The Small and Medium Bank Quiet Revolt: What to Consider

I first ignored the small-bank movement because I thought it sounded weird. But after doing a little research, it sounded compelling. The whole idea is based on "people-powered" (read: populist) regulation of the Too Big to Fail (TBTF) banks. It encourages consumers to move their money from these large, risky banks to smaller community banks and credit unions who invest with the local community. Who can argue with that?

So I sat down and considered all that had to happen to make this a possibility for me. And it's a pain to do. Think about all the things you have in the typical checking account: your paychecks and refunds, and other "income" are linked to this account. You have online billpay for all your "outgo" spending. Your PayPal, Amazon, and other store accounts, credit cards etc., are all connected to your account.

However, banks are getting more and more annoying. You get charged fees out the wazoo for withdrawing money from the wrong place (like other ATMs), paying money in the wrong place (like international payment fees), drawing out too much money, etc. Also, many banks (especially the TBTF Guys) tend to engage in mean practices to extort as much money as it can from its customers. For instance, some banks like to screw over smaller customers with balances close to overdrafting by debiting larger transactions to draw them in the red, then processing the smaller charges one-by-one to build up overdraft fees. The industry is indeed shady; and it may not need to be taken over, but you need to protect yourself.

Plus, there are other, intangible benefits you can experience by going local:

...community banks offer something big banks find nearly impossible to compete with -- local ownership and the ability to talk with a familiar face in the event of unexpected financial hardship, said Tyson of the community bankers group....

Here's a link to Move Your Money, a site that will help you identify area banks with a grade of "B" or better with respect to financial strength and customer service. I'm not advocating you make that jump just yet. I haven't. But it's a good way to start the research that I'm doing. But you should also ask yourself these questions.

What Values Matter to Me?
It may seem strange to consider, but you should try to find a bank that can align with your values. Do you want a banker you can talk to when you get in a tough spot? Or do you value the "long-distance relationship" where everything is done online? Remember--you may need a loan for a car or home one day, and better rates are given to the well-known customers.

What are the Fees Like?.
Some banks like to lure you in with a free "X" but it's only for a few months. Then you can get gouged on the back end with loads of fees for minimum balances, checks written, ATM withdrawals, etc. think about how many hand-written checks you write per month how often you withdraw from ATMs, and where. Just walk into the bank, and tell them you're interested in opening an account, and ask for a fee schedule for various accounts. Some will hand it over, others won't. Its important to track down the schedule of fees for banks to find the right fit for you.

Go Slow
Finally, if you decide to make the transition, do it at your own pace. I suggest opening an account at your small/medium new bank (or banks) and begin transferring funds and switching accounts a few at a time. Maybe start with the online shopping ones. Once you get the rhythm, you can move a little more money a few more accounts. Perhaps you can draw your TBTF Bank's Account down to the required minimum funds (if they have one) and leave it there. Then go to your HR department and redirect your deposits to your new bank.

And enjoy the peace of mind!

Or something. I'm just beginning to do my research and plan to move. We'll see what happens, and I'll keep you posted.

Will Executive Pay Caps Work?

I think it will, and here's why.

As a reminder, the Obama Administration has proposed a new approach to the companies seeking bailouts: Top executives at these companies must cut their pay to $500,000 (excluding stock) The average reader may think "That's a nice piece of change!" until you realize that these cuts are very, very deep. However, extraordinary circumstances warran extraordinary ideas. Obama's plan is creating, at least on the surface, even conservative political allies on this idea:

"In ordinary situations where the taxpayers' money is not involved, we shouldn't set executive pay," said Sen. Richard Shelby of Alabama, the top Republican on the Senate Banking Committee.

"But where you've got federal money involved, taxpayers' money involved, TARP money involved, and the way they have spent it, with no accountability, is getting close to being criminal." Source

Supporters of his move on executive pay included the leader of the Republicans in the U.S. House of Representatives, John Boehner. Many Republicans in the Democrat-controlled Congress have been resistant to government bailouts, even when fellow Republican Bush was president.

"I think if anybody is looking to the taxpayer to help bail their company out, these kind of executive compensation limits are appropriate," Boehner said.

Republican Representative Mike Pence, who said he had opposed the finance sector bailout to begin with, said, "maybe it is going to wake up American business -- that there is a cost when you invite the 800 pound gorilla of government into your boardroom." Source

I think executive pay restrictions is a good way to make the private industry think twice before heading to the feds for public funds. But there's more--as I mentioned above, the 500,000 cap excludes stock. The Obama Administration wants to allow companies to pay their top executives past the 500,000, but it has to be in frozen stock. By frozen, I mean they cannot cash out that stock until they pay the government back, then all caps (including the salary) will be lifted. How is this "good"? Well, if the executives has enough strategy to turn around a company, the stock price will most likely rebound, and the CEO is rewarded for..let's say it together now...PERFORMANCE!

Bailout Bonanza!

Remember that 700 Billion Bailout? It's a "shade" higher now…

And the shade we're talking about is the size of the one caused by a solar eclipse. The government, hoping you don't know how to add, wants you to believe that they're asking for "only" $700 billion in bailout money from the much-publicized bailout. However, the number now is about 10 times the original asking amount. Again: the number now is about 10 times the original amount—about 8.3 TRILLION dollars. Here's the invoice, as of Monday December 8th:



Not included: a $15 billion bridge loan to the Big Three American automakers.


Some numbers are so big most people just gloss over the number. But taxpayers are on the hook for it, and it is a really big number. Just how much will $8 trillion cover? Look at the federal departments' average annual budgets below, funded primarily with taxpayer dollars:



NASA: $17B

US Postal Service: $34B

Dept of Labor: $10B

EPA: $7B

Dept of Treasury (in a normal year): $12B

Dept of Energy: $24B

Dept of Transportation: $12B

Dept of Justice: $20

Dept of Agriculture: $20

Dept of Interior: $10

Dept of Homeland Security: $120B

Dept of Defense: $515B



Total: $801B



So the money the government has pledged to save our capitalist system is enough to run these government entities for 10 years, and they are giving this money out to a handful of banks and financial entities within the next year or two. There is now a plan to give the Big Three auto companies $15 billion, (small potatoes now) and a pending stimulus package of between 700 billion and 1 trillion dollars. And the automakers are, in my opinion, trying to scare people into believing that they either need bailout money or that they will cease to exist. It's a false either-or choice (but more on that later on).


Our leaders are telling us deficits don't matter. I'm not an economist by any stretch, but to me it doesn't seem to pass the common-sense test. But man, I really hope they're right. I really want their plan to work. Because if it doesn't work, we're really going to be in trouble after we add more to the stratospheric rise of our debt to other countries if said countries lose faith in our ability to pay the debt back.

Financial Markets--What Just went Down Last Week?

AND WHY IT IS EXPECTED TO CONTINUE...

I want to keep this one simple this week. The following is my attempt to explain what's going on with the government bailouts and explain if it will have a direct effect on you. This week, I hope to explain how everyone--the mortgage borrowers, the mortgage lenders, investment banks, and even the federal government have some of the blame in the debacle we have now. it almost reads like a script with the way all the pieces to this issue fall into place:

The Backdrop
It started when the government started to put more pressure on lenders to help increase home ownership among Americans and end borderline racist processes like redlining (where lenders couldn't give you loans if you lived in certain zip codes). The government also promised to guarantee (co-sign) on the loans. Lenders then aggressively started seeking ways to give our risky loans and to make nice profits while spreading the risk. Thus you saw the re-emergence of adjustable-rate mortgages, intro (teaser) rates, and sub-prime mortgages among buyers. Also, construction companies begin to build lots of homes in anticipation of buyers filling them.

The Ingenious Plan
Buyers applied and refinanced for home loans they couldn't possibly afford, and lenders were eager to give them out. You see, financial engineers had a genius idea: local banks could collect all the loans they gave out (good and bad) sell them to investment banker firms who would "package" and sell them as an investment. Buyers of these packaged, of 'securitized' loans were then sold on the secondary market--businesses like Bear Sterns, AIG, Lehman Brothers, Freddie Mac, Fannie Mae, and Eula Jean (well, maybe not that last one) spread the risk of these securities among investors (remember, they are a collection of mortgages). Investors would make money as people paid their mortgages, and as people sold their homes for a profit (because housing prices ALWAYS go up, right) investors got paid too. These securities were sold everywhere. Investment banks. Businesses. People who owned mutual funds bought them if their mutual fund invested in it.

Trouble
Then, problems started to arrive. Anticipating a sharp rise in the number of homes needed, contractors and construction companies built. And built. And built. And you know what happens to the value of product if the market is flooded with it right? Prices fall. And people were not about to move out of a house that's losing value right? So houses continued to fall in value. No one was moving/upgrading to newer houses because the prices were too expensive and the housing inventories got larger. Then, those teaser rates expired. The adjustable rate mortgages..adjusted up (they were already at 40-yr lows and had nowhere to go but up). Suddenly, people couldn't afford those mortgages they had anymore.


The Perfect Storm Develops
More trouble developed--the economy started to slow down and companies began to cut jobs in manufacturing--people then got under-employed and still couldn't keep up with house payments. They tried borrowing against the increased value of their home, but remember there were too many houses on the market so it wouldn't go up much. Up the chain, those people who were holding on to those mortgage-backed securities saw that people were not paying up, and so they began to bail. However, some of these companies were so heavily invested in these securities that they didn't have the cash on hand to pay everybody who wanted their investments back.

Remember how a bank works? Simplified, a bank takes the money you deposit and keeps maybe about 10% and lends the remainder to other banks and business. So if you deposit $100, they may keep $10 on hand and lend $90 to another bank, who keeps $9 and lends $81, and so on. So your $100 in this could easily turn into $1000. Back to our story.

What happens when a bank can't cover all it's deposits? Who do banks, keepers of money, turn to? Other banks. As long as they trust each other, banks can borrow money from other banks so they can continue making loans to people and businesses and (by extension) keeping the economy going. So we're cool, right?

Trust
Except that the trust was beginning to disappear. Soon banks stop believing other banks would pay the loans back after customers and businesses--even big businesses began filing for bankruptcy because they couldn't pay their loans back. Banks started raising the interest rates (the cost of lending out the money). Some banks stopped lending money altogether, which is bad. The federal reserve stepped in and tried to calm things by lowering the interest rate, but the problem continued to worsen.


And Now?
Well, last week we dodged a huge bullet. When you hear people talk about the "credit tightening up in the market," it refers to money banks lends to corporations (and each other). Basically, companies large and small go to banks all the time to get money to run their everyday operations until the money they get for their transactions come in. Companies depend on banks extending these lines of credit, called commercial paper, to start new businesses and ventures. Well, last week, the banks ran out of this commercial paper. The federal reserve stepped in at the last minute and (ahem) "made more money available." without it, US company operations would have started shutting down pretty quickly.


So I'll leave it there for this week. Next week, we'll get into what's next and the ideas people have on how to fix this problem. If you need a funny summary of this issue, click here (warning, there is strong language there).

Renters Not Escaping the Mortgage Meltdown

From USA Today, there's word that the mortgage meltdown (correction) isn't just affecting the homeowners, but those who are in the rental market are feeling the pain as well:

Already, one in four renters are paying more than half their income on rent — the highest level in at least two decades — according to a study being released Thursday by the Center for Housing Policy. That's up from one in five renters in 1997.

As a renter, all I can say is "Yay, just great.." I personally have locked in my rental rate for the next two years, but I can definitely see it happening. My rent went up about 15% over last year, which did put a significant dent in my budgeting. "Well," you make ask yourself, "How would it affect me, in the future?"

Rents are projected to rise about 4% this year and next. In part, that's because of a shortfall in apartment construction. At the same time, more renters are renewing their leases because they can't qualify for a mortgage. And rising foreclosures are turning some homeowners back into tenants.

I think this 4% number is a bit low. As the mortgage industry continues to shake out those who made a poor choice by buying homes too soon, people will move into rental units in larger numbers. I've also spoken against a bailouts for Wall Street, lenders, and homeowners alike--and actually in support of foreclosed homeowners downgrading to rental units until they can get back on their feet.

I know there are those who may disagree, but I think it definitely will go a long way in preventing this debacle again. What happened is Wall Street took sub-prime mortgage lender debt which are comprised of and sold it on the world markets--often with AAA ratings (meaning that the loans were guaranteed on the same level as the US Treasury). Then, they were astonished when the borrowers, many who weren't saving and overusing credit couldn't pay the lenders, and of course the lenders bombed (and so did Wall Street, at least until they got their bailout).

Long story short--unless you locked in a fixed rate as a homeowner, you may feel the burn of the sub-prime correction until it shakes out. Renters should brace for impact--it won't hurt as much as homeowners feel, but you'll feel it nevertheless.