One factor you must understand when evaluating economic data is that the data is far from straight forward. Even theoretically it is often confusing what something like “savings rate” should represent. And even if that were completely clear the ability to get data that accurately measures what is desired is often difficult if not impossible. Therefore most often there is plenty of question about economic conditions even when examining the best available data. Learning about these realities is important if you wish to be financially literate.
Bigger U.S. Savings Than Official Stats Suggest
A closer look, however, shows that Americans have tightened their belts more sharply than the numbers report. The reason? Official figures for personal spending include a lot of categories, such as Medicare outlays, that are not under the control of households. They also include items, such as education spending, that should be treated as investment in the future rather than current consumption.
After removing these spending categories from the data, let’s call what’s left “pocketbook” spending – the money that consumers actually lay out at retailers and other businesses. By this measure, Americans have cut consumption by $200 billion, or 3.1%, over the past year. This explains why the downturn has hit Main Street hard.
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Finally, for technical reasons the BEA throws in some “spending” categories where no money actually changes hands. The biggest is “rent on owner-occupied housing,” the money that people supposedly pay themselves for living in their own homes. Despite the housing bust, this number rose by 2.6% over the past year, to $1.1 trillion.
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A closer look at BEA numbers shows that Americans reduced spending by 3.1% in the past year, indicating that the savings rate has risen to 6.4%
He raises good issues to consider though I am not sure I agree 100% with his reasoning.
Related: The USA Should Reduce Personal and Government Debt – Financial Markets with Robert Shiller – Save Some of Each Raise – Over 500,000 Jobs Disappeared in November (2008)
Starting next Monday GM and Citigroup will no longer be in the list of 30 companies making up the Dow Jones Industrial Average. I posted in 2005 that GM should be dropped from the DJIA. GE has lasted in the Dow for more than 100 years. 12 of the 30 stocks have been added since 1997. Cisco and Travelers are the companies that are joining the Dow on June 8th.
The 30 stocks of the Dow Jones Industrial Average, as of June 8th, 2009:
| Stock | Market Capitalization | Year Added |
|---|---|---|
| Exxon (XOM) | $347 Billion | 1928 |
| Walmart (WMT) | 195 | 1997 |
| Microsoft | 189 | 1999 |
| Proctor & Gamble (PG) | 155 | 1932 |
| Johnson & Johnson (JNJ) | 153 | 1997 |
| GE | 147 | 1896 |
| AT&T (T) | 145 | 1999 |
| IBM | 143 | 1979 |
| JPMorgan Chase (JPM) | 141 | 1991 |
| Chevron (CVX) | 138 | 2008 |
| Coca-Cola (KO) | 113 | 1987 |
| Cisco (CSCO) | 112 | 2009 |
| Pfizer (PFE) | 100 | 2004 |
| Intel (INTC) | 91 | 1999 |
John Bogle was the founder of Vanguard Group and a well respected investment mind. He has written several good books including: The Little Book of Common Sense Investing, Common Sense on Mutual Funds and Bogle on Mutual Funds. This interview from 2006 discusses the state of the retirement system, before the credit crisis.
Frontline: How do they get away with that? Don’t they have to fund them?
John Bogle: No, they don’t, because a lot of it is based on assumptions. Our corporations are now assuming that future returns in their pension plan will be about 8.5 percent per year, and that’s not going to happen. The future returns in the bond market will be about 4.5 percent, and maybe if we’re lucky 7.5 percent on stocks. Call it a 6 percent return — before you deduct the cost of investing all that money, the turnover cost, the management fees. So maybe a 5 percent return is going to be possible, in my judgment, and they are estimating 8.5 percent.
Why? Because when they do it that way, corporation earnings become greatly overstated, and all the executives get nice, big bonuses. They are using pension plan assumptions as a way to manage corporate earnings and meet the expectations of Wall Street.
Frontline: So if a company overstates the value of its pension plan assets, it makes the company look better to Wall Street, so there’s an incentive to kind of exaggerate, if not cheat.
John Bogle: That is precisely correct. And let me clear on the cheating: It’s legal cheating; it’s not illegal cheating. In other words, you can change any reasonable set of numbers — and corporations have done this, have raised the pension assumption from 7 percent to 8.5 percent — and all of a sudden that corporation will report an earnings gain for the year rather than an earnings loss that they would otherwise have. Simple, legal.
The entire PBS series (from 2006) on 401(k)s (including interviews with Elizabeth Warren, David Wray and Alicia Munnell) is worth reading.
In February of 2009 he spoke to the House of Representatives committee exploring retirement security.
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Chart showing government debt as a percentage of GDP by Curious Cat Investing Economics Blog, Creative Commons Attribution, data from OECD, March 2009.The USA federal government debt is far too large, in my opinion. We have been raising taxes on future taxpayers for several decades, to finance our current spending. Within reason deficit spending is fine. What that reasonable level is however, is not easy to know. One big problem with the past few decades is that during very prosperous economic times we spent money that we didn’t have, choosing to raise taxes on the future (instead of either not spending as much or paying for what we were spending by raising taxes to pay for current spending).
By not even paying for what we are spending when times were prosperous we put ourselves in a bad situation when we have poor economic conditions – like today. If we were responsible during good economic times (and at least paid for what we spent) we could have reduced our debt as a percentage of GDP. Even if we did not pay down debt, just by not increasing the outstanding debt while the economy grew the ratio of debt to GDP would decline. Then when times were bad, we could afford to run deficits and perhaps bring the debt level up to some reasonable level (maybe 40% of GDP – though it is hard to know what the target should be, 40% seems within the realm of reason to me, for now).
There is at least one more point to remember, the figures in the chart are based on reported debt. The USA has huge liabilities that are not accounted for. So you must remember that the actually debt is much higher than reported in the official debt calculation.
Now on to the good news. As bad as the USA has been at spending tomorrows increases in taxes today, compared to the OECD countries we are actually better than average. The OECD is made up of countries in Europe, the USA, Japan, Korea, Australia, New Zealand and Canada. The chart shows the percentage of GDP that government debt represents for various countries. The USA ended 2006 at 62% while the overall OECD total is 77%. In 1990 the USA was at 63% and the OECD was at 57%. Japan is the line way at the top with a 2006 total of 180% (that is a big problem for them). Korea is in the best shape at just a 28% total in 2006 but that is an increase from just 8% in 1990.
Related: Federal Deficit To Double This Year – Politicians Again Raising Taxes On Your Children – True Level of USA Federal Deficit – Who Will Buy All the USA’s Debt? – Top 12 Manufacturing Countries in 2007 – Oil Consumption by Country
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Fluke? Credit crisis was a heist by James Jubak
Of course, just because the plan blew up on the looters, taking off a financial finger here and a portfolio hand there, you shouldn’t have any illusion that they’ve retired. In fact, in the “solutions” now being proposed — by Congress — to fix the global and U.S. financial systems, you can see the looters at work as hard as ever.
He is exactly right.
Answer: Because the federal government had forced them to back off. An aggressive interpretation of the definition of insurance could have let state insurance agencies regulate the derivatives contracts that AIG’s financial-products group was writing out of London. These were, in fact, insurance policies that guaranteed the companies taking them out (banks, other insurance companies, investment banks and the like) against losses on securities in their portfolios.
But Congress had made it very clear in the Commodity Futures Modernization Act — supported by then-Federal Reserve Chairman Alan Greenspan, steered through Congress by then-Sen. Phil Gramm, R-Texas, and signed into law by President Bill Clinton in December 2000 — that most over-the-counter derivatives contracts were outside the regulatory purview of all federal agencies, even the Commodity Futures Trading Commission.
With the new law on the books, the market for credit default swaps exploded from $632 billion outstanding in the first half of 2001, according to the International Swaps and Derivatives Association, to $62 trillion in the second half of 2007.
Question: Wasn’t anybody worried about the risk to the financial system posed by a market that dwarfed the assets of the sellers of this insurance?
Answer: Worry about leverage? You’ve got to be kidding.
In 2004, the Securities and Exchange Commission, after hard lobbying by Wall Street, reversed its 1975 rule limiting investment banks to leverage of 15-to-1. The new limit could be as high as 40-to-1 if the investment banks’ own computer models said it was safe.
Understanding the people paid lots of money to politicians and then (after they got lots of money) those politicians enacted laws that endangered the economy to favor those giving them lots of money. Now maybe these politicians just like letting exceptionally wealthy people endanger the economy for personal gain. Maybe they think that is a good idea. I tend to think instead they do what those they give them lots of money want. But maybe I am wrong on that.
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The recent performance of investments can be discouraging. However, the most damaging reaction to your financial future is to reduce your contributions to retirement savings. IRAs and 401(k)s are great ways to save for retirement. In fact the recent performance has convinced me to increase my contributions. This is for two reasons.
First, I had been somewhat optimistic in my guesses about investment returns. The current decline means that investments in the S&P 500 have returned about 0% over the last 10 years. That is a horrible performance and it will take many years to even bring that up to a bad performance. So if you reduce your long term investment performance expectations you need to add more while you are working (or reduce your retirement expectations – or work longer).
Second, I think now is a very good time (long term) to be investing. I think the declines in the markets (both the stock market and real estate market) now provide good investment opportunities. Of course I could be wrong but I am willing to make investments based on this believe. And I believe there are plenty of place real estate prices may still be too high, but I believe there are also good buys.
A third reason worth considering is the damage done to the economy over the last 10 years and the costs of dealing with that today. Those costs are going to have long term impacts. Likely the economy will be stressed paying for the over-indulgences of the past for quite a long time. That means the risks to those in that economy will increase. And therefore having larger reserves is a wise course of action to survive the rough times ahead. Those rough times include a substantial risk of inflation. Investing to protect against that risk is important.
I would recommend starting with at least a 200 basis point increase in retirement contributions. For example, if you were saving 10% for retirement, increase that to 12%. If you have not added to your IRA for 2008, do so now (you have until April 15th to do so). In fact, if you haven’t added to your IRA for 2009, do so now.
Related: How Much Will I Need to Save for Retirement? – Nearly half of all workers have less than $25,000 in retirement savings – Investing – What I am Doing Now
There is no invisible hand by Joseph Stiglitz, 2001 Nobel Prize in Economics
In particular, last year’s laureates implied that markets were not, in general, efficient; that there was an important role for government to play. Adam Smith’s invisible hand – the idea that free markets lead to efficiency as if guided by unseen forces – is invisible, at least in part, because it is not there.
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That such models prevailed, especially in America’s graduate schools, despite evidence to the contrary, bears testimony to a triumph of ideology over science. Unfortunately, students of these graduate programmes now act as policymakers in many countries, and are trying to implement programmes based on the ideas that have come to be called market fundamentalism.
Let me be clear: the rational expectations models made an important contribution to economics; the rigour which its supporters imposed on economic thinking helped expose the weaknesses underlying many hypotheses. Good science recognises its limitations, but the prophets of rational expectations have usually shown no such modesty.
Related: Greenspan Says He Was Wrong On Regulation – Ignorance of How Markets Work – Leverage, Complex Deals and Mania – Estate Tax Repeal – Misuse of Statistics – Mania in Financial Markets
Don’t let the talking heads on TV convince you that capitalism is about corrupt businessmen that think they are entitled to loot companies. That is about the powerful accepting money from their golfing buddies to share the loot among themselves. Capitalism is about places like Trickle Up, micro-finance, appropriate technology and entrepreneurs making better lives for themselves and their families. Donate to Trickle Up (I do).
Related: High School Student Provide Clean Water Solution – Creating a World Without Poverty – Microfinancing Entrepreneurs – Ignorance of Capitalism
The recent reactions to the credit and financial crisis have been dramatic. The federal funds rate has been reduced to almost 0. The increase in the spread between government bonds and corporate bonds has been dramatic also. In the last 3 months the yields on Baa corporate bonds have increased significantly while treasury bond yields have decreased significantly. Aaa bond yields have decreased but not dramatically (57 basis points), well at least not compared to the other swings.
The spread between 10 year Aaa corporate bond yields and 10 year government bonds increased to 266 basis points. In January, 2008 the spread was 159 points. The larger the spread the more people demand in interest, to compensate for the increased risk. The spread between government bonds and Baa corporate bonds increased to 604 basis points, the spread was 280 basis point in January, and 362 basis points in September.
When looking for why mortgage rates have fallen so far recently look at the 10 year treasury bond rate (which has fallen 127 basis points in the last 3 months). The rate is far more closely correlated to mortgage rates than the federal funds rate is.
Data from the federal reserve – corporate Aaa – corporate Baa – ten year treasury – fed funds
Related: Corporate and Government Bond Rates Graph (Oct 2008) – Corporate and Government Bond Yields 2005-2008 (April 2008) – 30 Year Fixed Mortgage Rates versus the Fed Funds Rate – posts on interest rates – investing and economic charts
The lowest 30 Year fixed mortgage rates in 37 years is great news for those looking to buy a house or to re-finance. However, that truth (the lowest rate) masks another truth, that it is available to a somewhat limited pool of borrowers. The rates for jumbo 30 year fixed mortgages and for regular 30 year fixed mortgages, for those with lower credit ratings, are not at the lowest rates they have ever reached. And getting mortgage rates that don’t require a 10-20% down payment and fully documented financial position are not as low as they have ever been. 15 year fixed rates are also low, but are not at all time lows. FHA loans still allow very low down payments, but others have moved away from this practice (which is a wise move).
Current rates, national average, from Bankrate: 30 year fixed 5.26%, 30 year fixed jumbo 6.96% (a full 170 basis points higher rate), 15 year fixed 5.07%. Jumbo rates have been less than 40 basis points higher than conventional rates most of time (based on my memory – I am looking for a source to confirm). The site does not present the credit score but my guess is these rates are based on a credit score of 700, or higher. Last week the jumbo rates increased by 11 basis points and regular 30 year rates fell by 3 basis points.
Related: Jumbo v. Regular Fixed Mortgage Rates: by Credit Score – historical mortgage rate chart – Nearly 10% of Mortgages Delinquent or in Foreclosure – misinterpreting data
Changes in the Market For Jumbo Mortgages
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On Nov 12, 2008 I shopped for an $800,000 30-year fixed-rate mortgage on Mortgage Marvel, an on-line site that I reviewed earlier in 2008 (see A Look at Mortgage Marvel). The mortgage companies on the site quoted rates of 8.125% to 8.375%. The credit unions and banks, in contrast, quoted rates ranging from 5.875% to 7.875%. I have never before seen rate differences on the same transaction this large. They no doubt reflect wide differences in lender access to funding, which is symptomatic of a market in turmoil.