Web Exclusive: Economic Crisis part 2

1. **Don't you think to stimulate the economy it would have been cheaper and better to have given $1 million to each person in America rather than the $700 billion bailout? - Zeller W.**John Watkins: *It certainly would not have been cheaper. Assuming a population of 300 hundred million, to give $1 million to every American would cost approximately $300 trillion dollars. As it is, giving $700 billion is equivalent to giving every American $3,500. But your point is well taken: would it have been more beneficial to stimulate the economy by increasing spending than by purchasing the toxic assets of financial institutions? Perhaps. It's unclear how purchasing toxic assets of financial institutions or purchasing stock in banks will induce them to make loans. If you give people money, they will likely both pay down debts and spend the money, which in turn will benefit business. In any case, the government will have to employ some variation of your suggestion to pull the economy out of this crisis.* Bruce Lefavi: *No I don't because $700B is about $1900.00 per person.* Kelly Matthews: *This concept was the basis if the first stimulus program earlier this year. And with approximately 300 million people in the US- the numbers at $1 million don't add up to $700 billion. More like $300 trillion.* 2. **What measures should the average middle-class family take right now when it comes to money in savings accounts and consumer debt? Is it better to pay off debts or keep more money in savings? --Michelle J.**Aric Krause: *Both have distinct advantages, Michelle. Personally, I advocate having very liquid savings equal to about 3 months of your "take-home" income. If you have that, pay off that consumer debt as soon as possible. Beyond that, continue saving. To the big picture: America will begin to shift away from a ‘consume like there's no tomorrow' attitude, and into a more frugal picture. So following the suggestion above is really a constant, and doesn't really have much to do with the crisis. It might be better to dedicate yourself more to the savings right now unless you know that there is no chance that your household's income may be impacted by the economy (layoffs, terminations).* Lefavi: *It's almost always better to pay off debts, especially if it's high interest rate.* Matthews: *The most important thing is to pay off the highest credit card debt. And make sure you take full advantage of a 401k plan especially if your company is matching.* Watkins: *It depends. If you are paying high interest rates on the debt, pay it down. If you fear losing your job, it's probably better to hold onto your cash. Money is like insurance, it enables you to settle debts, purchase goods and services, and provides a source of purchasing power during emergencies. During financial crises, money is king.* 3. **My question is with the economic situation so bad, why are the NFL and college football games sold out? Baseball playoffs too? Seems some of us are not worrying about the price of the ticket. - Carol, West Jordan**Matthews: *These people probably still have jobs and a little discretionary income and are simply enjoying the night out, escaping from some of the other worries.* Watkins: *People need entertainment. First, those who likely can afford NFL games are more affluent, and hence can afford the high prices. Second, consumer purchases are habitual. People grow accustomed to a certain standard of living, which is difficult to reduce. But you are right, as the crisis affects the real economy, people likely will cut back.* Lefavi: *As in any economic downturn some people are hurt while others are not, that's why the tickets are selling out.* Krause: *Carol, in times like these, households sometimes react in seemingly confusing ways. It may seem as if some continue to seek entertainment even while curtailing other parts of their spending. This is quite normal. You may find, for example, that you still find ways to indulge your hobbies or interests even while cutting off other expenditures from your budget, depending on how expensive that indulgence is. Not all spending is equal - each of us is currently evaluating what we can do without, and those items that help us be "fulfilled" are usually the last to go, whatever they may be. It might also be the case that those you are seeing at sporting events made those spending choices before the economy fell here in the last month or two. For example, someone may have bought tickets to a sporting event way back in March, in which case they'll still go since they're already paid for. It is likely that if the economy stays in a poor state for another year, we'll see participation in even these events decline.* 4. **Is not the reason for the crisis that the money we use is integrally worthless!? Had I gold or silver instead I could buy that which I need. -Gary F., Salt Lake City**Watkins: *Gary, I will offer you ten cents for every dollar you have. Of course, you will refuse, but the offer makes a point. So long as people accept money in exchange for goods and services, it is not worthless. But you raise an interesting point: our money has value because people believe it has value. That is, people have faith that the US government will not collapse. Will the purchasing power of money decline in the future? Most probably. But in the short term, money will increase in value as prices fall. The reason: as prices fall, the same amount of money can purchase more goods and services.* Lefavi: *Money is not completely worthless. In fact, the dollar has been going up quite dramatically since the crisis started. The reason you don't buy a lot of silver and gold itself is because they basically haven't been really great investments in and of themselves.* Matthews: *There has been no metallic backing to American for many, many years. Our money is worth only what it is deemed to be worth by the backing of our government. Gold and silver are not a medium change- you can't go out and spend it, only trade it.* 5. **How much of this stock market crisis is caused by foreign investors dumping stock to influence our domestic events? -Troy, Taylorsville**Lefavi: *The international markets are so intertwined that quite frankly even our worst enemies really don't want our economy to go down the drain because it would just them too.* Matthews: *There are people all over the world who own stock in our stock market and they are probably selling like everyone else- looking out for themselves, not looking to take down the American market. However, the current state of our stock market is an indication that there is a little lack of confidence from both foreign and local investors.* Krause: *Not much at all, Troy. Institutional and other investors are making their purchase decisions based on the future value of the company or market. US insurance companies, mutual fund companies, and banks are a major part of the market, and right now holding US stocks doesn't seem like a good financial decision since no one knows where the bottom of the market is. US investors comprise a larger portion of the market than international investors, so their actions are more determinate in where the market is. Much trading that occurs is computerized because the stock markets are so large; computers cause market fluctuations to be even larger because they are programmed to make movements when the market reaches specific points - to trade automatically without any hesitation or conscience. But looking at the larger issue - foreign investors are not an organized block acting in unison. Instead, it is individuals seeking the highest rates of return around the world. For the last several weeks, the rate of return on holding US assets was low, so money began shifting to other markets, out of the US market. We've seen this happen many times - in Asia, for example, in 1997-1998. As soon as investors lost confidence in the Asian "Tigers", billions of dollars flew out of stock markets throughout the region almost immediately - not because there was an attempt to influence the country, but because the expected rate of return was low. That's one of the difficulties with a globalized financial market.* Watkins: *People generally do not buy and sell stocks to influence events. They buy and sell to make money, or avoid losing more money. Moreover, few investors have so much wealth that they can single-handedly make markets rise or fall.* 6. **Why shouldn't we just incorporate the Euro into America? Would that change anything at all? -JR, Santaquin**Matthews: *Because we would have to join Europe or it would have to join the U.S. Plus, while there is just one monetary authority in Europe, it does not have a common fiscal policy or sovereignty on taxes.* Lefavi: *I wouldn't want to have the euro here in the United States because the European Union, which we would have to join, brings with it a tremendous amount of socialism and that's why many countries in Europe have a 15% unemployment rate while ours is at 6.1%.* Watkins: *If you mean that we allow the Euro to circulate in the US, some retail businesses in New York already accept Euros for payment. But for most of us, accepting Euros would be inconvenient. Making change, setting prices, and so on would be cumbersome. Moreover, the government would not accept Euros. In the future, however, as the world becomes more integrated, we will likely need to move to a world currency.* 7. **I am a recent college graduate and looking to go on to graduate school, which will be paid for with mostly student loans. Will the economic/credit crisis have an effect on my ability to obtain new student loans for graduate work? - Traci, Salt Lake City**Krause: *Traci, if you are sourcing your loans from the Department of Education, funding is secure for the rest of this year. We won't know the impact on those loans next year until the federal government completes its budget process next summer. Private loans, on the other hand, are more difficult to get, depending on the source bank. I encourage you to talk with a financial aid officer at your university of choice about where the market is before you make your final decision. I do commend your decision to go to graduate school - whatever the expense, it is an investment in your future. Some see education as an expense, but it is not: it is an investment that will help you achieve your professional goals. Well done.* Watkins: *Possibly. But I expect there will be such pressure on the government that they will ensure that you will be able to get loans. Moreover, our competitive advantage in the world lies in our education labor force. To deny people loans for educational purposes would be counter productive in the long run.* Lefavi: *If the credit crisis were to continue there's no question that it would affect your ability to get a student loan, but the government's taking the right steps to make sure that doesn't happen.* Matthews: *Some suppliers of student loans have moved out of the market. Yet many still remain. You should find plenty of loans with no serious trouble.* 8. **My wife and I are looking to buy our first home, but we are afraid of purchasing now and seeing the value drop and eventually being upside down in such a large investment. What do you suggest? - Ryan, Orem**Lefavi: *I think we're in for a couple more down years in the real estate market, but a home is a different thing all together because you buy it and keep it because that's where you want to live forever. At least that's my attitude. Therefore, whether the price goes up or down is a non-issue if you feel as I do.* Matthews: *if you really need a home- it is a pretty good time to buy because interest rates are desirable and prices are lower. But if you don't need one right now- prices will still go lower in the future.* Watkins: *What is your primary purpose in buying a home: a place to live or an investment? If you want a place to live, purchase a home. If you are looking for an investment, then purchasing a home may not be the best choice in the short term.* Krause: *It depends a lot on the house and the location, Ryan. You may have read in the press that houses in different segments of the market are changing value at different rates. In some metropolitan areas, houses above $500,000, for example, have dropped in price faster than houses below $500,000. That has everything to do with the affordability factor. You may have also noticed that housing prices in other metropolitan areas have adjusted more, on average, than those in the Utah market have thus far. I personally believe that strong evidence exists to suggest that the Utah market has more price adjustment coming, but it really depends on the individual house. I encourage you to find someone you trust to help you when you are ready - someone who can help you determine what the house is WORTH, as opposed to what the asking price is.* 9. **The housing and mortgage is a problem, but why are they not doing more to help the oil problem? Oil is causing the layoffs, due to the higher cost of everything to run a company. -Troy, Ogden**Matthews: *Oil prices have dropped about 50%, gas prices are down only 25%. That means there is still room for gas prices to drop. But the big problem is what about domestic production. If we want to be dependent we need to address domestic production.* Watkins: *Fortunately, the high cost of energy is falling as oil prices fall. Energy is certainly a problem that needs to be addressed. But the source of the current crisis lies in the inability of millions of home owners to pay their mortgage combined with the indebtedness of financial institutions. Higher energy costs reduce profits, which in turn can predicate a recession; the collapse of our financial institutions, however, could lead to a collapse in the system of payments, which would mean depression.* Krause: *You are right, Troy, in that oil is contributing to the problem - but oil isn't the same issue of a failure of the market. The oil market is working reasonably well, telling us that global demand is increasing and therefore so will the price. Oil is exacerbating the other problems in the sense that it is pushing the household's budget even further. I think most experts agree, though, that doing anything to change the oil market will simply cost money and prolong the problem. We need new energy solutions, and that realization gets more obvious when we look at the high prices of energy. Lowering the price of energy through intervention will cause us to become complacent again, as we were from 1973 to 2008 - yes, we got a glimpse of a possible future in 1973 and again in 1979, but we have done very little about it since then. It is more expensive to run a company these days, especially in those industries that have substantial transportation costs or those that use synthetic (oil-based) materials, again adding to the price pressure consumers are feeling. But companies having difficulty getting credit to make payroll, to fill new orders, to research new solutions, or to build new facilities, is a far more serious problem.* Lefavi: *They don't have to do anything about the oil prices, they've already fallen in half and they're still going down.* 10. **Should I put my money into retirement plans at work, like 401k or company sponsored retirement or should I just save money in the bank? - Susan C., Salt Lake City**Watkins: *The advantage of a 401k is that you can defer your taxes. So you receive a return immediately.* Lefavi: *Bank, no. 401K, yes, provided that the 401K has decent investment selections in it. It's also tax deductible.* Matthews: *In my opinion if you have a company that matches the 401k is the best route to saving your money.* 11. **I have a small 401k, which is just big enough that after taxes and penalties it would pay off all my debt and leave me virtually debt free. Should I pull it out while I still can and pay off my debts? - David S., Taylorsville**Lefavi: *If the debt is on your home, I definitely would not do that because you would be taxed on the money taken out of your 401K and if you're too young, penalized as well. In addition to that, you would pay more taxes because you've eliminated a loan on your home if that's where the debt is, which is also a deduction. Losing two deductions, bad idea.* Krause: *That is a difficult question, David. There are proposals being thrown around that have to do with removing the penalties for premature withdrawals from retirement accounts, but whether or not these become realistic is a whole other issue. Short of that, you will be required to pay those difficult penalties and taxes. Another significant question: how old are you? If you are far from retirement, the answer is different than if you are closer to retirement. Would you be asking the question if we knew the market were at its bottom and that you could gain significantly from this point forward by leaving your money in the market and even investing more? What if you thought you could make 10-15% returns on your investments over the next few years? If your cost of debt were 7%, then clearly you would be advised to leave your money where it is. There are so many questions that there is really only one answer: you must consult your investment professional before making any decisions. This is too serious of a question for a brief answer. If you don't have an investment professional, find one!* Matthews: *Assuming you're still working- I'd cut back on spending, try to manage your debt and keep your 401k intact.* Watkins: *Generally speaking, it is unwise to liquidate your 401k to pay off you debts. The penalties and taxes are generally not worth it. Moreover, if you can manage your debt, and if the interest rate is relatively low, I would not liquidate your 401k.* 12. **I'm 37, own my own business, have no retirement of any kind. Is now a good time to start putting lots of money into a retirement plan due to the low stock prices, instead of paying off business debt and other low interest obligations? - Brook B., South Jordan**Matthews: *I believe you should be doing both. You should be reducing your business debt and planning for retirement. But, of course, how you invest for retirement is really important. You should diversity and have a well thought out, conservative plan.* Lefavi: *One of the few absolute certainties is that this is a great time to be a buyer in the stock market and it would be a smart thing to set up a SEP IRA which would give you a tax deduction for everything that you put into it. Paying off your business loan would lose a deduction there as well and if it's really low interest, as you indicated, why get rid of cheap money?* Krause: *Brook, the answer to this question is the same as that offered to David in question #11. Let me reiterate that this question is far too important to rely on results from this article or from your neighbor - - get in touch with a professional wealth planner and get this analyzed by an expert.* Watkins: *Again, it depends. The return from paying down debt is a sure thing: the interest that you save. The return from stocks is much less certain. So it depends in part the interest rates that you are currently paying on your debts.* 13. **If stocks are on sale, what is the best way to purchase them: through a broker or on your own (to conserve broker fees)? Also, if people start to buy up stock, how soon would the market recover? - Angela, Taylorsville**Watkins: *Online brokerage fees are very reasonable. I would look into them. Difficult to tell how long the market will be down; it could languish for some. People must have confidence for markets to rise. And right now, confidence appears to be scarce.* Lefavi: *The smartest way to buy stock is through a really great mutual fund because you have professional management and 100-200 different investments instead of just a few. If everybody started buying stock now the market would go up immediately.* Matthews: *You need to decide, do you need advice or just someone who can enter a transaction. If it is the latter, shop around and look for the lowest fees. If you need direction- it is going to cost you more. No one knows how soon the market will recover, but it is acting a little bit like we are getting close to what may be a bottom. That means a recessionary period for at least a year and that implies 2-4 years before the stock market approaches levels like we've seen.*

- John Watkins, Ph.D. Professor, Bill and Vieve Gore School of Business, Westminster College - Aric Krause, Ph.D. Associate Professor, Bill and Vieve Gore School of Business, Westminster College - Bruce Lefavi, Founder & President of Lefavi Wealth Management - Dr. Kelly Matthews, Executive Vice President & Economist for Wells Fargo Utah