The FDIC, Hat in Hand

The Dow slipped backward a bit on Tuesday after the big gains we saw on Monday, but that was hardly Tuesday's most discouraging news. Of more long-term consequence is the fact that the Federal Deposit Insurance Corporation is asking member banks to kick in $45 billion by the end of the year, to cover losses from bank failures that are now projected to reach $100 billion over the next four years.

Bank of America could have to pay $3.5 billion, JPMorgan Chase as much as $2.4 billion, but the hits the banks are taking are the least of our worries. More problematic is the signal that the banking crisis is far from over, with more than 400 banks remaining on the FDIC's problem-child list. Ninety-five banks have already failed so far in 2009, and the problem figures to extend to at least 2013.

The punchline to all this is that for ten years, from 1996 to 2006, the FDIC collected no premiums at all from its member banks. None! Who would have ever guessed, in those heady days of the late 1990s, that American banks would start failing again? Certainly not the FDIC, which could be flush with funds right now if it had bothered to collect the premiums it was owed all along. And those member banks could have chipped in a few billion when they could have afforded to do so, rather than during the current tough times.

The Dow at the Doorstep

The Dow Jones average took another step forward on Monday to close at 9789, tantalizingly close to the magic 10,000 mark that once seemed like a floor rather than a goal. The index was up 124 points on the day.

What was the cause for the rise? It depends on who you ask:

* Two announced mergers helped the market along, supposedly because they're a sign that the credit markets are open again, or because investors have started buying up shares of potential takeover targets.

* Investors are expecting third quarter earnings numbers to be strong.

* The general sense among investment professionals is that the recession is really over.

* Business Week also noted: "Wall Street also weighed a Wall Street Journal report Monday that $35 billion in support of state and local housing agencies will be committed by the White House to provide mortgages to low-income earners."

It could be any of these things, or none of them. The government has pumped plenty of money into the mortgage market in the past, and Xerox, one of the major players in the day's mergers, lost value on the day. Perhaps the best news of the day was how broad-based the optimism was: The S&P 500 and the Nasdaq were up in addition to the Dow, Treasurys were up, the dollar was up. With all that, it was a day full of good news.

Name Recognition

What makes stock prices move? People put an awful lot of effort into reading technical analysis and economic indicators, but one recent study suggested that might be less than half the story. According to professors at the Universities of Michigan and California, the biggest part of a stock's movement is name recognition.

The researchers claim that as much as 70 percent of the variation in stock returns is explained by changes in investor recognition, which they define as the number of investors who know about a stock and hence consider it for their portfolio. “Efficient market theories say sophisticated arbitragers would step in to keep the prices in line with fundamentals, and we show that doesn’t happen," says Richard Sloan, the California professor. "When a lot of investors get excited about a stock, the price moves accordingly."

This is not so surprising, especially to investors who subscribe to the Peter Lynch school of investing, in which people buy into companies that they see doing well. But the magnitude of the effect is eye-opening, particularly if you're trying to choose between buying Apple or buying Air Products & Chemicals Inc.

The Importance of the Business Tax Climate

As we're struggling to emerge from this recession, there was a bit of a slap in the face to New Jersey this week. An organization called the Tax Foundation released its annual list ranking the states according to the State Business Tax Climate Index. Bringing up the rear, ranked 50th out of 50, was the Garden State.

The ranking is based on corporate income, individual income, sales, property and unemployment insurance taxes. New Jersey was downgraded because of the recent enactment of a millionaires' tax, among other things, although it had already ranked in last place last year as well.

At the same time, there's something a bit off about this list. Ranking just above New Jersey, in 49th place, is New York, and California is in 48th place. But at the top of the list is a state that's never been known for its thriving business community, South Dakota, and it's followed by Wyoming and Alaska.

What we really seem to be seeing on this list is that states with solid environments for business growth, like New York and California and, yes, New Jersey, can afford to tax those businesses a little more, while states in desperate need of business growth have to use tax policy to attract that growth.

The Fed States Its Case

The Fed emerged from its two-day meeting yesterday afternoon with a message that was a little unsatisfying: The economy keeps getting better, they said, but not so much better than we can change our tactics. "Economic activity has picked up following its severe downturn," read the Fed's report. "Conditions in financial markets have improved further, and activity in the housing sector has increased."

But conditions haven't improved so much that the Fed is taking its foot off the gas. The Fed is still planning to end its mortgage-bond purchase program - but it will keep going past the end of the year, longer than had been originally announced. They'll also keep interest rates at their near-zero levels for an indefinite period.

This is one of those situations that suggests you should watch what someone does rather than what someone says. When the Fed feels it doesn't need to do things like buy up mortgage debt, then we'll believe the economy has really turned a corner.

If you'd like to read the Fed's full statement, you can find it here.

The Bull Market in Bonds

You may have seen a recent report from Morningstar that investors have put $209 billion into bond mutual funds this year, through the end of August. That's a whopping thirteen times more money than they've put into stock funds. To put that in a little perspective, from 2003 to 2006, when the stock market was roaring, inflows into bond funds totaled just $113 billion.

A big part of that is because people have been reluctant to sink more assets into this stock market, and need some place to put their money. But those bond investments have paid off. Some more numbers:

* The Barclays Capital U.S. Aggregate Bond Index, which mimics the entire bond market, is up nearly 14 percent since October 2007, just before the recession started.

* Over the past five years, bonds have returned an average of 5 percent a year to just 1 percent for the S&P 500.

* Over the past ten years, bonds have had an average annual gain of 6.2 percent, compared to an average annual loss of 0.5 percent for stocks.

* What used to be called junk bonds are on fire; Fidelity’s High Income fund has returned 41 percent so far this year.

New Jersey Housing Trends

The nation's HUD secretary, Shaun Donovan, was in New Jersey yesterday talking about the housing crisis. He pointed out that New Jersey has had a tough time of it in the foreclosure department: We've seen foreclosures rise by 17 percent over the past 12 months, while at the national level, they've declined 16 percent over the same period.

At the same time, though, we've seen prices stabilizing, and the Times ran a piece last week about how the northern half of the state was showing the symptoms of a full-blown housing recovery. They listed seven Jersey counties with the healthiest real estate markets: Bergen, Essex, Morris, Union, Mercer, Middlesex and right here in Somerset county.

What we appear to be seeing is a bifurcated housing market, where the upper end is recovering nicely and the lesser end is still struggling. There's no such thing, really, as a statewide housing market, just as there's no such thing as a national housing market; the people shopping for a home in Basking Ridge are very different from the people shopping for a home in Trenton or in Ocean City.

Looking Ahead to the Fed

The Fed opens one of its two-day policy meetings tomorrow, and there is much anticipation for its report on Wednesday afternoon, when it will offer it assessment of the economy and announce any changes to monetary policy. They could very likely reinforce Fed chairman Ben Bernanke's opinion from last week that the recession is "likely over."

The Fed has already indicated that it would at least slow its purchase of Treasury bills. Its program of buying T-bills - it's bought $300 billion so far- is scheduled to end in October, and the consensus is that it won't be renewed. Getting out of that market would signal that the Fed has increasing confidence in the economy and the government.

One thing they're not expected to do is lift the Fed funds rate above its current state at zero to 0.25 percent. A Reuters poll last week showed economists expect the Fed to hold rates steady until as late as the third quarter of next year.

The report is officially issued at 2:15 on Wednesday afternoon. We'll keep you posted on what transpires.

An End to Money Market Insurance

The Treasury Department's guarantee of all funds put into money market accounts expires today, a year after the program was introduced. The program started after the Reserve Primary Fund, a major money market fund, broke the buck, or fell below a dollar a share and saw its assets actually decline in value.

There has been some talk of big institutional investors taking their money out of money market funds now that it's no longer guaranteed; indeed there has been more than $50 billion taken out of money market finds this week, which is a much higher number than normal.

But some perspective is in order: There is still $3.5 trillion invested in American money market funds, which means this week's withdrawals amounted to little more than 1 percent of the total assets. And if those assets are coming out of money market funds, they are probably going into stocks and bonds, which is a healthy place for them to be.

And finally, let's not forget why the Reserve Primary Fund broke the buck: It had a huge stake in Lehman Brothers when that investment bank collapsed. It's safe to say that if we reach another point where major investment banks are failing, money market funds won't be the foremost of our concerns.

More Unemployment Dipsy-Doodles

New Jersey's jobless rate hit a 33-year high in August, climbing to 9.7 percent, which also happens to be the national average. New Jersey also gained the sum total of 800 jobs in August.

How can these two things both be true? It's our old friend the revised estimate of earlier results. When the state's Labor and Workforce Development Department released the August figures, it also revised its estimate of July's unemployment figures. A month ago, the department thought New Jersey had added 5,900 jobs; now it thinks we actually lost 500 jobs in July. Hence the new unemployment rate is much worse than what had been reported for July, which was 9.3 percent. It's not clear what the July unemployment rate really was, but it was worse than 9.3 percent.

Still, there's more good news here than bad. The 800 jobs we gained in July balance out to 2,900 gained in the private sector and 2,100 lost in the public sector, mostly as cities and towns lay off people in reaction to a lower tax base. It's nice to see the private sector leading the way in job creation - although you should probably check back here a month from now, and see whether we've still gained all those jobs.

Recession's End

Fed chairman Ben Bernanke has now said that the recession, which began in December 2007, is "very likely over." But of course he doesn't know for sure yet - none of us do. As we've said many times, these things can only be decided in hindsight.

So when we will know if the recession has ended? The Commerce Department issues quarterly reports on the changes in gross domestic product, and there's one due for the third quarter - July through September - around the end of October. So we have another month and a half to go before we'll know if Bernanke was correct.

And even then, we won't be positive. The last time Commerce released the quarterly GDP figures, at the end of July, in addition to providing a figure for the second quarter of '09, it revised the numbers for all of 2008 as well. So even if, on Halloween, we find out the recession ended over the summer, it might get revised back into existence next January.

The bottom line is, of course, that it's really not important to know exactly when the recession ends. Other economic and financial numbers are critical to follow, but the day that GDP moved from shrinking at a pace of 0.1 percent to growing at a pace of 0.1 percent is not especially significant.

Golden Years

Last week, we noted that gold futures had popped up to $1,000 an ounce; prices have now stayed at that level for a couple of days. One reason for that is the fear of inflation that has been floating around. Precious metals have long been a popular hedge against inflation.

Gold, silver, and other metals have long been seen as sort of an alternative currency when the paper currency start to get beaten down, as the dollar has been lately. The greatest price spike in the history of gold, as many of you will remember, took place around 1980, at a time of great inflation. Back then, the price of gold peaked at $850 an ounce. But remember, because of inflation, that price is equivalent to well over $2,000 an ounce in today's dollars.

There are two ways to look at that price spike:

1. The price of gold today is far below its historical inflation-adjusted high, so there may be room for more upward movement.

2. Following that 1980 high, gold went into a bear market for more than two decades, and didn't reach that lofty price again until January 2008. And it's never come close to matching that 1980 peak in inflation-adjusted terms.

The Banking Landscape, One Year Later

Over the weekend the New York Times had a special package on the aftermath of the Lehman Brothers bankruptcy, which happened a year ago tomorrow. There was a graphic showing the market capitalization of the major players in the finance industry at its peak, at the trough, and as of today.

The peak for these financial companies was October 9, 2007, shortly before the recession began. At that point, there were 13 financial corporations with markets caps exceeding $50 billion, ranging from Citigroup at $236.7 billion to Bank of New York Mellon at $51.8 billion. At the lowest point of the market, March 9, 2009, there was only one such banking concern worth $50 billion: JPMorgan Chase, at $59.8 billion.

As of last week, the banking business had rallied to the point where there are now five firms with that $50 billion market cap. A lot of that is because of consolidation: JPMorgan Chase, still the largest although now at $167.1 billion, snapped up Washington Mutual and Bear Stearns. The other four are Bank of America ($146.8 billion), Wells Fargo ($128.1 billion), Citigroup ($105.5 billion) and Goldman Sachs ($91.8 billion).

In all, at the market peak, the financial sector held 20.4 percent of the value of the stock market. At the bottom, it was down to 11.8 percent, and now it's back up to 16.6 percent: an impressive rebound, but not back to full health yet, especially considering the market itself is still only at 65 percent of its peak value.

A Day to Remember

Eight years ago today, we woke up to a beautiful late-summer morning, under brilliant blue skies. A new school year had just started, and the air seemed filled with optimism and possibility. Then, at 8:46 a.m., everything changed, forever.

There have been many tears shed since that awful day, many hardships and difficult times that can be traced back to the morning of September 11. There have also been tremendous acts of heroism, and inspirational moments when we saw our communities and our country banding together. Our experiences from that day and its aftermath have left none of us quite the same.

On this anniversary, all of us here at Echelon Wealth Strategies remember the friends and family we lost on 9/11, and the heroes we discovered - many of whom we lost as well. Let us pray that our nation, and our state, would never encounter such a tragedy again.

One State Split in Two

The Federal Reserve issued its so-called Beige Book on Wednesday, providing information on the economic conditions for each of its 12 districts. Overall, the report was what you might expect: "economic activity continued to stabilize in July and August," and "the outlook for economic activity ... remained cautiously positive."

The Beige Book slices New Jersey in two, with North Jersey being covered by the Fed's New York office and South Jersey being covered by Philadelphia. The New York office, representing North Jersey, said the economy had shown signs of stabilizing, while Philadelphia, representing South Jersey, said there were signs of improvement, a somewhat more optimistic view. The New York half of the state noted that the first-time home buyer tax incentives were spurring home sales, while the Philadelphia half said it saw more gains in high-end homes. The South Jersey report had commercial real estate vacancies increasing, while the North Jersey side was more mixed.

Did the two offices agree on any aspects of the recovery? Both said demand for loans was decreasing, a negative sign, but both said that manufacturers were expecting positive growth over the next year, a positive sign. In general, the outlook is the same all over New Jersey: Things aren't great, but they're starting to get headed in the right direction.

Credit Where It's Due

There was a story in yesterday's news about the decline in the amount of debt American households have taken on, as the total amount of consumer credit fell by a whopping $21.6 billion in July, a record for a single month. The stories came with some concern over whether this might be troubling for the economy.

Most of the time, of course, we are bombarded with the opposite message: Americans spend too much and take on too much debt without saving enough. And while carrying excessive credit-card debt isn't a wise move for an individual, in the aggregate, credit creates wealth. Free-flowing credit from banks creates wealth for businesses, and using credit cards can help create wealth for individuals as well. Think about it: If you make $100,000 in a year, and end the year with $10,000 in credit card debt, you've spent 10 percent more than your salary would have otherwise allowed. If you're concerned about losing your job, and thus end the year without any credit-card debt, you've spent around 10 percent less than you otherwise might have. If everyone's purchasing power declines by 10 percent, we've got a recession on our hands.

Let me stress that I'm not suggesting that you go out and buy a bunch of big-ticket items on your credit card for the good of the nation. It's sort of a tragedy of the commons problem: What can be a bad thing for people to do, taking on a lot of debt, can be good for the economy as a whole.

The other thing to point out is that the sky-high credit-card rates we noted the other day have had their own deleterious effect on the economy. If credit card rates were lower, people would borrow more, and the economy would be stronger. And we'd all be better off - even the card companies.

Trading Gold

Although yesterday was a holiday here in the U.S., the markets marched on around the world, with gold reaching an important landmark: It hit $1,000 an ounce, the first time it has been at that level since February. Actually, there's a distinction to be made here, because if you went to buy a chunk of gold on Monday that weighed an ounce, you'd have paid $998.25 for an ounce. What happened is that gold futures went to $1,000 an ounce. If you bought a contract for delivery of an ounce of gold in December, you had to pay a thousand dollars.

Why would you choose to buy a futures contract rather than gold itself? Mostly, it's because futures contracts can be leveraged. Exchange margin rules allow you to control one contract for $4,050, so that $4,050 can give you control over a much larger amount of gold - say $50,000 or more - in December. And since the physical gold never changes hands, there's less concern about logistics, security, storage, etc.

One estimate I've seen indicates that there is 20 times as much trading of gold futures as there is of actual gold. This will continue to be an important diversification opportunity for many investors.

Thoughts for Labor Day

"Every occupation, of whatever nature, is more efficiently performed if pursued for its own sake alone, rather than for the results to which it leads." - Wilhelm von Humboldt

"Work is desirable, first and foremost, as a preventive of boredom. It also makes holidays much more delicious when they come." - Bertrand Russell

Ford Motors On

A bit of good news for the American auto industry yesterday: On the heels of the success of the Cash for Clunkers program, which has helped fuel a steady rise in the sales of Ford cars, Moody's announced it was raising its credit rating for Ford Motor Co. While that's certainly a step in the right direction, as with so many developments in the recovery, it's a step that looks good only because things have been so bad.

Ford's new credit rating is Caa1, up from Caa3.The old rating was Caa3, the kind of assessment given to junk bonds. The rule of thumb is that investors should expect some degree of loss on Caa3-rated bonds. The new rating, Caa1, is still below investment grade: The bonds will still have to move up one more step, to B3, in order to have what Moody's calls "generally poor credit quality."

It's a positive for Ford, the only major American automaker that was able to avoid bankruptcy. On the other hand, it's a sign of how awful this crisis has been when the mighty Ford Motor Co., once one of the world's most powerful corporations, is celebrating the fact that its bonds are now slightly less junky than before.

Double Dipping

There has been much talk lately of the possibility of a double-dip recession, especially after NYU economist Nouriel Roubini, Dr. Doom himself, warned of such a possibility last month. A double dip is one in which the economy recovers from a recession and returns to growth, but then begins to contract again after a quarter or two.

It's probably premature to talk of such a thing, since we're not even sure the economy has begun growing again. But it might be instructive to look at the last double-dip recession, back in 1980-82. The American economy contracted violently in the second and third quarters of 1980, then posted two strong quarters before falling back into recession. What's scary about that one is that the economy didn't really start growing again until the end of 1982. The second part of the double dip ended up being longer than the first part.

There was also a nasty sort of double dip in the Great Depression; while we tend to think of it as one long era of misery, the economy had started to expand again in 1933, only to snap back into recession in 1937. But technically, those were separate recessions and not really part of a double dip.

So it's a very rare occurrence - but if it does happen, after a recession that has already been the longest since the Depression, it promises to be exceedingly nasty.

Why Do People Hate Their Credit Card Company?

In the annals of things that are completely unsurprising comes a survey from J.D. Power and Associates finding that U.S. customers are less satisfied with their credit cards than they were a year ago. As you probably know, many struggling financial companies have raised interest rates on their credit cards, looking for some way to earn some profits.

Because of that, 20 percent of credit-card users saw their interest rate increase in the past year, while in the survey from a year earlier only 10 percent did. More customers reported having to make late-payment fees, which makes sense given how many people are out of work.

J.D. Power does a lot of surveys like these that are very interesting, but sometimes they just make themselves look foolish by stepping beyond that. For instance, in this report, J.D. Power adds, "Credit-card issuers' best weapon against deteriorating satisfaction is to clearly communicate any changes to customers ahead of time." Perhaps neither the credit-card companies nor J.D. Power has considered this, but their best weapon against lowered satisfaction would be satisfying their customers by reducing those inflated fees.

The So-Called TARP Profits

The New York Times had an update yesterday on a story we've been following here, the banks that have been repaying their TARP bailout money. According to the Times, the federal government has now reaped $4 billion in profits from the program. That's profits, not simply paybacks.

What the Times calls profits derives from the warrants that the banks sold to the government, the rights to buy their stock at deflated prices; the banks have now been buying back those warrants, resulting in profits to the government.

It's great that these have provided some money for our beleaguered Treasury Department, but let's not go overboard here. When the government lays out $700 billion in funding for struggling banks, it's of small comfort to hear that it's earned a profit of 4414 million on its investment in American Express.

The TARP program wasn't intended to be a money maker for the government, of course. It was intended to stabilize the banking system, and it seems to have done a fairly good job of that. To the extent that the taxpayers have been seeing some of our investment returned, that's a welcome sight as well. But the so-called profits are a minor, unimportant part of this entire deal.