WONKESS

Flight to Safety...

I was scanning the NYT this morning, and I saw that these were the top 6 articles being emailed today:

1. Your Money: Doing the Right Thing by Paying the Nanny Tax
2. Your Money: Preparing Your Budget for Disaster
3. Home Insurance: What You Need to Know
4. Estate Planning: What You Need to Know
5. Annuities: What You Need to Know
6. Cost of Living: Bankruptcy as a Step to Solvency

#1, clearly being triggered by recent bruhaha and rumours surrounding Geithner and Kennedy, but then after that, one after another, articles dealing with preparing yourself for a financial crisis.

I was particularly intrigued by the article on Preparing Your Budged for Disaster.  As I've discussed in this blog before, my family is in crisis mode, partly because as we were entering into this recession, we were heavy on the debt (all student, and all mine) and light on the savings.  And with an almost countdown like deadline for when crisis is likely to strike for us (J's contract renewal, which will be determined by April of this year, and which is not looking good due to the college's plunging endowment; and my law firm's ongoing layoffs, less than a dozen attorneys at this point, but more inevitably on the horizon), I've spent the last 6 months doing what in my mind is emergency preparedness, the financial edition.

We've managed to save about 6 months of bare-bone expenses now in our emergency fund through our reduction in our 401(k), cutting costs (including cutting back childcare costs), and selling off some extraneous things we had in storage from our life in bfv (not to mention the elimination of storage cost itself).

But to the artice:

CONSIDER BORROWING NEXT Mr. McKinley’s [the financial planner consulted for the article] most radical notion is to use the drill to assess your borrowing capacity. You do that in anticipation of taking out loans before spending much savings. “You borrow money when you can get it, then pay it back out of assets as slowly as possible,” he said.

The logic here is that available credit, whether it’s a home equity line or credit cards, can disappear at any moment. It’s vanishing, in fact, with increasing frequency for all sorts of people who are still employed. So if it’s clear that your financial situation is dire, the theory goes, tap the credit while you can.

For instance, if you have a $2,000 car repair, Mr. McKinley might suggest that you put that on a credit card rather than take the money out of savings. “You can still pay that off more slowly and then, when you’re back on your feet, pay the full balance,” he said. “Meanwhile, you still have the $2,000 in the bank, and a working vehicle.”

[Or] if you have a working spouse, you could borrow twice as much money from the spouse’s 401(k) as you think you’ll need for living expenses. Pay it back slowly, as you would with the credit card. Then, if at some point your spouse is out of work, too, at least you have the money you need in addition to money left over to pay taxes and penalties you may be assessed if your spouse’s employer demands immediate loan repayment and you can’t comply. Once your spouse lost the job, you probably wouldn’t be able to borrow against the 401(k) anymore.

These sorts of moves assume a couple of things. First, that you have savings in the first place with which to repay the loans. Second, that you’ll find a new job soon that will allow you to pay back the debt quickly.

Our decision to move away from retirement investing and putting that money into our emergency fund is a bit like the plan recommended above.  Except rather than actually borrowing from a 401(k), we've just gone and redirected those amounts towards our savings.  We had done this to avoid the penalties and taxes that are mentioned above.  For J and I, we decided that whatever market gains we might be foregoing by not contributing now is far outweighed by what we'd have to put our family through if we had to go a significant amount of time without generating income. When (and if) we get our emergency fund up to our comfort level (1 1/2 years of expenses), we will start contributing again. 

I really hope people reading the article paid particular attention to the highlighted portion above, though.  The whole "borrow now instead of using your savings" approach only works if you already have savings at least equal to the amoung you are borrowing.  The idea being that the interest payments on the borrowings is less onerous than what it would take to come up with the money to carry you through a no-income period.  I would also point out that this approach should only be used in times like right now, when there is a reasonable likelihood of unemployment.

The financial planner also had this to say about IRAs.

Mr. McKinley notes that a Roth I.R.A. is a good account to tap, because you can generally withdraw your initial contributions (though not your earnings) before retirement without taxes and penalties.

I didn't know this!  I don't know the exact rules about contributing to IRAs, but I know that I wasn't allowed to contribute to an IRA while I was fully contributing to my 401(k).  I wonder if that is still true now that I'm not fully contributing to my 401(k).  If we're allowed to do this, I suppose I could take some of our emergency fund and ensconse it in an IRA, with the expectation that we'd tap it in an emergency.

I Want Some Tarp...

Cause they're givin money away for free...

Re: Banks... FIX IT!!

From Luigi Zingales (emphasis, except for headings, mine):

Get a strategy

To begin, you need an overall strategy. Even a mediocre strategy is better than an ad hoc approach that confuses markets and fuels the perception of playing favorites. Legendary portfolio manager David Swensen (who in 23 years transformed the $1 billion of Yale endowment into $23 billion) in reference to the government intervention in this crisis commented “the government has done it with an extreme degree of inconsistency. You almost have to be trying to do things in an incoherent and inconsistent way to end up with the huge range of ways they have come up with to address these problems.”

How to restart the lending

One solution is the one I advanced last Fall. It requires passing a new piece of legislation introducing a new form of bankruptcy for banks, where derivative contracts are kept in place and the long term debt is swapped into equity. As Pietro Veronesi and I have shown in a recent article, such conversion will fully recapitalize the banking sector and bring down the level of risk of debt (as measured by the credit default swaps level) to pre-crisis level.

When I proposed it in September they told me that there was not enough time. When I re-proposed it in October they told me that there was no chance to reconvene Congress after the election. But time has passed and the Congress has been reconvened after the election, but there has been no discussion of this alternative that can save hundreds of billions of dollars to taxpayers.

Other plans

That is not the only possible plan. An alternative would be to allow banks to divide themselves into two entities, a bad bank with all the toxic assets and a good bank, with lending etc. Ownership of these two entities will be allocated pro quota to all the financial investors as a proportion of the most updated accounting value of these assets. So a bank with 30 billion of bad assets and 70 billion of good assets will see its debt divided 30-70 and its equity divided 30-70. Each $100 debt claim will become a $30 debt claim in the bad bank and a $70 debt claim in the good bank. The same would be true for equity.

On the face of it, it looks like a useless exercise. If each investor receives pro rata the two parts of the bank, what difference does it make? The answer is very simple. After the spin off, the toxic assets will not contaminate the lending part of the business anymore. On the one hand, bad banks would simply be closed-end funds holding the toxic assets. If these assets turn out to be worth more, the original investors will be rewarded. If they are worth less, the most junior claimants (common and preferred equity) will be wiped out.

The good news is that these entities could be allowed to fail, because their failure would only be a rearrangement of their liability structure with no negative consequences on the economy. On the other hand, good banks will have a clean balance sheet and will be able to raise private capital without too many problems.

The easy way and the right way

If the solution is so simple why has it not be done before? First, because it is much simpler to get money from the government than to obtain it through hard work. So no bank would consider doing this spinoff if it hopes to receive extra TARP money. Second, because most bank debt has covenants prohibiting exactly these splits. Even if the liabilities are shared equally between the two entities, the equityholders tend to gain from this split and the debt holders tend to lose. If the shortfall in the value of toxic assets is large enough equity in the whole entity would be entirely wiped out, while with the two split entities equity holders will retain some value in the good bank, at the cost of a lower overall repayment for the debt holders.

This problem, however, can be dealt with by giving debt holders of the bad bank a warrant on the equity of the good bank, increasing their payoff at the expense of the equityholders. Furthermore, the creditors have benefited so greatly from all the government infusions of money so far that it would only be fair that they will share some of the pain for their bad investment. To allow banks to spin themselves off in two units, however, we need to pass a new law. As in October the “nay sayers” will say it is impossible. It was possible to write a $700 billion check to Paulson, it is possible to approve a $825 billion stimulus package, why it is not possible to pass a very short law allowing banks to spin off?

I recommend reading the entire article.  There's a great section that I didn't excerpt discussing how the interests of the financial companies really are not aligned with those of the country.  Also, from Henry Blodget:

You don't have to subsidize banks and their stakeholders at taxpayer expense to avoid another Lehman. You just have to fix the banks the right way.

What's the right way?

• Temporarily seize the banks 

• Write their assets down to nuclear-winter levels (or, if desired, put them in a big bad bank, as Sheila Bair wants to do.)

• Convert enough of their debt to equity to put them in a strong capital position.

That's it. No taxpayer money. No citizen outrage. No comical "Yes, we're lending" assurances when what the banks are really doing is, sensibly, hoarding everything.

The drawbacks? It's hard to even call them drawbacks:

• Today's common shareholders would get wiped out

• Today's preferred shareholders would get wiped out

• Today's debtholders would take a big hit, with unsecured debtholders ending up with equity stakes.

But wait--isn't that unfair? Arbitrarily deciding that shareholders and debtholders will get dinged? Isn't that an abandonmnent of free-market capitalism?

Please. These banks have already failed. If it weren't for our having already abandoned free-market capitalism, they'd all have ended up like Lehman. Adults made bets on these securities on their own free will (on the apparent assumption that they come with implicit taxpayer guarantees). These adults can now, finally, accept responsibility for their decisions.

Blodget's solution is effectively having the banks go into reorganization.  I prefer Zingales' proposal of a new bankruptcy regime for financial institutions, which would take into account the precarious nature of counter-party risk. 

But in the end, what both authors are suggesting to the almighty Fed is... it's time that the shareholders in these financial institutions have their legs cut out from under them.  This is not a mere credit crunch/liquidity situation, these are companies that are flat-out insolvent.  And shareholders, as the risk-bearers in companies, should actually bear the risk.  First.  Before taxpayers.

Of course, given that BOA's CEO Lewis and JPMorgan's Dimon both put enormous amounts of money buying their own companies' respective stocks today (in other words, becoming even larger shareholders in these two financial companies), how likely do you think it is that our government might actually listen to some voices of reason? 

Can you say Special Interest... FAIL!

Monday Morning, cha-cha-cha...

Well, tomorrow, Obama will become President of the United States.  I wish him great luck, because I feel that we've all placed a little too much faith on what he can/should/must do as President.

A few of the MOMocrats are going to be at various inauguration functions, so please check out our website at www.momocrats.typepad.com.  You can also get direct tweets via twitter from @lawyermama or @queenofspain (though, according to the NYTimes today, the cell phone operators are telling potential message senders not to get their hope up w/r getting out timely messages).

And finally, in the spirit of being bitter because one has to be at work when it feels like everyone else in the world has the day off (and most notably, hubs and the kids -- though, don't feel for J, our nanny very graciously agreed to help out today), here are some Monday choice notes:

(1) the FT talks about the possibility of Eurozone sovereign debt default.

(2) the Bronx Zoo fires a top member of its organization (it's tough out there for everyone, folks)

Prickly Situation at the Bronx Zoo from Gothamist on Vimeo.

(3) Countdown to inauguration:

Happy MLK day!

Politicians Behaving Badly...

I've been getting a bit...um... un-awesome... in my posting frequency.  But I've been feeling physically, emotionally, and spiritually sick, so it's been hard to rally up the spirit to write anything.  And this is mostly a rant, so beware.

On the physical illness front, my entire family decided to come back from our vacation with the 24 hour stomach virus, which had a ferocious tenacity.  We were felled like Christmas tree, one after another, and though I have the dubious honor of being the last to be stricken, stricken I was, and stricken hard.  As anyone with children knows, when bugabooed with a persistent illness like this bugger of a bug, there is a whole 'nother level of complexity as J and I struggled to figure out who could be around when to take the girls to the doctor, or pick up Loo when school called mid-day with the dreaded, "you need to come get your child" message.  Nanny had extra hours, but there are limitations, as she does not drive.

On the emotional front, I've realized that I've become increasingly paralyzed with fear about what is happening to the US economy.  Now, I am an eternal pessimist... I know this of myself, which is why I've consistently rejected the entrepreneurial in favor of the risk-free (hello! lawyer, anyone?).  But I like to be a rational pessimist, a logical pessimist.  And there is a lot of conflicting signals out there.

Deflation/Inflation

Clearly, at least in the short term, we are experiencing mild deflation.  The bursting of the housing bubble has caused housing prices to decline, significantly in certain areas, though only (frustratingly) modestly in my own region.  Oil prices have collapsed pretty magnificently, and even with the brief run-up we've been seeing due to the Israel/Hamas conflict and the Russia/Gazprom situation, we're back down below $40/barrel as I write this.  Retailers had a staggeringly bad December, reflecting both poor demand and the insane margins that retailers were willing to take in order to trim inventory.  And, more importantly, there are starting to be lots of talk of people taking wage cuts in order to prevent mass lay-off.  A good sign of humanity, though pretty shit bad for deflation (as it signals wages becoming "unsticky").  As far as I can tell, the only things that are increasing in prices are certain foodstuffs....  and gold.

But the amount of "money printing" has been nothing short of extraordinary.  Outside of TARP and the proposed Obama stimulus, which already add up to $1.5 trillion, the Federal Reserve's balance sheet has exploded by a magnificent $1.2 trillion.  I understand that this is not money printed today, but money that we're promising to someone, and mostly foreign someones, tomorrow.  

This is a transference of leverage from the private sector to the public sector.

But the funny/ironic thing is.  The very people that we are borrowing from won't allow the US dollar to get weaker.  This is the part of this economic recession that has been so endlessly mind-boggling.  That because a whole lot of Americans took out mortgages for homes that they shouldn't have, and a whole lot of American banks packaged those mortgages into supposedly risk-free securities, countries like Iceland, Ireland, Spain, Greece, Latvia and to a lesser degree, Germany and China are in far worse economic shape than they could have ever expected.

Japan has all but said that they wouldn't allow the Yen to get stronger than 70 to the dollar (if that), and China has stealthily (or not so stealthily, I guess) pegged the Yuan (and hard) back to the dollar.  Who knew that for these Asian governments, it would be more important to maintain the trade imbalance between themselves and the world's consumer nation than to literally have that country (that would be the US) at their mercy financially?

And, unsurprisingly, if other countries won't let the US dollar inflate, then guess what, apparently, the US dollar won't inflate.

Credit Crunch/Insolvency

So the fed is oh so proud of itself because the credit market has been showing marked signs of improvement.  The TED and A2/P2 spreads have both narrowed, and significantly (both signs that interbank lending and commercial paper lending are moving again).  I've heard that most of the lending volume is still clustered around loans w/ short maturities, so things are not perfect.  But on the whole this is theoretically considered promising.

Yet, at the same time, there is now a whole lot of hand-wringing about how the first 1/2 of the TARP funds have been used and the expansion of the Fed's balance sheet.  Which lead to this doozy of a House hearing:

I know how this plays, and I know that us blues are supposed to love a Fed Vice Chair coming off as a total slime-bag asshat tool, but honestly, I want to know...

Do any of the politicians in Washington actually understand WTF they are talking about?

(1) Congressman Grayson is apparently asking the Fed Vice Chair about the expansion of the Fed balance sheet (by $1.2 trillion), and Kohn is trying his very best to explain that the money is lent and not spent.  Then Grayson wants to know which financial institutions got the loans. 

Oh, this is such disingenuous crap.

The "categories" under which Fed has lent money is actually known.  In fact, here is a chart of them:

What this chart says, right off the bat, is that a HUGE chunk of money is what was committed when Bear Stearns was bailed out (Maiden) another huge chunck is the Commercial Paper Lending Facility (CPLF), which yes, was probably lent to specific banks to guarantee their commercial paper, but was something that everyone and their mama was very insistent on when Lehman's failure caused that money market fund to break the buck.  And of course the Term Auction Facility (TAF).

My point being, it's hugely hypocritical to be the congress that passed the TARP on the one hand, which was all about propping up the failing banks, and then on the other hand be all up in arms about the expansion of the Fed Balance Sheet, which has been all about propping up failing banks.

(2) In these lending situations, Mark-to-Market is as much a fiction as anything else.  The point is that banks have some really bad, worthless crap that they can't get any money (which they need) for.  The Fed is lending them cash and holding that really bad crap as collateral.  Two things can happen.  Either the banks will pay the Fed back, in which case the Fed is out nothing.  Or the banks won't, in which case the Fed will get to keep the really bad crap, which is worthless, and the Fed will be out what it loaned.  However, if the objective is to prop up failing banks, and you insist that the collateral be valued at market, they would be valued at crap (near 0) and then the Fed won't be able to lend any money to the banks because they can't pony up any valuable collateral.  No banks saved.

So either you just decide that the bad banks should fail (my personal preferred option) or you play this ball.  Asking for marked-to-market accountability on collateral when the goal is to save desperate financial institutions is... idiotic.

(3) It is, and I have no link now, but I believe this is true, a long standing, well-established principle that the Fed does not reveal who it lends to at the Discount Window.  Like the FDIC's watch list, which banks are never revealed, this is to prevent runs on weak banks, which would pretty much completely destroy any chance a bank might have at preventing insolvency.  Of course, it is arguable that all banks are weak at this point, so what does it hurt to reveal.

I think this shield principle is rational.  And it works reasonably well when not every financial institution is on the brink of insolvency. If we want to change this, say, for exigent circumstances, then we should do it through the appropriate procedures, and not during some 10 minute congressional cross-examination.

(4) And finally, let's remember, this is the Fed's lending program, and not the TARP, which was money given away (yes, with theoretical upside, but let's face it, it is a bank handout program), which should have accountability and transparency, and which, at least according to the New York Times, some amount of transparency does in fact exist.

The two are not the same, they are not interchangeable.

And don't get me wrong, I have so many many problems w/the lending facilities.  But I go back to the core and really think that we needed price discovery, and a few more Lehmans, despite the inevitable pain.  But this, this is hypocritical idiocy.

Oh, craptastic, it's late.  I need zzz's.  More later.

Personal Finance 2009: Don't Buy Cr@p You Can't Afford...

Clusterstock reminded me of this oldie but goodie.

Note: of course, this plan is unavailable to the US government, which has promised to keep buying stuff it cannot afford.