SAFE MONEY in TOUGH TIMES

Everything You Need to Know to Survive the Financial Crisis

By JONATHAN D. POND

The McGraw-Hill Companies, Inc.

Copyright © 2013 Jonathan D. Pond
All rights reserved.
ISBN: 978-0-07-162961-4

Contents

PrefaceAcknowledgmentsPART I Understanding the Economic Crisis1. What’s Going On in the Economy?2. This Time It’s Different, but We’re Not Headed for a Depression3. Checklist of Things to Do Now to Get Your Financial Act TogetherPART II Coping with Tough Economic Times4. Twelve Winning Strategies to Cope with Tough Times5. Budgeting for Tough Economic Times6. What to Do when Your Expenses Are Increasing Faster than Your Income7. Getting Your Debts under Control8. Forewarned Is Forearmed—Preparing for the UnexpectedPART III Investing in Tough Economic Times9. Investment Strategies for Frightened Investors10. Ten Rules for Investing Successfully in Turbulent Markets11. Making the Right Stock Investments12. Making the Right Bond Investments13. Making the Right Real Estate Investments14. Keeping Safe Money SafePART IV Tackling Special Situations15. If You Lose Your Job16. If You Think You Might Lose Your Job17. Evaluating Early-Retirement Incentive Plans18. Finding a Job in Tough Times19. Coping with Debt Problems20. Advice for Homeowners21. Advice for Home Sellers22. Opportunities for Home Buyers23. Getting the Kids through College24. Tips for Worried Preretirees25. Tips for Worried Retirees26. Survival Tactics for Small Business Owners27. The Psychological Side of Money Problems28. Bankruptcy—The Last Resort29. If Inflation Heats UpPART V Planning for a Secure Financial Future30. “Been Down So Long”—Getting Back on Your Feet31. How the New Administration May Affect Your Pocketbook32. Profiting from ProsperityAppendix: Web Sites to Help You in Tough TimesIndex

Excerpt

CHAPTER 1

Understanding the Economic Crisis

1 What’s Going On in the Economy?

What’s going to happen to me?

There’s no doubt about it: these are tough times for Americans—indeed, forfamilies throughout the world. Safe Money in Tough Times will help youand your family deal with the challenges. Whatever problems the bad economydishes out to you, you will find help in these pages. How bad are things? Injust one day in late 2008, the following events were in the news:

• Stocks drop another 4 percent; they’re down almost 40 percent so far thisyear.

• Seventeen major retail chains may be in jeopardy.

• Small business owner optimism index is at a multidecade low.

• Bailout plans strain as a growing number of companies need assistance.

• Circuit City files for bankruptcy.

• U.S. auto manufacturers are on the brink of bankruptcy; General Motors stockis at a 66-year low, with some analysts predicting that the stock price will goto zero.

• Orbitz lays off 10 percent of its workforce.

• American Express gets access to bailout money, as a rising number ofcardholders are having trouble making payments.

• Economists predict that the recession will be one of the longest in history.

• Starbucks’ profit tumbles 97 percent.

• Leading home builder reports that customer traffic and sales hit record lows.

• AIG reports a huge loss; rescue package is raised to $150 billion.

• Worldwide economic crisis worsens; China announces $586 billion stimuluspackage.

• A survey of large businesses reveals that none planned to hire over the nextthree months.

• DHL announces 9,500 jobs to be cut.

• 280,000 homes entered foreclosure in the previous month.

What’s going on with the economy? And more importantly, what does it mean toyou? How will you and your family be affected? What should you do now to protectyourself from the tough times ahead? Some people have been severely affected bythe worldwide economic crisis. What if you’re one of them? This book will helpyou understand what’s going on and, more importantly, will show you what you cando to survive the economic doldrums, no matter how badly you are affected.What’s more, Safe Money in Tough Times will show you ways to takecontrol over and manage your finances in such a way that you’ll emerge from theGreat Recession well positioned to prosper during better economic times.

How We Got into This Mess

There is a lot of blame to go around for the global financial meltdown. Aconglomeration of factors converged to make a perfect storm. The complexproblems hit a crescendo when banks found themselves unable to make loans.

Many people blame lax financial regulation and consumers who, along with theU.S. government, borrowed like there was no tomorrow. Then there were thelenders who carelessly made loans to borrowers with poor credit. Of course,investors who failed to research their investments and Wall Street firms thatengaged in excessive risk taking share the guilt. Add in securities ratingagencies that overrated risky securities and credit-scoring companies thatallowed human beings to be removed from much of the lending decision-makingprocess. It was a recipe for disaster.

Thirty Years in the Making

The seeds of the financial meltdown may have been planted as far back as the1970s under the Carter administration. The economy was stagnating, and taxeswere high. Many people believed that deregulation of the financial industrywould result in more private investment in stocks and bonds and spur economicgrowth. It also would allow U.S. financial institutions to better competeglobally.

At the same time, government policies focused on homeownership and smallbusiness, which many considered the keys to building economic prosperity. TheCommunity Reinvestment Act of 1977 required commercial banks and savingsinstitutions to make loans in low- and moderate-income neighborhoods. Subsequentadministrations, both Democratic and Republican, built on these programs, whicheventually led to the unraveling of the economy.

The Federal Housing Enterprises Financial Safety and Soundness Act of 1992required two secondary mortgage market players to support affordable housing.The government-sponsored players were the Federal National Mortgage Association,or “Fannie Mae,” and the Federal Home Loan Mortgage Corp., or “Freddie Mac.”This action led to the proliferation of riskier no- and low-down-paymentmortgages.

Subsequently, the Clinton administration encouraged home loans in the nation’sinner cities and rural areas. The Financial Services Modernization Act of 1999repealed the Glass-Steagall Act of 1933, which prevented banks from engaging ininvestment banking and vice versa. As a result, banks began getting into thesecurities business in a big way—and vice versa.

The bursting of the technology and dot.com bubble at the turn of the century wasfollowed by an extended period of low interest rates and skyrocketing homeprices. An industry of third-party mortgage brokers blossomed, with limitedregulation or accountability.

The combination of these political initiatives fueled widespread aggressivelending and relaxed standards for home loans, and encouraged speculation.Competition among several types of lenders led to loans with increasingly lowmonthly payments and no income documentation. Unfortunately, these lower-payment”option” loans were often riskier and more costly than traditional 30-yearfixed-rate mortgage. Yet, those loans increasingly were made at higher interestrates to lower-income borrowers. Many people who ordinarily would not qualifyfor a mortgage were issued home loans.

A Double Whammy

The straw that broke the camel’s back came in 2007, when interest rates rose andhome prices fell. The U.S. government put Fannie Mae and Freddie Mac intoconservatorship in the last half of 2008 because they were nearing bankruptcy.Making matters worse, mortgages had been packaged by Fannie Mae and Freddie Macand sold to investors. Borrowers often did not know who actually owned theirloans. In addition, quasi-insurance contracts transferring the risk of themortgages to others had also been sold, with little regulation or oversight.Today, the big question has become how to value those “credit default swaps” andother so-called credit derivatives created from mortgage pools. The disasterstarted in the United States but quickly spread overseas.

The government will move to stimulate the economy under the Obamaadministration. Rebate checks or tax cuts will be given to lower- and middle-income Americans in an attempt to prop up the sagging economy. Massive jobcreation programs will also be undertaken. Efforts by leading banks and the U.S.government will help stem foreclosures.

This debacle will eventually begin to subside. But even then, individuals andfamilies will probably spend years getting out from under the adverse effects ofthe Great Recession.

A Guide for Surviving the Great Recession

Now that you have some understanding of how we got into this mess, it’s time tobegin to consider what actions you need to take, both to survive the downturnand to emerge from it in sound financial condition so that you can takeadvantage of the prosperity that always follows recessions. After showing youwhy we’re not headed for a depression, despite some irresponsible talk about itin the media, Chapter 3 provides some information on things you can doright away to minimize the effect of the recession on your finances. Theremainder of the book is divided into four sections: “Coping with Tough EconomicTimes,” “Investing in Tough Economic Times,” “Tackling Special Situations,” and”Planning for a Secure Financial Future.” Since the Internet can be a wonderfulresource for guidance and software to help you deal with your financialchallenges, I have listed my favorite financial Web sites in the Appendix.

Parts II and III will guide you through a variety of concerns asyou try to grapple with your personal finances, including saving, managing yourdebt, budgeting, reducing expenses, maintaining your insurance, and, of course,investing wisely and well after the terrible drubbing that investors havesuffered.

Part IV deals with special situations that may be of concern. In fact,it is quite likely that a few of these special situations will apply to you andyour family. They include coping with unemployment, working through creditproblems, challenges for homeowners, and helping your family survive thepsychological problems that often accompany distressed family finances. Thissection also includes tips for worried preretirees and retirees, paying forcollege in tough times, and survival strategies for small business owners.

The last section of the book will provide some advice to help you recover fromthe effects of the economic tsunami so that you can prosper in the next economicboom. It also takes a look at how the new administration may affect yourpocketbook.

Finally, my special Safe Money in Tough Times reader Web site will keepyou up to date on matters affecting the economy and your financial well-being.The address is www.jonathanpond.com/ safemoney.html.

When all is said and done, financial security is what personal financialplanning is all about. Unfortunately, we are going through a period of time thatmay interrupt a lot of people’s progress toward achieving their financialaspirations. I hope that after reading the pages that follow and takingappropriate action, you will be able to look back at this time as an annoying,but not overwhelming, disruption in your personal financial progress, one thathelped you prepare for an even better financial future.

2 This Time It’s Different, But We’re Not Headed For A Depression

The scary word depression has been popping up on the air-waves, butdon’t let it rattle you. A depression is a severe decline in economic activitythat lasts for years. Economists already acknowledge that we are in the midst ofa recession, which is a temporary but significant decline in economic activity.In fact, many have called this country’s economic state the worst recessionsince the Great Depression of the 1930s.

The Great Recession

Although the recession is likely to turn out to be severe, economists havestopped short of calling it a depression, even though that may be how you feelwhen you open up your monthly investment statements. Why? The U.S. governmenttakes a much more active role in the economy than it did during the GreatDepression of the 1930s.

Today we have safety nets, like federal deposit insurance, social security,unemployment benefits, and welfare programs. If the situation gets particularlydire, the government can step in and lower interest rates, or even take overinstitutions or companies. We’ve already been watching this happen in thegovernment bailouts of Fannie Mae, Freddie Mac, AIG, and Citigroup, with morenames to be added to the list.

You might think that residential real estate is one sector of the economy thatis experiencing problems similar to those in the Great Depression. New housingstarts have dropped 64 percent since their peak in 2006. That sounds like a lot.It’s certainly similar to the decline during the 1974 recession. But in the1930s, housing starts dropped a whopping 90 percent.

As in the Great Depression, unemployment is rising. It could hit 8 percent ormore, based on estimates. But that, too, is a far cry from the 1930s, when aboutone of every three persons was out of work.

Fortunately, we are benefiting from low inflation, running at around 21/2 percent.That’s mild even when compared with the double-digit inflation rates of the1970s. During the early part of the 1930s, there was a 20 percent annualdeflation rate. That means that prices dropped 20 percent annuallybecause no one had any money to spend or save.

Economists acknowledge that we could see economic growth decline further. Butthey expect nothing like the gross domestic product decline of 26 percent thatoccurred during the period from 1926 to 1932.

Lessons Learned

Even if things do get worse, we have already learned many hard lessons, and weare better prepared to deal with crises in the economy and the investmentmarkets. In the wake of the 1929 stock market crash, the Federal Reserve was tooslow to lower interest rates and stimulate the economy, and there was no federaldeposit insurance. Thousands of bank failures resulted. This time around, theFederal Reserve and the U.S. Treasury have already acted to keep the financialcrisis from spreading. They’re on the lookout for ways to pump money into theeconomy and help companies and homeowners. In fact, we even saw global unity,with several countries taking economic action simultaneously.

There’s no denying that we’re in a mess. For years, both businesses andconsumers borrowed from Peter to pay Paul. Banks made low-rate adjustable-ratemortgages to persons who could not afford the homes they bought. Meanwhile,banks packaged these loans into securities and sold them to institutionalinvestors. The institutional investors purchased credit default swaps to protectthemselves against losses from mortgage defaults.

The end result: homes went into foreclosure, and banks and investors inmortgage-backed securities and credit default swaps lost their shirts. The realestate bubble burst, interest rates rose, and housing values plummeted. Itbecame impossible to place a value on certain investments, and insurancecompanies were unable to cover losses.

Unlike what happened in the Great Depression, however, our government came upwith an initial $700 billion to bail out our financial system. Lenders startedmodifying mortgages to avert foreclosures. Some beleaguered homeowners were ableto make lower, more affordable monthly payments. In addition to financialinstitutions, other struggling companies lined up for government largesse.

Other major differences between now and the Great Depression: some corporations,such as Microsoft, are maintaining low debt levels and still have tons of cashon the books. And on the employment side, there are still a lot of peopleearning money and, hopefully, saving it.

No one knows for sure exactly how much it will take to get us out of this mess.Does all this mean that Uncle Sam is buying consumers and businesses a freelunch? Heck, no! Uncle Sam is borrowing more money. Our country’s budget deficitwill be in the trillions of dollars. Future generations, unfortunately, will payfor our mistakes. I can only hope that every-one—individuals, families,businesses, and governments—will learn a lasting lesson.

3 Checklist of Things to Do Now to Get Your Financial Act Together

I remember past recessions. We had a real tough time— we almost lostthe house. We’re in better financial shape now, but I still worry about what’sgoing to happen, since the economy is going to take a long time to get back ontrack. I want to be prepared this time.

Tough economic times affect us all; unfortunately, some people suffer more thanothers. Don’t wait for recession problems to affect your personal finances anymore than they already have. You can do a number of things today to prepare forthe troubles that may lie ahead. The rest of this book will describe theseimportant matters in more depth and help you address problems that may beaffecting you now or in the near future, such as investing when most people arescared of the stock market, family money problems, and unemployment. Thefollowing checklists can help you begin to organize your financial life so thatyou will not be taken by surprise if and when a financial problem arises duringthis long and severe recession. It’s never too late to prepare.

Budgeting and Record Keeping

• Prepare a household budget that lists past and expected future income andexpenses. Through this budget, you can identify spending patterns and adjustthem, if necessary, to reflect changes in your financial situation or outlook.If you’re not into budgeting, accomplish the same objective of improving yourfinancial position by increasing your savings through automatic transfer fromyour paycheck or bank account into an investment or savings account. (SeeChapter 5.)

• Evaluate your sources of income and how you spend your money so that you canplan ways to reduce expenses or earn extra income should the need arise. (SeeChapter 6.)

• Prepare a summary of your assets (home, investments, and so on) andliabilities (debts) so that you can get an idea of what you own and what youowe. This summary will help you identify what resources you have available tomeet future obligations.

• Organize your personal records so that you have ready access to importantfamily documents and personal financial information. If you need to address apressing financial problem, the last thing you’ll want to have to spend yourtime on is locating and organizing your records.

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(Continues…)Excerpted from SAFE MONEY in TOUGH TIMES by JONATHAN D. POND. Copyright © 2013 by Jonathan D. Pond. Excerpted by permission of The McGraw-Hill Companies, Inc..
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