Текст книги "101 Things Everyone Should Know about Economics: From Securities and Derivatives to Interest Rates and Hedge Funds, the Basics of Economics and What They Mean for You"

Автор книги: Peter Sander

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Why You Should Care

The SEC, while under fire from Congress and the general public, plays a vital role in ensuring the safety and integrity of your investments. It’s helpful to know what the SEC does, and how your key investments and “nest egg” are protected. It is also important to know that the SEC won’t—and shouldn’t—prevent you from losing money in the securities markets, so long as everything that happens is within the law.

45. FEDERAL DEPOSIT INSURANCE CORPORATION (FDIC)

The banking collapse in the Great Depression, during which some 20 percent of all banks failed and their customer deposits were gone forever, led to new protections of deposits. As part of the Glass-Steagall Act of 1933, the Federal Deposit Insurance Corporation was set up within the government to guarantee deposits meeting certain criteria. As a bank depositor, your deposits are most likely covered, and would be paid back in the event of a bank failure, but it’s worth reviewing the rules.

What You Should Know

Today, deposits are covered up to $250,000 per depositor per bank for most types of checking and savings accounts. This amount was raised from $100,000 during the 2008 banking crisis. The “per depositor per bank” rule makes it fairly easy to achieve greater levels of coverage; you can have one account and your spouse can have another at the same bank, and both are covered. Or you can have joint accounts at two separate banks (they must be completely separate—not Wells Fargo and subsidiary Wachovia, for example). If you have several accounts at one bank, the coverage considers the total, not each account separately.

If you have millions, there are ways to extend this coverage further by having an intermediary spread your accounts through the Certificate of Deposit Account Registry Service (CDARS). If you have millions in savings, check out www.cdars.com. If you’re more like the rest of us, with a few accounts, the FDIC ownership and coverage rules can be found at the FDIC’s website: www.fdic.gov/deposit/deposits/insured/ownership.html.

One thing to remember: FDIC does not cover investment accounts. The most common example used for savings is money market funds (not to be confused with so-called money market accounts, a product offered by some banks that is covered.). Some funds, however, might be covered by optional insurance offered by the U.S. Treasury in the wake of the 2008 banking crisis. The FDIC doesn’t cover credit union accounts per se, but the National Credit Union Share Insurance Fund (NCUSIF) offers nearly identical coverage.

Investment accounts are covered by SIPC (Securities Investor Protection Corporation) for up to $500,000, but this coverage is against failure of the broker, not investment losses, and so rarely applies.

Why You Should Care

It is very important, especially in this day and age of financial volatility, to have at least some security for your savings. You should ask questions and take the necessary steps to ensure that your core savings are covered. It’s worth keeping track of changes in the laws too.

46. GOVERNMENT-SPONSORED ENTERPRISES (GSES)

Government-sponsored enterprises have been created by Congress over the years, starting during the Depression-era New Deal, to provide credit to targeted sectors of the economy like farming, housing, and education. The most visible GSEs today are Fannie Mae (once called the Federal National Mortgage Association, now officially called Fannie Mae) and Freddie Mac, once the Federal Home Loan Mortgage Corporation. Other GSEs include the Farm Credit System created in 1916, and Sallie Mae, once the Student Loan Marketing Association, created in 1972. Sallie Mae is no longer a GSE; it became the private SLM Corporation during the period 1997–2004.

What You Should Know

For almost all of us, the two mortgage finance GSEs and the twelve additional Federal Home Loan Banks are most important. These institutions have created what’s known as the secondary mortgage market, buying mortgages from mortgage bankers and other lenders, and repackaging and selling them as mortgage-backed securities into the financial markets. This activity provides greatly expanded liquidity in the mortgage markets and thus makes mortgages much more “available” and affordable for all of us. These institutions also “guarantee” certain loans, making them more attractive to investors, and thus lowering the interest rates and qualification requirements.

Before the 2008 financial crisis, the GSEs were pressured by policymakers to make more loans more affordable for more people to accomplish stated federal government goals to expand U.S. home ownership. This led to deterioration in credit quality requirements (that is, the standards applied to borrowers for income, credit ratings, and general ability to pay). This relaxation in standards expanded the market for so-called subprime mortgages; the GSEs and many institutions they sold to took a big hit when these mortgages started to fail. The GSEs, most of which had existed since the late 1960s as standalone publicly traded stock companies, had to be largely taken over and “bailed out” by the federal government, an act consistent with their original GSE charters, but something of a shock to the financial markets.

GSEs, specifically Fannie Mae and Freddie Mac, are not explicitly guaranteed by the federal government. This issue was tested in late 2008 as these two GSEs were caught with bad loan portfolios, and the question arose as to whether they would “make good” on guarantees and loans they had given or sold to others. The government didn’t do that, but essentially took them over by putting them into a conservatorship, wiping out private investor equity, and they still do function today, but at a diminished level. Their future is still being debated.

Why You Should Care

Fannie Mae and Freddie Mac still ultimately buy, repackage, and sell a healthy portion of home mortgages granted in the United States today.

Additionally, Fannie Mae and Freddie Mac set the limit on the maximum size of a loan they consider “conventional”—that is, eligible for preferred interest rates and guarantees. Until 2008, that limit was $417,000; a mortgage exceeding that amount was said to be “not conforming,” and thus would be a “jumbo” loan having higher interest rates—currently 1 to 1.5 percent higher. In 2008, the GSEs raised the limit to $625,500, depending on geography.

47. TAX POLICY AND INCOME TAXATION

The proper coverage of the subject of taxation obviously would take more than a single entry. The Government Printing Office reported in 2006 that the U.S. Income Tax Code, the body of law administered by the Internal Revenue Service, was 13,548 pages in length. Additional rulings, opinions, and supplemental documents run the total up to about 44,000. And that’s just U.S. income taxes—there are other kinds of taxes like sales (consumption), excise, estate, and many others. It’s a complex subject.

What You Should Know

Taxation is obviously designed to raise revenue for governments and public entities to fund their operations and for redistribution—that is, to move money to needy parts of society in the form of entitlements like Social Security and Medicare and other direct and indirect aid programs (see #50 Entitlements). Considerable debate has occurred over how much of this is appropriate.

Income taxation began in 1861 in the United States to pay for the Civil War—the rate was a flat 3 percent on incomes exceeding $800. It went away after the war but returned briefly in 1894, and more permanently in 1913 as the Sixteenth Amendment. It’s been with us, with much change and increased complexity, ever since. Regarding income taxation and tax policy, a few fundamental principles are important:

Income taxation is progressive. Following the edict “from each according to his ability,” rates go up the higher your taxable income. Just how progressive is a subject of tax policy; as of this writing the current top tax rate is 39.6 percent, but has been as high as 92 percent (1952–53). Of course, how much tax you pay is defined not just by the rate but by how much of your income is taxable.

Tax policy is fiscal policy. The federal government can—and has—used tax policy to stimulate the economy, as was most famously done in the Reagan years with a dramatic lowering of top, or marginal, rates and average tax rates paid. The top income tax rate was lowered from 70 percent to 50 percent in 1982 and again to 33 percent in 1987. It has varied between 33 percent and 39.6 percent ever since. It is felt that a lower top rate does two things: first, it gets wealthier and higher-income people to invest in the economy, thus providing jobs and creating more tax revenue downstream; second, it reduces the amount of effort made to avoid taxes!

The IRS does not create tax law. Congress creates tax law; the IRS merely enforces it. Also, doing the most you can within the law to avoid taxes is considered a good thing; it is neither the intent of Congress nor the IRS that you pay taxes that you don’t owe. Evasion is when you knowingly try to get around taxes that you do owe, and that’s where severe consequences can result.

Why You Should Care

Current tax policy and laws naturally determine how much of your income—all forms of it—you’re entitled to keep. Most view taxes as a necessary evil, and are resigned to pay whatever their accountants say they owe. With a deeper understanding of taxes and how they might affect your current financial situation, you can take charge and plan your taxes so as to minimize them. That is also a good thing, and encouraged by the IRS. Just as you would budget a business or your personal finances, it pays to put some energy into saving money on taxes—taxes of all types, from all jurisdictions. Don’t be afraid to do this.

48. CREDIT PROTECTION

The dangers of unfair credit practices, or “lawlessness” in this area, are obvious—it’s too easy for unknowing or unsuspecting people to be “sold” on the idea of borrowing money to buy something under unreasonable terms. The federal government has passed an assortment of laws over time to make credit practices more consistent, fair, and understandable. In making things fair, they help the economy function more efficiently, as people can trust lenders to a greater degree—and vice versa.

What You Should Know

Federal laws serve mainly to clarify the responsibilities of creditors and debtors in consumer credit relationships, although the most recent 2009 legislation goes a bit farther by providing ground rules for what credit card companies can and can’t do. Here are four of the most important laws governing credit and credit fairness:

TILA—Truth in Lending Act. This act hit the books in 1968, and since that time has had a handful of revisions. TILA is mostly about disclosure, and for all types of consumer lending, requires written disclosure upfront of lending terms, cost of credit (annualized percentage rate, or APR), fees, and so forth. TILA has been amended more recently to require specific disclosures for adjustable-rate mortgages and reverse mortgages. TILA also allows a three-day “rescission” period to cancel any loan, and a three-year “extended right to rescind” if disclosures aren’t made properly.

FCBA—Fair Credit Billing Act. This 1986 law covers the fair disclosure and billing of credit card accounts, and covers such topics as how to dispute a charge and cardholder liability in the event of unauthorized use (setting a maximum liability of $50).

FCRA—Fair Credit Reporting Act. The FCRA of 1970 covers your rights to review, fix, or authorize others to use your credit report and score. Key features include the process to dispute and resolve reporting, the requirement to give you a free credit report once a year, and a score (not necessarily free) when you want it. You also have some control over who can use the score, including the ability to opt out of using your credit rating as a factor in insurance and credit company solicitations.

FDCPA—Fair Debt Collection Practices Act. Finally, this 1977 law covers what collectors can and can’t do, including hours and means of contact, and disclosure of your debt problems. It’s not hard to find out more about these laws by simple online search. The Federal Trade Commission consumer protection site also helps; see: www.consumer.ftc.gov/topics/credit-and-loans.

A few years ago, Congress passed the Credit Card Accountability, Responsibility, and Disclosure (CARD) Act of 2009. This is a broad credit cardholder’s “bill of rights” limiting the ability of credit card companies to raise interest rates without adequate notice or triggers, and dealing with a host of other consumer-unfriendly practices in the credit card industry. As a user of credit and especially if you have a lot of credit cards, you should understand this new law.

Why You Should Care

While most credit problems are corrected by getting spending habits under control and making required payments, mistakes or aggressive creditor practices do happen, and sometimes it makes sense to consider your legal options. Like any game, it helps to know the rules and how to cry “foul.” You should learn what questions to ask and how to communicate with creditors, but don’t expect the law to mitigate the effects of bad habits.

49. BANKRUPTCY LAW

Everybody makes mistakes. In the old days, if you ran out of money or your debts exceeded your assets, you would be sent to debtors’ prison—or worse. What would happen if debtors’ prison existed today? Very simply, people wouldn’t take risks, and they wouldn’t spend money. If people didn’t take risks, we wouldn’t have the conveniences and technologies we have today. And people wouldn’t spend money at all for fear of that cold, dark debtors’ prison.

The bankruptcy process and set of laws around it are designed to clean up people’s financial mistakes in a fair and equitable way. While bankruptcy certainly isn’t good for the individual or company going through it, it stops short of being a draconian, desperate measure. So yes, bankruptcy is a bad thing, especially for the individuals and companies involved. But the way the process is set up actually helps the economy.

What You Should Know

Bankruptcy happens when an individual or corporation declares its inability to pay its creditors (voluntary bankruptcy), or when a creditor files a petition on behalf of a debtor to start the process (involuntary bankruptcy). The U.S. Constitution puts bankruptcy under federal jurisdiction, and a uniform Bankruptcy Code sets the rules, with some state amendments. Bankruptcy proceedings occur in federal court.

The most often used and discussed chapters in the Bankruptcy Code are Chapters 7, 11, and 13:

Chapter 7: used by both individuals and corporations; leads to a simple and total liquidation of assets to pay creditors.

Chapter 11: mostly occurs in the corporate sector, and leads to a reorganization and recapitalization of the company, usually with creditors receiving some portion of their debts in a predetermined order of priority.

Chapter 13: for individuals; does not liquidate all assets but rather creates a payment plan to discharge the bankruptcy individually.

Bankruptcy usually allows certain property, such as personal effects and clothing, to be exempt from liquidation; these rules can vary by state. Chapter 7 rules allow only one bankruptcy filing in eight years, and during that eight-year period your credit rating and your ability to borrow will be severely impaired. Specific rules cover spousal property. In Chapter 13, the debtor doesn’t forfeit assets, but must give up a portion of future income over the next three to five years. In Chapter 11, the business continues to run while creditors and debtors work out a deal in bankruptcy court. Eventually a plan is presented to the debtors, who must approve it.

Legislation in 2005, known as the Bankruptcy Abuse Prevention and Consumer Protection Act, made it harder for debtors with means to simply file and walk away; they must discharge their debts if they can. There was a large “bubble” of bankruptcy filings before this law went into effect. Even with this law, bankruptcy filings have been on the rise over the years, as consumer debt and the likelihood of catastrophic medical bills has increased. Many Chapter 13 filings allow a complete discharge of medical debt alongside the payment plan for ordinary debts. The economic crisis, not surprisingly, triggered a rise in business and personal bankruptcies. According to federal statistics, nonbusiness bankruptcy cases rose from about a million in 2008 to over 1.5 million in 2010; they are projected to drop to a level near 1 million for 2013.

Why You Should Care

Even with the protection that bankruptcy affords, you don’t want to go there if you don’t have to. That said, it’s good to know that there’s a fair and reasonably unthreatening way to settle insolvency should it ever become your unfortunate circumstance. So if you’re planning to build and market that breakthrough electric car, go for it—you won’t go to jail if you fail. And while prudence in personal finance and consumer debt is always the best path, if you lose a job or have a major medical catastrophe, bankruptcy does give you a way to deal with it.

50. ENTITLEMENTS: SOCIAL SECURITY AND MEDICARE

Entitlements, or “social insurance” programs, are designed to stabilize the economy in several ways. First, they allow people to retire with some degree of financial security, else they would have to keep working well into advancing age. That would, of course, not be good for them or their employers, and it would fill jobs that would otherwise be available for younger employees. Second, these programs take the burden of caring for elder family members off younger family members.

What You Should Know

Social Security is a child of the Great Depression, an era where some 50 percent of citizens over sixty-five reportedly lived below the poverty line. The program stands largely as originally conceived and passed in 1935. The most important component is the Old-Age, Survivors and Disability Insurance program, or OASDI. Benefits are paid for retirement, disability, survivorship, and death. Retirement and survivorship are the most substantial parts of the program; disability benefits are difficult to qualify for, and the death benefit is minimal.

When a citizen reaches a certain age, a retirement benefit is calculated based on work and earnings history. The “full retirement” age was once sixty-five, but now has been extended depending on birth date. A reduced benefit can be taken starting at age sixty-two; if the retiree chooses to defer benefits to age seventy, those benefits increase. Both adjustments are done by spreading a projected benefit over a different number of years; that is, the total projected benefit is the same, just divided differently. In rough numbers, the payout increases 8 percent for each year you delay retirement. The Social Security Administration has an informative website covering benefits and other topics; see www.ssa.gov.

Social Security is funded by the so-called FICA tax (which stands for Federal Insurance Contributions Act) taken from every paycheck or collected as “self-employment tax” from self-employed individuals. The FICA tax, which combines Social Security and Medicare, is 15.3 percent of gross income; in the case of employees, employers pay half. Of that amount, 12.4 percent is for Social Security; the remaining 2.9 percent is for Medicare. Social Security funds are collected on the first $113,700 of gross income, while Medicare collections have no limits. In addition, Congress passed an additional Medicare tax of 0.9 percent for individual earnings over $200,000, which now also includes “unearned” income (from investments, etc.).

The Social Security funds collected go into the Social Security trust funds. Those funds are used to pay current beneficiaries and to buy U.S. Treasury debt obligations—that is, to fund current deficits. Currently receipts exceed payouts, but many economists are concerned that the trust funds are a giant Ponzi scheme—that future receipts will go to support current recipients, leaving insufficient money for future retirees who are currently paying in. Social Security is the world’s largest government program, and continues to represent about 20 percent of overall U.S. government expenditures.

Medicare, the “single-payer” health insurance and care program for those over sixty-five, came into existence in 1965. Medicare benefits are divided into four groups. Summarizing the four parts:

Part A provides basic hospitalization, and is free for seniors otherwise eligible for Social Security—those who have paid into the trust funds for forty quarters (ten years).

Part B provides outpatient benefits such as doctor’s office visits and other care, and costs $104.90 per month in 2013 for individuals earning $85,000 or less, $170,000 filing jointly (rising to $325.70 monthly for individuals with over $214,000 in income, $428,000 filing jointly), a premium typically deducted from the Social Security Benefit.

Part C, or “Medicare Advantage,” was created in 1997 to help those who had private coverage through an employer health benefit plan or who chose to purchase such coverage; the benefits are modified to dovetail with such a plan, and often include items otherwise not included, like prescription drug coverage.

Part D is a prescription drug benefit started in 2006 and costs $31.17 per month, again rising for higher earners.

Beyond Medicare, Medicaid provides additional benefits and pays some of the deductibles for seniors in serious financial need. Unlike Medicare, Medicaid programs can also cover qualifying needy families, and are administered at the state level; each state has different rules, although most of the funding is from the federal government. Typically, eligible seniors must have no more than a few thousand dollars in assets in addition to a home or car to qualify.

Why You Should Care

Beyond plugging what could be a huge—and growing—gap in the economy, these entitlement programs are important for your future financial planning. It’s a good idea to develop a basic understanding of Social Security benefits (the annual statements they send you are helpful) and of Medicare before you reach your golden years.

51. RETIREMENT PLANS

Someday you’re going to retire. And when that day comes, you should be eligible for Social Security, assuming you’re at least sixty-two when you decide to leave that cubicle or workshop for good. But most financial experts expect that Social Security will only cover 20 to 50 percent of your income needs, especially if you are still paying for or renting a home.

That’s where retirement savings plans come in.

What You Should Know

First, it’s important to distinguish retirement plans from retirement planning. Retirement plans are special savings plans set up in the eyes of the law to provide tax incentives both for you and your employer to induce greater savings. They are also set up to be legally at “arm’s length” from your employer, so that your savings cannot be tapped or otherwise manipulated should your employer get into trouble. That’s important in these days of economic crisis and rapidly changing corporate (and public sector) fortunes.

Retirement planning is the active pursuit and calculation of your retirement needs, and how those needs will be funded in retirement—which you can do yourself if you have the skills, or with the help of a professional adviser.

There are three types of retirement savings plans. The first two are offered and administered through employers:

Defined benefit plans, as the name implies, specify the benefit. For example, you and your surviving spouse will receive $2,000 a month for as long as you live, come heck or high water. Your employer funds the plan, and its investments usually are managed by a third party; how they come up with enough to pay you is their problem. Traditional pension plans, as offered by most government agencies and legacy corporations, are defined benefit plans. These plans are going out of style because companies don’t want the burden of extra funding for the plans in bad times. The Pension Benefit Guaranty Corporation, a government corporation set up to guarantee pension benefits, estimates there were 22,697 such plans in effect in early 2013, down from 80,000 such plans in the United States in 2005, and down from 250,000 in 1980. If you have a defined benefit plan, consider yourself fortunate.

Defined contribution plans, on the other hand, define the employee (and employer) contribution—what goes in—not the benefit that comes out. The widely used 401(k) plan is most common, allowing an employee to set aside up to $17,500 in funds each year, with an additional catch-up amount of $5,500 for employees over 50 years of age; some company plans offer matching funds. Public entities use 403(b) plans as an equivalent, and there are many other flavors. You must understand that the benefits you realize from these plans are both a function of how much you set aside and how well your investments perform; there are no guarantees. This lack of guarantee is of considerable concern to economists and savvy individuals alike; there is no assurance that retirees in the future will have sufficient funds to retire on, regardless of how much they set aside. Hit by the triple whammy of reduced earnings, lower stock prices, and increased emergency withdrawals, the Great Recession created a large drop in 401(k) balances to an average of $30,200 across 17,000 corporate 401(k) plans, according to plan administrator Fidelity Investments. More positively, that number recovered to an average of $75,900 by 2012, with sizable increases in employer and employee contributions along the way.

The third type, as the name implies, are individually set up and administered—individual retirement plans, or “arrangements” (IRAs). These plans behave like defined contribution plans, except there is no connection to an employer. You set them up and fund them yourself. They have different tax advantages—traditional IRAs allow you to deduct contributions if you qualify, and pay taxes upon withdrawal; Roth IRAs don’t allow the deduction, but withdrawals (including investment gains) are tax-free. Many people use these individual arrangements to supplement employer-sponsored plans, subject to specific rules. As with other defined contribution plans, there are no guarantees, except in the case of the failure of the broker or institution with which you have the account. With some exceptions, individuals can contribute $5,500 per year, $6,500 if over fifty. These accounts are widely used but not that deeply funded—in the wake of the financial crisis it was estimated that 75 percent of individuals nearing retirement age had less than $30,000 in their retirement accounts.

Why You Should Care

It pays to know what kind of retirement savings plans you have or are available to you, and to make the best use of them. While there is no single source or website that covers the entire gamut of resources, some consumer-friendly brokerages, like Fidelity (www.fidelity.com), get pretty close. Providing for retirement involves two steps: retirement planning to arrive at your needs, and retirement savings plans to get you there. For most, this two-step process is best done with a professional who has the tools and knowledge of the laws and plans, as well as your finances, to help you make the right decisions.

52. UNEMPLOYMENT BENEFITS

When unemployment rates double to over 10 percent in one year as they did during the Great Recession, obviously there’s a big impact on the economy. Not only does the absence of income hurt the one in ten who aren’t working, but it also hurts the economy at large, which of course leads to more unemployment. Thus, unemployment insurance, or “Jobseeker’s Allowance,” as it’s called in the United Kingdom, helps to stabilize the economy and reduce the effects of boom and bust cycles.

As part of the 1935 Social Security Act in the wake of the Great Depression, unemployment insurance and benefits were established to help people through such times of general strife—or individual strife inherent in the transition of an individual company or industry. Although no longer part of Social Security, these benefits continue today and have been bolstered to a degree to mitigate the effects of the Great Recession.

What You Should Know

Today’s unemployment insurance programs are actually a joint venture of the federal government and the states. They are funded through employer-paid payroll taxes paid to the states and to the federal government; the federal funds are then reallocated back to the states. The federal unemployment tax is collected under the Federal Unemployment Tax Act (FUTA) from most employers, exceptions being made for small companies with few employees. The base FUTA tax is 6.0 percent of the first $7,000 in wages. You won’t see this tax on your paycheck; it is paid by the employer. State taxes vary by state, and may offset some federal taxes. FUTA funds are then given back to the states to administer unemployment and jobs programs, and to fund state-paid benefits.

Benefits are paid as a percentage of wages up to a maximum, and are typically available for twenty-six weeks upon filing a valid claim. Legislation may be invoked during bad times to extend benefits, as was the case in late 2008, and benefit periods have been extended since. Eligibility varies by state. To find the rules in your state, one resource is the “CareerOneStop” locator, maintained in conjunction with the U.S. Department of Labor, at www.servicelocator.org/OWSLinks.asp.

Why You Should Care

Most people get through their working lives without having to file for unemployment benefits, but obviously they can help a great deal in times of stress. Particularly if you feel your job is in jeopardy, it’s worth knowing about the rules before something bad happens—that way, you can plan, for instance, on how you will get by on two-thirds of your salary for six months. Also, the more you know and the sooner you know it, the faster the application process can be. If you feel unemployment is imminent, it’s worth checking the rules and resources with your human resources department and with your state unemployment office.