By 2 Cents on September 3rd, 2010 | Category: Book Reviews | . . . too many people are unwilling to do what’s necessary to get their financial house in order. . . . Everyone wins when we have our financial affairs in order.
~ Scott Feher, Your Life & Your Money
If you’ve been reading this blog for any period of time at all, you know that I write a lot about imbalances in the global economy and in our society at large. Scott Feher, author of Your Life & Your Money, seems to have noticed some of the same trends. He writes:
“We live in an age of delusion. . . . Our biggest delusion is a sense of entitlement. . . . People delude themselves into believing everything is fine while engaging in behavior that’s definitely not fine. Then, when something goes wrong, they stand there blankly and do nothing about it, expecting somebody else to pick up after them!”
You may recognize some of these themes from a piece I wrote a while back that asked Have We Become a Society of Financial Adolescents? A lot of this type of sentiment can sound pretty negative, but the purpose is not to wave a finger at people. It is to incite them to take control of, and responsibility for their own destiny – financial and otherwise. But how? That’s the question that Mr. Feher aims to answer in this book.
Family CFO Basics
One of the key principles of the book is that, like any good corporation, every family needs a good Chief Financial Officer (CFO). The CFO needs to educate him/herself on financial matters and follow some basic rules in order to secure the family’s future prosperity. Here are just a few of the ideas discussed:
- Write a financial mission statement: This is just a written outline of goals and priorities the family will work toward according to specific timelines. Of course, it should remain flexible as life progresses and inevitably throws us the odd curveball.
- Don’t invest in any product or service that isn’t aligned with your mission statement: If a product doesn’t fit with your goal to limit spending, don’t buy it. If an investment doesn’t fit your risk profile, choose a different one.
- Know where your money goes: “Buying what you can’t pay for is called living beyond your means. It’s delusional, so don’t do it.”
- Master your expenses or you’re destined to fail: If you can’t say no to some expenses, you’re going to have a hard time living within your means.
- Don’t let financial mistakes become your permanent life story: We all make mistakes. The key is to learn from them, fix them, and move on.
- Keep apprised of economic issues that affect your finances: Taxes, risk, and inflation can have a big effect on how much of your money you get to keep. Understand the trends and how they could affect your money plans.
- Understand asset classes and how to use them: Mr. Feher offers a comprehensive review of the different types of asset classes and how to use them to plan your financial future.
Who Should Read This Book?
This book offers a concise review of the basics of personal finance and investing. The simple writing style is suitable for a novice, but also offers advice and perspectives that more seasoned family CFOs might appreciate as well. Scott Feher is a financial adviser himself, and he explores some ideas on whether you need an adviser and how to go about choosing one that’s right for you.
The book is written from an American perspective, and some portions deal with investment products that are unique to the U.S. market. There is a full chapter on the best ways to hold your assets that looks at pensions, annuities, and government programs, some of which would not apply to Canadians. Still, the basic financial principles espoused here are universal and the message is clear: You are responsible for your financial life and ultimately, only you can improve it.
I liked the way Mr. Feher put as much emphasis on personal finance basics as investing principles. He stresses learning about covering the basics before you move on to more advanced investing and planning techniques. It’s difficult to hear about folks trying to figure out which fund or stock to invest in when they are swimming in debt. Walk before you run.
Like many books on personal finance, Mr. Feher’s work ends with the idea that it’s not really about the money. Money is only a tool that we can use or misuse. If we use it wisely, we can enhance our life balance sheet as well as our financial balance sheet. If we misuse our money, we can do some real damage to both types of balance sheet.
With headlines becoming increasingly populated with stories about economic difficulties and household financial challenges, it seems that this book has come at the right time. As noted in the opening quote, fiscal responsibility at home is not only good for your personal balance sheet, it can help society at large. The more people who have a good handle on their finances, the fewer our over-indebted governments will need to bail out. In the end, that’s good for all of us.
Your Life & Your Money is straightforward and relatively short, making it very easy to digest. It’s only about 140 pages long, not including a couple of useful appendices which include an inventory of expenses and an investing questionnaire. If you’re ready to improve your balance sheet and you’re looking for some ideas on how to get started, this just might be the book for you.
Does this book sound interesting to you? What types of questions would you like answered in a book like this?
By 2 Cents on September 1st, 2010 | Category: 20 Cents |  As the summer winds down and the kids head back to school, it’s time to reflect on a few of my favourite articles from the web in the month of August. I always try to mix it up a bit, so you’ll find some insights from perennial favourites as well as a few from some new voices that I’ve discovered recently. Savour one last summer beverage and enjoy!
1. Bret at Hope to Prosper wrote about some important Economic Trends Affecting Americans. They’re just as relevant for Canadians, and I thought Bret’s thoughts on these issues were right on the money.
2. When will we ever learn? Big Cajun Man ponders this question in Lessons Learned Financially at Canadian Personal Finance Blog. Many of us make similar financial mistakes, sometimes repeatedly. This post looks at some of those, served up with a characteristic dose of “Canajun” humour.
3. BJ readers know that there’s a certain former Merrill Lynch chief economist (recently repatriated to Canada) who I usually agree with and quote regularly. How, then, could I resist including David Rosenberg Belongs in Your Inbox in today’s collection of articles? Thanks to Kevin from Today’s Economy Blog for sharing his thoughts.
4. If you’re not in the habit of reading Len Penzo’s weekly Black Coffee, you’re missing out. Whether you agree with Len’s point of view or not, you’re sure to find the information interesting and amusing. I’ve actually spit out my coffee on occasion when I come across a particularly hilarious line or two. For a tasty free sample, check out Black Coffee: Send in the Clowns (Never Mind, They’re Already Here.).
5. There are a number of websites and anecdotes out there about people who have chosen to live extremely lean in order to retire early or just live a simpler life. Shawn over at Watson Inc. raises some interesting ideas, asking Is Extreme Frugality for You? I like my consumption to be calculated rather than conspicuous, but I’m not sure I’m ready to cut as close to the bone as some folks.
6. Even if you’re not prepared to go to extremes, B Simple offers a Cure for the Financially Overwhelmed at Simple Financial Lifestyle. Simple is always better, if you ask me. When things get too complex, trouble often follows.
7. Jim Yih writes that there’s Lots to Know about Canada Pension Plan at Canadian Finance Blog. He’s not kidding. You might not have realized how much there is to know until you read this article. It offers lots of links to information every Canadian should be aware of.
8. 50 and Broke? Early Retirement Planning Can Help. So says Canadian Dream: Free at 45. There are lots of retirement planning strategies that will work even if you’re a little late getting started.
9. Doctor Stock had a couple of posts on How Volume and Candlesticks Reveal Market Momentum over at Invest in the Markets. Part 1 looks at some examples of market bottoms and Part 2 examines market tops. I know some people think technical analysis is about as useful as a ouija board, but I couldn’t invest without it. A chart is like a Rorschach Test for the market, and volume is its lie detector.
10. I’ve got another “twofer” here in honour of the final holiday weekend of summer. This one comes from Boomer and Echo, a relatively new Canadian financial blog that features views from two authors of different generations. I’ve enjoyed their posts so far, and I think you might too. Check out Boomer’s Short Term Goals and then compare them to Echo’s Short Term Goals. It’s always informative to read about how others approach their financial planning.
I hope you enjoyed reading all of these as much as I did. Feel free to comment on your favourites below! 
By 2 Cents on August 30th, 2010 | Category: Economics | Numbing the pain for a while will make it worse when you finally feel it.
~Albus Dumbledore, Harry Potter and the Goblet of Fire
 Is the Federal Reserve a hero or a villain? You can find plenty of Nobel Laureates, pundits, and civilians like myself on either side of that debate. Nassim Taleb, author of The Black Swan  has been saying for quite some time that the Fed steered us into the ditch and that it’s shameful that the same group that got us here is still in the driver’s seat. Perpetual overspending and record low interest rates have not only failed to solve our problems, but are the major causes of them. It is therefore ridiculous to turn to them to solve our current challenges.
Paul Krugman is probably the most vocal Nobel Laureate who supports the Keynesian spend-till-you-drop/debt-levels-don’t-matter viewpoint. He has been a supporter of stimulative monetary and fiscal policy. His response to critics of higher spending, zero interest rates and quantitative easing is that central bankers and governments are not spending enough to rescue the economy. He says the stimulus would have worked if only it were bigger.
Thus, Alan Greenspan is either a messiah, evil incarnate, or simply incompetent, depending on who you ask. Ben Bernanke has mainly followed Greenspan’s approach to monetary policy, although he has been forced to become a lot more creative courtesy of the economic mess he inherited from Greenspan’s Fed, of which he was a member. Will continued quantitative easing work?
What on Earth Is Quantitative Easing?
Prior to, and following Fed Chairman Bernanke’s key speech at Jackson Hole on Friday, cyberspace, trading floors, and water coolers were abuzz with debates over what he might say in terms of future prospects for the economy and further quantitative easing. For those who aren’t familiar with the idea, QE, or quantitative easing is a way for the Fed to increase the money supply when traditional methods like lowering interest rates are no longer available, usually because rates are already at or near zero.
To implement QE, the central bank credits its own account “with money it has created ex nihilo (“out of nothing”).” It uses that money to buy assets like government bonds and mortgage-backed securities from financial institutions. The idea is to provide liquidity to the financial system in hopes that a) banks will lend that money out to consumers and businesses and b) that buying bonds will keep interest rates low.
As with any action taken to cure an illness, 4 main outcomes are possible: The remedy could work, it could actually make things worse, it could relieve the symptoms without curing the underlying illness, or it might just do nothing. We’ll take a look at each of these possibilities as they relate to the QE prescription.
QE: Cure, Cause, Palliative or Placebo?
QE as Cure
Here are a few ways that quantitative easing might be able to keep the economy from slipping into a depression:
- Lower bond yields will force investors into other asset classes like stocks, commodities, and real estate, raising the prices of those assets and creating a wealth effect for investors. The hope is that consumers will see the value of their investments rise and feel confident enough to spend and invest more.
- Lower interest rates will improve housing affordability and make it easier for consumers, corporations and governments to service and roll over their considerable debt loads.
- Lower yields will weaken the U.S. dollar and help with the trade deficit.
QE as Cause
Many would argue that easy money policies created the asset and debt bubbles that are now plaguing us, so it doesn’t seem like more of the same would be helpful. Here are a few ways QE might hurt more than it helps:
- Continued low yields hurt savers, retirees, and pension plans who do not want to invest in riskier assets. In order to maintain an annual investment income of $40 000, you would need to have $2 million invested at a 2% rate of return. If yields were at 5%, you would only need to have $800 000 saved to achieve the same income level.
- Lower yields can lead to asset and debt bubbles as people begin to feel that low rates and rising asset prices can go on forever. If rates rise and/or asset prices fall, it can get pretty ugly, as we saw in 2008.
- Asset price and money supply increases are inflationary. If the Fed takes QE too far, we could end up with hyperinflation and extremely high interest rates. It goes without saying that higher rates in an over-leveraged financial system would be disastrous.
QE as Palliative
Quantitative easing could make it look like things are getting better, when in reality they are staying the same or getting worse. If you had a bacterial infection, you could take something to alleviate the pain, but the infection would likely continue to worsen until you got an antibiotic that actually killed the bacteria. Some believe QE has already had this type of palliative effect and will continue to do so:
- Rising prices in assets like stocks, commodities and real estate can make us feel like the economy is recovering. But if debt levels continue to rise, they will eventually hurt the economy as consumer, corporate, and government entities are forced to use an increasing amount of their income to service debt rather than contribute to economic growth.
- If people get the idea that interest rates will be held artificially low forever, they may take on risks and obligations that they will not be able to honour later if interest rates rise and/or the economy turns down.
- If the U.S. dollar falls as a result of QE, commodity prices could spike as they are priced in U.S. dollars. Some may interpret the rise as a signal that the economy is improving.
QE as Placebo
You could easily argue that this one is the same as the palliative argument above, but I’ll make the following distinction: While neither the palliative nor the placebo treat the root cause of the problem, the palliative at least temporarily alleviates some of the symptoms. The placebo really does nothing but make us think we might feel better even if neither our symptoms nor disease are any better in reality. Here’s the placebo case:
- Every time the Fed announces new policy measures like QE, the shorts cover their positions and we see a huge snap-back rally in equities.
- Some investors and pundits feel better as they believe that the Fed is on the job, and they will cure what ails us.
- Some investors will follow the Fed into Treasuries, or whatever security they are buying as they see the Fed as providing a floor for prices in those securities.
My 2 Cents
I agree with the weekend article in the Washington Post that argued that the Fed’s Capacity to Stimulate the Economy Is Limited. I think QE might be a cause, a palliative, or a placebo, but I’m pretty sure it’s not a cure. The problems we face are structural, not cyclical. We need structural solutions at the legislative level, not at the monetary policy level.
What does this mean for our financial plans? Of course, each of us will answer differently. I’m worried the Fed is caught in a liquidity trap where they will not be able to stimulate the economy. Quantitative easing is based on money created out of nothing. That just sounds like cheating to me. We may see strength in commodities if the fall in the U.S dollar outpaces that of other currencies, but I will remain in cash until commodities rise on real economic prosperity rather than palliative measures rooted in nothing.
Further, it seems like much of the economic and stock market success of the 1980-2000 era was created ex nihilo as well. It was built on a foundation of debt. I can’t invest in that, so I’m not buying into Friday’s placebo rally.
What about you? Do you think QE will work?
By 2 Cents on August 27th, 2010 | Category: Book Reviews | If there is one common theme to the vast range of crises we consider in this book, it is that excessive debt accumulation, whether it be by the government, banks, corporations, or consumers, often poses greater systemic risks than it seems during a boom. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are.
~ Carmen Reinhart & Ken Rogoff, This Time Is Different
 The subtitle of This Time Is Different indicates that the book covers “Eight Centuries of Financial Folly”, but its release date (September, 2009) makes it extremely relevant to our most recent and ongoing bout of financial folly. In fact, the authors devote the final four chapters of the book to what they call “The Second Great Contraction” (the first being The Great Depression) triggered by the U.S. subprime mortgage crisis. The authors do a great job of outlining the “huge regulatory mistakes” that lead to the current financial crisis, from the deregulation of the subprime mortgage market to the 2004 SEC decision to allow investment banks to triple their leverage ratios.
They describe 4 main types of financial crises (sovereign debt, currency, banking, and inflation) but concentrate quite a bit on the sovereign debt and banking varieties. They do note, however, that these crises tend to occur in clusters and one type can easily trigger another. In the run-up to the subprime crisis, they note that the U.S. exhibited “all the signs of a country on the edge of a financial crisis – indeed, a severe one.” Those signs were: “asset price inflation, rising leverage, large sustained current account deficits, and a slowing trajectory of economic growth”.
The This-Time-Is-Different Syndrome
Of course, the main tenet of the book is that the aforementioned financial follies are exacerbated by the “this-time-is-different syndrome”. It refers to ideas we often hear from financial professionals and government officials during boom times and is characterized by the following lines of thinking, which are eventually proven false:
- Old valuation rules no longer apply.
- We are smarter now. We’re doing things differently, and we have better systems in place.
- We have learned from past mistakes.
- The new boom is built on sound fundamentals, structural reforms, technological innovation, and good policy.
Does any of that ring a bell? It should. We heard all of the above right up to the point when the U.S. housing and mortgage markets imploded in 2007-2008. Too much debt eventually leads to problems and this incident was no different. The aftermath will likely follow the historical form Reinhart and Rogoff have noted as well:
- Asset market collapses are deep and prolonged.
- Profound declines in output and employment ensue.
- The amount of government debt explodes.
This Time Is Not Different . . . But It Sort of Is
There is a bit of an inherent contradiction in the this-time-is-different thesis. I once heard Ken Rogoff discuss it in an interview and it goes something like this: This time is not different in the sense that history shows that financial crises happen quite often. But there is also a tendency for financial and government leaders to fail to recognize that the economic trajectory after a crisis-induced recession is very different from the one we might see following a normal business cycle-induced recession. Therefore, “standard macroeconomic models calibrated to statistically “normal” growth periods may be of little use.”
In that sense, this time is different. It differs from normal cyclical economic activity, but not from what usually happens following a financial crisis. If you think of it that way, it seems like we shoot ourselves in the foot twice when afflicted by the this-time-is-different syndrome: once, when we fail to see the crisis coming, and again when we try to get ourselves out of it by using solutions that are effective for a different set of problems.
In the wake of the recent financial crisis, we have repeatedly witnessed governments and central banks attempting to treat the symptoms without really attacking the source of the disease: debt. Instead, they have tried to cure a debt hangover with another round of debt. Hair of the dog anyone?
“This Time” Is Worth Your Time
When I received my copy of the book, my first impression was “Gee, this is a lot longer than it looked online.” It’s a little over 460 pages, but the main text of the book ends around page 290. The remainder is a treasure trove of historical economic data aggregated for your convenience. There’s also an extensive notes section, plenty of references and two different index choices – one for names and one by subject.
Before the core of the book even gets started, there is both a Preface and a Preamble, both of which are worth your time. They set the tone for the information in the book and offer some succinct overall impressions. The first twelve chapters deal with the description and causes of various types of financial crises throughout history, including The Big One (the Great Depression). The remainder deal with the current crisis and how the information in the preceding chapters might apply today.
The first sentence of the Preface announces that “this book provides a quantitative history of financial crises in their various guises”. If you are not an economist or a big fan of mathematical or statistical analysis, you may find that the quantitative part of this text goes over your head a bit. In between the charts, tables and statistics, however, you will also find that some very compelling ideas emerge. The plethora of valuable information means this book deserves a spot in your personal library, both as a reliable reference and a reminder that human folly can and does regularly wreak havoc on our finances.
If you’ve read the book, I’d love to hear your impressions. If not, does it seem like something that might interest you?
By 2 Cents on August 25th, 2010 | Category: Investing | Accidents, and particularly street and highway accidents, do not happen – they are caused.
~Ernest Greenwood
 Accidents in the financial markets do not just happen either. They often result from conditions that persist for quite some time before some seemingly insignificant bend in the road causes us to veer off course and wind up in a ditch. How long did a chorus of critics warn of a bubble in the U.S. housing and structured finance markets before it actually popped?
In traffic parlance, a rollover accident is one in which a vehicle ends up on its roof or side, usually as a result of one of these factors: excessive cornering speed, tripping, collision with another vehicle or object, or traversing a critical slope, such as when a vehicle crosses a ditch.
Rogoff and Reinhart, authors of the book This Time Is Different observe that “what one does see, again and again, in the history of financial crises is that when an accident is waiting to happen, it eventually does. When countries become too deeply indebted, they are headed for trouble.” (I’ll have a full review of the book for you on Friday.)
Bonds Keep Rolling
When companies or governments issue bonds, they mature on a given date. Some are very short term, maturing in only 30, 60, or 90 days. Other maturities can range from 1 to 30 years. Once the bonds mature, the corporation or government must pay back the bondholders’ principal in full. Next, the borrower will usually look to “roll over” those bonds by issuing new ones in order to fund their continuing operations. It’s sort of like how you need to refinance your mortgage once your term is up.
This is the proverbial bend in the road. Accidents can happen here. One of the problems is that banks and governments will be vying for financing at the same time, and this could raise the cost of capital for everyone, including small businesses and consumers. If fewer investors want to buy those bonds for whatever reason, the price will fall and the yield will rise, raising the cost of capital. In extreme situations where buyers refuse to step up to the plate at all, we would have a full blown credit freeze on our hands. We’ve seen what that looks like already and I’ll go out on a limb and say that no one wants to go there again.
When the European sovereign debt crisis was coming to a boil a few months ago, many worried that European countries and their banks would not be able to roll over their significant debt issues. The New York Times reported: Crisis Awaits World’s Banks as Trillions Come Due. “Banks worldwide owe nearly $5 trillion to bondholders and other creditors that will come due through 2012, according to estimates by the Bank for International Settlements. About $2.6 trillion of the liabilities are in Europe.” U.S. banks will need to refinance about $1.3 trillion over the same period of time. That’s a lot of paper for the bond market to swallow.
China has traditionally been a huge buyer of U.S. debt, but they have recently sold some of their holdings. Some worry that this means there will be less demand for the massive quantities of debt the U.S. will need to issue. A recent article from The Daily Reckoning explains why that may not necessarily be the case.
Will Short-Term Gains Lead to Long-Term Pain?
One of the recent borrowing trends is for banks to borrow money for shorter periods of time. By accessing the next-to-free short term money made available by global central banks, many financial institutions have been able to work on improving their balance sheets. They borrow money at near 0% rates and lend it out to individuals and businesses for longer terms at higher rates. It’s a great racket, if you can get into it.
According to the New York Times article, “government bank guarantees extended in response to the crisis also inadvertently encouraged short-term lending. The guarantees were typically only for several years, and the banks issued bonds to match.” What happens when those government guarantees expire? Governments can extend them, but what if the market loses confidence in the balance sheets of those governments? Many of the countries offering such guarantees aren’t exactly swimming in black ink themselves. That includes the U.S. and the U.K..
Why the Infatuation with Bonds?
The European stress test results seemed to defuse worries about a rollover accident, although many (myself included) felt that those tests were less than rigorous, to put it mildly. In the meantime, it seems that investors, both retail and institutional, can’t get enough bonds. Many reports point to rivers of capital flowing out of equity funds and into bond funds. As long as this continues, rolling over debt may not be a problem.
A recent Globe and Mail article inquired Whither the Bond Vigilantes? (The title was later revised to “Where Are the Bond Vigilantes?”, but I much prefer the original.) Bond vigilantes are supposed to hold governments accountable for their debt loads by demanding higher rates in return for putting their capital at risk. Not only have the bond vigilantes gone missing in action, but there seems to be a mob of bond groupies forming that just can’t buy enough debt to sate it’s appetite.
Jeremy Siegel recently warned that the bond market is a bubble. Wall St. Cheat Sheet begged to differ. Regardless of who’s right, bubbles can continue to inflate much longer than anyone thinks they can. This particular bubble is backed by the full faith and credit of the U.S. government. The Federal Reserve recently outlined its own rollover plans: it will use proceeds from maturing mortgage-backed securities that it holds to buy U.S. Treasuries.
It would be folly for any trader to fade the Fed. So with fixed income short sellers on a leash, the Fed providing the incentive for investors to continue to buy bonds, and most investors turned off by the stock market, it seems that the U.S. government will have no trouble issuing the trillions of dollars of debt it will require to finance itself – until it does have trouble. I’ll leave you with one last quote from Reinhart and Rogoff in which they explain “why financial crises tend to be both unpredictable and damaging“:
“Perhaps more than anything else, failure to recognize the precariousness and fickleness of confidence – especially in cases in which large short-term debts need to be rolled over continuously – is the key factor that gives rise to the this-time-is-different syndrome. Highly indebted governments, banks, or corporations can seem to be merrily rolling along for an extended period, when bang! – confidence collapses, lenders disappear, and a crisis hits.”
They admit that economic theory doesn’t provide very much insight into the exact timing or duration of such crises, but when all of the elements are there, it’s pretty likely a crisis will occur at some point. It’s doubtful whether even the Federal Reserve can hold off real market forces forever – if such forces have not yet been permanently been relegated to the realm of folklore and mythology.
Do you think the market is headed for a rollover accident?
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