XChange - The NBR Blog

The Odds for a Jobless Recovery Rise

2009-11-06T23:32:42Z

I don't know about you, but today's employment data makes me thankful to have a job. Now 1 person in 10 is out of work. In my anecdotal experience, things feel even worse. I see an increasing number of fathers doing drop off at kids' schools, something I didn't see a year ago. And there doesn't seem to be any change in the number of requests I'm getting for job contacts -- and not just for leads in my field.

One interesting fact I came across: If the 15.7 million unemployed lived in one state, that state would be the country's fifth largest. Wow!

But, even more distressing than today's jobs report is the outlook for employment. After the Q3 GDP report came out, hopes were high that the Great Recession was over, and recovery was finally underway.

]]> Now economists say that the peak in the unemployment rate probably will be close to 10.5% and probably not until the middle of next year. Even worse -- the unemployment rate is expected to stay high for several more years.

So, it seems that the risk of a jobless recovery is rising. Let's hope this month's data is an aberration, not a harbinger of a deteriorating economy.

Elizabeth Warren Wants to Keep Banks Honest

2009-11-06T22:37:19Z

The largest financial firms made out under the government's asset guarantee program. That's the conclusion of the panel overseeing the program for Congress. Harvard Law School Professor Elizabeth Warren chairs the panel. She says while the program hasn't lost taxpayers money so far, it has fundamentally changed our system. Now all big financial firms have an implicit guarantee by Uncle Sam. Warren says reforming the financial regulatory system is our "only hope" to fix that moral hazard.

Warren has also championed a new Consumer Financial Protection Agency to keep banks honest. Congressman Barney Frank wants Warren to lead that agency, but her critics say she doesn't have any "real world" experience. Warren says she hates banks that cheat their customers. Watch the video clip below to hear some of her thoughts on how banks treat their customers. Then let me know what you think.

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No Place to Hide from Unemployment

2009-11-06T22:35:00Z

The teen unemployment set a new record in October: 27.6%.

Faced with the scary job market, many young people are heading for college or graduate school. Most of the increase in college enrollment is at community colleges.

It makes sense. If teenagers and young workers can't find a job, they can ride out the storm and use the time to improve their skills.

The only problem is that many other young people have the same idea. With employers cutting back and more people going to college, we could face a glut of new grads in a few years.

In some sense, the added education only postpones the job market pain. And that pain is likely to last for a while. Younger workers are often the first fired and the last hired. The Economic Policy Institute's Heidi Shierholz thinks the soft job market could last for another five to seven years!

ETFs vs. Funds: How to Choose What's Best for You

2009-11-05T13:14:56Z

Charles Schwab, the discount brokerage, made a bit of news this week by offering eight new exchange-traded funds, or ETFs. That wasn't such a big deal in itself, since the ETF business is booming with new offerings from just about every mutual fund firm and brokerage. But Schwab has upped the ante by allowing its customers to trade the house-brand ETFs for free - without paying the $12.95 brokerage commission for trading other types of stocks.

Now that's interesting. Commissions have been one of the few drawbacks to ETFs, because they can chew up accounts of investors who want to add modest sums frequently. That $12.95 is 6.5 percent of a $200 purchase, for example. You wouldn't want to pay that every month. With an ordinary mutual fund, as opposed to an ETF, you can buy and sell with no fee if you deal directly with the fund company.

]]> ETFs are a big deal. At the end of 1998 there were just 29 of them with a mere $16 billion in assets, according to the Investment Company Institute, the fund-industry trade group. At the end of last year there were 728 ETFs with $531 billion in assets. Growth has continued this year, raising assets to nearly $900 billion by the end of August, according to one tally. Mutual funds have nearly $9 trillion in assets.

So, with the landscape changing all the time, it's worth taking a moment to look at the pros and cons of ETFs versus funds. For just about every ETF there is a comparable index-style mutual fund, making the choice tricky.

Both represent pools of investor money used to buy specific types of securities, mainly stocks for ETFs. Most ETFs are index-style investments, meaning they automatically buy stocks contained in an underlying index, or market barometer, such as the Standard @ Poor's 500.

The chief difference is in the way each is bought and sold. ETFs are stocks, and are traded like stocks - through a broker, usually by paying a commission, at any time during the trading day based on a price that can fluctuate moment by moment. If you thought the day's Federal Reserve statement would push stocks up, you could buy an ETF in the morning and sell it in the afternoon. In fact, if you thought the statement would drive stocks down, you could do a short sale, selling borrowed shares in hopes of replacing them with ones bought cheaper, profiting on the difference. There is even options trading with some ETFs, allowing investors to make risky bets or insure against losses.

Mutual funds are dull by comparison. Put in an order anytime during the day and it will be filled at the end of the day at a price based on the closing values of the securities in the fund. There are no short sales and no options trading. Obviously, ETFs serve the needs of short-term speculators; funds don't.

Once an ETF is created and sold, it continues trading on the stock market, and the company that put it together has little contact with investors. If you want to get rid of your ETF, you just call your broker or make a few clicks of a mouse to sell it to someone else. With funds, it's quite different. The fund company takes your call when you want to buy, collects your money and uses it to buy more securities. When you want to sell, the company sells securities and sends you the money. All this is quite a bit of work, and it generally forces the fund company to charge a larger "expense ratio" than a comparable ETF charges. The Vanguard 500 Index Investor fund (VFINX) and the SPDR ETF (SPY) both mirror the moves of the S&P 500. But the fund's annual expense ratio is 0.16 percent of assets in the account, the ETF's is just 0.09 percent. Rock-bottom fees make ETFs appealing to long-term investors.

Mutual funds must sell stocks they hold to raise money for investor redemptions, and when those sales generate net profits for the year, the gains are paid out to investors, usually in November of December. These payments can trigger tax bills even if the money is automatically reinvested in more fund shares.

Since ETFs do not sell holdings to satisfy redemptions, they typically don't present the same problem of taxable distributions. Instead, gains are reflected in the ETF share price and you are taxed only after selling the shares. Morningstar Inc., the fund-tracking firm, has found that ETFs generally trigger smaller tax bills than comparable mutual funds, but not always. The Vanguard fund mentioned above has been more "tax efficient" than its ETF rival, mainly because Vanguard's managers use various techniques to keep taxes down. When selling a block of stock to meet shareholder redemptions, for example, they can sell the shares that had cost the most, minimizing the taxable gain. (You can investigate ETFs on the Morningstar Site.)

It all boils down to this: ETFs are preferable for short-term traders and speculators. Because their expense ratios are lower, they can also be better for long-term investors whose trades are large enough to make commissions insignificant. That generally requires using a discount broker charging less than $20 a trade. If you have a large sum to invest all at once, the ETF could be the best choice.

Mutual funds are better for ordinary investors putting in modest sums every month or quarter, since there are no commissions.

Of course this could change if many financial services firms follow Schwab's lead and offer commission-free trading on ETFs.

Jeff Brown is an experienced business journalist and personal finance columnist who has written for The Philadelphia Inquirer, The New York Times, and TheStreet.com. Read his bio to learn more about him.

Despite Pick Up in Economy, Layoffs Continue

2009-11-04T18:21:39Z

The number of workers receiving pink slips each month is finally beginning to tail off, but companies plan to keep laying off workers despite signs of a pick up in the U.S. economy.

Private-sector employers cut 203,000 jobs in October, after eliminating 227,000 jobs the previous month, according to a report out today by payroll giant Automatic Data Processing Inc. and Macroeconomic Advisers LLC, a consulting firm that specializes in economic forecasting.

On a more encouraging note, U.S. companies said they were planning fewer layoffs going forward. Planned layoffs at U.S. firms fell to 55,679 in October, down from 66,404 a month earlier, according to outplacement-consulting firm Challenger, Gray & Christmas Inc. The bulk of the layoffs are expected to come from the auto industry, non-profit firms, and state and local governments.

]]> Though layoffs are beginning to ease, that's still a whole lot of people about to lose their jobs despite a sudden surge in the U.S. economy. Gross domestic product -- the broadest measure of the economy -- expanded at an annualized rate of 3.5% in the third quarter, following four straight quarters of declining economic activity. The rebound had many cheering the end of a painful recession. (Two-straight quarters of negative growth traditionally defines a recession.)

So if happy days are here again, why do the layoffs continue? Historically, companies tend to be wary of turnarounds in the economy and so are slow to react.

John Challenger, chief executive of Challenger, Gray, said in a statement: "Companies will, at first, be very cautious not to over-hire, in case this recovery is not sustainable," he said in a statement.

Employers have even more reason to be cautious of this economic turnaround, because much of it was fueled by government-spending programs, such as the $8,000 first-time home buyer tax credit and "Cash for Clunkers." Many of these stimulus programs have expired, or are about to expire, so it remains to be seen if consumer spending (the greatest driver of economic growth) will pick up enough to sustain the economy's recovery.

Until that happens, workers can expect the layoffs to continue. Those workers who are left behind will be expected to do more with less.

Readers, are you worried about losing your job? Have you had to take on more work because some of your coworkers were laid off this year? Share your stories with me!

Terri Cullen is an award-winning financial journalist. She was one of the original team of editors who helped to launch The Wall Street Journal Online. Terri is also the author of "The Wall Street Journal. Complete Identity Theft Guidebook." Read her bio to learn more about her.

Parsing the Federal Reserve

2009-11-03T21:09:55Z

"[P]arsing, or, more formally, syntactic analysis, is the process of analyzing a text, made of a sequence of tokens (for example, words), to determine its grammatical structure with respect to a given (more or less) formal grammar."

Let us now learn to parse the Federal Reserve's Open Market Committee statement.

To begin with, the Federal Open Market Committee -- FOMC for short -- sets interest rate policy. These 12 people have a lot to say about how much you pay for a mortgage.

The statement comes out at 2:15 after the FOMC meets. You can find a statement here.

The first paragraph of the statement usually describes the Fed's take on the economy. The major sectors of the economy -- employment, industrial production, etc. -- are usually discussed. Important economic trends are mentioned here.

The second paragraph is often the "inflation paragraph." The Fed opines on any "slack" in the economy. Slack is often a fancy way of saying lots of people are out of work. If there is lots of slack in the economy -- unemployment -- people can't find jobs or are worried about finding jobs meaning they are unwilling to buy much. That means businesses can't raise prices.

The final paragraph is traditionally the "balance of risks" paragraph. As the financial crisis took hold, the balance or risks became a balance of terror. This paragraph became devoted to listing all the ways the Fed is fighting the credit crisis. Look here now to find hints on how fast the Fed is "unwinding" the various credit supports it has put in place.

]]> If you want to go deeper, you can parse the specific phrases the Fed uses to signal its intentions to markets. For example, there is the "extended period of time" language. Wall Street takes comfort in this because it means there is little risk interest rates will rise in the near future.

But what does "extended period of time mean?" One year? Six months? Until the Fed changes its mind? These questions have spawned an industry of Fed-parsers. Will the Fed switch from "extended period" to "some time" or " a while" or "as long as we feel like it?" Stay tuned!

For mere mortals, none of this parsing is necessary. Over the last few years the Fed has made a huge effort to communicate clearly it's intentions. Fed Chair Ben Bernanke actually thinks that is a good idea. Unless, of course, you make a living parsing the Fed.

Mutual Fund Fees: How to Pay 30 Percent and Never Know It

2009-11-03T18:16:23Z

You don't mind paying 1 or 2 percent in annual mutual fund fees? Okay, how would you feel about 10, 15 or 20 percent? Maybe even 30 percent?

Numbers like that would get most investors' attention - if they were real. In fact, they are. I'll get back to that in a moment.

What brings this up is news of a U.S. Supreme Court case involving investors' complaints about high fees. They are unhappy that the Oakmark family of mutual funds charges individuals twice what it does institutions like insurance companies and pension funds.

]]> The target of the suit, Oakmark's investment advisor, Harris Associates, argues it's perfectly proper to charge individuals more because they require more customer services.

How the court will rule is anyone's guess. But the case highlights the conflict of interest that has long plagued much of the fund industry. Most funds have a financial incentive to charge the highest fees they can, since that's how they make their money. But at the same time they have a fiduciary responsibility to put investors' interests first.

Vanguard Group, the Malvern, Pa. fund company known for its index products, has addressed this conflict by using a mutual ownership system, so the company belongs to the people who invest in Vanguard funds. The owners therefore want to keep fees to a minimum.

But most other companies are either publically held corporations, with stockholders, or privately held companies with a handful of owners. Maximizing fees boosts the owners' profits.

In a hearing Monday on the Oakmark case, Chief Justice John G. Roberts Jr. noted that investors can easily find funds' fees, or expense ratios, on the Internet. The implication is that competition in the marketplace should keep fees from getting excessive.

In fact, there's some evidence that this is so. For a number of years, studies by the Investment Company Institute, the trade organization for the fund industry, have shown that investors tend to select funds with lower fees. In 2008, the average expense ratio for stock funds was 1.46 percent, according to the ICI. That "simple average" is figured by adding together the fees charged by all funds and dividing by the number of funds. But because investors put more money into funds with lower fees, the average investor actually paid 0.84 percent, the ICI says, using an "asset-weighted" calculation.

Still, many experts have wondered why fees have not dropped dramatically given the huge growth in fund assets over the years. After all, it takes the same effort to research a stock regardless of whether a fund subsequently buys 100,000 shares or one million. The average stock fund charged 1.48 percent in 1994, virtually the same as in 2008, though total assets grew from about $853 billion to $3.7 trillion, according to the ICI.

The reason fees don't shrink significantly is that too many investors are willing to pay more than they have to. Many investors end up with funds recommended by brokers or other financial advisors pitching house brands that charge more than competitors do.

And many investors feel all this nagging over fees is just picky -- a preoccupation of people like me who have nothing better to do than make a mountain out of a mole hill.

The problem is that fees are always expressed as a percentage of assets. Pay 1.5 percent a year on your actively managed stock fund and you're out just $1.50 for every $100 invested.

It looks very different if you see fees as a percentage of investment returns, which is a much more appropriate view. Invest $100 in a fund with assets that gain 10 percent and that 1.5 percent fee chews up 15 percent of your profits. If the fund gains only 5 percent, the fee comes to 30 percent of profits.

On the other hand, you could invest in an index-style fund and pay fees of only 0.2 percent. If the fund assets grow 10 percent, the fees equal only 2 percent of your gains. With 5 percent growth, the fees would be just 4 percent.

Think of the investment return as your income. Would you rather pay income tax of 4 percent or 30 percent?

Of course, this would not matter if the managed fund's returns were big enough to offset the fees. But study upon study say that very few managed funds can do that consistently, and it's virtually impossible for the ordinary investor to figure out which ones will do it in the future.

When you see fees as a portion of returns rather than assets, it's easy to understand the daunting challenge that fund managers face. If the index fund returns 7 percent, the investor ends up with 6.8 percent after paying fees of 0.2 percent. To match that after-fee result, the managed fund must select holdings returning 8.3 percent. That means its return has to be nearly 19 percent better -- 8.3 vs. 7

That's too much to expect. It's why investors should do all they can to keep fees to an absolute minimum.

Fiscally Fit: Building a Budget

2009-11-03T17:04:04Z

Authored by Stephanie May, NBR Summer 2009 Intern

Over the summer we dove into the idea that if you spend less during the week, you can make up for times when spending gets a bit more out of control (e.g. the weekend). But now I'm really starting to question that theory.

October was a semi-normal month for me until this last week. Boulder, Colorado puts on a Halloween celebration that rivals the best of them. It's not just one night up here. It's a whole week affair. And forget costume repetition. Creative, elaborate, and different costumes are a must. As you can imagine, this can get extremely expensive. Halloween wiped out my bank account, leaving me with a grand total of 6 dollars. Would I trade the fun I had for a bigger bank balance? Absolutely not. But, when I saw what I spent, I did wonder, "When will this get easier?"

]]> My first thought was, "This will be easier in November." My logic was that like the weekend, October was a time of higher spending. November, like the regular week, would be more relaxed...and inexpensive. Then I realized that's absolutely not true! I have a friend coming into town this weekend, and I am going to Ohio the following weekend to visit another friend. Then the month wraps up with Thanksgiving. I'll be off of school for an entire week, spending time (and money) with all my friends back home. November is going to be much worse!

Then I looked to December. I wished more than thought, "December will be the month my spending will go down." But, OF COURSE, that's not true. With all of the holiday festivities and buying of Christmas presents, December won't be a month of cut backs for me.

All of this thinking finally led me to accept a conclusion I've been fighting against for months: I need to figure out how to budget. I have dabbled in budgeting, but I haven't found a formula that works. For a while Mint.com was really helping. Then I got frustrated because it took several days for the site to process my purchases. So I gave up.

I am surviving. I haven't gone over my allowance, and I'm not in any kind of debt. So overall I'm still coming out on top. But I know that there's a better way. If I made and kept a budget, I would be able to put aside some money for my Costa Rica mission trip in January. I'd probably be able to put some money into savings for next year, and I might even be able to buy some new winter clothes!

So, I guess I figured out the answer to my question. When is this going to get easier? NEVER! There will always be something to spend money on. The only way to cut down and to make sure I am spending money in a conscious, effective way is to embrace budgeting.

I don't know exactly how I'm going to make this work. I might go back to my old friend Mint.com, or I might try to keep a running total of how much money I'm spending in each category. I really don't know. It might be time to call up my financial guru Aunt Tracy for some advice.

If you have any ideas let me know. My Fiscally Fit followers... It's time to build a budget!

Follow me on Twitter @FiscallyFit!

Jones v Harris and Your Mutual Fund Fees

2009-11-02T20:31:32Z

For the last couple of weeks, we've been having a huge national debate over what to pay people.

Ken Feinberg, the Treasury's Special Master, has weighed in on bailed -out banks. The Federal Reserve is getting into the act, asking banks to explain the relation between pay practices and risk.

Today it was the Supreme Court's turn to dip a toe into the national discussion.

The case at hand is Jones v Harris Associates. Jones and two other plaintiffs are individual investors. Harris Associates is the sponsor of the Oakmark Funds and the investment adviser, a common feature of the mutual fund industry. To manage the conflict of interest between the adviser and the fund it operates, the law requires compensation be set by an independent board of trustees representing the fund.

The shareholders in this case argue Harris' fees are excessive because they are twice as high as those charged to institutions for virtually identical advice. Harris -- and the mutual fund industry -- argue the advice and services are very different, justifying the higher fees.

]]> Also, the industry argues an independent board knows better than a court whether an investment fee is excessive or not.

On the flip side, advocates for investors cite evidence showing that most of us don't really make rational decisions about mutual fund fees. In other words, the market is not a sufficient check on the industry.

In oral arguments today, the justices of the Supreme Court seemed uncomfortable with the idea of judges setting pay for an entire industry. They also wrestled with the right "fiduciary responsibility" standard for the industry.

Fiduciary is a word every investor should understand. In lay terms, it means the person you are dealing with -- your fiduciary -- should act in your best interests. That is a very different standard than, say, a salesman who might just have to follow a law against fraud.

We'll find out more about what the proper fiduciary standard is for the mutual fund industry when the Supreme Court issues its ruling sometime next year.

Pros and Cons of Extending Unemployment Benefits

2009-11-02T20:03:19Z

Law makers are closing in on approving an extension of federal unemployment-insurance benefits. The bill would provide an extra 14 weeks of benefits for people who've exhausted their benefits. Those who live in states where the unemployment rate is more than 8.5 percent would get up to 20 weeks of extended benefits.

It's tough to argue that extending unemployment benefits is a bad idea at a time when more than 15 million people are out of work. The extension would come at a time when as many as 7,000 people a day are exhausting their unemployment benefits.

But that doesn't stop some people from trying.

]]> Most economists agree that extending benefits is good for the economy, because it does more than just help financially strapped families ride out a long-term job loss. How so? Unemployment benefits provide the greatest assistance to lower- and-middle-income households, ones that typically don't have a fat severance package or rainy-day savings to draw on. So these people are most likely to spend their extended benefits right away. According to a 2004 study by Mark Zandi, chief economist at Moody's Economy.com, "[Unemployment insurance] benefits support hard-pressed households that spend it as quickly as it is received."

Consumer spending has been key to the economy's fledgling recovery. (Consumer spending accounts for 70% of the nation's economy.) Fueled in large part by federal stimulus programs, such as "Cash for Clunkers" and the $8,000 first-time home-buyer tax credit, consumer spending rose over the summer months. But consumer spending slowed in September, raising fears that the recovery will stumble without more stimulus.

An extension in unemployment benefits might help. The Zandi study estimated that every $1 spent on extended benefits would increase the U.S. gross domestic product by $1.73. That's a whole lot of bank for the buck.

Or not.

The Heritage Foundation, an influential conservative think-tank in Washington, DC, has argued that extending unemployment insurance doesn't stimulate the economy at all. In a policy briefing , the Foundation called the Zandi study "flawed," noting that the government needs to borrow money to finance extended benefits. The individuals it borrows from then have less money to spend or invest elsewhere in the economy, offsetting the stimulus provided by benefits extension. And that loan must be repaid, so the government will either have to cut back on its own spending or take money out of consumers' pockets in the form of higher taxes.

The Foundation researchers also claimed that 50 cents of every dollar in extended benefits would go to pay for things the household would have paid for anyway, either with money from other household members working longer hours, or by dipping into savings. (They cite this study from the National Bureau of Economic Research.

The arguments for and against extending benefits both have some merit. The Zandi study is right on the money in terms of lower- and middle-income families needing to spend benefits right away -- it's a stretch to think these households are hoarding cash. But the Heritage Foundation has a point: The money to pay for extended benefits has to come from somewhere. More government stimulus will add to our economy-sucking public debt.

But I can't get on board the argument that individuals and families would have found the money to pay bills through other means without the extension. People can't work longer hours when employers are cutting back on overtime. As for rainy-day savings, if you've been out of work long enough to exhaust weekly benefits, it's likely any available emergency funds have already been tapped.

In fact, millions of households are well past the point when "getting rid of premium cable channels" or "eating out less" is enough to keep the lights on. Without extended benefits more families are going to be forced to cut back on real necessities, and they and the economy will suffer.

Instead, I would argue not only for extending benefits, but would urge lawmakers to tie the benefits to a far more-aggressive approach to job retraining. Too many people are waiting and hoping for the economy to recover and restore their jobs, not grasping that many of those jobs aren't coming back. Yes, it will mean borrowing more at a time when we as a nation are already maxing out our credit, but it's an investment that could reap huge returns if we help workers get the skills needed to find and fill the jobs in industries and entities that are hiring (health care, education, government, "green jobs," etc.).

Would you vote to extend unemployment-insurance benefits? Are you or someone you know relying on extended benefits to pay the bills? I'd love to hear your thoughts.

The Administrative Costs of a Public Health Plan

2009-10-29T22:40:15Z

That old adage, "lies, damn lies, and statistics," popped into my head after finishing my story tonight. How much will a public health care plan cost? The House bill allows for $2 billion dollars to seed a public option plan. That money would pay for administrative start-up costs and initial reserves. The bill expects the plan to pay back that money over ten years. The American Academy of Actuaries and the Society of Actuaries figures it would take between $1 billion and $42 billion in the first ten years to start up a public plan. The wide range depends on how many people enroll, how high their claims are, and how much they pay in premiums.

]]> As Cori Uccello of the American Academy of Actuaries explained to me, pricing is the key. She said, "If the plan is under priced then there is more likelihood that there is going to be insolvency." Lawmakers seem sensitive to that. A portion of the bill, under Section 322 reads, "NO BAILOUTS - In no case shall the public health insurance option receive any Federal funds for purposes of insolvency in any manner similar to the manner in which entities receive Federal funding under the Troubled Assets Relief Program."

Sources on Climate Change

2009-10-29T21:15:54Z

Climate change is one of the most complicated subjects I have ever taken on. It involves intricate scientific topics and will likely have broad economic impact.

And clearly many Americans are having a tough time making up their mind on this topic. A recent poll by the Pew Center shows the number of people who think climate change is caused by human activity is falling. This alarms many scientists who consider the evidence to be clear cut.

Rather than opine on this, I thought I'd point readers to some of the sources I have found useful on this topic.

]]> The CBO did a very good report summarizing much of the thinking on climate change and its potential impact on the United States. You can find that report here.

The United Nations IPCC report is technical and tough to read, but is worth wading through if you are serious about this issue and have had lots of coffee. You can find that report here.

The Energy Information Administration does a lot of work on the economic impact of climate change and has an excellent website here.

Publications by James Hansen, a leading expert on climate change, can be found here.

Publications by Richard Lindzen, the most prominent critic of the scientific consensus can be found here.

Have at it. It is a fascinating topic and I believe we are only beginning to understand and grapple with the environmental consequences of our industrial revolution.

Government Meddling in Bank Executive Pay is Not Going to Help

2009-10-29T19:31:24Z

The recent moves by the Obama Administration and the Federal Reserve to "examine" what they believe is excessive pay to bank executives is yet another example of contemporary policymakers not learning the lessons of the Great Depression. Putting aside the question of whether bailed out banks have any right to complain about their sugar daddy now wanting to call the tunes, the bigger issue is whether this move will have any positive effect on the economy. A look back at the 1930s suggests that not only won't it help, it may well make matters worse.

One of the notable features of the entire decade of the 1930s was the abysmally low level of private investment. The economic historian Robert Higgs has argued that investors were hesitant because they simply were not clear what the rules of the game were. The inconsistent policy moves by the Hoover and Roosevelt Administration as well as FDR's increasingly anti-business rhetoric and policies through the mid-30s led people to not want to take chances on longer-run investments.

]]> Evidence from survey data and bond prices in the mid-30s shows both the degree of investor concern about their property and the future of capitalism more generally, as well as their more specific pessimism about longer-term investments. They clearly expressed that FDR's policies and rhetoric were a big part of their hesitance. The result was that private investment, which was $16.5 billion in 1929, remained under $9 billion from 1931-36. Private investment never really recovered fully until after World War II, when the worst excesses of the New Deal were phased out and FDR's hostility toward business was replaced by Truman's more even-tempered approach.

Although banks who took bailout funds last fall have no real ethical grounds for now complaining about stricter government oversight of pay, it still seems that such meddling is nothing more than an attempt to satisfy some irrational need to find a scapegoat for the misguided policies of the last 20 years. The irony is that bank executives weren't the primary cause of the crisis, the very politicians and Federal Reserve who are now on their moral high horse were. Capping executive pay may make them feel good, but the consequences will be that the talent needed to restore confidence in the financial system will not see the lower pay as worth the trouble and will take their skills elsewhere.

More generally such meddling in markets sends broader anti-capitalist signal to the private sector. Other executives and investors, whether or not they were bailed out, will quite reasonably wonder "are we next?" And as they do, we may well begin to see their confidence in the system fall, leading to a broader withdrawal of financial and human capital. Obama and the Fed are playing with fire by flexing their political muscle this way. An understanding of the Great Depression suggests that they will get burned, further scorching an already crispy economy.

Steven Horwitz is Charles A. Dana Professor of Economics at St. Lawrence University. His opinions do not necessarily reflect the views of Nightly Business Report. To learn more about Steven Horwitz, read his bio.

The 401(k): Don't Believe the Hype

2009-10-29T14:51:45Z

If someone made me America's personal-finance dictator, I'd scrap the 401(k). These workplace retirement plans are inequitable, as some companies offer good ones, some bad ones and others none at all. Fees are often too high. And even the better plans often don't provide enough investment options.

Instead, I'd like to see the Roth IRA opened up to allow 401(k)-sized contributions - $16,500 a year instead of $5,000. (Or $22,000 and $6,000 for people 50 and over.) And I'd like to see the Roth's income limits lifted, so anyone could have one.

Roth's don't offer tax deductions on contributions, as 401(k)s do, but Roth withdrawals are tax free, while money taken out of 401(k)s is taxed as income, at rates as high as 35 percent. Most importantly, with a Roth you can invest in just about anything you want, not just a set of funds picked by the boss.

But since I'm not running things, the best I can do is suggest ways to make the traditional 401(k) work best.

]]> The first issue, of course, is whether to participate at all. The simple answer is "yes" - to the extent you can receive all the matching contribution your employer offers. Plans vary, but if the boss contributes a dollar for every dollar you put in, up to, say, 6 percent of annual salary, you could get $3,000 in matches if you earned $50,000. I wouldn't walk away from that even if the match came in a less-than-ideal form, like shares of stock in the company.

Once you reach that threshold, deciding whether to put more money in is trickier.

Start by checking to see whether you're eligible for a Roth IRA, or if you can get a tax deduction on contributions to a traditional IRA. Either would offer unlimited investing options rather than the dozen or so found in the typical 401(k).

As I said, Roths have no upfront deduction but withdrawals are tax free. With a traditional IRA, some people can deduct contributions, while all withdrawals are taxed as income. This Morningstar calculator will help you figure what you're eligible to do.

Once I'd put enough into the 401(k) to get the full employer match, I'd probably put all I could into a Roth or traditional IRA (if it allowed an upfront deduction) before I put more into the 401(k). This calculator will help you compare the Roth to the 401(k), and this one will compare the Roth to the traditional IRA.

(A traditional IRA with deduction should produce the same results as a 401(k), since both have upfront deductions and income tax on withdrawals. The only differences are investing options and contribution limits.)

Next, evaluate the investing options in the 401(k). Ideally, they should include low-fee index-style mutual funds for stocks and bonds, as well as "life-cycle" or "target-date" funds that automatically shift your money to more conservative holdings as you get older. Look at each fund's "expense ratio," a figure that shows how much of your holdings will be chewed up by annual fees. Good index funds have fees totaling no more than 0.2 percent of assets, or $2 a year for every $1,000 you have invested.

If the 401(k)'s offerings come with high fees and poor track records, think seriously about taking a pass. Remember, you can lose money in a 401(k).

By the way, if one option is to invest in your company's stock, you probably should avoid it. It's too risky to have both your income and retirement funds tied to the fortunes of just one company.

One of the 401(k)'s appeals is the tax deduction on contributions. This isn't worth very much if you are in a low income-tax bracket - less than 15 percent. The deduction can be valuable if you're taxed at 20 to 35 percent, but some of that benefit is offset by the income tax on withdrawals. The bottom line is that an investment could be taxed as high as 35 percent if it were in a 401(k), but only 15 percent if it were in an ordinary taxable account. That's because all 401(k) withdrawals face income-tax rates even if they come from long-term capital gains, which are profits on holdings sold for more than was paid. In taxable accounts, these profits are taxed at no more than 15 percent.

The 401(k) also provides tax deferral on investment gains. Even though tax is paid upon withdrawal, the deferral leaves more money in the account to compound. Also, the deferral allows you to make changes, such as selling one fund and buying another, without triggering annual tax. That makes the 401(k) useful for annual portfolio adjustments, though IRAs do this just as well.

As you see, there's no simple rule about whether investing in a 401(k) makes sense - except to get the maximum employer match. The 401(k) does impose discipline, requiring that you contribute regularly and leave your money alone for the long term. That's a benefit, for sure, but you could do that on your own with a Roth IRA, traditional IRA or taxable account.

Beyond that, you'll have to experiment with the calculators to figure which type of investment would work best for you.

Pondering the CBO Health Care "Score"

2009-10-28T20:34:17Z

In general, Americans dislike their government. Washington is an epithet. A foreign land where people who are out of touch do silly things.

Get specific and Americans admire and respect their government. We honor the courage of our soldiers. We watch movies and TV shows about the exploits of our FBI agents.

Less glamorous, but still worthy of respect is the Congressional Budget Office. These are the wonks and numbers nerds who try to keep lawmakers honest by costing out proposals and asking the tough question: "How much will this cost?"

CBO will be answering those very questions soon on health care reform. CBO's answers will help determine whether the public option lives or dies. Even whether we get reform or not.

]]> Whatever CBO does, we already know there will be a large margin for error. Former CBO Director Doug Holtz-Eakin tells me CBO faces a number of daunting challenges.

Many of the health care reforms Congress is considering make large changes. There is a lot that is new here -- interstate health insurance markets, health exchanges, new insurance rules. Whenever you have new stuff, Holtz-Eakin says you have more room for error.

CBO is also constrained to score what Congress tells it to score. Score is budget-speak for cost out. So, if the Senate Finance Committee says Congress will cut doctor pay by 20% in a couple years, CBO has to believe Congress. It can't label that unlikely and send out a cost-estimate based on a more likely reality.

And that's probably a good thing. CBO is known for trying hard to be non-partisan. It's a "just the facts" kind of place. They take the rules seriously. It's boring, but important. And courageous in a way. By resisting political pressure to tell lawmakers what they want to hear, CBO improves the health care debate.

That doesn't mean that CBO will get it right. In fact, they are probably likely to be wrong. But that is the nature of budget forecasts. It's hard to tell the future. But, Americans might be surprised to know just how earnestly some people in Washington are trying to get it right.