“I would gauge the market’s reward to risk as unattractive. To this observer, the market has priced in a smooth and self-sustaining global recovery and has not priced in any number of adverse outcomes (which seem to have a rising probability of occurrence).
“While it is impossible to see the future with precision, in broad terms, I see upside to the S&P Index to about 2070-2100 and the downside to approximately 1830-1870 over the next six to twelve months (compared to the current cash level of 2020) — a negative ratio of $2.60 of risk vs. $1.00 reward (170 S&P points of downside/ 65 S&P points of upside). I don’t like those odds.
“My strategy is to play defense and err on the side of conservatism as the potential for a market correction looms.”
For an explanation of the term “z-val” and a collection of more forecasts, see The Z-val Zone.
Look insideThe Kelly Letter
Thank you to Brenda Jubin of “Reading The Markets” for her pre-publication review of my new book, The 3% Signal. It ran on Investing, ValueWalk, and other sites. She concluded: “We often hear, and have come to believe, that models beat experts. Kelly offers the individual investor a simple, mechanical model that instills discipline, removes a lot of self-sabotaging emotion, and has a good track record. Will it continue to outperform? Actually, it just might.”
I appreciate her final sentence because it would have been easy to demur with something like “We’ll see” or “Only time will tell.” Jubin was evidently swayed by the book’s research and wanted to convey that, in fact, unpopular as it may be to admit this to cynical investing types, she does believe in the underpinnings of 3Sig and thinks it probably will continue outperforming. Thank you, Brenda. I hope others are as open-minded as you are when it comes to embracing a new approach.
I would also like to thank Nancy Zambell at Dick Davis Dividend Digest, who invited me to submit my top pick for 2015 and allowed mine to be 3Sig rather than another stock or fund. The Digest ran the following in Issue 268 sent last Wednesday:
In case it’s hard for you to read it in the screen capture, here’s the full text:
“My pick is not a stock, but a technique: The 3% Signal. This is the title of my new book and the name of the method it explains. Rather than trying to time the market, this approach is indifferent to future market direction and focuses its effort instead on rational reaction to prices already recorded.
“By dividing an account along an 80/20 split, putting the 80 in a small-cap stock index fund and the 20 in a bond index fund, then rebalancing the stock fund to a rate of 3% growth every quarter, the technique beats buying and holding the market and even beats the formidable dollar-cost averaging method into a market index fund. Because most professional money managers lose to indexes, the plan beats the vast majority of them as well — with low-cost index funds, no less.
“This is the stock market’s new best practice, and I encourage everybody to use it with at least part of their assets, if not all. It works especially well in a retirement account, such as a 401(k).
“DD editor’s note: You may pre-order the book via Jason’s website, and are invited to join him in a live Twitter Q&A session on Tuesday, March 3 at 7pm EST.”
The book is available for publication day delivery on February 24 from Amazon for $12, a good discount off the $16 cover price. Here’s the link:
If you’re not already following me on Twitter, please head over to @TheKellyLetter at https://twitter.com/TheKellyLetter and follow me so you’ll be ready for the Q&A and whatever else I post there, like my recent interaction with Doug Kass of Seabreeze Partners. Kass wrote on Jan 6: “Perhaps, rather than ridicule outside of the box thinking – variant views should be sought out. And I do tweet this respectfully.” I replied: “Or no views since opinions about the stock market are proven to be wrong about 50% of the time. Reactive rebalancing rules.”
Why not make 2015 the year you finally take control of your investments? It’s not as hard as you might think. The market is less complicated than it’s made out to be in mainstream financial media. It’s a set of fluctuating prices that can be monitored for when they rise above a level indicating a time to sell, or fall below a level indicating a time to buy. That’s all it is, and opinions count for nothing in this construct where numbers and math can do the job. The showmen won’t tell you that, though. They prefer bloviating about where they think the market will go next, and they’re wrong half the time. They won’t tell you that last part, either.
On February 24, my new book, The 3% Signal, will be published. It shows why the usual methods of investing fail most people over time because they’re based on the false premise that it’s possible to time the market through forecasting. Then, it introduces a better way. Not just a better way, but the stock market’s new best practice: the 3% signal, or 3Sig to those already familiar with it. The former best practice was dollar-cost averaging, which is just sending more money to an investment on a regular basis regardless of market activity. The signal system is better because it reacts intelligently to where prices have gone, guiding the investor to add more capital when prices are weak and to harvest profits when prices are strong. This requires no predictive forecasting, only a proper response to prices that have already appeared.
The book presents in exacting detail how to put the plan to work in your investment accounts, including a 401(k) or other retirement account. The days of stress-free pensions are long gone. Everybody has been thrown into the market to sink or swim on their own in various forms of defined-contribution plans, whether they have an interest in investing or not. In this free-for-all, 3Sig is the ally everybody needs. It’s easy even for people who would rather not invest but are forced to do so in order to retire one day or send a child to college, but sophisticated and effective enough for even seasoned market participants to appreciate its results. Market veterans are the first to nod when reading the plan’s particulars, because they’ve learned the hard way that popular techniques don’t work and can see that 3Sig’s systematic nudging of performance beyond the market’s is all the edge anybody needs.
For a sneak preview of the plan’s basics, see “Value Averaging for Steady Growth” on page 119 of the 2013 edition of The Neatest Little Guide to Stock Market Investing. The section has been in my book for several editions now, but not with enough detail behind the superb 3Sig method to give readers the confidence to begin. You and others need to be convinced before abandoning mainstream financial media banter in favor of a methodical formula that needs prices fed to it only four times per year, not conjecture by zero-validity pundits sporting 50 percent mistake rates. On February 24, my new book devoted solely to this technique will do the convincing and give you the confidence to make the switch.
You read that part about feeding the plan prices just four times per year right. If you join the rest of us running 3Sig, you’ll beat the market and almost all pros (because the vast majority of them loses to the market, despite their projected confidence on TV, etc.) while checking in on your investments just four times per year. A 15-minute calculation at the beginning of each quarter is all it takes. I know, you think this is too good to be true, but read the book and you’ll see the history behind the method, its track record, and how easy it is to implement. You’ll wonder why it’s remained secret for so long — until you grasp that Wall Street is worried sick that it will catch on, thereby reducing trading profits and expensive research fees. Big firms don’t want clients to know that fees paid to them are money wasted. The 3Sig plan uses super-cheap index funds and low-frequency trading to keep costs minimal, and it still beats the blatherers. Watch for Wall Street’s coordinated attack on the book when it hits shelves in February, and watch famous pundits decline my challenge to compete head-to-head with the plan.
Enough background. You’re probably looking to get your retirement account and other stock accounts on a firmer footing this year, so let me offer a little brass tacks advice to help you get onto 3Sig and leave the noisy, ineffective frenzy of Wall Street in the dust.
First, start backing out of your current portfolio holdings. All of the stock ideas-of-the-day you’ve picked up over the years, all of the one-time all-star mutual funds that fizzled out, all of the detritus that accumulates in the portfolios of people who tune into mainstream financial media needs to go. If this happens in a retirement account, you can sell it all and sit in cash until the end of February without any tax consequences. In a regular brokerage account, you’ll need to report capital gains and losses in your 2015 tax return next year. Even so, you need to back out of all this investment garbage in order to make a clean break from mainstream folly and a fresh start with 3Sig, which will minimize future tax consequences while boosting overall profits. You may want to double-check the impact of selling capital gains in your regular brokerage account before proceeding, but will probably find that it’s going to be worth it over the long-term of 3Sig success in your future.
Put the cash in the cheapest medium-term or general market bond index fund in your account for a couple of months. No kidding, ignore all the new-year stock and fund ideas in the press and just put the cash in bonds. Go skiing or something to bide your time. There is no rush to jump on any pundit’s hot tip du jour. You’re done with that discredited approach. Such random ideas come in a never-ending stream and half of them crash and burn anyway, so just reject the whole sham out of hand while you wait to begin 3Sig. Keep your regular contributions going to the bond fund in the account, but don’t take any action.
While you’re waiting, pre-order The 3% Signal so it will be delivered to you exactly on February 24, its publication date. Read it right away and you’ll be ready to participate in the live Twitter Q&A session I’ll be hosting on Tuesday, March 3 at 7pm EST. This gives you a week to read the book and prepare a list of questions. I’ll summarize the session afterwards in an article at jasonkelly.com as well.
Finally, take what you learned in the book and the Q&A session to get going. It’s easy to do, requiring only the cheapest small-cap index fund and bond fund available in your account, and knowledge of how the system moves capital into and out of the stock market based on price fluctuation: no commentary required, just the unvarnished clarity of prices alone. Let the herd tune into the false promise of “what’s hot now” and other distractions. You’ll just glance at prices once per quarter and run 3Sig to beat all the so-called pros.
I wish you a happy new year! With this plan on your side, life will be different on the investing front, which I believe will also improve other aspects of your life as you leave behind low performance and high stress in favor of high performance and low stress. You’ll be amazed at how much of your mind and time 3Sig frees up, enabling you to focus your talents on the parts of life where intuition and skill make a difference. In the zero-validity environment of the stock market, they don’t. If you doubt this, read the book.
Most investing media perpetuate the image of stock market participation as a fast-paced, frenetic activity requiring breaking news feeds and input from experts. Emphasizing this trader’s mentality makes sense for their business models, which require attracting viewers, listeners, and readers with tabloid bids for their attention. Falling prey to such productions is detrimental to investors, who eventually learn that expert opinions are wrong half the time — a high enough mistake rate to severely hamper performance. Following stock tips from media experts produces more activity and higher costs, but lower performance.
You might think I’m using the phrase “wrong half the time” to indicate a vaguely high level of inaccuracy. No, I mean right around 50 pct, a failure rate confirmed by numerous studies. My favorite among recent efforts is CXO Advisory’s review of 6,582 forecasts by 68 experts in the 2005-2012 time frame, which found a terminal accuracy of 46.9 pct. We’ll give the experts the benefit of the doubt, though, and call it 50 pct. Keep in mind whenever hearing some guru’s idea-of-the-day that he or she is just tossing a coin.
Part of luring investors to a trader’s view of the market involves the constant reminder that nobody is perfectly positioned for what’s going on right now. The media frequently use hindsight to select experts who got recent coin tosses correct, invite them to present their victorious coin tosses as triumphs of skill, then ask their opinions about what to do next. These new ideas offer the same 50 pct odds of being wrong, but preceding them with a review of the by-chance correct previous coin toss lulls the audience into believing they’re paying attention to a skilled participant who got the last call right and will probably get the next one right, too.
What makes for the most compelling media of all? Exacerbating the primary emotions of the market, which are greed and fear. Rising prices produce greed for more profit; falling prices produce fear of more losses. Like sharks on blood, the media smell these emotions and release experts they know will play into the prevailing mood. When prices are dropping, they emphasize how much farther they’re likely to drop. When they’re rising, they focus on how much higher they’re likely go rise. Fear elicits the media message, “Be more afraid!” Greed elicits, “Be greedier!” This happens like clockwork despite the majority of experts being proven losers to the market over time.
In my upcoming book, The 3% Signal, I call these coin tossers “z-vals” in reference to their zero validity. I first encountered the fabulous term zero-validity environment in description of the stock market when reading Thinking, Fast and Slow by Nobel Prize-winning behavioral psychologist Daniel Kahneman, and shorthanded it to z-val. It sums up everything wrong with the most prevalent (but wrong) approach to investing, which is attempting to divine the future direction of prices.
Because movements happen independently of past price movement, there is no way to know where they’ll go next. Financial market forecasting is fantasy, categorically invalidated by academic and industry research, but made to look authoritative with jargon, charts, impressive firm names, and other accoutrements to tempt another unsuspecting investor onto the trapdoor of trading.
It’s easy for a media outlet to display a chart of a stock or index price history with low and high points circled officiously. The implication is that moving entirely in at the lows and out at the highs is what stock market perfection looks like, and what the “smart money” (whoever that is) is doing all the time. In fantasyland, yes, but not in the real world. Because nobody can know in advance where those highs and lows will appear, forecasts are merely poor guesses dressed in rich clothing, and wrong half the time. Looking back at past highs and lows, which are known in hindsight, to urge guessing future ones, which are unknowable, is disingenuous.
Do you want to know what perfection really looks like in the stock market? A system based on reactive rebalancing, not predictive rebalancing.
Every buy and sell order is just an act of rebalancing, or reallocating, capital. Buying a stock or an ETF is just reallocating capital from cash into it. Selling a stock or ETF is just reallocating capital back into cash. In the common, media-encouraged approach to the market, such reallocation happens in advance of predicted movements. A guru will say he or she thinks the market is going up, or the market is going down, and recommend that you allocate accordingly. A way to get around the guesswork is to ignore future price forecasts and focus instead on prices that already happened.
The 3 pct signal system (3Sig) does precisely this on a quarterly schedule, using only a stock index fund and a bond index fund, and it runs circles around the z-vals. It drives them nuts to see a simple quarterly rebalancing plan built on mathematics and cheap index funds put their huffing and puffing to shame, but it does so time and again. The most recent example concluded just last week, and I’ll share it with you here as a picture of what real stock market perfection looks like. Alongside it, we’ll venture a peek at the awful world of z-val coin tossing.
The S&P 500 topped out at 2019 intraday on Sept 19, bottomed at 1821 on Oct 15, and closed last Friday at 2018. It drew a picture-perfect v-shaped pattern on its chart, the least expected development among commentators.
Let’s pull one blathering bunny from a hat filled with z-val rabbits. Dennis Gartman told the WSJ’s MoneyBeat in May that he’d been wrong calling for a correction back then because “the world’s markets have not corrected,” then concluded, “It’s so silly for me to think I can call a correction. The market will correct when it corrects. That’s what I’ve learned in my 40 years in the business.” One would be forgiven for asking how it could take a supposed expert 40 years of being wrong half the time to wake up to the fact, then expecting the awakened pundit to finally stop contributing to the volume of distracting noise. No such luck.
Gartman opened his mouth again on Oct 16, almost exactly the bottom of the recent v-shaped swoon, saying the selloff in stock markets around the world was set to continue as a new bear market took hold “for a long period of time,” and warned investors not to buy stocks. He waved his bear-market flag once more on Oct 21, then furled it the very next day, Oct 22, after the S&P 500 gained 1.9 pct in the prior session during which he’d been cautious. He changed his mind, said he “should have embraced last week’s weakness enthusiastically,” and then chirped “this does still remain a global bull market …”
Once your head stops spinning, peruse the play-by-play: Gartman was wrong about markets earlier in the year, admitted so in May, said he was silly to think he could forecast, but continued forecasting. In September, he failed to warn people out of the market before it began its four-week drop, but showed up at the bottom in October to tell them then they should avoid stocks, thereby causing them to miss the recovery from the bottom, at which point he changed his tune to saying it was a bull market after all and he should have just kept quiet.
Worthy rivals, these z-vals are not. A well-designed system easily trounces them. It’s much harder to beat relentless dollar-cost averaging into an index fund. The 3 pct signal system beats DCA and the z-vals. Following it will improve your performance while reducing market stress in your life.
Here’s how the signal navigated the recent downturn that flummoxed Gartman and many others I could list. At the end of the third quarter, about halfway through the four-week sell-off, it advised buying weakness. After doing so, it produced this fourth quarter’s growth target level, what I call the signal line. It’s a balance that the signal compares to the plan’s stock-fund balance at the end of the quarter to determine whether to buy or sell. Mid-quarter, it provides interim guidance for newcomers by making it obvious when there’s a green-light shortfall for entry. In this case, it was clear for the first few weeks of October that a buying window remained open. All people had to do was compare the stock fund balance to the signal line to see the shortfall.
This is why the signal’s advice to newcomers was to buy the weakness. On Oct 12, the signal indicated a 7.7 pct shortfall, so its advice was to begin the plan at the target allocations. This meant putting 80 pct of capital into the small-cap stock index fund it uses. A week later, the signal indicated only a 2.4 pct shortfall, but still a good time to begin the plan. It was easy to see that the buying window was closing, however. From the Sunday, Oct 19 Kelly Letter: “[With the plan] still about a calendar quarter’s worth of growth below target, the case to get started now is reasonable. Once it pokes into surplus territory, however, I’ll revert to the standard advice for newcomers, which is to wait for a buy signal to begin the plan.”
That happened just last Sunday. The temporary shortfall became a 2.6 pct surplus. People who followed the signal to buy weakness were already ahead. As for the buying window: “Alas, it is now closed, and advice for newcomers in the tiers is to await the next buy signal.”
This clear guidance through the six-week drop-and-pop happened without a single forecast. The signal was not predicting what would happen next. All it did was compare prices already on the books with the quarter’s signal line, determined with basic arithmetic. This automated buying of weakness and selling of strength on a quarterly pace nudges an investor’s performance higher than the market’s without the need to pay attention for even a moment to the coin tossers. As Gartman and other z-vals sputtered and slumped, the signal put money to work. In other quarters, it skims excess profit into a safe bond fund for use later when the z-vals are warning of disaster ahead.
The effectiveness of this approach is remarkable, and I encourage you to use it in your portfolio. It works best in a tax-advantaged account, such as your IRA or 401(k), but can also work in a regular account with less tax impact than you might think. Why? Because the plan sells only profits beyond its quarterly growth target, which puts a limit on the frequency and size of sales. Many quarters, such as this year’s third, produce buy signals, which create minimal tax consequence when selling shares of the bond fund to buy the stock fund. Still, there’s no getting around the fact that your retirement account is the ideal home for the signal system.
The 3% Signal will be released on Feb 24. It fully explains this approach, along with enhancements to the basic idea outlined above. Prior to the book’s release, subscribers to The Kelly Letter can see the plan in action every Sunday morning, with commentary on current markets and a wry look at recent z-val follies.
To recap, stock market perfection looks nothing like what media purport it to be. It’s not a forlorn quest to buy exact bottoms and sell exact tops through forecasting. Rather, it’s the habit of defining clearly what constitutes weakness and strength, then buying the former and selling the latter using the clarity of mathematics alone. People adopting this approach do not need — or want — forecasts of any kind.
After a while, adherents of 3Sig look upon stock market punditry with a kind of detached pity. They understand the people engaging in it are just poor z-vals doomed to a 50 pct mistake rate that relegates them to trailing the market, greatly underperforming the signal, and one day realizing they’ve wasted their life’s energy on a pursuit that was purposeless from the start.
According to a recent Politico poll, the economy is voters’ top concern ahead of the 2014 midterm elections, ranking higher than national security. Yet campaign rhetoric is showcasing leaders unwilling to discuss the true state of the American economy. Incumbents point disingenuously to the falling unemployment rate as a positive, knowing full well it’s falling largely due to decreased labor participation. They probably also know that even if structural improvement were evident, they would deserve no credit. However, it’s not evident.
The Social Security Administration released wage statistics for 2013 last week. Among them, we find that half of all American workers earned less than $28,031 and that 39 pct made less than $20,000. The $20,000 line is a memorable one, as it’s the annual salary of a full-time worker paid $10 per hour with two weeks off. This did not used to be an especially difficult financial hurdle to clear, but well over a third of American workers were unable to do so last year. Plus, 72 pct made less than $50,000. The median household income of $51,939 is the same as it was in 1995. The once-feared lost decade is now the lost two decades.
No wonder both parents need to work full time to keep a family afloat amid rising prices outside the consumer price index. Have you seen the price of ground beef lately? The BLS says it averaged $4.10 per pound last month, up 17 pct on year to its highest level ever. The Food and Beverage index tracked by the BLS has risen from 40 in 1970 to more than 240 now, a 500 pct increase. Despite this, economic reports continue showing no inflation and the Federal Reserve keeps referring to this as a reason it can postpone raising interest rates. The decline in the price of oil has helped families via lower prices at the pump, but the overall cost of living is on the rise for most consumers.
This seeming disconnect between official economic reports and reality was discussed by Mike Bryan, vice president and senior economist in the Atlanta Fed’s research department, in a June 23, 2014 article on the bank’s macroblog, “Torturing CPI Data until They Confess,” from which:
“The Economist retells a conversation with Stephen Roach, who in the 1970s worked for the Federal Reserve under Chairman Arthur Burns. Roach remembers that when oil prices surged around 1973, Burns asked Federal Reserve Board economists to strip those prices out of the CPI ‘to get a less distorted measure. When food prices then rose sharply, they stripped those out too — followed by used cars, children’s toys, jewelry, housing and so on, until around half of the CPI basket was excluded because it was supposedly “distorted”‘ by forces outside the control of the central bank. The story goes on to say that, at least in part because of these actions, the Fed failed to spot the breadth of the inflationary threat of the 1970s.”
Bryan himself recalls a 1991 meeting of the Cleveland Fed’s board of directors, at which he was a scheduled speaker. He was welcomed to the lectern with “Now it’s time to see what Mike is going to throw out of the CPI this month.” He remembers, “It was an uncomfortable moment for me that had a lasting influence.”
So, the population’s income is stuck or shrinking, and the cost of living is rising but tracked in such a way as to hide the increase for most people. What about savings? Have people been able to squirrel much away? Given the above conditions, the answer would almost have to be “no,” and it is.
Wells Fargo surveyed more than 1,000 middle class Americans about their savings plans. About two thirds of respondents said saving for their retirement had proved “harder” than anticipated. One third said they won’t have enough to “survive,” a figure that rises to almost half among Americans in their 50s. A particularly sad finding of the survey is that 22 pct said they would rather suffer an “early death” than retire without enough money to live comfortably. Why don’t politicians pick up on this? It could be turned into a catchy slogan — “Why try? Just die!” — which even doubles as a rally chant.
Not everybody is doing as badly, which partially explains why the economy is the top concern this election. It’s one thing to feel we’re all in this together, quite another to feel the imbalance inherent in a meritocracy is reaching unhealthy proportions. The wealthiest 5 pct of American households owned 63 pct of wealth in 2013, up from 54 pct in 1989. That’s from the September 2014 Federal Reserve Bulletin, reporting on the triennial Survey of Consumer Finances (SCS). More from the SCS:
“Income also shows a strong positive association with education; in particular, incomes for families headed by a person who has a college degree tend to be substantially higher than for those with lower levels of schooling. Incomes of white non-Hispanic families are substantially higher than those of other families. Income is also higher for homeowners than for other families, and income is systematically higher for groups with greater net worth.” Related, the median net worth for white non-Hispanic families rose 2 pct in the 2010-2013 time frame, while falling 17 percent for the “nonwhite or Hispanic” demographic.
An established explanation isn’t agreed upon yet. One view is that the political system is so thoroughly owned by entrenched business interests that everything is skewed toward feathering wealthy nests. Those taking this view point to the bailout of bad banks with tax revenue, without sending a single suit to jail. Another view is that the wealthy actually exert no more influence over policy today than they did at any point in the past, but are naturally shrinking as a percentage of the population as the less wealthy demographic groups grow more quickly, creating the impression that the wealthy are taking more when in fact they’re just ending up with relatively more. Those taking this view point to unqualified home owners triggering the collapse of 2007-08.
The truth undoubtedly lies in the middle. Banks did dangle tantalizingly low-rate, low-down-payment loans to the unsophisticated NINJA crowd (no income, no job, no assets), knowing full well that most wouldn’t navigate the fine print successfully and would eventually default. This was mean-spirited, cynical, and ultimately bad for banking as well as the rest of the economy. A few bad apples looking to pad their closed-loan lists turned into a crop of bad apples following entrenched industry protocol. On the other hand, why is it that in an age of information abundance, so many financially stupid people exist? Understanding a 30-year monthly payment schedule, and where it’s vulnerable to a spike due to variable interest, should not be a rare ability.
We may face the worst possible combination of factors, taking a page from each side of the argument. If we grant that big banking and other parts of the financial business are out to profit off people in whatever way they can, and we grant that the percentage of the population growing the fastest contains the people most vulnerable to falling for scams, we have a real problem. The result would be not just another housing crisis on the way, but a steady widening of the gap between the haves and the have-nots as the economy’s good jobs become suitable only for the best-educated applicants, who are shrinking as a percentage of the population.
While the falling labor participation rate could be indicating just such a trend underway, most economists attribute it to an aging population. This is a legitimate factor, but doesn’t explain the whole story. Another way of looking at involvement is by tracking the economically inactive population, which the OECD defines as “all persons who were neither employed nor unemployed” during the reference period due to attendance at educational institutions, retirement, engagement in family duties, or some other reason for being economically inactive.
Focusing on US males age 25-54, we find that the figure has risen steadily since 1980, from 2.3 million to 7.3 million. The total pool of American males age 25-54 was 41 million in 1980; it’s 61 million now. Thus, the proportion of inactive people has risen from 5.6 pct to 12.0 pct. Why economists at the Fed and elsewhere refuse to acknowledge this when discussing the potential reason that labor force participation is falling, is a mystery. The only reason we’re ever offered is that people are retiring, but there’s more going on.
While government has been largely asleep at the switch, the central bank has been trying to repair the economy through monetary machinations. Low rates and asset purchases were intended to pack banks full of money that they would lend to businesses, home buyers, and consumers, which would then presumably invest in growth, improve the value of homes, and purchase goods in the economy. This has not happened to the extent desired. While some are quick to blame banks for not lending, the banks say they would have lent more if they’d been approached by more qualified applicants. As they’re being told to pay billions in damages for their role in the last round of lending to unqualified borrowers, banks have hesitated to join in again.
It seems government has given up addressing the real problem, which is that the modern work force is not the same one America had in the past. It is not as well-educated, and the poorly educated, less wealthy segment is growing at a faster rate than the educated, wealthy segment. Rather than meeting this challenge head-on by designing dramatic changes in education, immigration, vocational training, social spending, and tax benefits for employers, politicians have accepted that the population isn’t as well-off as it was in the past, and that the middle class is in danger of extinction. The rich are rich, so they’re fine; the poor are helped by tax revenue; but the middle class are seeing their resources drained.
Just in time to bolster the view that government is giving up on improving the financial situation for most Americans, we received the FHFA’s mortgage overhauls last week. Its current director, Mel Watt, has been in place since January. His confirmation sparked long battles due to some conservatives believing Watt would move to immediately broaden access to mortgage lending, thereby lowering the average credit score of successful applicants, which could spark another subprime crisis.
Sterne Agee analyst Jay McCanless wrote in May that Watt’s comments indicated a new approach for Fannie Mae and Freddie Mac, in which they would shift from “a capital preservation, bunker-like mentality to an amenable and active buyer of mortgages at and potentially below the credit score averages of the last two years.” Robert Sichel, professor of business law at Kennesaw State University in Georgia, said in January that he expected Watt to change policy “from the goal of stabilizing the mortgage market from the lender’s perspective to a focus on addressing the difficulties existing on the borrower’s side of the market. The emphasis will shift from protecting the lenders to protecting borrowers.”
Last week’s announcement confirmed these predictions. The FHFA is, indeed, swinging the pendulum away from the strict lending rules that followed the Wild West lack of rules that preceded the crisis. The question is whether the pendulum missed the middle territory and already swung all the way back to the Wild West. Reducing the down payment requirement from 20 pct to 3 pct would seem to indicate “yes.”
This bears watching.
In the meantime, beware the campaign rhetoric. Republicans are wrong when they say America’s economic troubles began with the inauguration of President Obama. Democrats are wrong when they say policies under Obama have greatly helped the economy. No, the president has been all but irrelevant to the economy, which is possibly the most discouraging comment of all. The trends underway are independent of whomever wins the popularity contest. The job of a politician is to get elected, then stay elected, with policy solutions remaining strictly optional. The real show is run by unelected parties, hence little changes from one administration to the next.
Nonetheless, I wish more candidates would talk openly about the demographic crisis taking place in plain sight, and propose programs that would help people receive the education that interests them and is appropriate for their aptitude, and apply tax incentives to encourage employers to hire such qualified workers. Perhaps then people would be able to meet what was once considered the bare minimum down payment of 20 pct on a new home, and understand the rest of the payments involved after signing. Getting the population better educated and more economically active would produce stronger families, higher incomes, lower crime rates, and the ability of more citizens to pursue happiness, as the Founding Fathers intended.
Then again, why bother? Just give them mortgages.