Archive for July, 2006

In part IV our our Synthetic Financial Disaster Series, I’m writing about the one global crisis that may send the global economy into meltdown. I’ll start by stating a few obvious statements that may be contrary to the popular gloom and doom scenarios I’ve been reading about lately.

First, the Earth will NEVER run out of oil! There will ALWAYS be petroleum somewhere on planet Earth but it will become too costly to recover in the future. There is no point in spending x amount of energy extracting oil if you’re only getting x-1 in usable energy.

Second, the Earth won’t run out of energy! There will always be methods of utilizing, harnessing, and converting existing energy sources on the planet and surrounding environment (Sun, hydrogen, etc) so we won’t run out.

What about this Energy Armageddon then?

Well while there will always be energy on the planet it may not necessarily be affordable for the vast majority of the population to use energy FOR THE THINGS we would like to use it on. It is difficult for many people to understand, particularly for Americans that have rarely venture into third/fourth world parts of the planet, but most of the planet gets by with very limited energy. If the promise of democratization of the world truly takes hold then the US may come to regret having embarked on the journey. Imagine the world with not just one China but with 20 mini-China’s each requiring huge amount of energy to provide the “lifestyle” that we as Americans have lived for the past 100 years and now are trying to export to the rest of the world.

How does this impact me?

In Parts I, II, III of the Synthetic Disaster Series, I’ve discussed my belief that the global aging population presents some unique set of circumstances occuring at the same time:

  • The quickening pace of an aging population and how this will lead to lower productivity and lower tax revenue for world governments.
  • The special needs of an aging population and how this will tax already cash strapped governments
  • The migration patterns of an aging population and how this will impose unique costs to degentrified areas and support for others
  • The burden that cash strapped citizens will impose on FDIC/SIPC institutions by withdrawing funds from banks & brokerages

So what does this have to do with energy?

The basis for our current structure of trade relies on the transfer/trade of something of some denominated value (e.g. US Dollar, British Pound, Euro, Yen, etc) in exchange for an energy source (nuclear/uranium, oil/gasoline, coal, etc.). As the population ages, there is a greater demand for energy. Why? An aging population will have considerable more “idle” time and in theory, spend their time participating in leisure activities. There is nothing on the planet that consumes more energy and produces the least amount of value than leisure activities. Leisure activities simply produce “happiness” or “satisfaction” but rarely any productive economic benefit to societies. Yes, a tourist will spend money on trinkets and have a marginal improvement to a local tourist economy but there is no substantial benefit to society or the local area where money has been spent.

Additionally, if the planet will continue to “warm” over the next few decades, then there will likely be an increase in cooling costs for businesses and homes over the next few decades. Result: an increase in energy demand. The situation is further complicated by additional emerging countries with huge energy appetites. China, Brazil, Korea, India are just a few examples of countires with burgeoning populations and increased energy demands.

A recent article on the Wall Street Journal commented: “A broad coalition of utilities, government regulators and consumer advocates have come together to produce a National Action Plan for Energy Efficiency, which seeks to put regulations in place to reward utilities for promoting conservation. Currently, utilities in most states lose revenue for conservation. The announcement came on the heals of the week ended July 22 was, a record week for electricity use in the U.S. do to a national heatwave, during which utilities furnished consumers with 96,314 gigawatt hours of electricity, or nearly double the consumption logged in 1982, the baseline year for a utility consumption index by the Edison Electric Institute, a leading industry trade organization.”

Sounds pretty scary doesn’t it? In a 24 year time span, the amount of energy needed in the US DOUBLED. At the very least, we can expect that number to DOUBLE again within the next 10 years due to increases in the population, greater industrialization and economic expansion in places like Asia, South America and Africa.

Rest assured, there WILL be energy, the real question is how much will it cost? If energy consumption doubles over the next ten years, the higher cost will inevitably lead to either economic slowdowns, recessions and perhaps depression or a reduction in “lifestyle” and standard of living.

What should I do?

It would be prudent to invest in a DIVERSIFIED basket of energy companies (oil, coal, solar, nuclear, fuel cell, etc) and hold for the long term. Energy is a guaranteed growth industry.

In Part III of my Synthetic Financial Disasters series, I’m going to focus on the implicit trust we all seem to have in our financial institutions and whether that trust is truly warranted and what potential disasters loom in our near future.

Over the past few years I’ve frequently opened bank accounts (checking, savings, Certificate of Deposits, Money Markets, etc) and I’ve always made sure to select banks that had decent rating from and were FDIC insured. But I’ve recently begun in investigate what exactly it is that I’m getting with “FDIC insurance.”

What is FDIC?

FDIC is a government agency charged with making sure banks don’t go insolvent. FDIC does this by requiring banks to maintain certain level of cash reserves for their depositors. The rules generally breakdown something like this:

“In order to receive this benefit member banks must follow certain liquidity and reserve requirements. Banks are classified in 5 groups according to their risk-based capital ratio:
• Well capitalized: 10% or higher
• Adequately capitalized: 8% or higher
• Undercapitalized: less than 8%
• Significantly undercapitalized: less than 6%
• Critically undercapitalized: less than 2%
When a bank becomes undercapitalized the FDIC issues a warning to the bank. When the number drops below 6% the FDIC can change management and force the bank to take other corrective action. When the bank becomes critically undercapitalized the FDIC declares the bank insolvent.”

Now the critical component here is “when the number drops below 6% the FDIC can change management….take other corrective action.” The obvious questions to ask: What happens when MANY banks can’t meet this capitalization requirement? Does the FDIC take over EVERY bank? What exactly is corrective action?

Prior to 1980, FDIC only insured deposits up to $40,000 and in 1980; the limit was raised to $100,000 USD per depositor. Oddly enough, the insured amount hasn’t been raised since 1980 despite high growth of inflation of the past 26 years. In today’s inflation adjusted dollars (3% over the past 26 years on average), FDIC insurance should cover $217,935. No interest has been expressed in raising the limits. Why? Does the government expect people to be able to live off of $100,000 for the rest of their lives during a time of financial crisis?

FDIC was created to quell concerns about the stability of banks arisen after the 1933 Great Depression. Bank solvency issues arose again during the Savings & Loan crisis in 1980s where over 1000 institutions failed. The cost was about 150 billion to the US government.

We now appear to be headed into a “perfect storm” of bank failures. The US real estate market has been financed with risky ARM loans, consumers are up to their eyeballs in credit card debt and the American savings rate is now in negative territory. To make a bad situation worse, banks have instituted smaller and smaller fractional reserve requirements so they don’t actually hold on to their depositors money; they simply lend it out again as credit card debt, home equity lines, etc. It is also mind boggling that most of the wealth/debt in this country is nothing more than entries on a computer screen. There is approximately 500 billion USD in printed currency floating around the world but there is outstanding debt in the trillions of dollars!

The SIPC is in a similar situation but it concerns itself with brokerage account deposits.

“Though created by the Securities Investor Protection Act (15 U.S.C. §78aaa et seq., as amended), SIPC is neither a government agency nor a regulatory authority. It is a nonprofit, membership corporation, funded by its member securities broker-dealers.”
“ ‘Insurance’ for investment fraud does not exist in the U.S. The Federal Trade Commission, Federal Bureau of Investigation, state securities regulators and other experts have estimated that investment fraud in the U.S. ranges from $10-$40 billion a year.
With a reserve of slightly more than $1 billion, SIPC could not keep its doors open for long if its purpose was to compensate all victims in the event of loss due to investment fraud.”

“What is SIPC?” Did you read that last statement “With a reserve of slightly more than 1 billion?” SIPC has one measly billion dollars? One billion dollars / 300 million people = $3.33 per person. This is so ridiculous it’s hilariously funny. And note that this doesn’t cover “fraud” so if someone hijacks your brokerage account it’s gone!

How do you prepare for FDIC and SIPC failures?

I do not know other than converting your “digital/virtual/ethereal” money in your bank and brokerage into tangible assets such as jewelry, gold, diamonds, real estate that can generate income (commercial, rental, and investment property) or other tangible assets or perhaps your own small business.

As discussed in Part I: Baby Boomer Armageddon, the United States has some potential catastrophic financial disasters looming in the near future.  Today, I’ll write about a second lesser known issue that deals with real estate and healthcare which I’ve titled, “De-Gentrification & Geriatic-fication Armageddon”

What is De-Gentrification?

Gentrification is defined as “the process of renewal and rebuilding accompanying the influx of middle-class or affluent people into deteriorating areas that often displaces earlier usually poorer residents.”

I’ve added the “de” prefix to indicate the reversal of that processes.  The basic theory is that as the population ages into their 60’s so too does the desire to relocate from Northern colder and higher cost of living states like New York, Pennsylvania and Illinois to warmer less expensive states such as Arizona, Texas and Florida.

If the common assumption that most people simply don’t have enough money for retirement holds true and that most people’s greatest asset and net worth is tied into real estate then it makes sense to tap into that asset either via reverse mortgage or sale of property.

While reverse mortgages sound reasonable, seniors would still have to contend with higher costs of living in northern states.  New York, Pennsylvania and Illinois all have state income taxes.  Texas and Florida do not have any income taxes.   Both Texas and Florida do have higher sales taxes but seniors may be less likely to consume as many taxable products (Ipods, TVs, etc) such as those that aren’t (food, medicine).

So what does this mean?

In a nutshell, I suspect that seniors will tap into their real estate assets, liquidate them and use the proceeds to purchase lower cost housing in a southern/warmer state and use the remainder of the proceeds to pay living expenses.   As this process occurs, those areas that contain a greater amount of seniors (typically wealthier & larger homes in an area) will undergo de-gentrification.  “For Sale” signs will go up relatively quickly and friends that move away will encourage others to join them in warm and sunny Florida.

The complexity increases when you factor in the fact that most seniors typically live in larger homes and the population is generally shrinking.  Where a baby boomer might have had 4 or 5 kids and purchased a large enough home for this size family; todays typical family consists of 2.3 kids and can get by with smaller accommodations.

What about Geriatricfication?

Geriatrics refers to the fact that there is a specific field of medicine dedicated to treating disease and ailments relating to seniors. In this context, Geriatricfication, refers to yet another layer of complexity to the issues we face in the future.  Specifically, the aging population will have medical, housing and transportation needs that are radically different from today’s landscape.   I suspect the housing that will be preferred by seniors will be those homes that don’t have any stairs or steep inclines; homes whose bathrooms have railings, lower reaching cabinets, and lastly easily accessible transportation systems that can accommodate wheelchairs, walkers and other aides.

How is this a potential financial disaster?

If you live in northern states and have a great deal of money tied up in real estate such as homes, rental or commercial property, you need to truly asses who your customers are and where they will be in the near future.  In a worst case scenario, you could find yourself saddled with a great deal of overpriced real estate that no one will want much less could afford.   The local economic base may also deteriorate as high income seniors liquidate their holdings and move south.  Small business could suffer terribly if seniors no longer patronize flower shops, coffee shops, doctors, dentists, hospitals, jewelry stores, and such in the area.

What about the southern states?

Real estate and healthcare providers may benefit to some extent but my suspicion is that seniors will target smaller homes, condos and apartments to keep living expenses down.  Healthcare may become a boon in southern states and may explain why hospital growth in places like Houston is exploding.  One hospital chain, Memorial Hermann, is expected to add 13 more hospitals over the next 5 years to the Houston Metro Area alone!

What should the prudent investor do?

This is a tough one.  I’ve already explained why I will personally be avoiding mutual funds and the stock market general as 2011 approaches.  This scenario gives people some food for though who are thinking/planning on putting all their eggs in the real estate basket but it may be sensible to take some of the equity out of your home and purchase some property in the area where you plan on retiring.  Doing so now can help create an income stream and a possible future home for yourself when you get closer to retirement.

In my continuing series of Financial Disaster Preparedness, I’m going to focus on Synthetic and Systemic problems that have the potential to create financial Armageddon on a national and global economic scale. I’ve broken down these hidden disasters into four types:

  • “Boomer Armageddon”
  • “De-gentrification/Geriatric-fication Armageddon”
  • “FDIC/SIPC Armageddon”
  • “Energy Armageddon”

I’ll focus on the first and most obvious today “Boomer Armageddon.” The “Boomer Armageddon” is recognizable to many financial bloggers and the general public. The main stream media has occasionally mentioned the issue but even more importantly, outgoing Fed Chairman Greenspan made it a point to repeatedly warn Congress that this disaster is headed this way. It’s almost like we all know a Category 5 Hurricane is headed to New Orleans but no one wants to do anything about it….and we all know what happened next.

What is a “Baby Boomer?”

Boomers describe people born between 1946 to 1964 right after the end of WWII. Roughly speaking, there are between 78 – 80 million people “classified” as Boomers. Assuming there was an even breakdown of birth rates per year then this translates into 4.3 million people born each year from 1946 to 1964.

What is “Boomer Armageddon?”

There are roughly 78 million people retiring beginning from 2011 thru 2024. The first batch turns 65 in 2011. This would roughly translate to a work force drop off of 4.3 million people each year from 2011 through 2024. By 2018, there will be roughly 40 million people on retirement and on the dole to some extent.

The implication here is serious and dangerous and here are the reasons why. As a person enters retirement, several things happen such as:

  1. A retired person no longer draws a salary nor does he/she pay as high a level of taxes as during their work year. (The major negative here is the elimination of payroll tax contribution, lower income tax contribution)
  2. A retired non-working person no longer contributes money to his/her 401k and thus subsequently does not support/inflate the various financial markets
  3. A retired non-working person no longer adds to Growth Domestic Product. There is LESS productivity in America because of the shrinkage in workers. Yes, they will continue to consume and spend money but this is NOT PRODUCTIVE contribution
  4. A retired non-working person begins to WITHDRAW money from their investments. Imagine 4.3 million people each year withdrawing $2500/month each year –that’s $10,750,000,000! That is only the first year 2011; add an additional 4.3 million or 10 billion each year after than until 2024 when the bleeding slows down
  5. A retired non-working person begins to take social security benefits. Many will be in for a shock when their paltry checks aren’t enough to feed them, clothe them, medicate them or pay for living expenses. What will happen? They will vote for more tax increases to pay for increases in social security.
  6. A retired non-working person will begin to heavily utilize Medicare/Medicaid. Let’s face it, growing up during “boomer” times many people acted very unhealthily; Boomers smoked in their teens, they lived thru the 60’s drug revolution, sexed themselves through the 70’s, fattened themselves through the 80’s, and indebted themselves through the 90’s. The boomer population doesn’t have the healthiest lungs, livers, bones, or hearts so they WILL tax the healthcare system heavily. Who’s going to pay for all that medical help?

How do you prepare or fix this?

If this were a chess game, I’d say we were two moves away from being check-mated -game over scenario. There are many solutions to the problem but none of them are pleasant.

The most obvious solutions are to extend the retirement age, increase taxes, cut benefits, and reduce personal consumption. All of these things lead to a lower standard of living. In essence, Americans would turn into third world residents and this is why these suggestions are generally rejected by the public.

Other solutions include increasing the immigration rate, amnesty for the 12 million illegal residents in the US, and reduction of outsourcing. Unfortunately, immigrant bashing is in vogue these days and Congress is debating how to throw people out to appease those same voters that will be in desperate trouble a few years from now. I suspect a forthcoming irony over the next 10 years where perhaps people in Latin American countries do fix their economies and government and reduce their migration into the US exacerbating the boomer problem.

So what is there to do?

The goal is to help you try to financially prepare for the disaster so here are some suggestions:

  1. Buy real estate in a foreign country. If you have the cash, I would encourage you to buy a retirement/vacation home in a country with a relative low cost of living. Depending on your language skills, preferences and such you can pick from such places as Costa Rica, Panama, Argentina, or the Dominican Republic or far away places like Australia or New Zealand.
  2. Beginning around 2008, I would aggressively move out of stocks and into cash or Treasury bonds. Forget about trying to get 10 to 20% return from the markets beyond 2010, I just don’t see how that can happen unless so many problems are fixed.
  3. If you’re still working, be prepared to cash in. With a depletion of workforce on such a large scale, there should be a great deal of opportunity out there for those with the right skills and work ethic.

Scenario 2 -National disaster that impact the overall economy (e.g. 9/11, avian flu, grid blackouts, global war)

After the 9/11 terror attacks, trading shutdown for a few weeks and the national economy fell into a slump. How do you prepare for the next big disaster that will impact your personal net worth?

I will preface this topic with some confessions and a disclaimer.

  1. I have a strong DISLIKE for mutual funds and I rarely invest in them
  2. I have a strong PREFERENCE for Exchange Traded Funds (ETFs).
  3. With any investment advice, you should always do your own due diligence before investing. Also, speak with a professional if you need further support or assistance.

Why do I dislike mutual funds?

  • Most mutual funds have higher fees than other investment vehicles such as ETFs
  • Most mutual funds suffer from liquidity problems; you cannot instantly buy or sell a mutual fund. There is a “process” by which your position in a fund is liquidated.
  • Most mutual funds managers, when deciding to invest in a particular stock, do so over a period of up to 12 weeks. So if Exxon is selling at a great discount, you’ll have to wait a few weeks for your fund to buy up those shares by which time the price will likely have moved up or down during a sell process.
  • I often wonder whether mutual funds simply aren’t the main driving factors of stocks moving up/down in price. In its most naked form, it is the worst part of the “herd” mentality when everyone chases the hottest thing which is usually the time to get out.
  • There is no way to leverage your investment in a mutual fund. Yes leverage can be a bad thing but it can be a good thing when done right.

Why do I LIKE Exchange Traded Funds?

  • Lower fees than mutual funds on average
  • Instant liquidity. You can buy/sell an ETF just as instantly as any stock
  • Variety and TRUE diversification. Many people think that if you have a portfolio of 25% bonds, 50% stocks and 25% Real Estate that you’re diversified enough. The problem with this mentality is that it leaves out so much: Precious metals (gold, silver, platinum), currencies, commodities (oil, corn, uranium), and so much more!
  • Leverage! You can usually buy/sell options on ETFs. If you own an ETF why not earn a little extra cash buy selling the out-of-money calls a few months out? This alone can add 2% to 8% to your portfolio!
  • Volume – I get the feeling that ETFs will eventually overtake mutual funds as the preferred investment vehicle. Oddly enough, perhaps someone can come up with a mutual fund comprised of diversified ETFs just keep the fees low.

Let’s run through a hypothetical: Let us assume that Avian Flu hits the U.S. and millions are sick and many will likely succumb to the illness. How will this national disaster impact you and how should you prepare?

As in the previous scenario, you should likely have ample cash on hand but I would recommend that instead of $1000, you increase it to at least $2500. The reason for the increase is due to the possible demands placed on goods and commodities during a national crisis.

What about the bigger picture?

This is where having instant liquidity can be an asset. At the first sign of a pandemic, my first response would be to liquidate all my holdings and move to cash. It is inevitability that there would be a significant drop in the stock markets. The bond markets would likely also be negatively impacted. Cash would be king and given the uncertainty of the future it may be in your best interest to be able to take that cash anywhere.

It is been noted that during periods of black plague in England, the wealthy would often send their loved ones to their country estates to isolate themselves from the troubles of the city. I’m not sure how effective this would be in our modern day age of jets, trains, boats and automobiles but it may prove effective to leave the area or US during the crisis if possible. I would suspect having a boat would be a great plus since you can effectively move yourself out into the ocean and isolate yourself from the epidemic.

When do I get back in? Where do I invest?

These are perhaps the most difficult question to answer since it includes a hypothetical disaster than may have an unusual time horizon. I can only answer it by saying that I would not, while tempted, invest in healthcare or pharmaceutical stocks during or after the crisis. Why? Something as deadly as the avian flu may leave so many financially devastated that they would likely not have any way to ever pay back their debts for healthcare or medicine even though it may seem like a “sure” thing.

What I would most likely invest in as things began to recover would be consumer cyclical sectors but that would largely depend on the landscape at the time.

As before, here are the links to some disaster readiness sites

Scenario 1 – Localized disaster that impact you directly and personally (e.g. Hurricanes, Earthquakes, Tornados, Terrorist attack)

When Hurricane Katrina wiped out New Orleans, I was personally involved with the human recovery efforts in trying to help evacuees find housing, jobs, money, etc. I am still haunted by the desperation of so many and the failure of government to act quickly, decisively and effectively. I was even more troubled by Hurricane Rita and the problems that caused: ATMs ran out of money, Gas stations ran out of gas, grocers ran out of food, traffic tied for 10+ hours.

So what happens during a disaster?

  1. You will need food/water/clothing
  2. You will need shelter
  3. You will need transportation
  4. You will need money to accomplish 1, 2, and 3 for at least 10 days

So you’ve been prudent and you’ve saved $1000 in that emergency fund for a rainy day like this and you’ve been smart about it and have it earning 5% over at but you need the money now so how do you get it?

During Hurricane Katrina, every ATM in the greater area was either empty or not working but even if the ATMs had some cash how easily would you pull money out of that emergency fund?

This is where being a little more prudent with your bank selection comes in handy. If you opened an account at, you’d be earning that same 5% yield but you’d also have an ATM card which provides easy instant access to your funds. The alternative is an electronic transfer from Emigrant to your checking/ATM account but those transfers usually take 3 to 5 days if not longer. During both hurricanes however, electricity, internet access, telecommunications, and offices were all unavailable for a period of time compounding the problem.

I had intended on providing some details on preparedness but these links do a much better job. I will only comment that it is of paramount importance that you have access to CASH & credit cards during a disaster. Credit cards are best used to book hotels, rent cars, and buy emergency supplies. Cash is needed if the credit card network is down due to power outage, telecomm outage, etc. I would recommend at least $1000 in cash funds.

I’ve been reading a few blogs over the past week and have come upon an interesting phenomenon amongst many financial bloggers. The phenomenon is that many people in the financial blog world have implicit trust of financial institutions and operate on the continued assumptions that things will always be as they are today or things will only get better.

This week I’ll be focusing on Financial Disaster Preparedness and I will try to speak beyond the typical “you should have $1000 in an emergency fund” basic suggestions offered by many and whether the implicit trust is truly warranted or whether you should have a truly alternative financial backup plan.

The first step is to identify some key potential scenarios, the effects, and the theoretical solutions to the issues. In my mind there are three types of disaster scenarios that need to be addressed:

  • Scenario 1 – Localized disaster that impact you directly and personally (e.g. Hurricanes, Earthquakes, Tornados, Terrorist attack)
  • Scenario 2 -National disaster that impact the overall economy (e.g. 9/11, avian flu, grid blackouts, global war)
  • Scenario 3 -Synthetic/Systemic disasters that have the potential to create havoc on your personal financial life (e.g. retiring baby boomers, geriatric-fication of society, de-gentrification of states, government default on debt)

Tomorrow, I’ll start with Scenario 1 and while I don’t have all the answers, I hope it will offer everyone a good start. I also look forward to hearing some feedback and suggestions on how to make it better.

Well, I deposited the 24k check today and the bank put a hold of 10 days on my funds which really annoys the heck out of me. On the positive side, I ran across this credit union which is offering 8% interest for 8 months so instead of using Emigrant/HSBCDirect, I’ll move the money there.

Updated calculations: [8% * 24000] * (8/12) = $1280. Of course the catch is that I’m only getting 6 months at 0% so I’ll use funds from another account to pay off the loan when it comes due in December.

Remember that our goal is to Get Rich Slick and with this deal, we’re $1280 closer to getting rich.

Arbitrage is defined as the nearly simultaneous purchase and sale of securities or foreign exchange in different markets in order to profit from price discrepancies.  Of course, with banks in the US so willing to lend out tens of thousands of dollars at 0%, why bother going out on the forex market to do an arbitrage deal?

Today, I signed myself $24k from a balance transfer check and deposited into my bank account.  The goal here is to transfer the funds over to a high yield online account (e.g. HSBCDirect/Emigrant Direct) and earn the current prevailing rates of 5.05%+.  The balance transfer is only good for 6 months so I’ll earn 1/2 * (24,000 * 0.0505) = $606 assuming the rates don’t go any higher.  After paying a $75 fee for the transaction, I’ll net $531.

Although the amount gained here is relatively small, it is a step toward testing a more ambitious theory:  Is it possible to have a 0% to 3.99% mortgage using credit cards?  The stakes are high of course because a single late payment will usually rocket the rate to 20% and up but if you keep enough cash reserves it can easily be paid off.   We’ll see how the next 6 months unfolds with this arbitrage deal.

As an added bonus in using credit cards at 0% interest, I would be trading unsecured debt with a secured & protected asset.