JoeTaxpayer

A near daily post lets me address topics that I’d not think worthy of my monthly articles, either due to general interest, space, or some other reason. This is one such topic.
When gasoline started its recent climb, I soon heard of some congress people who missed much of their economics 101 class. They called for anti-gouging rules which to me sounded a bit like price controls which we know do not work. Let’s go back to the lecture on supply/demand for a moment. There is a supply curve (here shown as a line), showing that the manufacturer will be willing to supply ever increasing quantities of a product as the price offered rises. That actually stands to reason, doesn’t it? On the other side, we have the demand curve. The consumers, taken in aggregate, will want ever increasing quantities of a product as the price falls. Of course, there are limits at the endpoints, if milk were cheaper, it might reduce juice consumption (a phenomonon called cross elasticity of demand) , but at some point, even free milk could only generate so much demand. We are looking not at these extremes, but at the current point where the market clears.

In the case of any product, the natural clearing price is at B, where the supply and demand lines intersect. Now, what would happen if prices were capped by the government? At the artificial government maximum, there is a demand (C) and supply (A) which do not match. At best, that sounds like long lines for gas, but worse, it sounds like gas stations shutting down for a long vacation. Just my overdue thought on this. Shortly after this all occurred to me, Gene Epstein (of Barron’s) wrote with similar thoughts.

JOE

written by JOE

My Mastercard bill is due on September 3. That wouldn’t be an issue except that September 3 is a holiday in the US, and both the post office and banks are closed. Labor Day also happens to fall on a Monday, in fact, it’s always on the first Monday of September. That means my check will not be delivered on the Monday, or the day prior, or the day before that. Actually, if I don’t get the check out say the bank receives it by August 31, it will be late, and I’ll be charged interest and a late fee. I happen to pay my bills on line, and fortunately, my bank’s system will automatically warn me of the days banks are closed and suggest I make the payment earlier. These are the small things that I think about, but try not to sweat.
Update - my Amex bill just came in, and it’s due on Sept 4. I’ll keep an eye out to see if it’s ever due over a weekend or holiday, now I’m curious.

JOE

written by JOE

On my feature web site, I wrote an article on a couple different Strategies for Roth Conversion. I recently saw a link to an article from the Journal of Retirement Planning titled, “To Convert or Not to Convert, That is the Question.” (note - this is a link directly to a PDF file, it will offer to download directly to your computer. The carefully timed use of a Roth conversion can save you quite a bit of money, it’s worth reading up on this, and understanding the impact a Roth can have on your portfolio.

JOE

written by JOE \\ tags: Finance, Investing, roth ira, saving

So I was thinking on this a bit more over the last few day and have some more thoughts on the combination of events that came together:

1. The anomaly in rates, specifically, the short term rate dropping to record levels, 1%. And of course, the subsequent rise back to more normal levels.
2. The surge in the high end home prices. Of course you can say that the rates drove the prices higher, as the same dollar bought far more mortgage at 3% than it did at 9%.
3. The no-doc mortgages, brokers filling in applications that were signed when still blank.
4. Between fancy computer modeling and ratings agencies that did not do their job, much of the paper got rated AAA when it should be C or less. (my thanks to Douglas Johnson for pointing this last factor out to me)

An article in the August 5th New York Times gave a good overview called “Housing Busts and Hedge Fund Meltdowns: A Spectator’s Guide.” It still leaves some questions unanswered, but it’s worth a quick read.

JOE

written by JOE \\ tags: Finance, Investing, money, Mortgage, Subprime

How did the housing bubble turn into the current credit meltdown? Well, the system was able to handle the ‘normal’ default rates until recently. A normal default, to me, is one occurring in a real estate market where values are increasing each year (amount doesn’t matter, it’s positive) and when a buyer defaults, the bank is able to recoup say 80-90% of the money owed. A 10% loss on 5% of loans offers manageable numbers. Now, in more recent times, we had a cycle where short rates dropped to 1%, and a standard ARM, was offered at under 4% (this is not the teaser, this was the real rate). Now, with the 1 year t-bill at 5% or so, the rate has adjusted to near 8%. A $250K mortgage payment would jump from $1200 to $1800 over this 2 year period.
Next, add the fact that the homes were over valued and these weren’t $250K loans but two to three times that. Then to top it off, the initial payment in my example wasn’t really $1200, but an interest only teaser rate of 3% offering a payment of $625. (So for a $500K loan the payment rose from $1250 to $3600!)

This all created a cycle where nothing was normal. A large number of mortgages were offered as ARMs that were time bombs, financially, all of which would create a potential problem of some sort. This wasn’t just new homes, there was refinancing as well. Stories of people moving from a 30 year fixed at 5% to an ARM which was destined to go to 8%, to pull cash out to do God knows what, just broke my heart.

The sheer magnitude of the amount of paper involved is the answer to this question. If this were isolated regionally, or to a small number of lenders, it would have less impact. As Nouriel Roubini’s article (what a gem, I didn’t realize he maintained a blog) states, half the mortgages originated in 2005-2006 were of the nature I described.

Then next thing to note is that these loans are not just held by the banks that lent out the money. For some time there has been a market in CMOs (collateralized mortgage obligations) which has created the potential for defaults to have an impact which is far reaching. Businesses have invested their hoards of cash in CMOs as have pension funds and 401(k)s. We are now in the midst of a meltdown on a scale not seen since the Savings and Loan Crisis in the 80s. Maybe it takes this long to forget the events that precipitate such a meltdown, as if ‘this time things are different’. Once again, those who forget the past…..

JOE

written by JOE \\ tags: Finance, Investing, money, Mortgage, Subprime

I’ve been sketching out the next few months of articles I plan to publish on my main site. The only way to not miss my monthly deadline is to think a couple months out. So here are my thoughts on the next few months:

1. Getting Started - The first things to do when when you have no money to invest
2. Bi-Weekly Mortgages - Good or Bad?
3. Immediate Annuities - What are they, why do I want one?

I may still post the occasional book review and update the book list randomly, as well as continue the blog posts. Enjoy the weekend.

JOE

written by JOE