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Depression Fears Overblown. It may seem like the financial world is imploding, but many safeguards remain. |
Buffeted by weeks of withering financial news, nearly six out of 10 Americans now believe the U.S. economy is somewhat or very likely to fall into a depression, according to an October 4–5 CNN/Opinion Research Corp. poll. But while the U.S. economy is not as strong and our financial system isn’t as healthy as it needs to be, we’re nowhere near the types of economic difficulties seen in the depths of the Great Depression—nor does Schwab believe we’re headed there.
For context, consider these two realities. First, the U.S. economy is much stronger today than during the Great Depression. In the 1930s, America was primarily an industrial powerhouse, and industrial production shrank 52% from peak to trough, while gross domestic product (GDP) shrank 27%. As an example, if we assume December 1, 2007, is ultimately declared the start of a recession, you can see below that GDP and industrial production are nowhere near depression levels. Industrial production declines suggest a garden-variety recession, and GDP is still positive (although we don’t expect it to stay that way).
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| Second, the employment situation is much better. Although today’s employment environment certainly doesn’t feel good to those who are unemployed—or fear they might become so in the near future—the current rate of unemployment is 6.1%, about a quarter of the peak rate of 25% during the Depression. While we see the unemployment rate getting worse, we don’t foresee depression-era jobless rates.
What about all the bad news swirling about? Isn’t GDP going to get to Depression levels? Wasn’t the Depression a downward spiral that just kept getting worse and worse? Aren’t we at the beginning of that spiral? Schwab doesn’t believe so, for the following seven reasons:
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Jobless recovery. Remember this phrase? It refers to the slow rate of hiring by businesses after the last recession. We believe that past corporate tightfistedness is now helping to prevent the job losses currently being reported from becoming even worse. Why? Because firms didn’t overhire during the recent expansion, there are fewer jobs to cut during this downturn. We expect this should prevent the unemployment rate from getting out of control. |
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Fiscal policy. In the early years of the Depression, the linkages between fiscal policy and the economy weren’t as well understood as they are today. At that time, the prevailing view seemed to be that the federal government should have a balanced budget except in times of war. There’s a lot to be said for the efficacy of that approach under normal circumstances, but it backfired under the Hoover administration. From 1929 to 1933, the federal government deficit was a tiny 1.4% of GDP. As private spending and investment declined, federal spending wasn’t there to pick up the slack. Today, policymakers are far more willing to open up federal spigots to soften the blow when the economy first begins to list, and over short periods, fiscal stimulus can work. The increase in real GDP growth from 0.9% in the first quarter of this year to 2.8% in the second quarter is an example of what fiscal stimulus can do. |
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State unemployment benefit programs, which can smooth out the effects of normal fluctuations in the economic cycle, will also help. And although continually using deficit spending to prop up the economy will have negative, long-term consequences, fiscal stimulus can provide short-term relief while more permanent fixes can be put into place. Federal policymakers didn’t use that cushion in the early 1930s. Fortunately, we see today that they are. |
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Globalization. Complaining about globalization has been a fashionable pursuit over the past few years, but don’t forget its benefits. In the 1930s, the infamous Smoot-Hawley Tariff Act became law. Its intent was to choke off imports, and it worked, as U.S. imports dropped 65%. The politicians who voted for it either forgot, didn’t care or didn’t understand that global trade is a two-way street: U.S. exports also dropped 66%. Did anyone win in that global trade war? In our view, it was a tie—everyone lost. Today, trade is more open between countries, and the U.S. economy as a whole has benefited. We shudder to think where it would be right now without the recent boom in exports. Since December, exports have risen 15%, providing an important outlet for U.S. industries seeking to offset weak domestic demand. We’re optimistic that a new administration and Congress will remember history and, when weighing trade bills, won’t pull this source of strength out from under the economy. While we have some concerns about the ability of other countries to absorb U.S. exports given their own weakening economies, we believe that a two-thirds drop in trade just doesn’t seem likely. |
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The FDIC. Banks exist to loan money, but they can’t do it without depositors. The Federal Deposit Insurance Corporation (FDIC) was created in 1933 in reaction to the huge number of banks that had gone under, evaporating the savings of many depositors. As a result, confidence in banks was gutted, as was consumer spending. FDIC insurance is a key pillar in preventing that from happening again. As long as the program continues to work smoothly, we think depositors will have the confidence to leave their money in banks, providing another important stabilizer to the overall system. The temporary increase in the FDIC insurance limit from $100,000 to $250,0002 only helps boost that confidence. Likewise, we see European governments taking similar actions to boost confidence in their banks. |
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Money supply. While well-known to economists, the role that monetary policy played in increasing the severity of the Great Depression is probably less understood by the general investing public. The Federal Reserve constricted money supply, causing it to plunge 29% during the 1930s. When money gets that tight, deflation occurs, and in the early 1930s, the Consumer Price Index declined 27%. These days we spend a lot more time worrying about inflation—so much so that we don’t recall the devastating impact that deflation can have. Japan’s economy was crippled for the entire 1990s as a result of a bout with deflation. |
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What’s wrong with deflation? Think about it from the standpoint of a business. The business purchases raw materials and invests in the infrastructure to turn those raw materials into a product. Deflation means that by the time this process is complete and the product is ready for sale, the retail price has fallen, preventing the business from turning a profit. Price deflation within just a few industries is manageable (think of computers, for example). But when it affects almost every industry, the economy and stock market begin to suffer in a big way. Compare the actions of the Fed today to the Fed of the past—it’s pumping very large sums of money into the economy to try to make sure that the required liquidity is present. |
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Housing near the bottom. Multiple related, yet distinct crises are occurring simultaneously. However, the bursting of the housing bubble is the best candidate for the root cause—which means that the road to recovery begins with home price stability. We at Schwab don’t think we’re there yet, but don’t be misled by the continuing scary double-digit year-over-year price decline statistics. To get a glimpse of the future, pay more attention to the month-over-month declines. What you’ll see there is a fairly steady reduction in the magnitude of the losses. Inventories of new homes seem to have plateaued, and builders are cutting back considerably on new construction. We’re not bullish on housing, but because we do think a bottom is in sight, we’re confident that the overall slide we’ve been experiencing will stop. |
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Emergency Economic Stabilization Act. This law authorizes the U.S. Treasury to buy troubled mortgage-backed securities from financial institutions. Rarely is one law ever a panacea for big problems, but the credit crunch had reached a state where even well-qualified borrowers were unable to borrow (e.g., small companies were finding access to credit cut off, and outstanding commercial paper—very short-term bonds issued by businesses—suffered the biggest one-week drop on record). Businesses can’t function without access to credit, and it’s hoped that this law will begin a thawing of the credit markets. We think this will occur. Right now, banks won’t lend to banks because it’s difficult to ascertain the true credit quality of the borrower. By allowing banks to sell hard-to-value securities to the Treasury, the law should improve transparency and enable banks to sell off securities to raise capital, which should in turn help them begin lending again.
Now that the Emergency Economic Stabilization Act has finally squeaked through Congress and has been signed into law by the president, the question is, how will it work? Schwab’s Washington expert Jeff Brown shares his perspective:
How will the rescue plan play out?
Immediately, the Treasury will get $250 billion to start implementing the auction, direct purchase, and insurance program for troubled securities. This will take a tremendous effort. I don’t think the auctions or direct purchases will start before mid-November, and the process will likely take several years to unfold. It’s not clear if Treasury will use the insurance program at all, given the Treasury secretary’s dismissal of it. But, hopefully, the passage of the plan will calm the markets. And as the banks get rid of their bad paper, they’ll presumably get back to the business of lending.
How much will this cost the taxpayers?
In my view, the cost won’t reach $700 billion, because private money will eventually return to the market. Let’s say the Treasury offers 22 cents on the dollar for asset X. Before long, some private investor will offer 25 cents, and another will pay 30 cents. In the end, I doubt that the government will need to spend all of the money that’s been allocated.
Will the election impact the rescue plan?
The candidates are being tight-lipped. But it’s very possible, with the discretion granted to the Treasury secretary under the statute, we could see significant variances in implementation. Under an Obama administration, we might see a more aggressive use of new Treasury powers to modify whole loans held by homeowners. Under a McCain administration, we might see the insurance program given greater emphasis, as it was supported by congressional Republicans. Under either administration, we likely will see more rigorous federal oversight of banks and financial service companies.
Do you see other big differences between the candidates?
Well, taxes are a big one. In addition to proposing to raise income taxes on people earning more than $250,000, Senator Obama has discussed protecting Social Security by taxing incomes above $250,000 an additional 2% to 4% in FICA taxes; the current tax on the first $102,000 would remain. Senator McCain’s views on Social Security reform include supporting private accounts and increasing the retirement age. In the end, it’s unlikely either candidate will be able to do what he has proposed. The rescue plan and the state of the economy will limit their fiscal flexibility.
Article courtesy Charles Schwab and Mark Riepe Senior Vice President,
Schwab Center for Financial Research
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Tax Preparation Guide and Tips
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Are you getting the most out of creating your tax stats for your accountant? Here is a helpful checklist to ensure you won't miss any important paperwork that could result in tax savings!
PERSONAL DATA
q Social Security Numbers (including spouse & children)
q Child Care Provider: Name, address & Tax ID or SS#
q Alimony Paid: SS#
q Last year’s Tax Return if verification needed for online tax preparation
EMPLOYMENT & INCOME DATA
q W-2 forms for 2007
q Unemployment Compensation: Form 1099-G
q Miscellaneous income including rent: Form 1099-Misc
q Partnership, S Corporation & Trust income: Schedule K-1
q Pensions & Annuities: Form 1099-R
q Social Security/RR1 Benefits: Form RRB-1099
q Alimony received
q Jury Duty pay
q Gambling and Lottery winnings
q Prizes & Awards
q Scholarships & Fellowships
q State & Local income tax refunds: Form 1099-G
HOMEOWNER/INVESTMENT DATA
q Residential address(es) for 2007
q Mortgage Interest
q Sale of your home or other real estate: Form 1099-S
q Second Mortgage Interest paid
q Real Estate Taxes paid
q Rent paid during 2007
q Moving Expenses (if applicable)
FINANCIAL ASSETS
q Interest income statements: Form 1099-INT & 1099-OID
q Dividend income statements: Form 1099-DIV
q Proceeds from broker transactions: Form 1099-B
q Retirement plan distributed: Form 1099-R
FINANCIAL LIABILITIES
q Auto Loans & Leases (account # & car value) if car used for business
q Student Loan Interest paid
q Early withdrawal penalties on CD’s & other time deposits
AUTOMOBILES
q Personal Property Tax information
q Hybrid Vehicle Tax deduction
EXPENSES
q Charitable Contributions (need written statement from charity) for any amount
q Unreimbursed Expenses related to volunteer work
q Unreimbursed Expenses related to your job
q Investment Expenses
q Job-hunting Expenses
q Job Related Education Expenses
q Child Care Expenses / Adoption Expenses
q Medical Savings Account
q Alimony Paid
q Tax Return Preparation Expenses & Fees
SELF-EMPLOYMENT DATA
q Business Income: Form 1099-MISC
q Partnership SE Income: Schedule K-1
q Business Related Expenses: Receipts, etc.
q Farm Related Expenses: Receipts, etc.
q Employment Taxes & other Business Taxes for 2007 tax year
MISCELLANEOUS TAX DOCUMENTS
q Federal, State & Local estimated income Tax paid in 2007
q Estimated tax vouchers, cancelled checks & other payment records
q IRA, Keogh & other retirement plan contributions. Identify whether for you or employees
q Records to document medical expenses
q Records to document casualty or theft loss
q Records for any other expenditures that are deductible
q Records for any other revenue or sales of property that may be taxable/reportable
www.irs.com
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Taking the Mystery out of Credit
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What is a Credit Score?
A credit score is the result of a mathematical equation that evaluates
many types of information that are on your credit report. Lenders with
whom you have applied will usually review your credit report and credit
score, along with other factors, such as your ability and likelihood to
repay debt. Credit scores are also often called “FICO scores” because most credit scores are produced
from software based on a model developed by Fair Isaac and Company (“FICO”). For more information
about FICO scores, visit www.myfico.com.
What Makes Up a Credit Score?
The FICO score generally ranges from 300 to 850,
and a higher score indicates a lower credit risk. FICO
scores are calculated from many sources of information
in your credit report, which is based on the importance of the following five categories for the
general population:
Payment History 35%
Were Payments Made on Time?
Amounts Owed on Accounts 30%
Is the balance owed close to the limit?
Length of Credit History 15%
How long have your accounts been open?
New Credit 10%
How many new accounts have been opened?
Types of Credit Used 10%
What is Not in Your Score?
• Your race, color, national origin, sex, age, marital status
• Your salary, occupation, title, employment information, or residence address
• Any interest rate being charged on your credit accounts
• Any items such as family/child support, rental agreements, credit counseling participation
What Can Affect My Score?
• Your FICO score is a “snapshot” of your
credit history at a given point in time, and
can change based on the factors that make
up your credit score.
• Late Payments - Pay your bills on time and if you have missed a payment, get current.
• Credit History - When you pay off a debt or collection, or close an account, the credit reference remains
on your credit report for a minimum of seven years.
• High Balances - Keep outstanding balances low on credit cards and other “revolving” accounts
• New Credit - If you have been managing credit for a short time, don’t open a lot of new accounts.
Make sure the information in your credit report is correct. You are entitled to one free
credit report annually from the three credit bureaus – Experian, TransUnion and
Equifax. Visit www.annualcreditreport.com to obtain your free reports. You may also
purchase a copy of your credit score report through this website.
Review your credit report for accuracy (date opened, account balance, account limit,
last activity) and have incorrect or erroneous information updated.
Pay down high credit card and revolving account balances, but don’t close the
account. Don’t apply for credit that you don’t need – excessive credit report
“inquiries” can lower your score.
Avoid moving credit balances from one account to another just to take advantage of
low introductory interest rates. The combination of “inquiries” and “new accounts”
can negatively impact your score.
If possible, avoid “finance company” type credit accounts, including “90-day” and “12
months same-as-cash” accounts. Mortgage loans, installment loans and revolving
credit card accounts impact your score more favorably than finance company
accounts.
Your score can improve by managing your credit responsibly over time and following
some basic tips:
Make sure the information in your
credit report is correct
. You are entitled to one free
credit report annually from the three credit bureaus – Experian, TransUnion and
Equifax. Visit www.annualcreditreport.com to obtain your free reports. You may also
purchase a copy of your credit score report through this website.
Review your credit report for accuracy (date opened, account balance, account limit,
last activity) and have incorrect or erroneous information updated.
Pay down high credit card and revolving account balances
, but don’t close the
account. Don’t apply for credit that you don’t need – excessive credit report
“inquiries” can lower your score.
Avoid moving credit balances from one account to another
just to take advantage of
low introductory interest rates. The combination of “inquiries” and “new accounts”
can negatively impact your score.
If possible, avoid “finance company” type credit accounts, including “90-day” and “12
months same-as-cash” accounts
. Mortgage loans, installment loans and revolving
credit card accounts impact your score more favorably than finance company
accounts.
Information provided courtesy of:
Washington Metro Mortgage Marysville is a division of Metrocities Mortgage, LLC, a Delaware limited liability company exempt under the state of Washington’s Mortgage Broker Practices Act. Information is subject to change without notice.
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