Troubled Times How We Got Here What May

Troubled Times How We Got Here, What May Lie Ahead and What We Can Do About It Ned C. Hill National Advisory Council Professor of Finance Fellow, Wheatley Institution Marriott School of Management Brigham Young University March 2009

Outline Prophetic warnings Seeds of the economic crisis 14 suggestions on how we might deal with the crisis – Managing debt – Building reserves for the future – Protecting your family – Building on what you have learned

President Gordon B. Hinckley Priesthood Meeting, October 3 rd, 1998 Story of Pharaoh’s dream of the seven fat cattle and the seven lean cattle “…I want to make it very clear that I am not prophesying, that I am not predicting years of famine in the future. But I am suggesting that the time has come to get our houses in order. There is a portent of stormy weather ahead to which we had better give heed. ” “So many of our people are living on the very edge of their incomes. In fact, some are living on borrowings. ”

President Gordon B. Hinckley (cont. ) “I urge you, brethren, to look to the condition of your finances. ” “I urge you to be modest in your expenditures; discipline yourselves in your purchases to avoid debt to the extent possible. ” “Pay off debt as quickly as you can, and free yourselves from bondage. ” “That’s all I have to say about it, but I wish to say it with all the emphasis of which I am capable. ”

President Gordon B. Hinckley General Conference, October 7 th, 2001 “The economy is particularly vulnerable. We have been counseled again and again concerning self-reliance, concerning debt, concerning thrift. So many of our people are heavily in debt for things that are not entirely necessary. ” “I urge you as members of this Church to get free of debt where possible and to have a little laid aside against a rainy day. ”

Elder Joseph B. Wirthlin April 2004 “Remember this: debt is a form of bondage. It is a financial termite. When we make purchases on credit, they give us only an illusion of prosperity. We think we own things, but the reality is, our things own us. ” “Some debt—such as for a modest home, expenses for education, perhaps for a needed first car—may be necessary. But never should we enter into financial bondage through consumer debt without carefully weighing the costs. ”

Elder L. Tom Perry November 2008 “We have been encouraged at almost every general conference of the Church I can remember not to live beyond our means. Our income should determine the kind of housing we can afford, not the neighbor’s big home across the street. “President Heber J. Grant once said: ‘From my earliest recollections, from the days of Brigham Young until now, I have listened to men standing in the pulpit … urging the people not to run into debt; and I believe that the great majority of all our troubles today is caused through the failure to carry out that counsel. ’” (in Conference Report, Oct. 1921, 3).

The Global Fixed-Rate Investment Market Who Are These Investors? Insurance companies, individuals, pension funds, mutual funds, governments, investment funds, banks, municipalities, etc. 2009 2000 $36 Trillion $70 Trillion Enter—New-fangled Mortgages

Mortgages from Start to Finish AA A Tranche 1 CDS (AIG) AA Tranche 2 A Tranche 3 Tranche 4 BB B s O G M rou or pe tg d ag es CM In M div or idu tg a ag l es $70 Trillion Fixed-Income Market

Factors Contributing to the Economic Crisis Huge Global Demand for Fixed-rate Debt The Federal Reserve and other Regulators The Housing Market (Easier Qualifications) Creation of New “Packaged” Mortgage Securities Accounting Rules

Then the Inevitable: The Housing Bubble Burst August 2007, housing prices began to slip in key markets like Phoenix, Las Vegas, California, Florida, etc. We had built 1 M to 2 M excess homes! The actual risk of mortgages began to emerge. No one wanted to buy mortgage-related “toxic securities. ” Very difficult to value. Precipitous drop in the prices of these securities —used to be “AAA” but now almost worthless. Accounting rules—write them down

We Can’t Have Huge Losses What to Do? Close or sell the institution – Bear Stearns (1923) sold 3/2008 to JPMorgan. Chase for $10/sh (previous year was $133/sh) – Countrywide Financial was bought by Bank of America (7/2008) – Indy. Mac (Independent National Mortgage Corp. ) seized (7/2008) – Lehman Brothers (1850) sold to Barclays (9/2008) and Nomura Holdings (10/2008) – Washington Mutual seized by FDIC, assets sold to JPMorgan. Chase Find a stronger institution to merge with – – Merrill Lynch merging with Bank of America (9/2008) Wachovia merging with Wells Fargo (10/2008) Infuse more capital – Government took over Freddie Mac and Fannie Mae – Government is pumping $150 B into AIG

Result—A Credit Freeze No bank wanted to loan money—even overnight—to another bank or anyone else. They’re afraid the borrower might be “next on the chopping block. ” The economy runs on credit—even healthy companies borrow frequently to meet short-term swings in cash flows. Consumer credit—dropped through the floor We ran the risk of seeing the entire economy shut down. We are connected to the rest of the global economy, too – Iceland’s major banks fail—British savers lose $8 B – Some European banks failing – Etc. , etc.

Government Bailout Efforts—A 1. Federal Reserve Bank infused massive amounts of cash into the banking system and is assisting in mergers, sales and rescues of troubled institutions 2. Congress passed “Troubled Asset Relief Program” (TARP)—government authorized Treasury to use $350 B (done) and $350 B more (if authorized by Congress) to buy equity in troubled

Government Bailout Efforts—B Recent stimulus package of $787 B infuses money into states, federal agencies, consumers (through lower taxes), etc. Plans to aid homeowners in danger of foreclosure

What Are Possible Outcomes? Worst case—prolonged depression similar to the 1930’s (25% unemployment, no growth for 35 years, great personal hardship) Best case—short recession (unemployment 68%, no/slow growth for 12 -18 months) Most likely case—serious recession (unemployment 7 -10%, no/slow growth for 18 months to 2 years)

Other Outgrowths of the Crisis More regulation of securities industry Restrictions on the mortgage/housing industry Government may make a good return on much of the bailout investments: buying toxic assets, buying stock in troubled institutions, etc. Eventually we will see higher taxes to pay for bailout. Inflation may be a problem in the recovery. Some businesses (even whole industries) will fail, stronger ones will eventually emerge.

How Individuals and Families Might Deal with the Crisis 14 Suggestions

Net Worth Helps You Think About Debt Net worth = Assets - Liabilities Assets – Market value (not purchase price) – Real and financial Liabilities – Credit card and other consumer debt – Mortgages Why do this? – – – Net worth helps you do stuff in the future Track over time--should be growing Identifies assets that could be used to reduce debt

Net Worth—A Picture Liabilities Assets Net Worth

Impact of Credit Card Purchase Stereo System Credit Card Debt Liabilities Assets Net Worth

Impact of Credit Card Purchase Stereo System Credit Card Debt Liabilities Assets Net Worth How do you balance this?

What Adds to Net Worth? Stereo System Assets Credit Card Debt Liabilities Net Worth Must Shrink!

Suggestion 1 Avoid Unproductive Debt It Makes Net Worth Shrink Productive debt Unproductive debt Home Consumer goods Education Vacations Minimum transportation Business Car Most credit card debt

Origin of Most Debt Problems? Spending Problems Debt Income Expenditures

Suggestion 2 Control Your Spending Step 1: Track past cash flows – – – 1 -3 months back Find all expenditures Determine assets and liabilities Step 2: Agree on goals – What do we want to accomplish? – Agree on a budget for future cash flows Step 3: Track ongoing cash flows--compare budget to actual – Use computer or any other method Step 4: Review monthly Step 5: Make adjustments

Why You Need a Spending Plan Communicate with spouse and family Find out what you are spending Extract more money for saving and investing Get out of debt Prepare for the future Keep money from slipping through your fingers

Remember the Pioneer Motto “Use it up, wear it out, make it do, or do without. ” Hugh Nibley story

Suggestion 3 ~500% Be Careful Where You Borrow! Finance companies Credit cards Banks Credit unions Savings Pay-day lenders

Suggestion 4 If You Have Debt, Reduce It Plastic surgery Reduce spending Use assets to pay off debt Reduce interest rate – Careful of home equity loans! – Use another lower cost source of borrowing Make a plan -- stick to it Talk to a credit counselor if needed

Suggestion 5 Protect Your Family with Life Insurance Term life -- pure death benefit – No savings component – About 1/10 th the cost of whole – Expires at age 65 (usually) Whole life -- death benefit plus savings – Builds cash value – Does not expire – Low but fixed rate – Use for estate tax purposes

Insurance--Makes Up for Low Net Worth Problems If you have low or negative net worth? – Heirs may have difficulties – Severe cash flow problems Insurance creates an instant estate--it becomes an asset if you die Assets Liabilities Net Worth Cash from Insurance Added Net Worth

What Kind and How Much? Term insurance (6 -10 times annual income) Consider convertible term Group is least costly but what if you leave? Have some for non-employed spouse

Suggestion 6 Prepare for Retirement Yes, Even When You Are Young! Some Retirement Myths “I’ll live on Social Security benefits” – SS will replace only 24% of your pre-retirement income “Someone else will take care of me” “Better be safe and invest conservatively” Biggest regrets for retirees – Didn’t take full advantage of tax deferred investments – Didn’t start earlier to save for retirement

Example Bill starts saving for retirement at age 20 Joe starts saving for retirement at age 40 ($2, 000 per year at 8%) $903, 800 $172, 702 Bill has accumulated over 5 times what Joe did by 65!

How Does This Work? Compound interest Bill started earlier--compound interest has more time to work its miracle If someone had put $1 in an account back in 1776 at 8% interest how much would the account have in it today? $61, 000 !!

How Much Will I Need in Retirement? Money Magazine Survey People Estimate: 53% Actual: 71% One third of retirees support children and grandchildren Health care costs generally higher You’ll want to serve missions, visit grandchildren, etc. So you may need much more than 71%

Suggestion 7 Save at Least 10%-20% of Income (000’s) Life Cycle Savings Retirement Save 20% Save 10% Borrowing To heirs Age

Good Rule to Live By! Pay Heavenly Commitments First— 10% Pay Your Future Self Second— 10% and then increase it to 20%

What Should I Invest In? Important principle: risk-return trade-off – High risk--high return – Low risk--low return What? – Stocks -- ownership in a company (risky) – Bonds -- loan to a company/government (less risky) – Deposit accounts -- (insured, no risk) How should I invest? – Mutual funds – Tax-advantaged investing

Best and Worst Total Returns (since 1926) 54% Stocks: S&P 500 U. S. T-bills 20% 17% 15% 9% 0% One year holding period -43% 0% -1% 10 -year holding period 8% 3% 0. 4% 20 -year holding period

Chances of Beating Inflation % Holding Period

Chance of Loosing Money

Question: When Was the Best 5 -year Period for Stock Returns? #1: May 1932 -April 1937 367% Return Second Best? #2: July 1982 -June 1987 267% Return

Suggestion 8 Invest to Match Your Timing Short period (5 years or less)—put your money in less risky investments like savings accounts and secure bonds Longer period (10 -20 or more years)— put your money in a well-diversified portfolio of stocks

Suggestion 9 Use Tax Deferred Investments That means You don’t pay taxes on that portion of your income You don’t pay taxes on the income or growth of the investments UNTIL you take money out at retirement How do you do it? Individual Retirement Accounts (IRAs) Roth IRAs (not tax deductible, but…) 401(k) (or 403(b)) -- retirement plans – Employer may participate (match your contribution) – Loan provisions

Suggestion 10 Diversify! Never put all or even most of your eggs in one basket Mutual funds can help Index funds may be best for most of us Do n Be rna ’t be r a inv d Ma est dof f or!

Suggestion 11 Consider a Trust Estate taxes: about 50% of assets above $2, 000 person (indexed) Spouse may pass on unlimited amount to surviving spouse BUT…then only one gets the $2, 000 exemption If a couple has more than $2 M, need A/B trust There is huge uncertainty in the future of the tax law pertaining to estates!

Suggestion 12 Avoid “Get Rich Quick” Schemes

Case Study: the Ponzi Scheme End of January, 2006 Student reports finding this card in the Tanner Building Reverse side claims: Invest $6 to $6, 000 Earn 44% over 12 days New economic paradigm!

What is the Annual Return? (1 + 365/12. 44) – 1= 5, 600, 000%!

Ponzi Scheme—How it Works Etc. , etc. KEY: Return comes from new investors and not from any real economic activity.

How to Recognize Scams Is promised return unusually high? – Remember the risk-return trade-off Is product significantly above or below reasonable market price? Does sale require pressure tactics? Does seller emphasize “affinity”, e. g. , BYU or Church connections? Is most of the product purchased by end users or by other distributors?

Protect Your Data Identity theft is on the rise – Shred financial documents – Don’t give out account #, CC #’s, PINs, etc. over phone (unless you originated the call to known party) Be aware of phishing Don’t fall for “awards” or any other gimmick in which you have to send in a check Protect your computer with anti-virus programs Don’t give out SSNs Keep informed—new scams are created every day!

Multi-Level Marketing Tests Is the product sold primarily to other distributors or to actual customers? Is the product really of value in the marketplace? Is the price reasonable for the product? Are the real risks fully disclosed?

Where Should We Put Our Money? Start-ups Growth Stocks Corporate Bond Funds Government Bonds Specialty Funds Growth Mutual Funds Blue Chip Stocks GARBAGE: Speculative Investments, LPs, Derivatives, Gambling Conservative Stock Mutual Funds Tax-Advantaged Retirement Funds: Growth Stock Mutual Funds Insurance Food Storage Health Life MMMF, Ins. Savings Home Checking Account

Suggestion 13 Keep Track of Your Finances Organize and know how to read your financial documents (insurance, retirement, bank and investment statements) Create financial reports for your family (assets and liabilities) Know your monthly cash inflows and outflows Use the Web for financial information Develop a plan

Excel Mone y Man Internet Qu ic ken Y aho ager Computers and the Internet Can Help !Fi o nce na Tur bo. T ax Online Banking

Suggestion 14—Most Important of All!! Learn More about Managing Your Finances For example, read Benna, et al, Managing Your Money for Dummies Tyson, Investing for Dummies, 5 th Edition Engel and Hecht, How to Buy Stocks, 8 th Edition http: //providentliving. org/media/training/peacehe art/main. html (lds. org > Home and Family > Family Finances) http: //personalfinance. byu. edu/ (lds. org > Home and Family > Family Finances > Other resources > Personal Finance

Conclusions 1. Don’t panic—selling stock now may be the worst thing to 2. 3. 4. 5. 6. 7. 8. 9. 10. do. In fact, now may be a good time to buy—most stocks are at “bargain basement” prices. If you’re employed, become a very valuable employee, sharpen your skills, dust off your resume. Now may be a good time to go back to school. Make sure your food supply is in good order. Avoid/pay off unproductive debt. If you can, give even more generously to fast offering, other programs to help less fortunate Teach your children and grandchildren these principles. Wise financial management empowers you to serve more capably: family, community, church. Surely we will be held accountable for how we manage our resources

President Boyd K. Packer November 2008 “…in troubled times the Lord has always prepared a safe way ahead. We live in those ‘perilous times’ which the Apostle Paul prophesied would come in the last days. If we are to be safe individually, as families, and secure as a church, it will be through ‘obedience to the laws and ordinances of the Gospel. ’ ”