Questions on the Credit Crunch
As I write this the House has just rejected the plan proposed by Secretary Paulson to throw a lifeline to the markets.
Last week our local paper the Sun News asked me to respond to some questions from their readers who were concerned about how the credit crisis would affect them. You may have some of the same questions so I'll post my responses here.
Is there a safe place to put away money anymore?
Safety is always relative to what your needs are. If you need to earn 5% on your investments to pay for your living expenses, then the surety of earning 3.38% on a 10 year US Treasury Note isn't a safe strategy.
If your question is where can I safely park some money for a short time, then you should know that US Treasury Bills, Bonds, and Notes are considered the safest and most secure investments in the world. Bank certificates of deposit to the degree they are insured by the FDIC are also very safe for short term investments. However, be sure to stay within the FDIC limits of $100,000 per depositor ($250,000 for IRA accounts). Depositors only received 50 cents on every dollar over the FDIC insurance limit when Indy Mac was closed. Finally, money market accounts that invest only in treasury instruments are also a safe haven in uncertain times.
There are a few things that can go wrong. First, the 'safe reserves' could turn out to be not so safe after all, as has been the case with some mortgage investments. Secondly, the value of these reserves could fall. Because accounting standards require companies to mark the value of their reserves to market, and the market for many mortgage securities has dried up, the value of the reserves has gone down which is why you read about so many companies having to raise extra capital. Finally, the risk assumptions on which the reserve requirements are based could turn out to be wrong. As in the case of AIG, they were insuring against credit defaults of other companies and were hit by the perfect storm that proved too much to navigate. Too many things went wrong at once, exposing the fact that their reserves were inadequate.
Today many financial companies are being hit by a combination of all the above problems. That is why this is such a big problem requiring so much intervention by the Federal Reserve and the Treasury Department.
I am 55 yrs. old and have a 401 K-mostly stocks, Should I change my current contributions to Bonds?
This is a hard question to answer without more information. When do you plan to retire? Do you already have enough money to fund the retirement lifestyle you have always dreamed about? What other investments do you have? etc.
My advise to those who are contributing to a 401k or any other retirement plan is to first have a plan. Living along the coast we know that hurricanes come from time to time. We make plans for how to deal with these storms before the storm hits, not when we are in the middle of a storm. If you have a plan then you know what to do when the storm arrives and don't make mistakes in panic.
I have an account with AIG, buying stock...they bought out Sharebuilders.com ; Is this in danger too?
Not now. The government bailout of AIG means there will not be a bankruptcy filing - at least not for the next two years. In the meantime AIG will be selling some assets to repay the US Treasury and their broker-dealer unit may well be an asset they sell.
Can someone tell me, why don't the Bank's reverse the bad loan interest rates, instead of the American public trying to keep up with bad loans, and give everyone the same interest rates?
I believe what you are asking is why banks do not reduce the interest rates on the sub prime loans they have made. You should realize that they can't because they no longer own the loan. A large part of the mortgage problem is that banks and mortgage brokers have sold consumers loans on which they merely collect a fee or commission. The mortgages are then aggregated into large blocks, sliced and diced by Wall Street, and resold to individual and institutional investors around the world. The bank then collects a loan servicing fee to collect the payments on behalf of the mortgage holders. No one really knows who owns your mortgage, so the only way to reduce the rate is to refinance the entire loan (another fee for the banks). Banks are often unwilling to do this because, much to the surprise of many, the value of the real estate involved has gone down. In many cases the value of the underlying real estate is lower than the amount owned on the mortgage. This is the classic caught between a rock and a hard place.
I see a number of bank money market accounts paying rates of 3.75% listed on Money-Rates.com . Aren't these a lot better than money markets from mutual funds because they are FDIC-insured not to mention paying much higher rates?
You are right sometimes banks are willing to pay more for money market deposits than market rates allow money market mutual funds to earn and distribute to shareholders. As long as you arrange ownership of your accounts so that they are fully insured by the FDIC it is a good alternative. The FDIC even has an online tool you can use to help maximize your insurance protection. You can find it at http://www.fdic.gov/edie/.
But please beware of having deposits with any bank that are not covered by the FDIC. When Indy Mac was taken over by the banking regulators depositors with deposits not covered by insurance have so far received only 50 cents for every dollar that was not insured.
Last week our local paper the Sun News asked me to respond to some questions from their readers who were concerned about how the credit crisis would affect them. You may have some of the same questions so I'll post my responses here.
Is there a safe place to put away money anymore?
Safety is always relative to what your needs are. If you need to earn 5% on your investments to pay for your living expenses, then the surety of earning 3.38% on a 10 year US Treasury Note isn't a safe strategy.
If your question is where can I safely park some money for a short time, then you should know that US Treasury Bills, Bonds, and Notes are considered the safest and most secure investments in the world. Bank certificates of deposit to the degree they are insured by the FDIC are also very safe for short term investments. However, be sure to stay within the FDIC limits of $100,000 per depositor ($250,000 for IRA accounts). Depositors only received 50 cents on every dollar over the FDIC insurance limit when Indy Mac was closed. Finally, money market accounts that invest only in treasury instruments are also a safe haven in uncertain times.
I've heard that insurance companies have to keep a very high percentage of their assets
There are a few things that can go wrong. First, the 'safe reserves' could turn out to be not so safe after all, as has been the case with some mortgage investments. Secondly, the value of these reserves could fall. Because accounting standards require companies to mark the value of their reserves to market, and the market for many mortgage securities has dried up, the value of the reserves has gone down which is why you read about so many companies having to raise extra capital. Finally, the risk assumptions on which the reserve requirements are based could turn out to be wrong. As in the case of AIG, they were insuring against credit defaults of other companies and were hit by the perfect storm that proved too much to navigate. Too many things went wrong at once, exposing the fact that their reserves were inadequate.
Today many financial companies are being hit by a combination of all the above problems. That is why this is such a big problem requiring so much intervention by the Federal Reserve and the Treasury Department.
I am 55 yrs. old and have a 401 K-mostly stocks, Should I change my current contributions to Bonds?
This is a hard question to answer without more information. When do you plan to retire? Do you already have enough money to fund the retirement lifestyle you have always dreamed about? What other investments do you have? etc.
My advise to those who are contributing to a 401k or any other retirement plan is to first have a plan. Living along the coast we know that hurricanes come from time to time. We make plans for how to deal with these storms before the storm hits, not when we are in the middle of a storm. If you have a plan then you know what to do when the storm arrives and don't make mistakes in panic.
I have an account with AIG, buying stock...they bought out Sharebuilders.com ; Is this in danger too?
Not now. The government bailout of AIG means there will not be a bankruptcy filing - at least not for the next two years. In the meantime AIG will be selling some assets to repay the US Treasury and their broker-dealer unit may well be an asset they sell.
Can someone tell me, why don't the Bank's reverse the bad loan interest rates, instead of the American public trying to keep up with bad loans, and give everyone the same interest rates?
I believe what you are asking is why banks do not reduce the interest rates on the sub prime loans they have made. You should realize that they can't because they no longer own the loan. A large part of the mortgage problem is that banks and mortgage brokers have sold consumers loans on which they merely collect a fee or commission. The mortgages are then aggregated into large blocks, sliced and diced by Wall Street, and resold to individual and institutional investors around the world. The bank then collects a loan servicing fee to collect the payments on behalf of the mortgage holders. No one really knows who owns your mortgage, so the only way to reduce the rate is to refinance the entire loan (another fee for the banks). Banks are often unwilling to do this because, much to the surprise of many, the value of the real estate involved has gone down. In many cases the value of the underlying real estate is lower than the amount owned on the mortgage. This is the classic caught between a rock and a hard place.
I see a number of bank money market accounts paying rates of 3.75% listed on Money-Rates.com . Aren't these a lot better than money markets from mutual funds because they are FDIC-insured not to mention paying much higher rates?
You are right sometimes banks are willing to pay more for money market deposits than market rates allow money market mutual funds to earn and distribute to shareholders. As long as you arrange ownership of your accounts so that they are fully insured by the FDIC it is a good alternative. The FDIC even has an online tool you can use to help maximize your insurance protection. You can find it at http://www.fdic.gov/edie/.
But please beware of having deposits with any bank that are not covered by the FDIC. When Indy Mac was taken over by the banking regulators depositors with deposits not covered by insurance have so far received only 50 cents for every dollar that was not insured.
Labels: credit crunch
posted by Joe Taylor at 6:00 PM
0 comments
