How and Why Do Companies Pay Dividends?
by Investopedia Staff, (Investopedia.com) (Contact Author Biography)
Look anywhere on the web and you're bound to find information on how dividends affect stockholders: the information ranges from a consideration of steady flows of income, to the proverbial "widows and orphans", and to the many different tax benefits that dividend-paying companies provide. An important part missing in many of these discussions is the purpose of dividends and why they are used by some companies and not by others. Before we begin describing the various policies that companies use to determine how much to pay their investors, let's look at different arguments for and against dividends policies. (Read more about widows and orphans in Widow And Orphan Stocks: Do They Still Exist?)
Arguments Against Dividends
First, some financial analysts feel that the consideration of a dividend policy is irrelevant because investors have the ability to create "homemade" dividends. These analysts claim that this income is achieved by individuals adjusting their personal portfolios to reflect their own preferences. For example, investors looking for a steady stream of income are more likely to invest in bonds (in which interest payments don't change), rather than a dividend-paying stock (in which value can fluctuate). Because their interest payments won't change, those who own bonds don't care about a particular company's dividend policy.
The second argument claims that little to no dividend payout is more favorable for investors. Supporters of this policy point out that taxation on a dividend is higher than on a capital gain. The argument against dividends is based on the belief that a firm that reinvests funds (rather than paying them out as dividends) will increase the value of the firm as a whole and consequently increase the market value of the stock.
According to the proponents of the no dividend policy, a company's alternatives to paying out excess cash as dividends are the following: undertaking more projects, repurchasing the company's own shares, acquiring new companies and profitable assets, and reinvesting in financial assets. (Keep reading about capital gains in Tax Effects On Capital Gains.)
Arguments For Dividends
In opposition to these two arguments is the idea that a high dividend payout is important for investors because dividends provide certainty about the company's financial well-being; dividends are also attractive for investors looking to secure current income. In addition, there are many examples of how the decrease and increase of a dividend distribution can affect the price of a security.
Companies that have a long-standing history of stable dividend payouts would be negatively affected by lowering or omitting dividend distributions; these companies would be positively affected by increasing dividend payouts or making additional payouts of the same dividends.
Furthermore, companies without a dividend history are generally viewed favorably when they declare new dividends. (For more, see Dividends Still Look Good After All These Years.)
Dividend-Paying Methods
Now, should the company decide to follow either the high or low dividend method, it would use one of three main approaches: residual, stability, or a hybrid compromise between the two.
Residual
Companies using the residual dividend policy choose to rely on internally generated equity to finance any new projects. As a result, dividend payments can come out of the residual or leftover equity only after all project capital requirements are met. These companies usually attempt to maintain balance in their debt/equity ratios before making any dividend distributions, which demonstrates that they decide on dividends only if there is enough money left over after all operating and expansion expenses are met.
For example, let's suppose that a company named CBC has recently earned $1,000 and has a strict policy to maintain a debt/equity ratio of 0.5 (one part debt to every two parts of equity).
Now, suppose this company has a project with a capital requirement of $900. In order to maintain the debt/equity ratio of 0.5, CBC would have to pay for one-third of this project by using debt ($300) and two-thirds ($600) by using equity. In other words, the company would have to borrow $300 and use $600 of its equity to maintain the 0.5 ratio, leaving a residual amount of $400 ($1,000 - $600) for dividends. On the other hand, if the project had a capital requirement of $1,500, the debt requirement would be $500 and the equity requirement would be $1,000, leaving zero ($1,000 - $1,000) for dividends. If any project required an equity portion that was greater than the company's available levels, the company would issue new stock.
Stability
The fluctuation of dividends created by the residual policy significantly contrasts with the certainty of the dividend stability policy. With the stability policy, companies may choose a cyclical policy that sets dividends at a fixed fraction of quarterly earnings, or it may choose a stable policy whereby quarterly dividends are set at a fraction of yearly earnings. In either case, the aim of the dividend stability policy is to reduce uncertainty for investors and to provide them with income.
Suppose our imaginary company, CBC, earned the $1,000 for the year (with quarterly earnings of $300, $200, $100, $400). If CBC decided on a stable policy of 10% of yearly earnings ($1,000 x 10%), it would pay $25 ($100/4) to shareholders every quarter. Alternatively, if CBC decided on a cyclical policy, the dividend payments would adjust every quarter to be $30, $20, $10 and $40 respectively. In either instance, companies following this policy are always attempting to share earnings with shareholders rather than searching for projects in which to invest excess cash.
Hybrid
The final approach is a combination between the residual and stable dividend policy. Using this approach, companies tend to view the debt/equity ratio as a long-term rather than a short-term goal. In today's markets, this approach is commonly used by companies that pay dividends. As these companies will generally experience business cycle fluctuations, they will generally have one set dividend, which is set as a relatively small portion of yearly income and can be easily maintained. On top of this set dividend, these companies will offer another extra dividend paid only when income exceeds general levels.
Conclusion
If a company decides to pay dividends, it will choose one of three approaches: residual, stability or hybrid policies. Which a company chooses can determine how profitable its dividend payments will be for investors - and how stable the income.To read more on this subject, see Dividend Facts You May Not Know.
by Investopedia Staff, (Contact Author Biography)
Investopedia.com believes that individuals can excel at managing their financial affairs. As such, we strive to provide free educational content and tools to empower individual investors, including thousands of original and objective articles and tutorials on a wide variety of financial topics.
http://investopedia.com/articles/03/011703.asp?partner=basics4bb
Saturday 11 April 2009
How Low Can The Market Go?*
How Low Can The Market Go?*
Henry Blodget
Henry Blodget
Mar. 5, 2009, 4:49 PM59
*UPDATE: After today's 4% drop, the S&P 500 is now at 680, an 11.85 P/E.
EARLIER: On days like today, it helps to look at the silver lining. Here it is: The farther stocks fall, the cheaper they get--and the higher the expected long-term return becomes. Unfortunately, that doesn't mean we don't have a long way to go on the downside.
There were four massive stock bubbles in the 20th Century: 1901, 1929, 1966, and 2000. During each of these bubble peaks, the S&P 500 neared or exceeded 25X on professor Robert Shiller's cyclically adjusted P/E ratio.* After the first three of these peaks, the S&P 500 PE did not bottom until it hit 5X-8X. We're still in the middle of the last one.
The most recent bubble peak, 2000, was by far the most extreme we have ever experienced. In 2000, the S&P 500 by prof. Shiller's measure exceeded 40X (it had never before exceeded 30X). With the S&P 500 hitting 700 today, the PE has now fallen back to 12X. (See chart above.)
Three major bubbles are not enough historical precedent to confidently conclude where the S&P 500 will bottom this time around, but it seems reasonable to conclude that the trough will be in line with--or below--the preceeding lows (Given that we just had the highest peak in history by a mile, it doesn't seem absurd to think that we might be headed for the lowest trough in history by a mile.)
So where are we now?
Based on Professor Shiller's latest numbers, we're at about a 12X P/E. (Prof. Shiller's last update was at 805 on the S&P 500, which produced a 14X P/E. Plugging in today's 700 on the same earnings number, we get about a 12X P/E). The 12X PE compares favorably to the long-term arithmetic average of 16X, but it's still way above the historical troughs of 5X-8X.
So where would the S&P bottom if we hit the previous trough PE lows? It depends how we get there.
If the stock market stops falling and earnings eventually begin to grow again, we would be close to the bottom: The market could simply move sideways for 5-10 years while earnings growth gradually reduced the PE to the 5X-8X range. This is what happened in the 1970s.
Alternatively, the market could just keep dropping, as it did in the early 1930s.
Using Professor Shiller's latest earnings data, here's where the numbers would fall out if the market just kept dropping and 10-year average earnings didn't grow from today's level:
P/E S&P 500 Level
*UPDATE: After today's 4% drop, the S&P 500 is now at 680, an 11.85 P/E.
EARLIER: On days like today, it helps to look at the silver lining. Here it is: The farther stocks fall, the cheaper they get--and the higher the expected long-term return becomes. Unfortunately, that doesn't mean we don't have a long way to go on the downside.
There were four massive stock bubbles in the 20th Century: 1901, 1929, 1966, and 2000. During each of these bubble peaks, the S&P 500 neared or exceeded 25X on professor Robert Shiller's cyclically adjusted P/E ratio.* After the first three of these peaks, the S&P 500 PE did not bottom until it hit 5X-8X. We're still in the middle of the last one.
The most recent bubble peak, 2000, was by far the most extreme we have ever experienced. In 2000, the S&P 500 by prof. Shiller's measure exceeded 40X (it had never before exceeded 30X). With the S&P 500 hitting 700 today, the PE has now fallen back to 12X. (See chart above.)
Three major bubbles are not enough historical precedent to confidently conclude where the S&P 500 will bottom this time around, but it seems reasonable to conclude that the trough will be in line with--or below--the preceeding lows (Given that we just had the highest peak in history by a mile, it doesn't seem absurd to think that we might be headed for the lowest trough in history by a mile.)
So where are we now?
Based on Professor Shiller's latest numbers, we're at about a 12X P/E. (Prof. Shiller's last update was at 805 on the S&P 500, which produced a 14X P/E. Plugging in today's 700 on the same earnings number, we get about a 12X P/E). The 12X PE compares favorably to the long-term arithmetic average of 16X, but it's still way above the historical troughs of 5X-8X.
So where would the S&P bottom if we hit the previous trough PE lows? It depends how we get there.
If the stock market stops falling and earnings eventually begin to grow again, we would be close to the bottom: The market could simply move sideways for 5-10 years while earnings growth gradually reduced the PE to the 5X-8X range. This is what happened in the 1970s.
Alternatively, the market could just keep dropping, as it did in the early 1930s.
Using Professor Shiller's latest earnings data, here's where the numbers would fall out if the market just kept dropping and 10-year average earnings didn't grow from today's level:
P/E S&P 500 Level
10X 575
8X 460 (highest previous trough low)
7X 400 (average previous trough low)
6X 350
5X 300 (lowest previous trough low)
In short, if the S&P fell straight to the high-end of its previous trough range (8X PE, or 460), it would fall another 35% from today's level (700)
If the S&P fell straight to the low-end of its previous trough range (5X PE, or 300), it would fall another 55+% from today's level.
Here's hoping we don't set a new low on the downside.
--------------------------------------------------------------------------------
* Shiller's "cyclically adjusted" PE takes an average of 10 years of S&P 500 earnings instead of using a single year's. Why? Because the business cycle makes single-year earnings misleading. In boom times, profit margins are high, and P/Es look artificially low (and stocks look misleadingly cheap). In busts, profit margins collapse, and P/Es look artificially high (and stocks look misleadingly expensive--as is the case this year). Shiller's cyclically-adjusted PE mutes the effect of the business cycle and, therefore, provides a much more informative and predictive PE ratio.
Here's a link to Professor Shiller's site, where you can download an Excel spreadsheet with all of the S&P 500 data >
Today's Bear Market Now Not As Bad As The Great Crash!
Today's Bear Market Now Not As Bad As The Great Crash!
Henry BlodgetApr. 6, 2009, 6:17 AM7
We are happy to report, via Doug Short, that today's bear market is no longer as bad as the Great Crash, as measured by depth-of-decline-over-time. Thanks to the rally of the past month, we've crawled back above the Great Crash trendline.
Henry BlodgetApr. 6, 2009, 6:17 AM7
We are happy to report, via Doug Short, that today's bear market is no longer as bad as the Great Crash, as measured by depth-of-decline-over-time. Thanks to the rally of the past month, we've crawled back above the Great Crash trendline.
It's worth noting, however, that the rip-roaring bull market of the past month does bear an unnerving resemblance to a similar pattern in 1931...before the last leg of the Great Crash took the DOW from down 50% to down 89%.
Visit dshort.com for an interactive version of this chart, as well as a bunch of other cool charts and analyses >
Is the Stock Market Cheap?
In times of critical importance, the conventional P/E ratio often lags the index to the point of being useless as a value indicator. "Why the lag?" you may wonder. "How can the P/E be at a record high after the price has fallen so far?" The explanation is simple. Earnings fell faster than price. In fact, the negative earnings of Q4 is something that has never happened before in the history of the S&P Composite.
The P/E10 Ratio
Legendary economist and value investor Benjamin Graham noticed the same bizarre P/E behavior during the Roaring Twenties and subsequent market crash. Graham collaborated with David Dodd to devise a more accurate way to calculate the market's value, which they discussed in their 1934 classic book, Security Analysis. They attributed the illogical P/E ratios to temporary and sometimes extreme fluctuations in the business cycle. Their solution was to divide the price by the 10-year average of earnings, which we'll call the P/E10. In recent years, Yale professor Robert Shiller, the author of Irrational Exuberance, has reintroduced the P/E10 to a wider audience of investors.
April 3, 2009 revised April 6th
An old-fashioned way to answer this question is to look at the historic Price-to-Earnings (P/E) ratio using reported earnings (as opposed to earnings estimates).
The "price" part of the P/E calculation is available in real time on TV and the Internet. The "earnings" part, however, is more difficult to find. The authoritative source is the Standard & Poor's website, where the latest earnings are posted on the earnings page in a linked Excel file (see column D). More...
140 Years Of Bull And Bear Markets
140 Years Of Bull And Bear Markets
Henry BlodgetApr. 6, 2009, 3:25 PM
Doug Short has created a nice snapshot of 140 years of market history. It's a logarithmic chart, so it shows the impact of percentage rather than absolute price moves, and prices have been adjusted for inflation. Note that the chart is price-only: It does not include the impact of dividends.
Key points:
Bull and bear markets have always been with us (duh)
The market spends about half the time above trend and half below trend (duh)
The market has been above trend for about 20 years (ruh roh)
The trough-to-peak 18-year bull market that peaked in 2000 (+666%) was the biggest in history by a mile (ruh roh)
In the 5-year bull market in the middle of the Great Depression (1932-1937), the S&P jumped 266% (five years is a long time--don't want to miss that)
20 years after the 1929 peak, the S&P traded at half its 1929 value (ruh roh)
Doug short has more thoughts at dshort.com >
See Also:
Today's Bear Market Is No Longer Worse Than The Great Crash!
Henry BlodgetApr. 6, 2009, 3:25 PM
Doug Short has created a nice snapshot of 140 years of market history. It's a logarithmic chart, so it shows the impact of percentage rather than absolute price moves, and prices have been adjusted for inflation. Note that the chart is price-only: It does not include the impact of dividends.
Key points:
Bull and bear markets have always been with us (duh)
The market spends about half the time above trend and half below trend (duh)
The market has been above trend for about 20 years (ruh roh)
The trough-to-peak 18-year bull market that peaked in 2000 (+666%) was the biggest in history by a mile (ruh roh)
In the 5-year bull market in the middle of the Great Depression (1932-1937), the S&P jumped 266% (five years is a long time--don't want to miss that)
20 years after the 1929 peak, the S&P traded at half its 1929 value (ruh roh)
Doug short has more thoughts at dshort.com >See Also:
Today's Bear Market Is No Longer Worse Than The Great Crash!
How Bear Markets End
Posted April 7, 2009 05:15 PM (EST)
How Bear Markets End
Doug Short has taken a detailed look at the 10 bear markets and bear-market-recoveries since 1950. You can click through a slideshow showing each of these periods in detail here >
Importantly, Doug's charts do not include the horrific bear market of 1929-1932, which puts all of the post-war ones to shame. To get a more detailed sense of how that one "bottomed," click through to the last slide, which overlays our current bear market on top of the three nastiest ones in the last century.
Some key points:
* The 10 bear markets since 1950 have bottomed down 20% to 57% (the low in the current cycle) off the peak. The current bear is by far the worst since the Great Crash, which bottomed down 89%.
* The bear phases of these markets lasted from 3 - 30 months (we're currently in month 17). The drop from 1929-1932 was also about 30 months.
* Most of these markets offered some sort of "retest" of the low. Importantly, however, some did not. (As always, beware confident "technical" analysts)
* As this additional chart shows, the S&P is now trading about in-line with its long-term price trend after 15 years of trading above it. So even if we have put in the bear-market bottom, it is likely that the S&P will eventually trade below trend for a considerable period of time.
See Also: 140 Years Of Bull And Bear Markets
Friday 10 April 2009
How to Start a Business with No Money
Posted April 8, 2009 04:35 PM (EST)
How to Start a Business with No Money
Is it possible to start a business with little or no money? Absolutely. In fact, back in 2004 that's exactly what I did. I launched World 50, investing only $400.00, and that was to buy stationary to print invoices.
This was good news for me, because I had no money. Zilch, nada, goose egg, the bagel. And I quickly discovered that investors don't want to invest in you anyway until the model is proven, and then take everything for their investment. Bad idea, particularly if you don't have a track record.
I learned that with the right approach, starting a business with no money is not only possible; it results in a better company. Here are some tips:
1) Live off your current job as long as possible. There is no reason you cannot explore and experiment through your entire first year of launching a new business while holding down another full time job. The first year is about ideation, about coming up with bad ideas and letting other people explain to you why they are bad, and how they can be better. You can nurture and grow the idea, and also build the initial wave of enthusiasm with prospective customers and employees all while moonlighting.
Got fired? Even better. After the first few weeks of a job search, no one can spend 50+ hours a week focused entirely on finding employment. Think Jack Nicholson in The Shining. Use your non-search time to gestate and spin-up a new idea. It's healthy, and may really lead to something. This is what happened to me.
2) Let your customers fund your working capital. This is key, although it is not possible for every business model. Developing, testing and manufacturing many products requires significant capital up front. But for a service business, it is much easier. My company sold annual subscription memberships to executives. The fees were required to be paid up front, but our costs were not incurred until months later. With no salary (living on a couple months of severance) and no immediate expenses, we quickly built up a bank account of $300k and rising.
Even if your idea does require making a product, it can be launched inexpensively. My good friend, Sara Blakely, started the amazingly successful company Spanx with less than five thousand dollars. She researched and wrote most of the patent on her own (using attorneys for the clean up), then begged and borrowed to find a plant to make her prototype. From there, she lined up orders, and the cash flow equation fell into place.
3) Outsource your sales department. You can't afford to hire (or commit to) high-ticket sales people. Find companies who already have a relationship with your target customers, and rope them in. World 50 sold to the highest level executives in world, and I had a small problem - I didn't personally know a single one! But I was able to talk Accenture, Bain, Omnicom, WPP and others into making all the introductions for me - all I had to do was close the sale.
In fact, these partner companies quickly became so excited about my new business that they donated all of our branding work, technology development and PR - and each actually paid me $50,000 for the right to do so! Now that may be hard to replicate, but if you can find ways to get your partners excited, you can get them to contribute.
4) You don't need to give away equity. Many people I have spoken with think that if you don't have cash, then the only way to launch is to give away lots of equity - to partners, to employees, to initial customers. Not so. I seriously considered giving our first customers and partners equity in the company to get them to participate. But as it turned out...they didn't want it! Customers could easily sign up and write me a check, it was a simple transaction - but if they received even one share of equity, it went to their legal department - and good luck wading through that mess. As for my service provider partners? They just wanted to participate in what my company was doing, and NOT have any brand liability in case I screwed things up. Take the high rode. I kept 100% of the equity.
***
In the end, launching a company with no money will force you to
1) build a better model which has sustainable cash flow right out of the gate - one of the most important things,
2) truly engage your partners - you are unlikely to succeed without them (money or not), and
3) retain control! You need to steer the ship, not your partners or customers, and certainly not your external investors ("Hey Rick, it's been 3.5 years - time to sell!").
The bottom line is this: If you can't earn the interest and attention of customers, partners and employees, you WON'T be able to buy it. And if you can, then why pay for it?
This post was originally published at RickSmith.me
How to Start a Business with No Money
Is it possible to start a business with little or no money? Absolutely. In fact, back in 2004 that's exactly what I did. I launched World 50, investing only $400.00, and that was to buy stationary to print invoices.
This was good news for me, because I had no money. Zilch, nada, goose egg, the bagel. And I quickly discovered that investors don't want to invest in you anyway until the model is proven, and then take everything for their investment. Bad idea, particularly if you don't have a track record.
I learned that with the right approach, starting a business with no money is not only possible; it results in a better company. Here are some tips:
1) Live off your current job as long as possible. There is no reason you cannot explore and experiment through your entire first year of launching a new business while holding down another full time job. The first year is about ideation, about coming up with bad ideas and letting other people explain to you why they are bad, and how they can be better. You can nurture and grow the idea, and also build the initial wave of enthusiasm with prospective customers and employees all while moonlighting.
Got fired? Even better. After the first few weeks of a job search, no one can spend 50+ hours a week focused entirely on finding employment. Think Jack Nicholson in The Shining. Use your non-search time to gestate and spin-up a new idea. It's healthy, and may really lead to something. This is what happened to me.
2) Let your customers fund your working capital. This is key, although it is not possible for every business model. Developing, testing and manufacturing many products requires significant capital up front. But for a service business, it is much easier. My company sold annual subscription memberships to executives. The fees were required to be paid up front, but our costs were not incurred until months later. With no salary (living on a couple months of severance) and no immediate expenses, we quickly built up a bank account of $300k and rising.
Even if your idea does require making a product, it can be launched inexpensively. My good friend, Sara Blakely, started the amazingly successful company Spanx with less than five thousand dollars. She researched and wrote most of the patent on her own (using attorneys for the clean up), then begged and borrowed to find a plant to make her prototype. From there, she lined up orders, and the cash flow equation fell into place.
3) Outsource your sales department. You can't afford to hire (or commit to) high-ticket sales people. Find companies who already have a relationship with your target customers, and rope them in. World 50 sold to the highest level executives in world, and I had a small problem - I didn't personally know a single one! But I was able to talk Accenture, Bain, Omnicom, WPP and others into making all the introductions for me - all I had to do was close the sale.
In fact, these partner companies quickly became so excited about my new business that they donated all of our branding work, technology development and PR - and each actually paid me $50,000 for the right to do so! Now that may be hard to replicate, but if you can find ways to get your partners excited, you can get them to contribute.
4) You don't need to give away equity. Many people I have spoken with think that if you don't have cash, then the only way to launch is to give away lots of equity - to partners, to employees, to initial customers. Not so. I seriously considered giving our first customers and partners equity in the company to get them to participate. But as it turned out...they didn't want it! Customers could easily sign up and write me a check, it was a simple transaction - but if they received even one share of equity, it went to their legal department - and good luck wading through that mess. As for my service provider partners? They just wanted to participate in what my company was doing, and NOT have any brand liability in case I screwed things up. Take the high rode. I kept 100% of the equity.
***
In the end, launching a company with no money will force you to
1) build a better model which has sustainable cash flow right out of the gate - one of the most important things,
2) truly engage your partners - you are unlikely to succeed without them (money or not), and
3) retain control! You need to steer the ship, not your partners or customers, and certainly not your external investors ("Hey Rick, it's been 3.5 years - time to sell!").
The bottom line is this: If you can't earn the interest and attention of customers, partners and employees, you WON'T be able to buy it. And if you can, then why pay for it?
This post was originally published at RickSmith.me
Comparing Recessions: Chart
10.4.2009
Comparing Recessions: Chart
Earning season is in high gear, so it is a good time to take a look at the earning performance of the S&P 500.
This chart from Standard & Poors, pointed out by Chart Of The Day, gives some perspective.
The graph compares the earnings performance of the current recession, shown in the solid red line, to that of the 2001 recession in the dashed gold line, and the earnings performance from 1936 through 2006, shown as the dashed blue line.
As today's chart illustrates, the current decline in earnings is several orders of magnitude greater than the average decline during a recession. The current decline is also more severe than what was the most severe earnings decline on record - the decline that began in 2001 (gold dashed line).
Why not start a Trust Fund for your child?
From Times Online
February 20, 2008
The beginner's guide to Child Trust Funds
James Charles
Child Trust Funds (CTFs) were introduced by the Government in 2005 to encourage parents to save for their children's future About three million children now have funds.
Children gain access to the pot of cash in a CTF only when they turn 18, but nobody else, including parents, can access the money before that point. The interest earned by savings in a CTF are tax-free.
Who is eligible?
Any child born after September 1, 2002, who qualifies for child benefit, is eligible for a CTF. Children born after the introduction of CTFs in April 2005 are enrolled automatically. The Government sends parents a £250 voucher to open a fund and they can invest this in either a savings account or one that invests in stocks and shares (see below for information on the types of funds available).
How to save
Background
The beginner's guide to Child Trust Funds
National Savings & Investments explained
How to budget
Background
The beginner's guide to current accounts
How to reclaim bank charges
Bonds explained
Related Links
Those who save make best use of child funds
Labour caves in over charges for child trust funds
Families on income support are given a total of £500.
When children reach the age of seven they are sent a further £250 or £500 by the Government.
The Government will open a stakeholder Child Trust Fund automatically if a child's parents fail to do so within 12 months of the voucher being issued.
Parents of children born between September 2002 and April 2005 should apply for their children retrospectively. For more information, or if you have not received the voucher, call the Child Trust Fund helpline on 0845 3021470 or textphone on 0845 3667870.
Who can contribute?
Parents and relatives are encouraged to make regular contributions to the trust fund, although they can do so whenever they choose.
The maximum that can be paid into an account is £100 a month, or £1,200 a year. Government contributions do not count towards this limit.
The average amount that parents deposit each month is £23, according to figures from Revenue & Customs. Other research, by Nationwide Building Society, found that 60 per cent of CTF accounts received no additional contributions at all.
What are the benefits?
The idea is that the nest egg should grow in value over time. When children have access to the cash at the age of 18, they can then use it to pay for university, a deposit on a house or anything else they choose.
You can find out how big a fund will be when a child reaches the age of 18 by using a Child Trust Fund calculator.
The three options
There is a huge range of different CTFs available, particularly if you go online. It seems that everyone from Asda to Legal & General offer CTFs of some description. Indeed, there are many funds catering for niche markets, such as ethical or shariah compliant funds.
There are three main types of fund.
Savings accounts:
A savings account is the most secure option and mirrors the deposit accounts available on the high street, though the rates are usually a little better. There are also no tax liabilities.
Stakeholders:
Most experts recommend opting for a stakeholder equity fund, as these take advantage of stock market growth and are likely to produce a greater return than cash-only acccounts over the longer term. Your cash is invested in the stock market but is managed by your fund provider. Parents have a limited choice of the types of funds in which the money is invested.
The Government has made sure that the level of risk is small. When a child reaches the age of 13 the money will be moved to safer, cash-based accounts.
The Government has also capped the annual management charge on stakeholder CTFs at 1.5 per cent.
Stocks and shares:
The final option is a purely stock market-based option. This is the riskiest form of investment and allows for the greatest degree of investment freedom. Parents should remember that the management fees on these investments are not capped in the same way as stakeholder CTFs.
Over the long term it is likely that the return on stock market investments will be greater than cash investments, but parents should be aware that the value of the CTF can go down as well as up, although this is unlikely.
Five news stories
Labour caves in over charges for child trust funds
The 3Rs: reading, writing and interest rates
One in four parents ignore CTF
Teenagers urge curbs on spending CTF money
Parents spoilt for choice
Five features
Child funds grow up
The best places for your child trust funds
Make your child a millionaire
Parents’ alternatives to a child trust fund
Gifts that are not just for Christmas
Five websites
Child Trust Fund
HM Revenue and Customs
Direct.gov.uk - Parents Guide
Money Extra
Stakeholder Saving
February 20, 2008
The beginner's guide to Child Trust Funds
James Charles
Child Trust Funds (CTFs) were introduced by the Government in 2005 to encourage parents to save for their children's future About three million children now have funds.
Children gain access to the pot of cash in a CTF only when they turn 18, but nobody else, including parents, can access the money before that point. The interest earned by savings in a CTF are tax-free.
Who is eligible?
Any child born after September 1, 2002, who qualifies for child benefit, is eligible for a CTF. Children born after the introduction of CTFs in April 2005 are enrolled automatically. The Government sends parents a £250 voucher to open a fund and they can invest this in either a savings account or one that invests in stocks and shares (see below for information on the types of funds available).
How to save
Background
The beginner's guide to Child Trust Funds
National Savings & Investments explained
How to budget
Background
The beginner's guide to current accounts
How to reclaim bank charges
Bonds explained
Related Links
Those who save make best use of child funds
Labour caves in over charges for child trust funds
Families on income support are given a total of £500.
When children reach the age of seven they are sent a further £250 or £500 by the Government.
The Government will open a stakeholder Child Trust Fund automatically if a child's parents fail to do so within 12 months of the voucher being issued.
Parents of children born between September 2002 and April 2005 should apply for their children retrospectively. For more information, or if you have not received the voucher, call the Child Trust Fund helpline on 0845 3021470 or textphone on 0845 3667870.
Who can contribute?
Parents and relatives are encouraged to make regular contributions to the trust fund, although they can do so whenever they choose.
The maximum that can be paid into an account is £100 a month, or £1,200 a year. Government contributions do not count towards this limit.
The average amount that parents deposit each month is £23, according to figures from Revenue & Customs. Other research, by Nationwide Building Society, found that 60 per cent of CTF accounts received no additional contributions at all.
What are the benefits?
The idea is that the nest egg should grow in value over time. When children have access to the cash at the age of 18, they can then use it to pay for university, a deposit on a house or anything else they choose.
You can find out how big a fund will be when a child reaches the age of 18 by using a Child Trust Fund calculator.
The three options
There is a huge range of different CTFs available, particularly if you go online. It seems that everyone from Asda to Legal & General offer CTFs of some description. Indeed, there are many funds catering for niche markets, such as ethical or shariah compliant funds.
There are three main types of fund.
Savings accounts:
A savings account is the most secure option and mirrors the deposit accounts available on the high street, though the rates are usually a little better. There are also no tax liabilities.
Stakeholders:
Most experts recommend opting for a stakeholder equity fund, as these take advantage of stock market growth and are likely to produce a greater return than cash-only acccounts over the longer term. Your cash is invested in the stock market but is managed by your fund provider. Parents have a limited choice of the types of funds in which the money is invested.
The Government has made sure that the level of risk is small. When a child reaches the age of 13 the money will be moved to safer, cash-based accounts.
The Government has also capped the annual management charge on stakeholder CTFs at 1.5 per cent.
Stocks and shares:
The final option is a purely stock market-based option. This is the riskiest form of investment and allows for the greatest degree of investment freedom. Parents should remember that the management fees on these investments are not capped in the same way as stakeholder CTFs.
Over the long term it is likely that the return on stock market investments will be greater than cash investments, but parents should be aware that the value of the CTF can go down as well as up, although this is unlikely.
Five news stories
Labour caves in over charges for child trust funds
The 3Rs: reading, writing and interest rates
One in four parents ignore CTF
Teenagers urge curbs on spending CTF money
Parents spoilt for choice
Five features
Child funds grow up
The best places for your child trust funds
Make your child a millionaire
Parents’ alternatives to a child trust fund
Gifts that are not just for Christmas
Five websites
Child Trust Fund
HM Revenue and Customs
Direct.gov.uk - Parents Guide
Money Extra
Stakeholder Saving
Wells Fargo Gives Wall Street a Reason to Run
Wells Fargo Gives Wall Street a Reason to Run
By JACK HEALY and ERIC DASH
Published: April 9, 2009
Stock markets surged higher on Thursday after Wells Fargo, the nation’s largest consumer bank, said that it expected to report record profit for the first three months of the year, kindling hopes that financial companies may finally be closing the book on quarter after quarter of wrenching losses.
As financial stocks soared, the Dow Jones industrial average rose 225 points as trading near a close, crossing above 8,000 points. The broader Standard & Poor’s 500-stock index was 3.5 percent higher, increasing the gains of a bear-market rally that has lifted stocks more than 20 percent since it began one month ago. The technology-heavy Nasdaq rose 3.4 percent.
Just three months ago, Wells Fargo announced that it had lost $2.55 billion as the economy foundered and the bank absorbed billions of losses from the acquisition of the Wachovia Corporation. But a statement on Thursday, Wells Fargo said it expected to report $3 billion in profit for the first quarter of 2009, far exceeding Wall Street’s expectations, and said it was issuing mortgages at a fast clip.
Investors took the statement from Wells Fargo, whose shares gained 20 percent, as another harbinger that the tattered economy may be bottoming out.
Other major banks like Citigroup, JPMorgan Chase and Bank of America, which reported billions in losses last quarter, have said that they expected to be profitable this year, and wisps of less-bad data from the housing market, manufacturers and consumer surveys are giving rattled investors new hopes that a bottom is in sight.
But experts warn that corporate losses are simply radiating outward from financial firms to other corners of the economy, and they say the economy’s thin green shoots and bear-market gains could turn to dust if rising unemployment forces deeper, unexpected contractions in consumer spending and corporate profits.
Analysts expect that earnings for companies in the S.&P. 500 fell 37 percent in the first months of the year, and they say many of the losses will be borne by retailers, energy companies and businesses that make products like chemicals and building materials.
“What you’re now seeing is the nonfinancial segment really start to tail off,” said Nicholas Bohnsack, sector strategist at Strategas Research Partners.
Oil prices settled at $52.05 a barrel in New York trading, up $2.67.
In Asia, Japan’s Nikkei rose 3.7 percent after Japan announced its biggest-ever economic stimulus plan, a $154 billion package of subsidies and tax breaks that aims to stem a deepening recession in the world’s second-largest economy.
In Europe, the FTSE 100 in London gained 1.4 percent, the DAX index in Frankfurt rose 3 percent, and CAC-40 in Paris rose 1.8 percent.
http://www.nytimes.com/2009/04/10/business/10markets.html?_r=1&hpw
Thursday 9 April 2009
Could the IMF run out of money?
Bailing Out the Bailers
Could the IMF run out of money?
By Karim Bardeesy Posted Wednesday, October 29, 2008 - 6:21pm
Who’s your bailout daddy? Well, if you’re Ukraine, Iceland, Hungary, Belarus, and Pakistan right now, it’s the International Monetary Fund. New loan commitments made by the IMF in the last two weeks already exceed $30 billion; requests for billions more could be forthcoming. Which raises a troubling question: Could the IMF run out of cash?
Unlikely, but the IMF may have seen its financial heyday. It was created during the 1944 Bretton Woods conference to help manage the international monetary system and accumulated healthy reserves of currency after World War II. It continues to be funded by “quotas” charged to each member country largely based on the size of its economy. The quotas are a one-time charge, though. If the IMF needs more money, it has to go back to its member countries, and they’re in tough shape right now. The most powerful among them—the United States and the European Union—are shoveling money out the door to deal with their own problems, creating new debt to buy bank shares.
That said, right now the fund is flush and the balance sheet is strong. It now has the equivalent of $201 billion available to be lent out. (It calls this its “one-year forward commitment capacity.”) Before the meltdown, there was “only” around $18 billion in debt outstanding, half from Turkey and the remainder from poorer African, Caribbean, and Central Asian countries.
There’s gold, too. The IMF owns, at last reckoning, more than $9 billion worth of the stuff (but an 85 percent supermajority of its membership is required to sell or buy any of it). The IMF can also borrow more money from wealthy member countries, with up to $53 billion extra available through two supplementary agreements if need be. And flailing countries can turn elsewhere for financing; the United States gave cash and loan guarantees worth $20 billion directly to Mexico in 1995.
In emergency situations, when a country is having trouble paying back loans that are due imminently, a SWAT team will go to the supplicating country to figure out what policies and how much short-term financing are needed. The IMF doesn’t quite carry the Domino’s half-hour guarantee, but it claims to be able to have a decision back to you in as little as 48 hours after its board receives a report on the situation. Only the hardiest currencies, like yen and U.S. dollars, are lent out (although a few Botswanan pulas might be out on offer).
The aid doesn’t come for free. There are loan repayments—the IMF actually takes a cut on every deal, lending out to needy countries at a higher interest rate than it pays back to “donor” countries. Plus, the IMF might insist that the receiving country commit to cutting domestic food subsidies or reduce its budget deficit—“structural adjustment” policies that formed part of the “Washington consensus” in the 1980s and 1990s and which still inspire anti-globalization types to pull out their black balaclavas. The IMF remembers the bitter taste those policies left with local populations and has pledged “fewer and more targeted” conditions this time around (and on Wednesday agreed to waive austerity measures in emerging economies). But if a country stalls in its reforms, the IMF can stop the flow of cash—a pretty big stick when, say, Turkey is sitting at its kitchen table with bills to pay.
While there may be a lot of money tucked away that countries can use to bail one another out, recent events have put the IMF in a tough spot, both financially and politically. Like any other multinational agency, the IMF is only as good as its member countries. If a big country, say, South Korea, feels the heat from international lenders, the IMF could be looking at a $50 billion or $100 billion request. After the Asian financial crises of the mid-1990s, the IMF’s forward commitment capacity fell as low as 20 billion “Special Drawing Rights” (an IMF unit then equivalent to around $27 billion); it tripled only after the IMF increased the quota it charged member countries by 45 percent. Will there be political will to supplement the IMF in the coming weeks? Or will a new fund, topped up by new currency reserves, be necessary, as Gordon Brown has mused? In the “New Bretton Woods” era, the IMF might not go under, but it may get left behind.
Explainer thanks Massachusetts Institute of Technology professor and former IMF chief economist Simon Johnson, co-founder of baselinescenario.com and Yoshiko Kamata and Bill Murray of the International Monetary Fund.
http://www.thebigmoney.com/articles/explainer/2008/10/29/bailing-out-bailers
Could the IMF run out of money?
By Karim Bardeesy Posted Wednesday, October 29, 2008 - 6:21pm
Who’s your bailout daddy? Well, if you’re Ukraine, Iceland, Hungary, Belarus, and Pakistan right now, it’s the International Monetary Fund. New loan commitments made by the IMF in the last two weeks already exceed $30 billion; requests for billions more could be forthcoming. Which raises a troubling question: Could the IMF run out of cash?
Unlikely, but the IMF may have seen its financial heyday. It was created during the 1944 Bretton Woods conference to help manage the international monetary system and accumulated healthy reserves of currency after World War II. It continues to be funded by “quotas” charged to each member country largely based on the size of its economy. The quotas are a one-time charge, though. If the IMF needs more money, it has to go back to its member countries, and they’re in tough shape right now. The most powerful among them—the United States and the European Union—are shoveling money out the door to deal with their own problems, creating new debt to buy bank shares.
That said, right now the fund is flush and the balance sheet is strong. It now has the equivalent of $201 billion available to be lent out. (It calls this its “one-year forward commitment capacity.”) Before the meltdown, there was “only” around $18 billion in debt outstanding, half from Turkey and the remainder from poorer African, Caribbean, and Central Asian countries.
There’s gold, too. The IMF owns, at last reckoning, more than $9 billion worth of the stuff (but an 85 percent supermajority of its membership is required to sell or buy any of it). The IMF can also borrow more money from wealthy member countries, with up to $53 billion extra available through two supplementary agreements if need be. And flailing countries can turn elsewhere for financing; the United States gave cash and loan guarantees worth $20 billion directly to Mexico in 1995.
In emergency situations, when a country is having trouble paying back loans that are due imminently, a SWAT team will go to the supplicating country to figure out what policies and how much short-term financing are needed. The IMF doesn’t quite carry the Domino’s half-hour guarantee, but it claims to be able to have a decision back to you in as little as 48 hours after its board receives a report on the situation. Only the hardiest currencies, like yen and U.S. dollars, are lent out (although a few Botswanan pulas might be out on offer).
The aid doesn’t come for free. There are loan repayments—the IMF actually takes a cut on every deal, lending out to needy countries at a higher interest rate than it pays back to “donor” countries. Plus, the IMF might insist that the receiving country commit to cutting domestic food subsidies or reduce its budget deficit—“structural adjustment” policies that formed part of the “Washington consensus” in the 1980s and 1990s and which still inspire anti-globalization types to pull out their black balaclavas. The IMF remembers the bitter taste those policies left with local populations and has pledged “fewer and more targeted” conditions this time around (and on Wednesday agreed to waive austerity measures in emerging economies). But if a country stalls in its reforms, the IMF can stop the flow of cash—a pretty big stick when, say, Turkey is sitting at its kitchen table with bills to pay.
While there may be a lot of money tucked away that countries can use to bail one another out, recent events have put the IMF in a tough spot, both financially and politically. Like any other multinational agency, the IMF is only as good as its member countries. If a big country, say, South Korea, feels the heat from international lenders, the IMF could be looking at a $50 billion or $100 billion request. After the Asian financial crises of the mid-1990s, the IMF’s forward commitment capacity fell as low as 20 billion “Special Drawing Rights” (an IMF unit then equivalent to around $27 billion); it tripled only after the IMF increased the quota it charged member countries by 45 percent. Will there be political will to supplement the IMF in the coming weeks? Or will a new fund, topped up by new currency reserves, be necessary, as Gordon Brown has mused? In the “New Bretton Woods” era, the IMF might not go under, but it may get left behind.
Explainer thanks Massachusetts Institute of Technology professor and former IMF chief economist Simon Johnson, co-founder of baselinescenario.com and Yoshiko Kamata and Bill Murray of the International Monetary Fund.
http://www.thebigmoney.com/articles/explainer/2008/10/29/bailing-out-bailers
Inflation Expectations for Beginners
Inflation Expectations for Beginners
James Kwak Apr 9, 2009
For a complete list of Beginners articles, see Financial Crisis for Beginners.
Only a few years ago, the accepted remedy for a recession was for the Federal Reserve to lower interest rates - namely, the Federal funds rate. Now, however, the economy has been stuck in recession for over fifteen months and the Federal funds rate has spent the last several months at zero. (The Fed funds rate cannot ordinarily be negative, because one bank won’t lend $100 to another bank and accept less than $100 in return; it always has the option of just holding onto its $100.) As a result, the Fed has resorted to other policy tools, most notably large-scale purchases of agency and Treasury securities, funded by creating money. (Here’s James Hamilton’s analysis.)
As the Fed’s monetary policy plays a more prominent role in the response to the economic crisis, there will be more talk of inflation or, more accurately, inflation expectations. While inflation is what affects the purchasing power of the money in your wallet, inflation expectations are what affect people’s behavior in ways that have a long-term economic impact. Take the case of wage negotiations, for example: a union that believes inflation will average 5% over the life of a contract will demand higher wage increases than a union that believes inflation will average only 1%. Once those higher wages are built into the contract, the employer is forced to raise prices in order to cover those wage increases, and inflation begins to ripple through the economy.
One of the major objectives of modern monetary policy is to control inflation expectations, because controlling inflation expectations is the first step to controlling inflation. If there is a short-term burst of inflation - as we had a year ago, if you look at headline inflation numbers that include the prices of food and energy - the macroeconomic consequences can be limited if people believe that the Fed can and will bring inflation under control.
Unfortunately, it is impossible to know exactly what people’s inflation expectations are; in fact, it may not even be a sensible question, since different people have different understandings of what inflation is. However, there are three main approaches to estimating inflation expectations.
1. Inflation-indexed government bonds. (If you need a refresher on how a bond works, read the first part of this article.)
A traditional bond is a stream of payments that is fixed in nominal terms: for example, $100 in 10 years, and 6% interest, paid semi-annually ($3 every 6 months). Such a bond is not inflation-indexed; if inflation goes up, the purchasing power of that $100 goes down, and it’s too bad for the bondholder.
An inflation-indexed bond, by contrast, pays an amount that is indexed to some measure of inflation. In the U.S., where these bonds are called Treasury Inflation Protected Securities (TIPS), we use the Consumer Price Index. A TIPS bond may have a $100 face value and pay a 2% interest rate. However, every 6 months, that $100 face value is adjusted to reflect the change in the CPI, and the interest payment is calculated as a percentage of the adjusted value of the bond. Then, after 10 years, the bondholder gets back not $100, but $100 times the ratio between the CPI at the end of the period and the CPI at the beginning of the period. This way the bondholder is guaranteed a 2% real return (assuming he paid $100 for the bond), no matter what the rate of inflation is in the interim.
The implied inflation expectation, then, is the difference between the yield on an ordinary bond and the yield on an inflation-indexed bond with the same maturity. If the 5-year Treasury has a yield of 4% and the 5-year TIPS has a yield of 2%, then inflation expectations for the next five years are (about) 2% per year. The reasoning is that in order to buy the regular bond as opposed to the inflation-indexed bond, an investor has to be paid a higher yield to compensate him for the level of inflation that he expects.
Actually, in addition to expected inflation, the Treasury investor also has to be paid an inflation risk premium because, all things being equal, it is better not to have inflation risk than to have it. So the implied inflation expectation is actually slightly less than the spread between the regular and the inflation-indexed bonds. If you didn’t follow that, don’t worry, just remember that, roughly speaking, Treasury yield = TIPS yield + expected inflation.
2. Inflation swaps.
These are a type of derivative contract, where the payments under the contract depend on the value of an inflation index, such as the CPI. The swap has a nominal value of, say, $100, but $100 never changes hands. Instead, at the end of some period of time, party A pays party B a fixed rate of interest on $100 - say 2.5% per year. At the end of the period, B pays A the cumulative percentage change in the inflation index over the period. Assuming A has $100 in his pocket, he has now hedged the inflation risk on that $100, because no matter what happens, at the end of the period he will get an amount that compensates him for the impact of inflation on his $100. The price of this hedge is $2.50 per year. (Because these are over-the-counter contracts, there many variations on this, including swaps with periodic coupon payments.)
For the same reasons described above, the implied inflation expectation is roughly 2.5% per year: party B thinks inflation will be less than 2.5% per year, and therefore is willing to take 2.5% and pay the amount of inflation; party A thinks inflation will be more than 2.5% per year, and therefore is willing to pay 2.5% per year to get the amount of inflation back. So the market clears at 2.5%. (Actually, for the exact same reasons as with bonds - party B has to be paid an inflation risk premium for absorbing the risk in this trade - the inflation expectation is slightly less than 2.5% per year. There are also some complications having to do with the lag in the publication of inflation indices, but let’s ignore that for now.)
One curiosity is that the inflation-indexed bond method and the inflation swap method can produce different estimates. Theoretically this should not happen, because if two products that will have the same price in the long term (since they are based on the same index) have different prices today, there should be an arbitrage opportunity. Why this happens in practice is discussed on pp. 5-6 of this Bank of England paper. (Thanks to Bond Girl for pointing out the paper.)
3. Surveys.
You can also just ask people what they think inflation will be. Economists ordinarily prefer markets, under the principle that when people are paying money they are signaling what they really believe. But if you think there are sufficient problems with the markets you may want to go with surveys. Tim Duy has a post with a number of charts, including one of an inflation expectations survey.
So what do things look like today?
For more on measuring inflation expectations, there is a short primer from the San Francisco Fed, as well as the Bank of England paper mentioned above.
http://www.rgemonitor.com/us-monitor/256336/inflation_expectations_for_beginners
James Kwak Apr 9, 2009
For a complete list of Beginners articles, see Financial Crisis for Beginners.
Only a few years ago, the accepted remedy for a recession was for the Federal Reserve to lower interest rates - namely, the Federal funds rate. Now, however, the economy has been stuck in recession for over fifteen months and the Federal funds rate has spent the last several months at zero. (The Fed funds rate cannot ordinarily be negative, because one bank won’t lend $100 to another bank and accept less than $100 in return; it always has the option of just holding onto its $100.) As a result, the Fed has resorted to other policy tools, most notably large-scale purchases of agency and Treasury securities, funded by creating money. (Here’s James Hamilton’s analysis.)
As the Fed’s monetary policy plays a more prominent role in the response to the economic crisis, there will be more talk of inflation or, more accurately, inflation expectations. While inflation is what affects the purchasing power of the money in your wallet, inflation expectations are what affect people’s behavior in ways that have a long-term economic impact. Take the case of wage negotiations, for example: a union that believes inflation will average 5% over the life of a contract will demand higher wage increases than a union that believes inflation will average only 1%. Once those higher wages are built into the contract, the employer is forced to raise prices in order to cover those wage increases, and inflation begins to ripple through the economy.
One of the major objectives of modern monetary policy is to control inflation expectations, because controlling inflation expectations is the first step to controlling inflation. If there is a short-term burst of inflation - as we had a year ago, if you look at headline inflation numbers that include the prices of food and energy - the macroeconomic consequences can be limited if people believe that the Fed can and will bring inflation under control.
Unfortunately, it is impossible to know exactly what people’s inflation expectations are; in fact, it may not even be a sensible question, since different people have different understandings of what inflation is. However, there are three main approaches to estimating inflation expectations.
1. Inflation-indexed government bonds. (If you need a refresher on how a bond works, read the first part of this article.)
A traditional bond is a stream of payments that is fixed in nominal terms: for example, $100 in 10 years, and 6% interest, paid semi-annually ($3 every 6 months). Such a bond is not inflation-indexed; if inflation goes up, the purchasing power of that $100 goes down, and it’s too bad for the bondholder.
An inflation-indexed bond, by contrast, pays an amount that is indexed to some measure of inflation. In the U.S., where these bonds are called Treasury Inflation Protected Securities (TIPS), we use the Consumer Price Index. A TIPS bond may have a $100 face value and pay a 2% interest rate. However, every 6 months, that $100 face value is adjusted to reflect the change in the CPI, and the interest payment is calculated as a percentage of the adjusted value of the bond. Then, after 10 years, the bondholder gets back not $100, but $100 times the ratio between the CPI at the end of the period and the CPI at the beginning of the period. This way the bondholder is guaranteed a 2% real return (assuming he paid $100 for the bond), no matter what the rate of inflation is in the interim.
The implied inflation expectation, then, is the difference between the yield on an ordinary bond and the yield on an inflation-indexed bond with the same maturity. If the 5-year Treasury has a yield of 4% and the 5-year TIPS has a yield of 2%, then inflation expectations for the next five years are (about) 2% per year. The reasoning is that in order to buy the regular bond as opposed to the inflation-indexed bond, an investor has to be paid a higher yield to compensate him for the level of inflation that he expects.
Actually, in addition to expected inflation, the Treasury investor also has to be paid an inflation risk premium because, all things being equal, it is better not to have inflation risk than to have it. So the implied inflation expectation is actually slightly less than the spread between the regular and the inflation-indexed bonds. If you didn’t follow that, don’t worry, just remember that, roughly speaking, Treasury yield = TIPS yield + expected inflation.
2. Inflation swaps.
These are a type of derivative contract, where the payments under the contract depend on the value of an inflation index, such as the CPI. The swap has a nominal value of, say, $100, but $100 never changes hands. Instead, at the end of some period of time, party A pays party B a fixed rate of interest on $100 - say 2.5% per year. At the end of the period, B pays A the cumulative percentage change in the inflation index over the period. Assuming A has $100 in his pocket, he has now hedged the inflation risk on that $100, because no matter what happens, at the end of the period he will get an amount that compensates him for the impact of inflation on his $100. The price of this hedge is $2.50 per year. (Because these are over-the-counter contracts, there many variations on this, including swaps with periodic coupon payments.)
For the same reasons described above, the implied inflation expectation is roughly 2.5% per year: party B thinks inflation will be less than 2.5% per year, and therefore is willing to take 2.5% and pay the amount of inflation; party A thinks inflation will be more than 2.5% per year, and therefore is willing to pay 2.5% per year to get the amount of inflation back. So the market clears at 2.5%. (Actually, for the exact same reasons as with bonds - party B has to be paid an inflation risk premium for absorbing the risk in this trade - the inflation expectation is slightly less than 2.5% per year. There are also some complications having to do with the lag in the publication of inflation indices, but let’s ignore that for now.)
One curiosity is that the inflation-indexed bond method and the inflation swap method can produce different estimates. Theoretically this should not happen, because if two products that will have the same price in the long term (since they are based on the same index) have different prices today, there should be an arbitrage opportunity. Why this happens in practice is discussed on pp. 5-6 of this Bank of England paper. (Thanks to Bond Girl for pointing out the paper.)
3. Surveys.
You can also just ask people what they think inflation will be. Economists ordinarily prefer markets, under the principle that when people are paying money they are signaling what they really believe. But if you think there are sufficient problems with the markets you may want to go with surveys. Tim Duy has a post with a number of charts, including one of an inflation expectations survey.
So what do things look like today?
For more on measuring inflation expectations, there is a short primer from the San Francisco Fed, as well as the Bank of England paper mentioned above.
http://www.rgemonitor.com/us-monitor/256336/inflation_expectations_for_beginners
Pensions crisis means we will all be retiring later
Pensions crisis means we will all be retiring later
The economic crisis will force people to work longer.
By Hugo Dixon, breakingviews.comLast Updated: 12:29PM BST 08 Apr 2009
Higher fiscal deficits will make generous state pensions even more unaffordable, while the fall in asset prices is hammering private pension plans. There are three ways to cope: higher taxes, poorer old people and delayed retirement. All of these will be tried. But the last is by far the best.
Even before the crisis hit, the so-called demographic time-bomb was a worry for most rich countries and some poor ones. Thanks to better health care and a sharp drop in the average number of children per family, more old people will need to be supported by fewer workers.
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In many countries, the crunch point is coming in the next few years, as the last big bulge of babies, born after the Second World War, reaches retirement age. Statisticians measure the "dependency ratio" - the number of people over 65 as a percentage of those aged 15-64. By 2030, this ratio will have increased to 33 in the US, 40 in the UK and 65 in Japan - from 19, 25 and 35 respectively in 2010, according to the United Nations.
Traditionally, families took care of their own. But in rich countries, the government is now the main pension provider. The greying of the population was always going to squeeze government budgets. But the crisis has made a tough situation even worse, as Barack Obama, Gordon Brown and their peers have engaged in fiscal stimulation in an attempt to prevent the recession turning into a slump. The International Monetary Fund expects government debt in advanced G20 countries to jump from 79pc of GDP in 2007 to 104pc in 2014. That doesn't leave much room for pension-related borrowing.
In the UK and a few other countries, private pension plans are an important source of retirement income. Pension experts have long hoped they could step in when governments ran out of funds. But the crisis has also damaged them.
Private pensions come in two types. First, there are those provided by some companies which guarantee retired people a fixed percentage of their final salaries. The companies set up pension funds, portfolios which are supposed to make sure the retirees get what they deserve. The employers are on the hook to pay the pensioners, whatever happens to the funds' value.
The market tumble means that more companies are going to be called on to top up their pension funds. These "defined benefit" schemes have been on the retreat over the past 20 years, as companies have viewed them increasingly as toxic liabilities. The crisis could prove their final death-knell.
Second, there are pensions which depend entirely on a pot of funds accumulated and invested over the years - either by the individual or with some help from the employer. Thanks to the crisis, those pots have shrunk, bringing down the size of people's future pensions.
Pension funding is a problem. But it is important not to forget the good news: people are living longer and more healthily. What's more, if they are going to live to the age of 85, do they really want to retire at the age of 65 and slump down in front of the television getting depressed and lonely for 20 years?
Far better - for them and for their children - to work a few more years, keep their minds engaged and retire with a bigger pension.
For more agenda-setting financial insight, visit www.breakingviews.com
Business failures could be avoided
Business failures could be avoided
Hundreds of small businesses failures in the first quarter could have been avoided if owners had not ignored early warning signs and used a '33 week window' to save their venture according to research.
By Roland Gribben Last Updated: 9:37PM BST 06 Apr 2009
An estimated 880 small companies, accounting for one in six of insolvencies in the period, closed their doors because they had not taken remedial action early enough or failed to carry out any forecasting, the report adds.
Business adviser Tenon Recovery, which used its own client base for the research, estimates that a company has 33 weeks to discover whether turnaround initiatives could work after determining that future prospects are bleak. (i.e. half a year)
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UK production shrinks to lowest in over 40 years
The remedies include
Carl Jackson, head of Tenon Recovery, said many enrepreneurs "have little or no experience of operating in a recession and... are not used to having to keep such a close eye on their business".
http://www.telegraph.co.uk/finance/yourbusiness/5116161/Business-failures-could-be-avoided.html
Hundreds of small businesses failures in the first quarter could have been avoided if owners had not ignored early warning signs and used a '33 week window' to save their venture according to research.
By Roland Gribben Last Updated: 9:37PM BST 06 Apr 2009
An estimated 880 small companies, accounting for one in six of insolvencies in the period, closed their doors because they had not taken remedial action early enough or failed to carry out any forecasting, the report adds.
Business adviser Tenon Recovery, which used its own client base for the research, estimates that a company has 33 weeks to discover whether turnaround initiatives could work after determining that future prospects are bleak. (i.e. half a year)
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UK production shrinks to lowest in over 40 years
The remedies include
- establishing key business indicators,
- forecasting cash needs on a weekly basis,
- outsourcing specialist jobs like bookkeeping,
- reviewing and swapping suppliers, and
- continuous spending reviews.
Carl Jackson, head of Tenon Recovery, said many enrepreneurs "have little or no experience of operating in a recession and... are not used to having to keep such a close eye on their business".
http://www.telegraph.co.uk/finance/yourbusiness/5116161/Business-failures-could-be-avoided.html
Fund management: A game of luck?
Fund management: A game of luck?
A large part of the active versus passive debate has always revolved around whether an active manager's returns are through luck or judgement.
Last Updated: 8:14AM BST 08 Apr 2009
The debate was reignited at the end of last year when Inalytics, a specialist firm that helps pension funds to select and monitor equity managers, published research which showed managers typically get only half of their decisions correct.
The research, based on an examination of 215 long-only funds worth a combined £99 billion, found that the average manager's ability to identify winners and losers was no better than 50-50. Put simply, they would do no worse tossing a coin.
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The research looked at two measurements of fund manager skill: what it termed the hit rate and the win/loss ratio. The hit rate shows the number of correct decisions as a percentage of the total number of decisions. The win/loss ratio is a comparison of the alpha generated from good decisions with the alpha lost from the poor decisions. To judge these, Inalytics daily analysed every purchase/sale, underweight and overweight made by the fund managers.
Rick di Mascio, the chief executive and founder of Inalytics, says: "The industry maxim suggests that six correct decisions out of 10 would constitute good performance. However, we did not find one manager who got six out of 10. The average was five out of 10 (49.6pc) and the really good managers only managed to get a 53pc hit rate, which was a surprise as we expected the best manager to be a lot higher."
To compensate for this, di Mascio says the average manager is able to generate good gains from "winners" to offset the losses from "losers". According to the research, the average win/loss ratio was 102pc, which means the alpha gained from good decisions was 2pc higher than that lost from the poor decisions.
"The good managers had a win/loss ratio of 120pc, with the best getting up to 130-140pc," says di Mascio. "This is where the skill comes in, running your winners and cutting out the losers. It's what differentiates the also-rans from the best. There is nowhere to hide with these numbers."
http://www.telegraph.co.uk/finance/personalfinance/investing/5093111/Fund-management-A-game-of-luck.html
Shock warning on US municipal bonds
Shock warning on US municipal bonds
The creditworthiness of the entire US local government system is at risk, credit ratings agency Moody's has warned, as the global recession continues to pinpoint its latest victims.
By James QuinnLast Updated: 7:30PM BST 08 Apr 2009
The unprecedented warning – the first time Moody's has made such a warning about the US local government system as a whole – was made in the light of the continued recession and the problems that it is causing for city and state governments.
Moody's said that it was assigning a negative outlook to the entire $2.6 trillion (£1.8 trillion) US municipal bond sector – operated by local town, city and state governments – because of the combined collapse in the financial and housing markets.
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Analyst Eric Hoffman said what could prove to be the worst recession since the Great Depression of the 1930s will pressure "many if not most local governments" over the next 12 to 18 months.
The warning is important because municipal bonds are one of the key ways local authorities raise medium and long-term finance in the US, and if investors sense that they might not be paid, bond issues are likely to go unsold.
Local governments have been hit by reduced tax intakes as more residents lose their jobs, and as more companies in their areas either close or have produced losses.
The state of California has so far been the poster boy for the problems in local government funding, with Governor Arnold Schwarzenegger faced with reducing a deficit expected to reach $42bn by 2010.
But smaller entities are also hurting, such as Jefferson County, Alabama, which has been threatening to default of some of its bond payments for a number of months.
Mr Hoffman said that those localities most at risk of a downgrade will be those heavily reliant on car manufacturing, property and financial services, as well as those who have been heavily reliant on property taxes or those have a high proportion of fixed costs.
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5127023/Shock-warning-on-US-municipal-bonds.html
The creditworthiness of the entire US local government system is at risk, credit ratings agency Moody's has warned, as the global recession continues to pinpoint its latest victims.
By James QuinnLast Updated: 7:30PM BST 08 Apr 2009
The unprecedented warning – the first time Moody's has made such a warning about the US local government system as a whole – was made in the light of the continued recession and the problems that it is causing for city and state governments.
Moody's said that it was assigning a negative outlook to the entire $2.6 trillion (£1.8 trillion) US municipal bond sector – operated by local town, city and state governments – because of the combined collapse in the financial and housing markets.
Related Articles
Moody's warns UK companies face large pension fund deficits
US faces global funding crisis, warns Merrill Lynch
Barclays warns of a financial storm as Federal Reserve's credibility crumbles
Foreign investors veto Fed rescue
Gold hits record against euro on fear of Zimbabwean-style response to bank crisis
Analyst Eric Hoffman said what could prove to be the worst recession since the Great Depression of the 1930s will pressure "many if not most local governments" over the next 12 to 18 months.
The warning is important because municipal bonds are one of the key ways local authorities raise medium and long-term finance in the US, and if investors sense that they might not be paid, bond issues are likely to go unsold.
Local governments have been hit by reduced tax intakes as more residents lose their jobs, and as more companies in their areas either close or have produced losses.
The state of California has so far been the poster boy for the problems in local government funding, with Governor Arnold Schwarzenegger faced with reducing a deficit expected to reach $42bn by 2010.
But smaller entities are also hurting, such as Jefferson County, Alabama, which has been threatening to default of some of its bond payments for a number of months.
Mr Hoffman said that those localities most at risk of a downgrade will be those heavily reliant on car manufacturing, property and financial services, as well as those who have been heavily reliant on property taxes or those have a high proportion of fixed costs.
http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5127023/Shock-warning-on-US-municipal-bonds.html
Wednesday 8 April 2009
S&P: Record number of firms cut dividend in Q1
S&P: Record number of firms cut dividend in Q1
By Stephen Bernard, AP Business Writer
NEW YORK — Standard & Poor's said Tuesday that a record number of companies cut their dividend during the first quarter, while a record low announced plans to increase dividend payments.
It was the first time since S&P started tracking dividends in 1955 that dividend decreases outpaced dividend increases. The total dividend payments during the quarter declined by $77 billion, S&P said.
"Many companies were paying dividends on unrealistic earnings expectations," said Don Wordell, portfolio manager of the RidgeWorth Mid-Cap Value Equity fund. To be included in the fund Wordell manages, a company must pay a dividend.
"It's not surprising at all," that some companies would be cutting dividends, Wordell added. "The economic environment is very, very bad."
The ongoing credit crisis and recession have been the primary reasons given by many companies for cutting dividends in recent quarters. The financial services sector has been among the most active in cutting dividends, as it faces the worst credit crisis since the Great Depression.
Many banks slashed their dividends during the first quarter to preserve capital as loan losses continue to mount and profits decline. Capital One Financial, JPMorgan Chase, Wells Fargo, PNC Financial Services Group and U.S. Bancorp were among the financial firms that cut their dividends during the first quarter.
Wordell said many companies were too aggressive setting dividend policies in recent years and started out paying dividends that were not sustainable during down economic cycles. Investors looking for dividend stocks need to focus on companies that have been paying dividends for 25, 40 or even 50 years because that demonstrates a company can manage its cash flow and handle paying its dividend regardless of the economic situation, he said.
The bulk of dividend cuts might now be completed, Howard Silverblatt, S&P's senior index analyst, said in a statement. But, he noted that a second round of cuts could come again as companies review their 2010 budgets and expenses beginning in August and September.
Among 7,000 publicly owned companies that report dividend information to S&P, 367 slashed their payments during the first quarter, more than quadruple the amount that cut their dividend during the first quarter of 2008. A total of 83 firms cut their dividend payments during the first quarter last year.
Of the companies tracked by S&P, only 283 announced plans to increase dividends during the first quarter, a 53% drop from the 598 companies that announced dividend increases during the first quarter last year.
Since 1955, the average had been 15 increases for every one decrease. During the first quarter, there were about three dividend increases for every four decreases.
Copyright 2009 The Associated Press.
By Stephen Bernard, AP Business Writer
NEW YORK — Standard & Poor's said Tuesday that a record number of companies cut their dividend during the first quarter, while a record low announced plans to increase dividend payments.
It was the first time since S&P started tracking dividends in 1955 that dividend decreases outpaced dividend increases. The total dividend payments during the quarter declined by $77 billion, S&P said.
"Many companies were paying dividends on unrealistic earnings expectations," said Don Wordell, portfolio manager of the RidgeWorth Mid-Cap Value Equity fund. To be included in the fund Wordell manages, a company must pay a dividend.
"It's not surprising at all," that some companies would be cutting dividends, Wordell added. "The economic environment is very, very bad."
The ongoing credit crisis and recession have been the primary reasons given by many companies for cutting dividends in recent quarters. The financial services sector has been among the most active in cutting dividends, as it faces the worst credit crisis since the Great Depression.
Many banks slashed their dividends during the first quarter to preserve capital as loan losses continue to mount and profits decline. Capital One Financial, JPMorgan Chase, Wells Fargo, PNC Financial Services Group and U.S. Bancorp were among the financial firms that cut their dividends during the first quarter.
Wordell said many companies were too aggressive setting dividend policies in recent years and started out paying dividends that were not sustainable during down economic cycles. Investors looking for dividend stocks need to focus on companies that have been paying dividends for 25, 40 or even 50 years because that demonstrates a company can manage its cash flow and handle paying its dividend regardless of the economic situation, he said.
The bulk of dividend cuts might now be completed, Howard Silverblatt, S&P's senior index analyst, said in a statement. But, he noted that a second round of cuts could come again as companies review their 2010 budgets and expenses beginning in August and September.
Among 7,000 publicly owned companies that report dividend information to S&P, 367 slashed their payments during the first quarter, more than quadruple the amount that cut their dividend during the first quarter of 2008. A total of 83 firms cut their dividend payments during the first quarter last year.
Of the companies tracked by S&P, only 283 announced plans to increase dividends during the first quarter, a 53% drop from the 598 companies that announced dividend increases during the first quarter last year.
Since 1955, the average had been 15 increases for every one decrease. During the first quarter, there were about three dividend increases for every four decreases.
Copyright 2009 The Associated Press.
Investment primer charts path for beginners
Investment primer charts path for beginners
Get a Financial Life: Personal Finance in Your Twenties and Thirties, By Beth Kobliner, Fireside, $16.00, 336 pages
By Kerry Hannon, Special for USA TODAY
Get a Financial Life: Personal Finance in Your Twenties and Thirties, By Beth Kobliner, Fireside, $16.00, 336 pages
By Kerry Hannon, Special for USA TODAY
Sometimes the very best books are the simplest. And that's the beauty of Get a Financial Life: Personal Finance in your Twenties and Thirties. It offers the fundamental ABCs of how to manage your money.
Originally penned more than a decade ago by Beth Kobliner, a former staff writer for Money magazine and financial columnist for Glamour, the revised and updated new edition, is a model personal finance primer. Its return to the bookshelves couldn't come at a better time for a new crop of young people beset by today's financial meltdown.
The latest version delivers a dose of present day reality. For example: "It's easy these days to write off the idea of contributing to retirement savings accounts like 401 (k)s," Kobliner writes. "You've heard scary stories of people losing half their life savings in the chaos of the market. …You don't feel like you have any money to squirrel away. … You're off the hook, right? Wrong.
"401(k)s are the best savings opportunity you can possibly have — in this or any economy. And not taking advantage of them while you're young is a huge (and costly) mistake," she writes.
She goes on to discuss how 401(k)s are "supersmart savings accounts" that "offer terrific tax advantages that allow your money to grow exponentially fast."
Aside from the occasional au courant nod to collapsing investment portfolios, in general, Kobliner sticks pretty close to her original recipe of straightforwardly defining basic financial terms, such as mortgage, mutual fund and money market accounts.
After all, she's addressing an audience she presumes is clueless, or at the very least, one that has given little thought to these matters. That is until now, when they're holding a diploma and $25,000 in student loans and credit card debt, looking for a job in this tight economy, living on an entry-level salary or hoping to buy a first home.
Kobliner's a gentle guide, carefully walking her money neophytes through the nuts and bolts of personal finance — from health insurance, paying off debt, contributing to retirement plans to building an emergency cushion, investing in stock and bond funds, finding your credit score and improving it, buying a house or car. She even dabbles in income tax strategies.
There's no magic formula for taking control of your financial life here, but rather frank meat and potatoes money management moves that have proven the test of time.
To help readers evaluate whether their current saving and spending habits are "right on track, wildly off base, or somewhere in between," she lists a few tried and true financial rules:
•Your debt payments (not including your mortgage) should be less than 20% of your monthly take home pay.
•Spend no more than 30% of your monthly take-home pay on rent or mortgage payments. This might not be reasonable, if you live in a major city like New York or Miami, but in a small town or city, it works. No matter where you live, it's something to shoot for.
•Save at least 10% of your take-home pay each month. It's critical to think of your savings as a fixed monthly expense that's part of your budget, just like your car payments or rent.
One good way to start saving is with $50 a month in an automatic investment plan, she advises. Some no-load mutual funds will waive or lower their minimum initial investment requirement if you sign up for their plan. With these plans, you can have a fixed amount "siphoned off once or twice a month from your checking account and funneled into your mutual fund." You can set this up online with your initial investment.
"After that, you won't have to do much except sit back and watch the money accumulate," Kobliner writes. Fingers crossed.
If you serve or have served in the military or have a parent who did, she suggests USAA (www.usaa.com) as a good savings option. "It offers some low-cost actively managed bond and stock index funds, charging just 0.19%. It will also waive its usual $3,000 minimum if you sign up for its $20 per month automatic investment plan."
While Kobliner presents a sweeping course on personal finance, she's not fooled into thinking she has given her readers all there is to know. Tucked into the back of the book is a handy section, called Further Reading. It lists books she tells her friends to read which range in topic from investing to insurance to taxes and debt. She includes interesting blogs and message boards such as Get Rich Slowly (www.getrichslowly.org) and free online pamphlets and publications on subjects including choosing a credit card, how to build a better credit report and dispute errors — all available from the Bureau of Consumer Protection (www.ftc.org).
There are just a few key steps you need to dig out of debt, jumpstart saving, and plan for the future, Kobliner writes with assurance. "Once you nail these easy concepts, you'll be on your way — in good times or bad."
Kerry Hannon is a freelance writer based in Washington, D.C.
http://www.usatoday.com/money/books/reviews/2009-04-07-financiallife_N.htm
Tuesday 7 April 2009
Leadership needed over continental toxins
April 7, 2009
Leadership needed over continental toxins
David Wighton: Business Editor's commentary
Everyone at last week's G20 meeting was pretty much agreed — detoxing the banks of their poisonous assets was a necessary condition for global economic recovery. Curious then that so little was said about the issue in the official communiqué.
The world leaders pointed to what had already been done in terms of recapitalising banks and dealing with their impaired assets. And they underlined their commitment to do whatever was required in the future to restore the normal flow of credit. But that was it.
Experience of previous banking crises suggests that what is required is a comprehensive and systematic approach to bank balance sheets. Yet the approach we have at the moment remains ad hoc and piecemeal.
In Britain great strides have been made both in recapitalising the banks and ring-fencing their toxic assets. The taxpayer has put £37 billion directly into RBS and Lloyds; Barclays has raised £7.3 billion from investors and is expected to bring in another £3 billion from the sale of iShares; and HSBC has just wrapped up a very successful £12.5 billion rights issue. In terms of toxic debt, RBS and Lloyds have taken out insurance with the Government covering potential losses on almost £600 billion of assets.
Even so, some analysts believe more will be needed. Yet Britain is much further down the road than many other countries. And meanwhile, the scale of the problem just keeps mounting.
Only in January the International Monetary Fund doubled its forecast of total losses on US credit assets to $2,200 billion (£1,490 billion). As a result, it estimated that US and European banks would need to raise $500 billion to prevent their balance sheets from deteriorating further.
Now I hear that the IMF's economists are preparing to increase that figure to $3,100 billion, with a further $900 billion for assets originated in Europe and Asia.
This escalation reflects the spreading of the downturn from US property-related securities to the real economy around the world. Banks exposed to the crisis in central and eastern Europe look particularly vulnerable.
In a joint report by Morgan Stanley and the consultants Oliver Wyman, the authors argue that continental European governments need to come up with a more comprehensive approach to bolstering their banks, many of which have perilously thin capital cushions.
Meanwhile in the US, Mike Mayo, a veteran banking analyst now at Calyon Securities, warns that the worst is yet to come. He says that government action on impaired assets could trigger the need for further large capital increases for US banks.
The problem is that ploughing more taxpayers' money into their undeserving banks is politically toxic. What politicians need is the cover provided by concerted global action. And they need it before the next G20 summit. Now that Mr Sarkozy and Ms Merkel have their crackdown on tax havens, perhaps they can show some leadership on more urgent problems.
http://business.timesonline.co.uk/tol/business/columnists/article6047880.ece
Leadership needed over continental toxins
David Wighton: Business Editor's commentary
Everyone at last week's G20 meeting was pretty much agreed — detoxing the banks of their poisonous assets was a necessary condition for global economic recovery. Curious then that so little was said about the issue in the official communiqué.
The world leaders pointed to what had already been done in terms of recapitalising banks and dealing with their impaired assets. And they underlined their commitment to do whatever was required in the future to restore the normal flow of credit. But that was it.
Experience of previous banking crises suggests that what is required is a comprehensive and systematic approach to bank balance sheets. Yet the approach we have at the moment remains ad hoc and piecemeal.
In Britain great strides have been made both in recapitalising the banks and ring-fencing their toxic assets. The taxpayer has put £37 billion directly into RBS and Lloyds; Barclays has raised £7.3 billion from investors and is expected to bring in another £3 billion from the sale of iShares; and HSBC has just wrapped up a very successful £12.5 billion rights issue. In terms of toxic debt, RBS and Lloyds have taken out insurance with the Government covering potential losses on almost £600 billion of assets.
Even so, some analysts believe more will be needed. Yet Britain is much further down the road than many other countries. And meanwhile, the scale of the problem just keeps mounting.
Only in January the International Monetary Fund doubled its forecast of total losses on US credit assets to $2,200 billion (£1,490 billion). As a result, it estimated that US and European banks would need to raise $500 billion to prevent their balance sheets from deteriorating further.
Now I hear that the IMF's economists are preparing to increase that figure to $3,100 billion, with a further $900 billion for assets originated in Europe and Asia.
This escalation reflects the spreading of the downturn from US property-related securities to the real economy around the world. Banks exposed to the crisis in central and eastern Europe look particularly vulnerable.
In a joint report by Morgan Stanley and the consultants Oliver Wyman, the authors argue that continental European governments need to come up with a more comprehensive approach to bolstering their banks, many of which have perilously thin capital cushions.
Meanwhile in the US, Mike Mayo, a veteran banking analyst now at Calyon Securities, warns that the worst is yet to come. He says that government action on impaired assets could trigger the need for further large capital increases for US banks.
The problem is that ploughing more taxpayers' money into their undeserving banks is politically toxic. What politicians need is the cover provided by concerted global action. And they need it before the next G20 summit. Now that Mr Sarkozy and Ms Merkel have their crackdown on tax havens, perhaps they can show some leadership on more urgent problems.
http://business.timesonline.co.uk/tol/business/columnists/article6047880.ece
Recession: the penny finally drops...
April 7, 2009
Recession: the penny finally drops...
David Wighton: Business Editor's commentary
One of the great mysteries of the recession has been why consumer confidence has held up so well. To judge from the Asda survey we report today, the grim reality finally appears to have dawned. Half of those polled fear losing their jobs in the next six months while two thirds would take a pay cut or a reduction in the working week to protect theirs.
That represents a big shift from December, when only one third of those questioned said they expected their job security to get worse in the next three months.
One surprising result of the survey is that 21 per cent of those questioned said that they expected to receive a pay rise at least as good as last year's. Then again, maybe not so odd. This happens to be almost precisely the proportion of the workforce employed in the public sector.
http://business.timesonline.co.uk/tol/business/columnists/article6047897.ece
Recession: the penny finally drops...
David Wighton: Business Editor's commentary
One of the great mysteries of the recession has been why consumer confidence has held up so well. To judge from the Asda survey we report today, the grim reality finally appears to have dawned. Half of those polled fear losing their jobs in the next six months while two thirds would take a pay cut or a reduction in the working week to protect theirs.
That represents a big shift from December, when only one third of those questioned said they expected their job security to get worse in the next three months.
One surprising result of the survey is that 21 per cent of those questioned said that they expected to receive a pay rise at least as good as last year's. Then again, maybe not so odd. This happens to be almost precisely the proportion of the workforce employed in the public sector.
http://business.timesonline.co.uk/tol/business/columnists/article6047897.ece
Toxic debts could reach $4 trillion, IMF to warn
April 7, 2009
Toxic debts could reach $4 trillion, IMF to warn
Gráinne Gilmore, Economics Correspondent
Toxic debts racked up by banks and insurers could spiral to $4 trillion (£2.7 trillion), new forecasts from the International Monetary Fund (IMF) are set to suggest.
The IMF said in January that it expected the deterioration in US-originated assets to reach $2.2 trillion by the end of next year, but it is understood to be looking at raising that to $3.1 trillion in its next assessment of the global economy, due to be published on April 21. In addition, it is likely to boost that total by $900 billion for toxic assets originated in Europe and Asia.
Banks and insurers, which so far have owned up to $1.29 trillion in toxic assets, are facing increasing losses as the deepening recession takes a toll, adding to the debts racked up from sub-prime mortgages. The IMF's new forecast, which could be revised again before the end of the month, will come as a blow to governments that have already pumped billions into the banking system.
Paul Ashworth, senior US economist at Capital Economics, said: “The first losses were asset writedowns based on sub-prime mortgages and associated instruments. But now, banks are selling ‘plain vanilla' losses from mortgages, commercial loans and credit cards. For this reason, the housing market will play a crucial part in how big the bad debt toll is over the next year or two.”
In its January report, the IMF said: “Degradation is also occurring in the loan books of banks, reflecting the weakening outlook for the economy. Going forward, banks will need even more capital as expected losses continue to mount.” At the same time, there is a clear shift in congressional attitudes in the United States about simply pumping money into the system, Mr Ashworth said. The British Government is also under pressure to repair its tattered finances. Injecting more money into the banks could further undermine its fiscal position.
The IMF's jump will come as little surprise to economists who have suggested that the bad debts will be much higher than anticipated. Nouriel Roubini, chairman of RGE Monitor, expects bad debts from US-originated assets to reach $3.6 billion by the middle of next year. This figure is expected to rise when bad debts from assets elsewhere are calculated, he said.
http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article6047929.ece
Toxic debts could reach $4 trillion, IMF to warn
Gráinne Gilmore, Economics Correspondent
Toxic debts racked up by banks and insurers could spiral to $4 trillion (£2.7 trillion), new forecasts from the International Monetary Fund (IMF) are set to suggest.
The IMF said in January that it expected the deterioration in US-originated assets to reach $2.2 trillion by the end of next year, but it is understood to be looking at raising that to $3.1 trillion in its next assessment of the global economy, due to be published on April 21. In addition, it is likely to boost that total by $900 billion for toxic assets originated in Europe and Asia.
Banks and insurers, which so far have owned up to $1.29 trillion in toxic assets, are facing increasing losses as the deepening recession takes a toll, adding to the debts racked up from sub-prime mortgages. The IMF's new forecast, which could be revised again before the end of the month, will come as a blow to governments that have already pumped billions into the banking system.
Paul Ashworth, senior US economist at Capital Economics, said: “The first losses were asset writedowns based on sub-prime mortgages and associated instruments. But now, banks are selling ‘plain vanilla' losses from mortgages, commercial loans and credit cards. For this reason, the housing market will play a crucial part in how big the bad debt toll is over the next year or two.”
In its January report, the IMF said: “Degradation is also occurring in the loan books of banks, reflecting the weakening outlook for the economy. Going forward, banks will need even more capital as expected losses continue to mount.” At the same time, there is a clear shift in congressional attitudes in the United States about simply pumping money into the system, Mr Ashworth said. The British Government is also under pressure to repair its tattered finances. Injecting more money into the banks could further undermine its fiscal position.
The IMF's jump will come as little surprise to economists who have suggested that the bad debts will be much higher than anticipated. Nouriel Roubini, chairman of RGE Monitor, expects bad debts from US-originated assets to reach $3.6 billion by the middle of next year. This figure is expected to rise when bad debts from assets elsewhere are calculated, he said.
http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article6047929.ece
Has the economy turned?
Has the economy turned?
One swallow does not make a summer. But we have now had a veritable flight of the passerine birds, writes Harry Wallop.
By Harry Wallop, Consumer Affairs Editor
Last Updated: 3:11PM BST 02 Apr 2009
After 18 months of relentlessly falling house prices, the most severe financial crisis since the 1930s and the start of what is shaping up to be a brutal recession, a few green shoots have poked their heads out of the ground.
A blip? Probably, but the figures come just a few days after the Bank of England said mortgage approvals had jumped during February.
Estate Agents have been saying for months that buyers have started to come back through their doors. It's just that they don't have any funding to buy a property.
Well, maybe it's the spring weather – or maybe it's the billions of pounds of taxpayer money pumped into the system finally filtering through to consumers – but mortgage companies have started to trim their rates.
There are now a number of deals for under 3 per cent. Okay, this is six times the Bank Rate, and you will still need a big deposit to get the loan, but money is available for many people who need it, and at far cheaper rates than six months ago.
To cap it all, the FTSE 100 has climbed back above 4,000 for the first time since February.
The problem is it is sometimes difficult to tell, at this time of year, whether the shoots are your first spring peas, or a new, virulent weed.
Decisions made by consumers last year are only now hitting businesses. Job losses will continue to mount, which in turn will lead to repossessions and lower house prices.
And the tens of thousands of jobs that have been announced every week this year – even if they stopped today – will continue to cause repercussions for a good 12 months to come.
Yes, the bad news has become less relentless, but the best that can really be hoped for is that we have hit the bottom. Not that things are improving.
http://www.telegraph.co.uk/comment/5094693/Has-the-economy-turned.html
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UK house prices rose in March for first time since 2007, Nationwide survey shows
Green shoots in housing prices, stock market and banks, economists hope
One swallow does not make a summer. But we have now had a veritable flight of the passerine birds, writes Harry Wallop.
By Harry Wallop, Consumer Affairs Editor
Last Updated: 3:11PM BST 02 Apr 2009
After 18 months of relentlessly falling house prices, the most severe financial crisis since the 1930s and the start of what is shaping up to be a brutal recession, a few green shoots have poked their heads out of the ground.
A blip? Probably, but the figures come just a few days after the Bank of England said mortgage approvals had jumped during February.
Estate Agents have been saying for months that buyers have started to come back through their doors. It's just that they don't have any funding to buy a property.
Well, maybe it's the spring weather – or maybe it's the billions of pounds of taxpayer money pumped into the system finally filtering through to consumers – but mortgage companies have started to trim their rates.
There are now a number of deals for under 3 per cent. Okay, this is six times the Bank Rate, and you will still need a big deposit to get the loan, but money is available for many people who need it, and at far cheaper rates than six months ago.
To cap it all, the FTSE 100 has climbed back above 4,000 for the first time since February.
The problem is it is sometimes difficult to tell, at this time of year, whether the shoots are your first spring peas, or a new, virulent weed.
Decisions made by consumers last year are only now hitting businesses. Job losses will continue to mount, which in turn will lead to repossessions and lower house prices.
And the tens of thousands of jobs that have been announced every week this year – even if they stopped today – will continue to cause repercussions for a good 12 months to come.
Yes, the bad news has become less relentless, but the best that can really be hoped for is that we have hit the bottom. Not that things are improving.
http://www.telegraph.co.uk/comment/5094693/Has-the-economy-turned.html
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Earnings Concerns Push Shares Lower
Earnings Concerns Push Shares Lower
By JACK HEALY
Published: April 6, 2009
Wall Street took losses on Monday after four consecutive weeks of wins as traders hunkered down for a rough corporate earnings season.
Technology shares fell on reports that the computer giant I.B.M. had withdrawn its $7 billion offer to buy Sun Microsystems, which makes computer software and servers. Shares of I.B.M. fell 0.7 percent to $101.56, while Sun fell 22.5 percent to $6.58 a share as investors raised questions about the next step for the company.
The Dow Jones industrial average finished down 41.74 points, or 0.5 percent, at 7,975.85. The wider Standard & Poor’s 500-stock index fell 0.8 percent, or 7.02 points, to 835.48. The Nasdaq declined 15.16 points, or 0.9 percent, to 1,606.71.
The losses ate into last week’s 3 percent gains in the Dow and the S.& P. 500.
Financial companies fell about 3 percent, according to Standard & Poor’s financials index after a report from the banking analyst Mike Mayo, who recently joined Calyon Securities after leaving Deutsche Bank. Mr. Mayo, who is known for his bearish but independent analysis, predicted that banking loan losses this year compared with their total loans would “increase to levels that exceed the Great Depression.”
He rated 11 major and regional banks as sell or underperform. Shares of Bank of America, JPMorgan Chase and Citigroup fell slightly.
Defense companies including Lockheed Martin, Northrop Grumman and Raytheon rose as investors speculated that they would fare well under an overhauled Pentagon budget. On Monday, the Defense secretary, Robert M. Gates, outlined broad proposed changes in how the military spends.
With the major indexes up more than 20 percent since their March lows, analysts say earnings season could pose an important test of investor confidence in the stock market.
On Tuesday, the aluminum maker Alcoa will report its quarterly earnings after the market closes, reprising its role as the first major company to do so.
“What investors want to hear from executives — and what they may not get — is that things improved through the quarter,” said Jeffrey N. Kleintop, chief market strategist at LPL Financial. “The worry is we may not get that tone, that they might continue to take down guidance in the coming quarters.”
The price-to-earnings ratio on the S.& P. 500 is about 12 to 13, making stocks look cheap compared with the days when stocks sold for 20 times earnings, or more. But some analysts argue that while stock prices may look cheap, expectations of profits and revenues do not reflect the true scope of the global economic downturn.
Stock markets were lower in Europe. The FTSE 100 in London, the DAX in Frankfurt and the CAC 40 in France were all down just less than 1 percent.
The Treasury’s 10-year note fell 10/32, to 98 17/32. The yield, which moves in the opposite direction from the price, rose to 2.92 percent, from 2.89 percent late Friday.
Following are the results of Monday’s Treasury auction of three- and six-month bills:
http://www.nytimes.com/2009/04/07/business/07markets.html?_r=1&ref=business
By JACK HEALY
Published: April 6, 2009
Wall Street took losses on Monday after four consecutive weeks of wins as traders hunkered down for a rough corporate earnings season.
Technology shares fell on reports that the computer giant I.B.M. had withdrawn its $7 billion offer to buy Sun Microsystems, which makes computer software and servers. Shares of I.B.M. fell 0.7 percent to $101.56, while Sun fell 22.5 percent to $6.58 a share as investors raised questions about the next step for the company.
The Dow Jones industrial average finished down 41.74 points, or 0.5 percent, at 7,975.85. The wider Standard & Poor’s 500-stock index fell 0.8 percent, or 7.02 points, to 835.48. The Nasdaq declined 15.16 points, or 0.9 percent, to 1,606.71.
The losses ate into last week’s 3 percent gains in the Dow and the S.& P. 500.
Financial companies fell about 3 percent, according to Standard & Poor’s financials index after a report from the banking analyst Mike Mayo, who recently joined Calyon Securities after leaving Deutsche Bank. Mr. Mayo, who is known for his bearish but independent analysis, predicted that banking loan losses this year compared with their total loans would “increase to levels that exceed the Great Depression.”
He rated 11 major and regional banks as sell or underperform. Shares of Bank of America, JPMorgan Chase and Citigroup fell slightly.
Defense companies including Lockheed Martin, Northrop Grumman and Raytheon rose as investors speculated that they would fare well under an overhauled Pentagon budget. On Monday, the Defense secretary, Robert M. Gates, outlined broad proposed changes in how the military spends.
With the major indexes up more than 20 percent since their March lows, analysts say earnings season could pose an important test of investor confidence in the stock market.
On Tuesday, the aluminum maker Alcoa will report its quarterly earnings after the market closes, reprising its role as the first major company to do so.
“What investors want to hear from executives — and what they may not get — is that things improved through the quarter,” said Jeffrey N. Kleintop, chief market strategist at LPL Financial. “The worry is we may not get that tone, that they might continue to take down guidance in the coming quarters.”
The price-to-earnings ratio on the S.& P. 500 is about 12 to 13, making stocks look cheap compared with the days when stocks sold for 20 times earnings, or more. But some analysts argue that while stock prices may look cheap, expectations of profits and revenues do not reflect the true scope of the global economic downturn.
Stock markets were lower in Europe. The FTSE 100 in London, the DAX in Frankfurt and the CAC 40 in France were all down just less than 1 percent.
The Treasury’s 10-year note fell 10/32, to 98 17/32. The yield, which moves in the opposite direction from the price, rose to 2.92 percent, from 2.89 percent late Friday.
Following are the results of Monday’s Treasury auction of three- and six-month bills:
http://www.nytimes.com/2009/04/07/business/07markets.html?_r=1&ref=business
Buffett's Biggest Mistake (Swing the Bat)
Buffett's Biggest Mistake
By Rich Greifner April 6, 2009 Comments (5)
It doesn't happen often, but it does happen. Once in a blue moon, even the great Warren Buffett makes a mistake.
In his latest annual letter to his Berkshire Hathaway (NYSE: BRK-A) shareholders, Buffett lamented "some dumb things" he did in 2008. He apologized for his ill-timed investment in ConocoPhillips (NYSE: COP), as well as a smaller stake in two Irish banks, which he dubbed "unforced errors."
And those were far from the first flubs Buffett has made during his illustrious investing career. His purchases of shares in Pier One and US Airways were poor investments, and he compounded his ill-fated acquisition of Dexter Shoes by using Berkshire shares instead of cash as currency. In fact, Berkshire itself was a poor investment -- Buffett greatly underestimated the capital requirements and competitive pressures endemic to the textile industry.
The greatest mistake of all
But when prompted for his greatest investing miss in an interview last year, Buffett didn't mention any of those gaffes. In fact, Buffett's biggest mistake wasn't a bad investment at all -- it was a good investment that could have been great.
"There have been a few things where I've started to buy them and then they've moved up," Buffett said. But instead of adding to his position in these great businesses, Buffett "stopped at a tiny fraction of where we should have gone."
Buffett specifically cited his failure to purchase additional shares of Fannie Mae in the early '80s and Wal-Mart (NYSE: WMT) in the mid '90s. "Both of those deals would have made us as much as $10 billion, and I managed to absolutely minimize the profits," he said.
The Oracle was similarly wistful about Costco (Nasdaq: COST): "We own a little at Berkshire, but we should have owned a lot," Buffett lamented. He blamed his failure to buy more shares on "temporary insanity."
Don't be insane -- swing the bat!
Buffett often likens investing to a game of baseball, where every potential investment is a new pitch, and there are no called strikes. Patient investors can sit back and wait for the perfect pitch, ready to deposit that 2-0 fastball into the centerfield bleachers. But before you step in the batter's box, you must first identify what your perfect pitch looks like.
Buffett likes to swing at easily understandable businesses "whose earnings are virtually certain to be materially higher five, ten, and twenty years from now." After taking too shallow a cut on companies like Costco, he learned that "over time, you will find only a few companies that meet these standards -- so when you see one that qualifies, you should buy a meaningful amount of stock."
Finding your perfect pitch With the stocks of many great companies trading at significant discounts to intrinsic value, experienced gurus like Buffett are swinging for the fences right now. But many individual investors are standing with their bat on their shoulder, letting these perfect pitches float on by. Look at these three great opportunities available today:
Company
(Average P/E Ratio, Last 5 Years )
(Current P/E Ratio )
PepsiCo (NYSE: PEP)
24.2
16.3
Target (NYSE: TGT)
17.7
12.3
Yum! Brands (NYSE: YUM)
23.1
15.2
Data from Capital IQ, a division of Standard & Poor's.
Each of these companies is an easily understandable business whose strong brands mean their earnings are very likely to be materially higher five, 10, and 20 years from now. But while their future growth prospects remain strong, their share prices are the cheapest they've been in years. In such a volatile market, there's a chance these companies could fall farther, but I believe they're much closer to the bottom than the top.
Ready to swing?
Rich Greifner is convinced that this is the year for his beloved Chicago Cubs. Rich owns a Mark Grace rookie card, but none of the stocks mentioned in this article. The Motley Fool owns shares of Berkshire Hathaway. Berkshire, Costco are selections of both Motley Fool Stock Advisor and Inside Value. Wal-Mart is an Inside Value recommendation. PepsiCo is an Income Investor pick.
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http://www.fool.com/investing/general/2009/04/06/buffetts-biggest-mistake.aspx
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