Wednesday, December 31, 2008

Pick Your Home Price Index: Comparing the HPI with the Case-Schiller Index

The S&P/Case-Schiller Home Price Index has been released for October. The monthly percentage changes in the 10-metro composite (CSXR) and the 20-metro composite (SPCS20R) from July 2007 are illustrated in the accompanying figure. The graph also contains the same data for the monthly housing price index (HPI) published by the Federal Housing Agency.

Note that the declines have been much greater in the Case-Shiller indexes. These indexes are based on the paired repeat sales of single-family homes. The indexes include the sale of homes that were financed with subprime loans and homes sold in foreclosure. The FHA housing price index (HPI) is also based on repeat sales. However, it only includes the sale of homes backed by Fannie Mae or Freddie Mac, a subset of the homes in the Case-Schiller indexes. The HPI does not include the sale of homes backed by subprime financing that fell outside of FHA guidelines. The forced sale of these homes may explain why the Case-Schiller indexes have declined more than the HPI. It has been incorrectly reported that the HPI does not include the sale of foreclosed properties. The FAQ at the FHA website indicates that these sales are included.
Transactions that merely represent title transfers to lenders will not appear in the data. Once lenders take possession of foreclosed properties, however, the subsequent sale to the public can appear in the data. As with any other property sale, the sales information will be in FHFA’s data if the buyer purchases the property with a loan that is bought or guaranteed by Fannie Mae or Freddie Mac.

Tuesday, December 30, 2008

Is a Gap Year Worth the Cost?

A recent article in the WSJ, "New High-School Elective: Put Off College," by Toddi Gutner indicates that guidance counselors and college admission counselors have been increasingly advising students to take a year off between high school and college. The article names several social service programs that can provide broadening experiences. The formal programs can cost between $10,000 to $20,000.

It does seem strange that you would have to pay for the privilege of providing a social service. However, if the non-monetary benefits exceed the costs, this could be a good decision for many prospective college students who are on an uncertain career path or need the added maturity before entering college. Always choosing the alternative that maximizes the dollar return will not necessarily lead to the greatest happiness. You should carefully weigh the cost of your non-monetary pleasures against your opportunity costs. Guidance counselors might point out that the cost of a gap year will include not only the cost of the program, but also the cost of delayed labor market entry. This means one less year of worklife and a one year shift in your age-earnings profile, meaning all future increases in your annual earnings will be delayed by one year. Assuming you would have earned $40,000 in real dollars during your first year, that represents one lost year of earnings with a present value of about $40,000. Given an annual real increase in your earnings of 3 percent and a 36 year worklife, the shift in the age earnings profile results is another $42,000 ($1,200 x 35) in lost earnings. Thus, the cost of the gap year could be $82,000 plus program costs. The non-monetary benefits, whether they be personal or social ones, better be worth these significant costs. Otherwise, we all might be better off if you skipped the gap year and donated your increased earnings to charity.

Monday, December 29, 2008

If You're So Smart, Why Ain't You Rich?

In this working paper from the Harvard Business School, "If You Are So Smart, Why Aren’t You Rich? The Effects of Education, Financial Literacy and Cognitive Ability on Financial Market Participation," by Shawn Cole and Gauri Kartini Shastry, the authors examine factors that influence investor participation in financial markets. They find that one year of schooling increases the probability of financial market participation by 7-8% after holding other factors constant, such as income. They also find a positive correlation between cognitive abilities (smarts) and participation. Alternatively, they surprisingly discover that financial literacy programs have no impact on investor participation.

Staying in Your Home

The various methods and programs that are available for reducing your monthly mortgage payment and avoiding foreclosure are examined in Grabbing a Loan Lifeline In Sea of Choices (Ranae Merle, Washington Post). The article provides useful links to mortgage resources and government programs. Hat tip: Caveat Emptor

New Nursing Home Database

The Centers for Medicare and Medicaid Services has launched a new nursing home database with a five-star rating system.

CMS created the Five-Star Quality Rating System to help consumers, their families, and caregivers compare nursing homes more easily and to help identify areas about which you may want to ask questions. The Nursing Home Compare Web site now features a quality rating system that gives each nursing home a rating of between 1 and 5 stars.

Sunday, December 28, 2008

New Rules for Equity-Indexed Annuities

The SEC summarizes the principle characteristics of equity-indexed annuities. The sale of equity-indexed securities has grown from $23 billion in 2004 to $123 billion today. Recently, the SEC approved new rules meant to protect seniors from abusive practices related to the sale of equity-indexed securities. The rules extend investor protections to equity-index securities beginning in 2011

Friday, December 26, 2008

Financial Crisis Timeline

The St. Louis Federal Reserve has posted The Financial Crisis: A Timeline of Events and Policy Actions. The timeline begins with the announcement by Freddie Mac in 2007 that it will no longer purchase subprime mortgages. The trend line is continually updated with the most recent significant events. Links are provided to data and graphs that illustrate the financial meltdown.

The Mystery of the Baby Boomers and the Missing Savings Peak

The McKinsey Global Institute has published a comprehensive examination of the The Economic Impact of Aging U.S. Baby Boomers. Compared to earlier generations the Baby Boomers have earned more, but saved less. Exhibit 4 from the report illustrates the savings rate for the boomers and the preceding Silent Generation. Noticeably missing is a boomer savings peak in the 40s and 50s. The report attributes this to the wealth effect from asset appreciation and easy access to credit, both of which have been hurt by the current financial crisis. The likely result is a longer worklife.

Wednesday, December 24, 2008

Dow Jones Webinar on Financial Markets: The Basics

This webinar is not for sophisticated investors. However, it is a nice introduction for beginners who want to learn about financial markets. The webinar is over, but you can register to listen to the presentation and download a nice set of accompanying slides. This is recommended for the first class on financial markets. The presentation lasts about 1 hour.

The effects of the global economic crisis clearly demonstrate that everyone needs a basic understanding of how financial markets operate. The Dow Jones InfoPro Alliance Team is pleased to bring you this timely webinar, Financial Markets: The Basics, which presents the key concepts of how the world financial systems operate. During this webinar, presented by John Prestbo, Executive Director and Editor of Dow Jones Indexes, and professor extraordinaire of the former Dow Jones University, you will be given a broad overview of the financial markets and how they operate. Mr. Prestbo will explain market theory and define terms, from stock ownership and bond-holding, to mutual funds and commodities.

Attend this year-end webinar and expand your financial market vocabulary. Increase your value and contribution to your organization by gaining a fundamental knowledge of various types of financial instruments and regulatory bodies that will help you research, extract, and decipher market-moving and economic news.

Financial Markets: The Basics

Tuesday, December 23, 2008

Congress Suspends Minimum Distributions on IRAs for 2009

Congress has suspended minimal withdrawal requirements for those 70-1/2 on individual retirement accounts and 401ks for 2009. The President is expected to sign the legislation. Those who did not meet minimal withdrawal requirements based on their life expectancy (See IRS Pub. 590) would have been subject to an onerous 50% tax penalty. The relaxed requirements do not apply to 2008 withdrawals.

WSJ Story

50-State Foreclosure Relief Chart

The Pew Charitable Center on States provides information on what all 50 states are doing to provide foreclosure relief for homeowners.

Washington, DC - 12/17/2008 - States are stepping up their response to the nation’s housing crisis with new legislation and programs to help homeowners, limit high-cost lending and curb foreclosures, according to research released today by the Pew Center on the States. In April 2008, the Center released Defaulting on the Dream: States Respond to America’s Foreclosure Crisis, the first-ever, comprehensive look at what all 50 states and the District of Columbia are doing to address the subprime mortgage fallout. Updated state fact sheets released today highlight actions taken by the states through October 2008 to try to mitigate the crisis

You can view a 50-state chart of reforms across the country and fact sheets highlighting the actions of each state through October 2008 can be found below. You can also download a document that contains all of the state fact sheets.


Monday, December 22, 2008

EBRI Review of 401(k) Plans for 2007

The Employee Benefit Research Institute has posted 401(k) Plan Asset Allocation, Account Balances, and Loan Activity in 2007. The study does not reflect the most recent market losses. Among some of the more interesting findings:

About two-thirds of 401(k) plans included lifecycle funds in their investment lineup at year-end 2007. New analysis shows that at year-end 2007, more than 7 percent of the assets in the EBRI/ICI database were invested in lifecycle funds and one-quarter of 401(k) participants held lifecycle funds. Also known as “target date” funds, they are designed to simplify investing and automate account rebalancing.

401(k) participants continued to seek diversification of their investments. The share of 401(k) accounts invested in company stock continued to shrink, falling by 0.5 percentage point (to 10.6 percent) in 2007. That continued a steady decline that started in 1999. Recently hired 401(k) participants contributed to this trend: they were less likely to hold employer stock.

Saturday, December 20, 2008

Will More Regulation Limit Faud on Wall Street?

Chidam Kurdam attempts to answer that question in a recent article in the Independent Review, entitled, "Does Regulation Prevent Fraud? The Case of Manhattan Hedge Fund." This excellent article examines the collapse of the Manhattan Hedge Fund. In many ways, the failure of the Manhattan Hedge Fund parallels the Bernard Madoff's fraud on the street. The clientele was limited to the influential and wealthy. Many of them were seasoned investors and its collapse was used as an argument for more regulation. Investors received bogus reports showing profits and hiding a declining net asset value. The curious, who questioned the results given the rising market and short-selling strategy of the fund, were told, “If you don’t understand, it’s your problem.” Some who were not deterred by the manager's arrogance warned the SEC. This time, unlike with the Madoff fund, the SEC took action and terminated the fraud.

The Manhattan Hedge Fund offered protection against a falling market. As Kudam states,

Investors wanted a shelter for the end of the boom, but they didn’t want the losses that were the price of that shelter. Berger gave them the comforting impression that they were buying a safeguard plus a solid return. What he appeared to offer was especially tempting because it was a deal that you really cannot get: free insurance. Other short sellers were not faking, and their performance was at best mediocre. It looked as if his clients were having their cake and eating it, too. No wonder they were happy to pour money into the fund.

The same could be said of the Madoff fund. The false earnings record and the herd effect continued to attract new money. Kurdam labels this belief perseverance and confirmation bias. "[O]nce convinced that they were getting a great deal, they did not look for evidence of failure."

The Manhattan Hedge Fund has been used as an example of what happens without regulation. However, what was done here and by Madoff is illegal. Kurdam argues that there are plenty of applicable laws on the books. More laws will not help, because most frauds are only caught after one party complains and the damage is done. Frauds like this are perpetrated because of the willingness of clients to believe and the self-interest of third-parties that profit from the fraud. More regulations can create a complacency that assists the fraud. Bernard Madoff Investment Securities was a member of FINRA and Bernard Madoff sat on the advisory committee for the SEC. CBS reports that Madoff even joked with SEC members about his extraordinary profits. In addition, Mark Madoff served on the board of the National Adjudicatory Council, the division that reviews disciplinary decisions made by FINRA.

Mental blind spots are common to all humanity, whether in the markets or in the government. The people Berger misled were experienced, highly sophisticated investors with immense resources and every ability to intervene. The fiasco happened because they misperceived the situation. If insiders are subject to knowledge gaps and cognitive biases, outsiders must also be subject to such gaps and biases. Although government agents are independent, they are outsiders with less information, no special cognitive advantage, and weaker incentives. Unlike private actors who bear the costs and benefits of their own choices, public decision makers do not face all the consequences of their choices (Whitman and Rizzo 2007, 442–43), especially when their failures are attributed to a lack of power or resources so that they escape responsibility for their mistakes.

We will probably never know why Bernard Madoff, a well-respected and wealthy individual, did what he did. Kurdam leaves us with the impression that the manager of the Manhattan Hedge Fund initially did not have a criminal intent. He believed that his short-selling strategy was right and that if he could cover up the initial losses his strategy would prove profitable for investors in the long-run. His self-assurance and ego were so strong that he refused to accept the fact that he might be wrong. As losses snowballed, he was forced to perpetuate the fraud.

It may be that investors would have suffered smaller losses had they been dealing with a true criminal. A criminal will terminate the fraud when he believes he has maximized his profits or is likely to be caught. An egoist will continue the deceit past when a self-interested criminal would have made a hasty exit. An egoist thrives on the adulation he receives from the community of investors. He is smarter and is more insightful than others. If he can just continue a little longer, had a little more money, he can prove he is right.

Friday, December 19, 2008

IRS Speeds Lien Relief for Homeowners Trying to Refinance, Sell

Audio file: Tax Lien Relief

IR-2008-141, Dec. 16, 2008WASHINGTON — The Internal Revenue Service today announced an expedited process that will make it easier for financially distressed homeowners to avoid having a federal tax lien block refinancing of mortgages or the sale of a home.

Read more

Thursday, December 18, 2008

"Satisfaction Guaranteed" Does Not Mean You Get $67 Million When the Laundry Losses Your Pants

The crazy lawsuit in which Judge Roy Pearson sued a clearners for losing his pants has finally been settled. The court ruled against him on every issue denying him the millions he had requested. (See A "Satisfaction Guaranteed" sign does not mean you get to determine the value of the unsatisfactory service. As we all expected, just compensation is determined by industry custom.
Pearson’s claims regarding the “Satisfaction Guaranteed” sign are premised on his interpretation that the sign is an unconditional and unlimited warranty of satisfaction to the customer as determined solely by the customer, without regard to the facts or to any notion of reasonableness– a position he has consistently advocated both in the trial court and on appeal. ...Indeed, in his trial testimony, he confirmed that in his view, if a customer brings in an item of clothing to be dry cleaned, and the dry cleaner remembers the item, and the customer then claims that the item is not his when the dry cleaner presents it back to the customer after it has been cleaned, the dry cleaner must pay the customer whatever the customer claims the item is worth if there is a “Satisfaction Guaranteed” sign in the store, even if the dry cleaner knows the customer is mistaken or lying.

In fact, every Custom Cleaners customer who testified, other than Pearson, testified that if Custom Cleaners lost or damaged an item of clothing, Custom Cleaners should reimburse them only for the value of the clothing. This interpretation coincides with the interpretation of the “Satisfaction Guaranteed” sign given by Soo Chung.

Thus, the trial court, showing basic common sense, rejected this unlimited view of a “Satisfaction Guaranteed” sign, relying instead upon case law generally supporting the position that, as with a common law fraud claim, a claim of an unfair trade practice is properly considered in terms of how the practice would be viewed and understood by a reasonable consumer.

New Credit Card Rules

OTS 08-062 - OTS Approves Final Rule Barring Unfair Credit Card Practices

Washington, D.C. — The Office of Thrift Supervision (OTS) approved a final rule today to prohibit savings associations from engaging in unfair credit card practices. The Federal Reserve Board (FRB) and the National Credit Union Administration (NCUA) are expected to approve the same rule, thus providing consumers with uniform protections regardless of which type of financial institution issued their credit card.

Read more

The new rules contain the following provisions:

  • There are additional restrictions on when the interest rate on an outstanding balance may be increased.
  • There is a "safe harbor" of 21 days between when a statement is mailed or received and a payment is considered late.
  • Payments in excess of the minimum payment must be allocated to either the higher interest balance or proportionately to all balances.
  • Double-cycle billing is banned.
  • There are additional restrictions on how high fees for subprime cards may be financed.

08-062A UDAP Final Rule - Fact Sheet 482006.pdf (18.8 KBs)
08-062B UDAP Final Rule - Full 482007.pdf (696.5 KBs)

See also:

2008 Financial Crisis Primer

Just in time for the holiday season, law students at the Chicago-Kent School of Law have posted the 2008 Financial Crisis Primer.

This website brings together some of the best and most accessible materials related to the crisis. It provides resources such as articles on the failure of regulation, the Congressional testimony of key players, editorials on the government's bailout of banks, books on previous financial debacles, and the voices of people who have lost homes in foreclosures.

Judicial Hellholes 2008

Each year the American Tort Reform Association lists what they perceive are the most unfair jurisdictions in which to be sued. Depending on your point of view, these could also be the most favorable jurisdictions for awarding damages. West Virginia has received top honors for several years in a row.

Does a First Year Teacher Earn Enough to Pay Off Student Loans?

Some politicians worry that the increasing cost of college and the increasing burden of student loans might deter college graduates from entering public service jobs such as teaching. In "Unbearable Burden? Living and Paying Student Loans as a First-Year Teacher," Neal McCluskey compares first-year salaries for teachers with the average student debt and concludes there is no need to worry.

The findings presented here reveal that first year teachers in even the least affordable of the 16 districts examined can easily afford to pay back their debts. Indeed, with just some basic economizing, a first-year teacher could not only pay back average debt, but could handle debt levels nearly three times the national average. This does not mean that current teacher salaries or student debt burdens are “right”—only markets can determine that—but it does mean that there is no need for policymakers to intervene in either teacher pay or student aid to assure that college graduates can afford to become public school teachers.

Wednesday, December 17, 2008

IRS Lists Tax Law Changes for 2008

IRS Reminder: Make Use of Recent Tax Law Changes for 2008 and Dec. 31 Is the
Last Day for Most of These Actions
FS-2008-26, December 2008
Hear a podcast in English or Spanish.

— Tax year 2008 is quickly nearing an end. The Internal Revenue Service reminds taxpayers to avoid putting off important financial tasks until the last minute. The important deadline of Dec. 31 is fast approaching for many tax-planning issues.

The IRS also urges taxpayers as part of their year-end tax planning to be aware of recent tax changes as well as recently reinstated tax deductions. Some tax breaks and a review of your current tax situation may result in a bigger refund or less taxes to be paid come tax time.

Read more

See also Highlights of 2008 Tax Law Changes: Tax Breaks Renewed, Recovery Rebate Credit, Homeowner Relief

Tuesday, December 16, 2008

Run a FINRA Broker Check on Bernard Madoff

Interested in your brokers professional history? You can run a broker check at FINRA. Try one on Bernard Madoff.

Joint ICI/SIFMA Survey Finds Ownership Driven by Growth of DC Savings Plans

From Press Release

Washington, DC, December 15, 2008—Nearly half of U.S. households owns equities or bonds, a significant increase during the last two decades. But ownership of these investment assets has declined since 2001, as increasing market volatility has reduced Americans’ tolerance for risk, according to a new joint study released today by the Investment Company Institute and the Securities Industry and Financial Markets Association.

Based on a survey of more than 5,000 households, researchers at ICI and SIFMA calculate that 54.5 million households participated in the market through equity or bond ownership in early 2008. This represents 47 percent of U.S. households—up from 39 percent in 1989, the first year for which directly comparable survey data are available.

The two-decade rise in equity and bond investment was fueled by the rapid growth of defined contribution (DC) retirement savings plans, such as 401(k) plans, the researchers conclude. Between 1989 and 2004—the latest year for which comparable
data are available—the number of participants in private-sector DC plans nearly doubled, from 36 million to 65 million. The ICI/SIFMA survey shows that at every income level, working-age households are much more likely to be equity or bond owners if their employer sponsors a DC plan.

Monday, December 15, 2008

The Impossible Economics of a Ponzi Scheme

Bernard Madoff will be the Guinness Record Holder for running the largest Ponzi scheme. However, he will not hold the record for being the best Ponzi schemer of all time. To be the best, you need to time your exit and get out of town before the inevitable collapse. The economics of this house of cards is illustrated in the following table. It is linked to a spreadsheet that estimates the best time for grabbing your passport and making a hasty exit.

The numbers in the table are based on the following assumptions. You can change the growth rates in the linked table and see how the date of inevitable collapse changes.
  • The beginning contribution is $1 million. Each year thereafter the amount contributed by the unsuspecting investors increases by 5%
  • The expected amount that investors think they have in the fund each year is equal to the amount from the previous year compounded at the fictitious return (12%) plus contributions less withdrawals for the current year.
  • Withdrawals each year are equal to 5% of what investors think they have in their accounts based on the assumed fraudulent returns.
  • The actual amount in the fund consists of net contributions for the given year plus last years real balance compounded at the after-Ponzi rate of return. For example, if the actual amount earned on the fund is 3% and the Ponzi manager takes 6% then the after-Ponzi rate is -3%.
  • The criminals take-home pay is equal to a given percentage of the actual amount in the fund in the previous year. In this case a 6% Ponzi tax is assumed.

Assuming there are no expert financial analysts who might get suspicious, and given recent history that seems unlikely, this scheme could last 26 years. You can try out your own parameters and calculate your own get of of town date. One interesting insight is that a higher promised return can reduce the cumulative take-home pay for the criminal. A promised return of 20% will break the bank in the 19th year and and almost cut in half the cumulative profits. Because of a wealth effect created by the higher fictitious return withdrawals increase, cutting the life of the scam. Given that too high a promised return will also decrease credibility, the best promise seems to be an above normal but not exorbitant return. This is likely what Madoff promised.

The obvious factors that hasten the collapse during a recession include a decline in contributions, an increase in withdrawals, and a reduction in the underlying real rate of return.

Google Spreadsheet

Friday, December 12, 2008

Greed is Good, Trust is Bad

The first rule for arms control agreements and personal investing is inspect and verify. You may trust you friends and family, but don't trust your broker. Ponzi schemes need greed, but they only succeed because of trust. Bernard Madoff was the founder and former chairman of Nasdaq and an esteemed member of prominent country clubs. the Palm Beach Country Club and Boca Rio Golf Club. Who wouldn't trust a man like this? He was such a nice guy. He even tried to pay his employees their Christmas bonuses. As reported, "he wanted to pay certain employees portions of the $200 million to $300 million dollars that was left." Wait a second! Weren't those Christmas bonuses other peoples wrongfully taken money?

Trust is an expensive virtue that will likely cost investors over $50 billion. In the days ahead we will hear from investors who say that Madoff never fully explained how he was able to generate a steady stream of profits in these uncertain time. Everyone said he was a financial genius and others had profited. Given trust, there was no need to inspect and verify.

The second rule of investing is don't invest in something you don't understand. Madoff's investors probably received fancy looking reports on expensive paper with ambiguous explanations for past returns. But did any of these financial gurus that channeled clients funds to Madoff really inspect the books? Could any of them explain just how those returns were generated? Madoff would get upset with people that probed too much. They were probably told that they didn't have the financial skills to understand the advanced trading strategies that Madoff was engaging, such as the sideways arabesk or the perambulated put. Brokers closed their eyes, earned their commissions and put their trust in the man. His employees say he was "cryptic" about his business investments. According to one news report, financial consultants "couldn't figure out how he managed to produce steady returns, month after month, even when everyone else was losing money -- and leave almost no footprint while moving billions of dollars in and out of the markets."

Fraudulent schemes flourish in good times. If there is any benefit from a recession, it is that bad times expose fraud. If Madoff's investors didn't need to withdraw funds to cover other losses he could have continued his sham for many more years racking up even more losses. Recessions purge the system, exposing cancerous frauds and driving out failing firms and dying industries. They leave the body weak but intact. Joseph Schumpeter labeled this "creative destruction." You can't have creation without some destruction and if you are not willing to put up with the destruction then you must forgo the creation. It is the necessary preparation for future growth and recovery.

Thursday, December 11, 2008

Free Money For Uncle Sam

Now I like my Uncle Sam as much as anyone else, but I am not about to make him an interest free loan, no matter how credit worthy he may be. Why would anyone make the government an interest free loan when there are FDIC insured CDs with positive interest rates? Is there no premium on the time value of money? Today's Wall Street Journal, "Treasury Bonds: When You Can't Bury Cash in Your Backyard," attributes the drop to firms trimming their end-year balance sheets with safe investments and the need for collateral.

Wednesday, December 10, 2008

A Personalized Gift Envelope is Better Than a Gift Card

You know that gift cards are a bad deal, but you are just too lazy to go shopping and face all those crowds. Why not just give money? Well, cold hard cash just doesn't seem to reflect the Christmas spirit. Here's a way to change that. Print off your own personalized money gift envelope and fill it with some nice crisp bills supplied by your bank. Here is a web site, All Free Printables, with free templates for making your own money envelope. I am sure you can find others on the Internet. Nothing says Christmas more than something you made yourself. No doubt, the recipient will cherish the envelope more than the money inside. (Bah humbug)

Don't Put a Gift Card in That Christmas Stocking

Given the trouble many retailers are in, this is definitely not the season for gift cards. See the previous post When is a Gift Card Not a Gift Card? Echoing this seasonal sentiment is an FTC Consumer Alert: Buying, Giving and Using Gift Cards.

Shopping for gifts can be a real dilemma. Just what do you get your finicky Aunt Mary, your co-worker, or your child’s babysitter? Gift cards may be the answer: one size fits all, and the recipients can get exactly what they want from a retailer or restaurant.But before you buy a stack of gift cards, the Federal Trade Commission (FTC), the nation’s consumer protection agency, wants you to know that there are two types:

  • retail gift cards, which are sold by retailers and restaurants, and can be used only with those merchants. Retail gift cards may have expiration dates or a fee for inactivity that sometimes is called a “dormancy fee.”
  • bank gift cards, which carry the logo of a payment card network like VISA or MasterCard, and can be used at any location accepting cards from that network. There are more likely to be fees for activation, maintenance, or transactions on bank gift cards than on retail gift cards.

Read more

Tuesday, December 9, 2008

Time to Review Your Health Insurance Continuation Coverage Under COBRA

The Kaiser Family Foundation has posted a timely Issue Brief on Health Coverage in a Period of Rising Unemployment By Karyn Schwartz. With rising unemployment and a tightening job market it is time to consider the possibility of being laid-off and the related impact on your family's health insurance protection. As discussed in this issue brief you may be able to hold on to your existing coverage, but it may be expensive. Those with preexisting medical conditions may view that as a preferred alternative to taking out a less expensive policy that omits coverage for preexisting conditions and only covers major medical expenses.

Monday, December 8, 2008

FDIC Study Released on Bank Overdrafts

The FDIC has just released the "FDIC Study of Bank Overdraft Programs." Here are a few of the more interesting findings"

  • Customers with 5 or more NSF transactions accrued 93.4 percent of the total NSF fees reported for the 12-month period. Customers with 10 or more NSF transactions accrued 84 percent of the reported fees. Customer accounts with 20 or more NSF transactions accrued over 68 percent of the reported fees.
  • Customer accounts with 1 to 4 NSF transactions were charged $64 per year in NSF fees on average. Customer accounts with 5 to 9 NSF transactions were charged $215 per year in NFS fees on average. Customer accounts with 10 to 19 NSF transactions were charged $451 per year in NFS fees on average. Customer accounts with 20 or more NSF transactions were charged $1,610 per year in NSF fees on average.
  • Almost half (48.8 percent) of all reported NSF transactions took place at POS/debit (41.0 percent) and ATM (7.8 percent) terminals. Checks accounted for 30.2 percent of the reported NSF transactions.
  • Assuming a $27 overdraft fee (the survey median), a customer repaying a $20 POS/debit overdraft in two weeks would incur an APR of 3,520 percent; a customer repaying a $60 ATM overdraft in two weeks would incur an APR of 1,173 percent; and a customer repaying a $66 check overdraft in two weeks would incur an APR of 1,067 percent. More rapid repayment of the overdraft amount results in higher APRs, and slower repayment results in lower APRs.
  • Accounts held by young adults (ages 18 to 25) were the most likely among all age groups to have automated overdraft NSF activity. Among young adult accounts, 46.4 percent incurred NSF activity, compared with 12.2 percent of accounts held by seniors (over age 62) and 31.9 percent of accounts held by other adults. Nearly 15 percent of accounts held by young adults recorded more than ten NSF transactions during the year, compared with 12.1 percent of adult accounts and 3.0 percent of senior accounts. Most NSF transactions made by young adult accounts (61.7 percent) originated at a POS/debit terminal.

Almost half of the non-sufficient funds (NSF) withdrawals were by young adults using debit cards. No doubt most of these were honest mistakes from not keeping track of accounts. Given the electronic network that exists it would be easy for banks to notify users of insufficient funds at the point of sale. Having been notified, most would have chosen not to incur the overdraft fee. However, given the enormous fees these transactions generate, the banks seem to have little incentive for notifying account holders of a potential overdraft. They make the fees charged by payday lenders look good.

Sunday, December 7, 2008

The Individual Health Insurance Market

The American Society of Actuaries has posted an informative issue brief, "The Individual Medical Insurance Market: A Guide for Policymakers."

Insurance purchased in the individual market was the primary source of health coverage for about 5.4 percent of the nonelderly population, or 14 million people, in 2006.1 The individual market is an important segment of the health insurance market. People who purchase coverage in the individual market include those who are self-employed, between jobs, or don’t have access to either employer coverage or public coverage.

Saturday, December 6, 2008

What Happens to Your Health Insurance Coverage When Your Company Goes Bankupt?

The WSJ in "For Workers, Medical Bills Add to Pain as Firms Fail" (Dec. 6) contains heartbreaking stories of employees who lost their health insurance and were liable for thousand of dollars in medical expenses when their firms were shutdown or entered bankruptcy. The Department of Labor, Fact Sheet: Your Employer's Bankruptcy - How Will It Affect Your Employee Benefits?, has some questions you should ask your employer in the event of bankruptcy.
  • Will the plan continue or will it be terminated?
  • Who will be acting as plan administrator of the plans during and after the bankruptcy, and who will be the trustee in charge of the pension plan?
  • If the pension plan is to be terminated, how will accrued benefits be paid?
  • Will COBRA continuation coverage be offered to terminated employees?
  • If the health plan is to be terminated, how will outstanding health claims be paid, and when will certificates of creditable coverage (showing, among other things, the dates of enrollment in your employer’s health plan) be issued?

In a Chapter 11 reorganization the bankruptcy may or may not affect your pension and your health care plan. With a Chapter 7 bankruptcy the firm ceases to exist and the health plan is terminated, which means that you are probably not eligible for a COBRA extension on your coverage.

Friday, December 5, 2008

FDIC Advice on New Insurance Limits and How to Be Fully Protected

Fall 2008 – Special Edition: Your New, Higher FDIC Insurance CoverageHow You Can Be Fully Protected

With banks and the economy in the news so much lately, many people are thinking more about the safety of their money. The good news for consumers is that federal insurance coverage has significantly increased, primarily as a result of a temporary boost in the basic insurance limit from $100,000 to $250,000. That’s also why the Federal Deposit Insurance Corporation has issued an explanation of the new changes along with tips and information to help bank customers better understand their insurance coverage and how to be sure all their deposits are fully protected.

Kaiser Family Foundation Updates Medicare Primer

Medicare: A Primer

This primer explains key elements of the Medicare program, which now provides health coverage to 45 million people -- including nearly 38 million people age 65 and older and another seven million younger adults with permanent disabilities. It looks at the characteristics of the Medicare population, what benefits are covered, how much people with Medicare pay for their benefits and the program’s overall costs and future financing challenges.

Should a Detroit Executive Drive to Washington?: A Comparative Cost Analysis

Congress is blaming the top auto executives of being wasteful for flying private jets to Washington rather than driving. It makes nice headlines and the auto execs were sufficiently embarrassed by the babbling Washington elite and the news media, but was the choice really inefficient? I decided to try to answer that question by making some heroic assumptions in order to estimate the relative cost of flying versus driving for a top auto executive. In addition, the costs of flying commercial (first class, I thought it was too much to ask them to fly with the hoi polloi) and by private jet were also estimated. The results indicate that driving is the most costly means of travel between Detroit and Washington. Both commercial travel and private jet travel are cheaper. In fact, commercial travel is only slightly cheaper than flying private jet. If the private jet is shared with other passengers, it is most likely the cheapest alternative.

The most important variable in the analysis is the opportunity cost of time. What is one hour worth to a top auto executive and the company? Let's assume that the average annual salary including bonuses and fringe benefits is about $14 million. Let's also assume that these executives work realy realy hard putting in an 80 hour week, twice as hard at the rest of us. Given these assumptions the hourly wage of $3,365 represents a top auto executive's hourly opportunity cost.

The driving time and mileage was estimated with Google Maps. Flying also requires some driving. The first-class air option includes cab fare to and from the airport, while the private jet option assumes a limo. Both air options include one and a half hours flying time. However, I assumed that using the private jet and limo would reduce time at the airport, eliminating the time in line and waiting on the tarmac.

A review of flights on Orbitz indicates that a first-class one-way fare is about $700 and $10,000 was mentioned by the media as the cost flying private jet. Driving costs are valued at the IRS standard rate of 58.5 cents.

Given these assumptions the cost of driving is over ten thousand dollars more expensive than the least cost alternative. Do we really want Washington running the auto companies?

One-Way Cost of Travel Between Detroit and Washington for a Top Executive

Thursday, December 4, 2008

The Graham Ratio Indicates the Market Does Not Suffer From Irrational Pessimism

Christopher D. Carroll in "Recent Stock Declines: Panic or the Purge of “Irrational Exuberance”? The Economists Voice, Vol. 5 (2008) presents new data on the Graham Ratio. As originally proposed by Benjamin Graham it is the ratio of stock prices to a 10-year average of lagged earnings. Carroll revises the ratio for a 12-year average of lagged earnings in order to more closely follow the political cycle. As indicated in the above diagram from the article, high values of the Graham ratio have signalled lower subsequent returns over the next 12 years. The current Graham ratio is about right in the center of the data plot indicating neither irrational exuberance or pessimism.

Recourse and Non-recourse Home Mortgages

A home mortgage is secured by the property. The mortgage provides the lender the right to foreclose on the property in the event the mortgage payments are not made. Suppose the home sells at foreclosure for less than the outstanding balance on the mortgage? With a non-recourse loan, the lender may not come after the borrower for the remaining amount. With a recourse loan the borrower is responsible for any outstanding amount still owed after the sale of the home. Most homes are financed with non-recourse loans; however, this differs by jurisdiction. Moreover, in some markets the first mortgage may be non-recourse, while second mortgages may be recourse loans. The state laws governing home mortgages can be found at As always, the information should be checked with a lawyer in your state.

When debt is forgiven, it is generally taxed as income. However, the IRS has special rules when home mortgage debt is forgiven because of a non-recourse mortgage. The amount forgiven reduces the cost basis in the home.

Martin Feldstein has argued that non-recourse home mortgages give the homeowner too much of an incentive to walk away from the home when housing prices drop. He maintains that this has contributed to the current mortgage crisis. To alleviate the drop in home prices, he believes the government should offer to refinance a share of each homeowner’s mortgage at a substantially lower interest rate. In return for the lower interest rate and smaller monthly payments the borrower would be obligated to repay a full-recourse loan. The government loan would be a full-recourse loan that could not be discharged in a personal bankruptcy. Such a mortgage would eliminate the potential incentive for default and stem the rising tide of foreclosures. There is no doubt that the sale of foreclosed property has contributed to the decline in housing prices. The WSJ reports that the sale of distressed properties accounted for 35% to 40% of transactions in the third quarter. You can go to Freakonomics for a discussion of this proposal.

Wednesday, December 3, 2008

Terrorism and Homeowners Insurance

Now that Congress has issued a report indicating we are likely to suffer a terrorist attach by 2013 maybe it is time to review your homeowners policy. The Insurance Information Institute states the following:

Standard homeowners insurance policies include coverage for damage to property and personal possessions resulting from acts of terrorism. Terrorism is not specifically referenced in homeowners policies. However, the policy does cover the homeowner for damage due to explosion, fire and smoke—the likely causes of damage in a terrorist attack.

Condominium or co-op owner policies also provide coverage for damage to personal possessions resulting from acts of terrorism. Damage to the common areas of a building like the roof, basement, elevator, boiler and walkways would only be covered if the condo/co-op board has purchased terrorism coverage.

Standard renters policies include coverage for damage to personal possessions due to a terrorist attack. Again, coverage for the apartment complex itself must be purchased by the property owner or landlord.Auto insurance policies will cover a car that is damaged or destroyed in a terrorist attack only if the policyholder has purchased “comprehensive” coverage. Most people who have loans on their cars or lease are required by lenders and leasing companies to carry this optional form of coverage. People who buy liability coverage only are not covered in the event their vehicle is damaged or destroyed as the result of a terrorist attack.

Life insurance policies do not contain terrorism exclusions. Proceeds will be paid to the beneficiary as designated on the policy.

Looks like you should be pretty well covered. But what if the losses exceed the ability of the company to pay? That contingency is covered by the Terrorism Risk Insurance Act (TRIA).

The Financial Crisis and Private Defined Benefit Plans

The Financial Crisis and Private Defined Benefit Plans
by Alicia H. Munnell, Jean-Pierre Aubry, and Dan Muldoon

Between October 9, 2007 and October 9, 2008, the value of equities in retirement plans dropped by about $4 trillion, with the decline divided equally between defined benefit and 401(k)/Individual Retirement Accounts (IRAs). The decline in the defined benefit arena was in turn divided equally between private sector plans and those sponsored by state and local governments. This brief explores what a loss of roughly $1 trillion of private sector defined benefit equities means for the individual participants and for the firms that sponsor those plans.

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Mortgage Fraud Jumps 45% According to the Mortgage Asset Research Institute

Key Findings: Fraud Most Often Occurs at the Beginning of the Loan Process

RESTON, Va. - December 2, 2008 - Reported incidents of mortgage fraud in the U.S. increased by 45 percent on fewer loan applications in the second quarter of 2008 from a year ago, according to a new report released today by the Mortgage Asset Research Institute (MARISM), a LexisNexis service. The MARI Quarterly Fraud Report is based on data submitted by MARI subscribers on loans originated in the second quarter of this year that have since been classified as fraudulent.

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Monday, December 1, 2008

New Law Encourages Cash Donations for Midwest Disaster Relief

IR-2008-133, Nov. 25, 2008
WASHINGTON –– Taxpayers who make qualifying cash contributions for disaster relief efforts in the Midwest could benefit from a recently passed law that suspends the percentage-of-income limits that would normally apply when taxpayers deduct the contributions on their 2008 federal tax returns.

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Saver’s Credit; Tax Break Helps Low- and Moderate-Income Workers Save for Retirement

IR-2008-134, Dec. 1, 2008
WASHINGTON — Low- and moderate-income workers can take steps now to save for retirement and earn a special tax credit in 2008 and the years ahead, according to the Internal Revenue Service.

The saver’s credit helps offset part of the first $2,000 workers voluntarily contribute to Individual Retirement Arrangements (IRAs) and to 401(k) plans and similar workplace retirement programs. Also known as the retirement savings contributions credit, the saver’s credit is available in addition to any other tax savings that apply.

IRS Announces 2009 Standard Mileage Rates

News release IR-2008-131 gives the optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes beginning on Jan. 1, 2009.
Beginning on Jan. 1, 2009, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:
55 cents per mile for business miles driven
24 cents per mile driven for medical or moving purposes
14 cents per mile driven in service of charitable organizations