks at my order prices.”  Judy bought Target, Diamond ETF (I have no idea what that is) and Panera (based on her 18 year-old daughter’s advice).

Target and Diamond ETF went down, but Panera went up.

Jackie:

She opened her account, bought her stock, and hasn’t checked it since, so we have no idea how she’s done.   So, by default, unless she can prove otherwise, she moves behind me in this race.

So far…Race results are :

Judy

Debbie

Jackie

But don’t count anyone out yet.  The race continues!!!!

If you’d like to join in on the “race” leave a comment.

And, we welcome advice!

To read the bio for Deborah Heiser, click here.

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Our Race to Retirement: The Preparation Begins

Our Race to Retirement: The Preparation Begins

BLOGGER:  DEBORAH HEISER

Click this link to read the first article: Our Race to Retirement

On our midlife quest to use our newly acquired basic (and I mean basic) financial knowledge about stocks, bonds, mutual funds and all sorts of other gobbly gook (I mean important information), Jackie, Judy and I have been preparing for May 1^st . The- big day when we use our new financial skills to actually start trading! We’ve decided to take $1,000.00 and see if we can make it grow (and whoever does best…wins. I’m not sure what we win but anyway…).

I’ve been keeping track of what I’ve been doing since we took the course less than two weeks ago. Here’s what I’ve done so far:

Day 1

I came home at the end of the course filled with excitement. That evening I opened my binder. Then I closed it.

Day 2

The next day I got up and took out my binder again and opened it. Then I took a break and got a cup of coffee.

I came back and reopened the binder, took a deep breath and told myself it was now or never. I turned to the first tab: Day to Day Financial Planning. That was hard work. I needed another break, so I checked my email.

Once I got a grip on myself, I opened Excel and made myself sit at my desk. This was not easy. I got out the personal budget template, followed the category headings and made one for myself in Excel. Okay, not bad. I emailed Judy and Jackie to gloat…er…let them know I’d actually accomplished my first task. I felt pretty good!

Day 3

I was on fire. I turned the page in my binder and created my Personal Budget. This, I admit was not fun. Rationalizing all my take-out meals and other unnecessary necessities took a lot out of me. Granted, there wasn’t a real RED FLAG anywhere, all the spending just looks bad when it’s in black and white on a spreadsheet. Still, overall ICK.

Day 4

Drained from looking at spreadsheets, I took a day off to slack off a bit and tried to figure out how to rationalize my spending on take-out and eating in restaurants. This was tougher than I thought. So, I took anther day off to gather strength. Note, I didn’t even start to think about how I’d begin the investment part of the project.

Day 5

I still wasn’t thinking about investing, but figured I’d start thinking about the idea of thinking about investing. So, I set out to organize (which means open the file drawer) some of our accounts so I’d actually know what was in them. Lo and behold, I found an account I’d long ago forgotten about – an old Fidelity IRA account I had from a long ago job way before I even started grad school. It was one of those accounts where I received a statement in the mail periodically. I’d usually just throw it away, and ever so occasionally, I’d open it, see the amount had decreased yet again and then throw the statement away. That was the old me.

The new me phoned the company and asked all sorts of questions using my newly acquired financial lingo. I realized that I never called about my retirement accounts prior to this because I didn’t even know enough to know what kinds of questions to ask. I felt empowered.

I decided this account would be used as my starting point. My first steps were made – I have my $1,000 in an account and now I’m ready to start figuring out what stocks to buy. Wish me (oh yeah, and Jackie and Judy) luck!!!

If you have any tips or suggestions for us, please let us know.And…

Who do you think will win this competition?

Are you for Team Jackie, Team Judy or Team Debbie?  Leave your pick in the comment box below and it will be posted!

To read the bio for Deborah Heiser, click here.

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Our Race to Retirement

Our Race to Retirement

BLOGGER: DEBORAH HEISER

I’ve always had a fear of finance. Just the word scares me. I’m okay with balancing my checkbook and doing that kind of stuff, but when I hear about 401k plans, annuity funds, IRAs, and mutual funds, it all sounds like Charlie Brown’s teacher ‘s muffled “moia moia moia moia”. So, over the years, when people brought up the topic of retirement accounts, investing, and all that stuff, my eyes would glaze over, drool would form at the corner of my mouth, and I’d start to think about anything else. Laundry. Dinner, Vanilla. Well, I figured that now that I’m in my 40’s I’d best conquer my fear of finance. Take the bull by the horns (hehe). So, when my sister-in-law Jackie told me her best friend Judy was invited to a Financial Fluency course at her alma mater, Barnard, I decided it was worth it to pay 250 dollars to learn how to save money. Jackie, Judy and I all enrolled and took the two day course. Here’s what went down…

We all arrived, ate everything possible at the breakfast, guzzled enormous amounts of coffee, took about 7 free pens from the registration desk and went to our room to learn. The course had about 15 women in it, and the instructor that started it off was great. She made it seem perfectly easy for us all to achieve financial fluency – and beyond. This, however, was told to us after we learned that if we didn’t do anything about our finances, we could all end up eating cat food by the time we are in our 80s. Eeekkk…Fear and panic was an understatement. I made a note to myself. 1. Suck up to the kids so they’ll take care of me. 2. Tell husband he is never allowed to retire.

Jackie and I cowered as we learned we might have to learn to love Fancy Feast. Judy was more worried about keeping what she has (I don’t need to spell it out – but she’s the smart one of the three of us). Note to self. 1. Suck up to Judy. 2. Tell Jackie to suck up to Judy.

At the end of the first day, we felt empowered that we’d be able to learn about stocks, bonds, mutual funds and all the stuff you need to know about in order to be able to retire like the shop-aholic, vacation-loving ladies we are. I went home to my family to begin sucking up to my 4 and 5 year-olds and to tell my husband his working days were never going to end. Jackie and Judy, on the other hand, partied the night away. We all, however, were deeply inspired and ready to learn on the second day. We asked questions, we learned words and jargon, and we left at the end of day two with a mission.

The three of us felt so empowered, that we decided to each independently invest 1,000, beginning May 1^st. We also decided to make it a competition to see who could do the best with their thousand dollars. So, we three novices are going to compete to see who can become the best investor after having a two day course on Financial Fluency. We are going to each open an account, put 1,000 in it and invest it. We’re going to track our progress each month. So follow along with us!  We’ll keep you posted with our progress.

Here’s a little background on each of us:

Jackie is a single 40-something. Never invested anything but she can shop better than anyone I know.

Judy is a newly single 40-something with two children in college. She’s the smart one. She graduated from Barnard. She hasn’t invested before but knows people who do.

Debbie is a married 40-something with two young children and a husband who is never allowed to retire. Hasn’t invested and isn’t as good at shopping as Jackie.

If you have any tips or suggestions for us, please let us know. And…

Who do you think will win this competition?

Are you for Team Jackie, Team Judy or Team Debbie?  Leave your pick in the comment box below and it will be posted!

To read the bio for Deborah Heiser, click here.

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FINANCIAL HOUSE OF CARDS

Financial House of Cards

BLOGGER: BEN PIERSON

We have just seen earnings reports come from many of the major financial institutes and I thought it would be worth discussing their results.  Frankly, they scare me a bit.  The numbers they are reporting – especially the headline earnings per share numbers – are misleading.  Based on how their stocks have reacted, people don’t generally seem to care either (update: up until today, that is).  The system is now stacked to encourage this as well.  We love watching our 401k accounts go up, not down.  Politicians around the globe and the Financial institutions all want the public to believe the stimulus programs are working (to some extent they actually are) great, the banks are on the mend, and there’s light at the end of the tunnel.  That way may prove correct, but the way companies have been slick-talking their earnings makes me wary this light might in fact be another train… and this whole process reminds me a lot of how we got into this mess in the first place.

I will try to take a tip from fellow blogger Arin Goldman’s piece, “Financialese Simplified” (http://blog.imagineage.com/financialese-simplified/) and keep this discussion so non-financial folks can understand.  In other words, I’ll try to avoid using the kind of convoluted language and expressions the CEOs of these firms have been using.  For example we have this gem from Citigroup’s CFO Ned Kelly:

“My suspicion is, and somebody will quickly correct me if I’m wrong, I think the marks by and large are basically booked in New York. The European results reflect the fact that the marks are booked in New York so the relative out performance of Europe on one level given that in terms of that $4.2 billion of traditionally disclosed marks is what drives that.”

Wow.  If you’re reading that and thinking, ‘is this English?,’ the answer is no.  It’s gibberish.  More importantly the earnings numbers many of these firms presented are suspect as well.

Among the great headlines of the last week:  Goldman Sachs reports $1.8 billion in earnings; Citigroup declared their Q1 2009 revenue exceeded that from Q1 2008 by a staggering 99%; Wells Fargo says they completed their most profitable quarter… EVER.

Does anyone care?

This optimism has been reflected in the stock market.  As you can see here, since the market bottomed on March 9^th, financial shares have moved up at an incredible pace. 

Now, I’m not saying these banks are doing anything illegal.  However it’s important to understand some of what is going on under the hood.  As the government has progressed through all these TALF, TARP, PIPP programs they’ve realized banks needed additional help.  This help comes in the form of accounting regulations however, not cash.  I won’t rehash Arin’s discussion (in the post linked to above) of mark to market accounting changes, but to summarize:  the banks now have more discretion to price their own ‘toxic assets’.  Some of these assets may be priced more accurately now, but some may also be marked worse.  The point is that banks used huge changes in the way they priced their own assets to create some of the many gains in profit they are quick to brag about. 

Jonathan Weil writes a great piece on Wells Fargo for Bloomberg.com:  http://tinyurl.com/c3q2xa .  This is a fairly understandable piece and worth a quick read.  The crux of Wells Fargo – they reported great earnings, the stock went up 30% in one day (!), but these numbers were filled with more junk than a, errr, junk yard.

From Goldman Sachs:

Happy times!  They reported $1.8 billion in earnings for the first quarter in 2009.  Interesting, they decided to report their December earnings in a completely separate press release.  Also of interest, they lost $800 million in December.  So they report their bad month in a separate release and the good press release gets all the headlines.  Coincidentally, they are also selling $5 billion in new stock now, thus a higher share price is much better for them.

Now contrast all these glowing earnings reports from Wells Fargo, Citigroup, Goldman Sachs to the candor coming from UBS.  They reported a loss of $1.8 billion and their CEO admits that, “it will be a long road back to success without any quick fixes.”  Now, I’m proud to be an American as well, but it’s not like UBS is much dumber than everyone else and that’s why they lost money this quarter.  No, they are just being more straightforward.

Update:  Bank of America’s numbers came out today and the market fell hard with the S&P 500 losing 4.3%.  Bank of America dropped nearly 25% and many other banking stocks followed.  Even though Bank of America had good earnings, they significantly increased their loan loss reserves – the amount of loans they don’t expect to get their money back on – to $13.4 billion.

Dangerous Times:

We’ll probably see this type of ebb and flow for a while, especially now with earnings numbers coming out.  What Bank of America said, and what they reported in their finances, was not much different from what the other companies said…. Just today the market decided they were more fearful then greedy.  Please don’t take this as investment advice.  While I believe the banks are all in bad shape, the deck is also stacked in their favor.  Hearken back to my post on incentive systems (http://blog.imagineage.com/?s=incentive+systems).  Right now every global leader wants banks to look and act healthy.  Every bank also wants to look and act healthy (UBS’s candor being an exception).  As the numbers on the chart above show, these are very powerful cards. 

Bottom line – or ‘net net’ as we say – the banks are very far from being out of the woods.  These headlines on their earnings are misleading.  This cavalier attitude of deception reminds me way too much of some reasons we got into this mess.  There are many positive developments in the system, but this new course of deception is not one of them.

To find out more about Ben, click here.
   

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BUY NOW, SAVE LATER

Buy Now, Save Later

BLOGGER:  BEN PIERSON

Seriously, if you have savings and good job security (even if we hit 11% unemployment that means we’re still at 89% employment after all), go out and spend.  I don’t consider this a civic duty or patriotic act – I consider this a selfish one.  America is on sale.

Barring us slipping into a depression – not very likely considering the scope of worldwide government intervention – this is the best all around sale event we’ll see for at least the next decade.  By that point if you follow the plan, you’ll have saved again and be ready to again take advantage of the next cycle of sales.

In economics there is a term called consumption smoothing.  Essentially what this means is that if we knew exactly how much money we would make during our entire life, we would be happiest spending the same amount every year.  We would find a lifestyle that fits and then ride happily (happiest) into our sunsets.  For the first time in my life (I’m 30), I now see the greater wisdom behind this.

Economic cycles have gone on for thousands of years.  There will always be a next “up” and there will always be another “down”.  End of story.  The angel (and angle) lies in the details.  During those “up” periods, everyone has money and is buying.  Supply and demand says:  if more people are trying to purchase a finite set of goods, the price of these goods will go up.  So during the up cycles, goods generally cost more.  Houses cost more, vacations cost more, and cars cost more.  In a down cycle, houses become cheaper, vacations become cheaper, and cars are cheaper….  And so if you have money during these times, go out and spend!  It’s all on sale!!

I know someone who just took his family of four on vacation to Jamaica.  7 days at an all-inclusive resort, including airfare:  $2,200.  Yup, only $2,200 total for all 4 people.  I’m not saying $2,200 isn’t a lot of money to most of us, but the point is this vacation would have cost him over $5,000 anytime during 2004-2006.  I’m sorry if you paid $500,000 for a condo in Palm Beach over the last three years, because you can now buy that same condo for $300,000 or less.  One friend who works in Manhattan lived about a 45 minute train ride away in order to avoid Manhattan rents.  Well guess what?  Several buildings downtown now offer two months rent free and the rental prices themselves have gone down.  Thanks to his having saved up over the last two years he is now living in Manhattan at 30% off what he would have paid two years ago.

I’ll be the first to admit that I’ve done a very poor job of this myself.  Like many of you, perhaps, during the good times of the last several years I spent more and saved even less… the exact opposite of what I should have been doing.  In the midst of an economic boom of course it’s tough to think prudently and save up for a rainy or opportunistic day.  It’s tough not to take the $5,000 vacation when that’s what your neighbor is doing.  Well, Love thy Neighbor but don’t act like them.  When times turn good again, save save save!  Practice prudence and practice patience.  The boom times may go on for years, but they WILL end once again.  You may get jealous of your neighbor’s tan once or twice, but you’ll last laugh when you pay half as much for the trip he just took.

Arin Goldman wrote a great post earlier (http://blog.imagineage.com/?s=spend) on this question of spending.  Not to ruin the ending but she bought a pair of boots on sale and, slightly tongue in cheek, considers it her contribution to economic stimulus.  Certainly every extra bit of stimulus helps right now, but that’s not what I’m telling you to do.  I’m saying be selfish.  That shirt won’t be 70% off forever.  That car might not be this cheap again for years.  Do be prudent and don’t spend money you don’t have.  But if you have it, now’s the time – America’s on sale.

To find out more about Ben, click here

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FINANCIALESE SIMPLIFIED

Financialese Simplified

BLOGGER:  ARIN GOLDMAN

I’ve noticed that many people are having a hard time keeping up with a lot of what’s going on these days in the financial world.  Even the language seems foreign. Credit Derivatives, mark-to-market accounting, securitization, up-tick rules, what does all this stuff mean?  Why don’t those banks just hold on to mortgages the way they used to?  What’s a muni bond anyway?  I’ve spent most of my adult life immersed in banking and finance, though I am not sure it is safe to admit that anymore, and I frequently find myself baffled by what I hear on CNBC, Fox and Bloomberg. Sometimes that’s because the commentators are even more confused than I am but other times its because the concepts they are reporting are just so arcane.  So here’s my first attempt at simplifying some of the terms and concepts being bandied about these days.  I’ll address more in future blogs.  I am only skimming the surface here and am more of a generalist than an expert so I caution all that my explanations are basic, still I hope they help and at the very least I will try hard to avoid using financialese as much as I can.  If there’s anything else that you’d like me to take a stab at translating please post your question to the comment section and if I have a clue I’ll try to respond.     

Why don’t banks hold onto mortgages anymore?

Banks haven’t held mortgages to maturity for a long time.  In fact, previous banking crises have been caused by financial institutions going long low yielding mortgages in the face of rising interest rates. Since low yielding debt decreases in value when interest rates rise, mortgage lenders who held onto their portfolios sustained some huge losses.   Securitization initially came about to help  banks sell their mortgage portfolios, freeing up funds for additional mortgage loans.  A good deal of the problem in the current crisis is related to credit quality rather than interest rate volatility.  Many mortgages were made to borrowers with weak credit histories or previously solid borrowers who were stretching themselves too far.  Many of these borrowers either couldn’t or never intended to repay their loans.  At the same time the value of the property securing some of these mortgages was either overstated on day one and/or assumptions that increasing property values would bail out weak credits proved ridiculously optimistic. Further complicating all this, there was opportunity for unscrupulous behavior all the way along the line in the mortgage origination process as even legitimate borrowers, mortgage brokers, appraisers, securities firms and rating agencies all pressed the edges  of their collective envelopes. When the real estate bubble burst everything came crashing down at once. 

Just what is this securitization thing anyway?

In the old days, when a bank or other financial institution wanted to sell a mortgage loan they bundled it with other loans and sold thousands of them together as a package.  Overtime, the banks got more sophisticated and realized that they could deposit these bundles of mortgage loans into some type of trust instrument, hire one firm to service the borrowers and sell the collective cashflows.  Although the action of an individual homebuyer is hard to predict the collective behavior of thousands of borrowers is fairly predictable.  Bankers were able to allocate these predictable payment streams  to debt instruments with different maturities and/or different credit ratings.  They then sold these new securities to institutional buyers (insurance companies, pension funds, money managers, etc) with distinct credit and maturity preferences.  Since these securitized transactions maximized the value of the pool of loans, securitization became the favored way for banks to sell their mortgage loans.  After a few years this securitization technique was applied to other types of loans including car loans, corporate loans and just about any loan out there.  Anything that had a reasonably predictable income stream became a possible securitization candidate.  Securitization remains a useful tool. The problem comes about when the underlying loans don’t behave as predicted because of unexpected delinquencies and defaults or in the worst case, because the loans shouldn’t have been made in the first place.     

What’s the story with the uptick rule?

When you sell stock you don’t own you are “shorting” the stock.  Although shorting can be risky it is a legitimate financial tool.  For a long time rules governing the shorting of stocks required that a short sale could only be completed following a trade that had been completed at a price higher than the  the one that had preceded it – in other words  you couldn’t sell stock short unless the price of the stock was moving up or was reasonably stable. I am leaving out some details about the actual rule, but hopefully have gotten the concept across.  The uptick rule had been put into effect after the market crash of the twenties in an effort to stabilize the market and prevent bear runs on specific stocks.  Whether or not it worked is debatable but it stood until a few years ago when it was eliminated.  The SEC is now considering reinstating the uptick rule because many people believe that the absence of the rule accelerated the demise of companies such as Bear Stearns and Lehman Brothers last year.  Others argue that the uptick rule won’t do much given current technology and volumes.        

Mark-to-Market, not to be confused with a shopping spree with your friend Mark.

This is a concept that’s gotten a lot of press lately.  Rules governing how banks value their financial positions were rewritten a few years ago by the accounting standards guys.  Basically, rule changes required banks to adjust their financial statements to reflect the market value of all their securities positions, even the ones that weren’t in trading accounts.  This sounds pretty straightforward.  If you buy some US Treasury securities for $100,000 and interest rates move so that you portfolio is now worth $95,000 why not show them on your books at the lower, more accurate value?  Well, when it comes to US Treasuries and other highly liquid securities, this is pretty easy because the securities trade all day and everyone knows what they are worth. But it gets harder and harder to value securities that are further down the liquidity and credit scale.  Corporate bonds are harder to precisely value than Treasuries. Mortgage securities are significantly more challenging with their mix of credit issues and funky payment characteristics and subordinate subprime mortgage backed securities are among the toughest to value and sell.  Not surprisingly, it gets even harder when everyone needs to dump their positions of those unusual securities at the same time.  Even though many of the illiquid securities are still generating significant cashflows, their market values have gotten so low that these cashflows may not be fairly valued.  The banks argue that given time and the return of some market stability many of these securities will regain a significant portion of their value.  The mark- to-market guys argue the value is the value dictated by the market, period.  Since a number of very smart hedge fund managers are anxious to have the opportunity to buy the so called toxic subprime paper at current “market” prices its fair to assume that the banks probably have a point.  These securities are probably undervalued at the current time; just how undervalued remains hard to assess.  Recent changes in mark-to-market accounting seem to be geared to finding a bit of a middle round.    

To find out about Arin, click here to read her bio. 

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To Spend or Not to Spend, That is the Question

Out walking my dog this morning I ran into a former colleague from my investment banking days who was also out with her dog.  As our two pets tussled joyfully, blissfully ignorant of the dreadful state of the economy, we reminisced about our old banking days and the sad state of our former firm, one of the acquisitions that had been subsumed into the now teetering behemoth Citigroup.   Quietly she confessed that that she was close to completing a major renovation of her apartment.  Though her financial position is stable, her husband gainfully employed and their collective expenses under control she had considered cutting back on her apartment work, not because of any financial pressures on her family but because of the general economic mood.  She  didn’t want to be seen as insensitive, spending money while others were facing hard times.  Her embarassment at undertaking an apartment overhaul at this time made me think about expectations and attitudes in the face of our challenging economic times.  Without a doubt virtually all of us are substantially poorer, or should I say less weathy, than we used to be.  That said, do we all really need to cut back dramatically?  How will we get out of this mess if all of us, even those who haven’t lost their jobs or savings, stop shopping, going to the theatre, eating out, and going on vacation. I am not suggesting that we should all be throwing money away, but maybe now is a good time to take a realistic assessment of our financial positions.  If your expenditures were pretty reasonable to begin with and your job or income remains relatively stable, doesn’t cutting back now make things worse overall? 

Over the past few years I’ve gotten pretty lax about monitoring my spending.  With my income and savings impacted by the current environment I decided it was as good a time as ever to examine my cashflow. Essentially, I wanted to know precisely how much I spent last years so that I could compare it against what I expected to earn this year.  In mid-January I stopped thinking about this and began my examination.  Since I remain a Luddite when it comes to bill paying, my personal analysis involved pulling out my check book and calculator totalling all of my checks, netting out any offsetting deposits such as insurance reimbursements.  A tedious activity to say the least but still it didn’t take long to figure out how much I spent last year. The good news was that I hadn’t gone all that overboard.  After I netted out a few things that fell into the extraordinary category I felt even more comfortable.  Nevertheless, since a number of my 2009 expense items are on the upswing I wasn’t out of the woods yet.  Like most people my health insurance rates have jumped dramatically, followed closely by my apartment maintenance, a victim of the significant increase in New York City real estate taxes.  My garage costs, another uniquely New York City phenomenon, were also moving up for the first time in 20 years.  To help offset some of my expense increases I also took a look for places to shave a few outgoing dollars.  To this end, I cutback on my landline phone service and reduced the number of my premium cable channels.  Neither of these provide dramatic savings but still I’d rather spend that money on other things.  Net, net I’ve concluded that though I am not as well off as I used to be I can still maintain my standard of living without a draconian cut in my expenses.  Still like most people these days I’ve got to improve my own personal attitude because I have to admit though I am probably okay financially I am still stunned by the stock market’s swoon and the demise of the financial sector.  Last week I took my first step.  After avoiding all shopping during January and most of February,  in an effort to help the economy, I did buy a pair of not necessarily essential boots (on sale of course). Consider it my contribution to the economic stimulus!         

To find out about Arin, click here to read her bio.

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Incentive Systems: The Mortgage Industry

Incentive Systems: The Mortgage Industry

BLOGGER: BEN PIERSON

“People respond to incentives in predictable ways.”

This is the first rule I was ever taught during my high school economics class and remains one of the most powerful I’ve ever learned.  I’m reminded of this rule often, in all contexts.  And, this applies to the mortgage industry.

In some sense, a cornerstone of our society is that we are all role players.  In the industrial revolution we discovered the value of specialization.  Instead of one person making each whole shoe by themselves, one person would cut the leather, another would hit the same nail in each time, and yet another would sew the same spot each time…  We rely on predictability; we rely on people fulfilling their role.  It’s up to us to understand what each person’s role is and how each person is predictable.   

So what does this have to do with mortgages, you ask?

Mortgages provide a good example of how the incentive system got screwy. People acted rationally, oversight was negligible and consequences became severe.  Mortgage brokers were paid based off how many mortgages they originated (‘sold’).  It made zero difference to their payout if any – or all – of the mortgages end up defaulting in two or three years.  The future risk would be the bank’s problem since the mortgage broker has already gotten paid and the mortgage now belonged to the bank.  Banks didn’t want this risk either (they were conscious to some extent of the risk in the mortgages they were selling), so would take all of these mortgages and resell them to, say, an Investment Bank (eg Lehman, Merrill, etc), who would then package the mortgages up and resell them again (eg. Mortgage Backed Securities and CDOs).  The individuals working at the mortgage broker, bank, and investment bank all get paid off revenue.  They all get paid at the point of sale, with little exposure to the future risks.

So to sum this up, you have a system where the people working at almost every layer are exposed to vast reward with finite risk.  And we now have terms such as the NINJA Loan (No Income, No Job, No Assets… no problem!) with the corresponding mortgage malpractice that has now come to light. 

To give an example to better explain this, like many others, if I am driving at 4am, the only car on the road, I will likely drive fast.  What keeps me from going very fast was the risk of getting caught.  The mortgage system and those working in the field aren’t any different.

The calls for tighter restrictions and regulations on banks and hedge funds are, for the most part, erroneous as fairly comprehensive restrictions and regulations already exist.  The problem is there’s little to no enforcement and the enforcement which exists is painfully inadequate.  I’ve only been on Wall Street for 8 years, but since the beginning I remember people making fun of how woefully inadequate the S.E.C. is.  In addition to the S.E.C., the Ratings Agencies (Standard & Poor’s, Moody’s, Fitch, etc…) were supposed to help regulate companies as well.  So, you’d think there was an adequate system in place to keep problems like we are in right now from happening.  Right?  Wrong.

Most people who played a part in all this mess – Mortgage Brokers, Banks, Investment Banks, and Ratings Agencies – were really acting as we should anticipate the would given the incentive structure involved with them.  Failings must be placed in a large part on then regulatory bodies like the SEC and Ratings Agencies who were set up explicitly to be outside of the ‘incentive system’.  One must also then throw blame on the government – and rely on them to fix this – for it would seem the problem grew from the innate nature of the structure.

Should you want to read more on the rating agencies’ role, here are two comprehensive (very detailed) articles:

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ajs7BqG4_X8I

http://www.bloomberg.com/apps/news?pid=20601109&refer=home&sid=ah839IWTLP9s

Certainly this is a very complicated issue which has touched us all in some way.

What do you think?

 Leave a comment…

To find out about Ben, click here to read his bio.

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It’s 3 Am do you know where your 401k is?

BLOGGER:  ARIN GOLDMAN

I am a professional saver, one of those people who stashes money away whenever possible. Don’t get me wrong, I also have a weakness for designer clothing and shoes but my shopping excesses never came at the expense of funding my retirement accounts.  In my first post-college job I contributed to an IRA and when, after graduating from business school, I moved into the world of high finance I began funding my 401 K.  I immediately bought into the benefit of pre-tax contributions and caught on quickly to the value of deferring taxes until that very, very distant day when my fund withdrawals would begin.  All through the 1980s and 1990s I made those contributions paying scant attention to my balances.  Mostly they were growing but despite my so-called financial sophistication I never had any sense for how much of this increase was due to actual investment growth and how much was due to the simple sum of my ongoing contributions. I totally bought into the theory that overtime equities would outperform other more predictable investments such as bonds and money markets so with youth on my side I allocated my 401 K and IRA funds to an assortment of equity mutual funds, nothing concentrated or high risk for me, just run-of-the mill US and International funds.  I did not worry much about market dips and economic trends and pretty much ignored the impact of the October 1987 stock-market crash, the meltdown of the technology sector, 9-11, and the ongoing rise and fall of the emerging markets.  Nose to the grindstone at work, I managed to ignore my retirement funds as much as possible.  Surprising maybe, given my MBA in accounting and finance and chosen investment banking career, yet I suspect fairly typical.  After all it is hard to dwell too much on something as mundane as retirement funding when you are sailing through your twenties and thirties.

Not surprisingly, my investment banking career did not last forever.  After a 20 year sojourn on Wall Street I hit my wall, exiting in 2002.  There I was in my forties, figuring out what to do with the rest of my life and now totally focused on the adequacy of my financial assets.  I became fixated on daily movements in those 401 K balances.  Always an early riser, I checked my now bookmarked 401 K website daily. Some time around 3 AM the gremlins in benefits land would roll the balances forward to reflect the prior day’s market activity and there I was noting every change.  Still years away from 59 ½, the earliest age for penalty-free withdrawals, and even further away from 70 ½, the age when I would have to start withdrawing, I had become keenly aware that only investment growth would contribute to an increase in my retirement funds.  Further feeding my neuroses, in 2002 the market was still suffering the effects of the Enron debacle making it a rough year to be both unemployed and pathologically focused on 401 K assets.  Nevertheless, time passed, markets steadied and my funds really did grow.  Within five years my retirement assets had grown 65%.  By then with visions of substantial wealth ahead I had lost my 401 K fixation and gone back to only occasional balance checks.

Then the tsunami of 2008 hit.  I tried to shrug off the increasing market volatility, steep declines and the erosion of the whole financial sector.  After all hadn’t my strategy of remaining on the sidelines worked well enough during previous market drops?   Was this market storm any worse than prior catastrophes? Unfortunately, this time around seems really different.  Does anyone really understand a credit derivative or appreciate the finer points of a sub-prime mortgage? These are the true weapons of mass destruction and they seem to have landed right on top of my 401 K, wiping out virtually all the gains of the past six years.  Knowing that my pain is widely shared and it is not just my retirement funds that have been hit does not make me feel any better.

What now?  I wish I had an answer.  I am trying to avoid those 3 AM checks of the benefits website.  Still my blind trust in the historical market trends that were supposed to assure my future security seems awfully naïve right now.  I know I am still very fortunate.  After all I was lucky enough to have a high paying career, and though I have sustained investment losses I have what I hope are still adequate savings.  Still those withdrawal dates are a lot closer than they used to be and this major step backwards appears less like a theoretical bump in the road and more like a coordinated attack on my future standard of living.  Somehow or other I suspect that my accounts will start to grow again at some point, when that will be I don’t know and I am less confident about that future.

Remember the big debate about moving our social security funds into equities?  Now there is an idea that I hope never sees light of day again!

ps.  A few things that might help just a little:

1.  If you are 50 or over and qualify to make contributions into an IRA, you can contribute an extra $1000 for a total of $6000.

2. Congress passed legislation in late 2008 waiving mandatory withdrawals from IRAs and 401Ks for 2009.  This applies to individuals over 70 1/2 and only applies to 2009.  Check out the details and applicability with your accountant and/or financial advisor.

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