Don’t diss debt (just yet)

Debt has got a really bad reputation right now. It’s being blamed for tearing Europe apart, crippling the American economy, cheapening the US dollar and eroding its standing as the global reserve currency. And that’s just for starters.

But don’t be too quick to join the chorus of voices lashing out at leverage and damning debt to hell and back. Debt is not necessarily an instrument of the devil.

…just because some people overdid it doesn’t mean that all borrowing is bad. Have you ever heard the phrase “His ship came in”? It refers to someone who gets a windfall or cashes in on an investment. This adage dates to the fifteenth century, when an investor would finance a trading voyage to India or beyond. Some investors risked their own money, but others borrowed heavily, hoping the ship would return stuffed with spices, silks, and precious stones that would fetch a huge profit. Many of these ships disappeared on the high seas without a trace, but if the ship did eventually come in to its home port, the investor would rejoice, sell the cargo—and pay off his debt.

Indeed, borrowing money is one of the oldest engines of economic growth. If business owners hadn’t been able to borrow, the great trading fleets of Britain, China, Portugal, Arabia, and Spain, to name but a few, would never have been launched, the engineers of the industrial revolution would never have been financed, and the medicines and surgical technology that save so many lives today would never have been created.

Most of us learn how to go into debt before we can even walk. If you doubt this, take a close look at children playing in a schoolyard. The kids having the most fun are doing what every good parent encourages her child to do more than anything else: share. When children share with each other, they make friends, socialize, and mature as human beings. The child that refuses to share risks ending up friendless, isolated, antisocial, and emotionally stunted.

No parent would argue that sharing is a bad thing. And yet sharing is nothing more than borrowing and lending. Fiona learns quickly that she can’t simply take Jimmy’s toy truck if she likes the look of it. Jimmy has to agree to hand it over, and Fiona has to agree to give it back.

Children learn very quickly what an obligation is: Jimmy agrees to share his truck with the understanding that Angela is obliged to return it. Angela is also aware of her obligation. It’s a contract, the breach of which is likely to end in tears—and often does.

Excerpt from Man vs Markets Economics Explained, Plain and Simple, by Paddy Hirsch.

Available at Amazon, or wherever books are sold.


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What’s a bank run?

Now that the Cypriot government has voted down the dastardly plan to secure the country’s membership of the Eurozone by taxing the savings of its citizens, the worry is that Cyprus will leave the Euro, and cause the whole system to collapse.

The phrase on everyone’s lips now is “bank run.” Will Europe’s banks experience a bank run? and what effect could that have? No-one knows the answer to either of those questions, but if you wanted to know what a bank run actually is, here’s a definition:

When a handful of people go to the bank and ask for their money, the bank can usually handle it, thanks to the money they’re required to hold in reserve. When everyone wants their money back, however, it’s a problem. When a large number of depositors do this at once, it’s called a bank run (or a run on the bank). Why a bank run? Probably because in the old days (that’s before everyone had a telephone), if you heard a bank was making bad investments, the only way to get your money out was to run down there and try to get to the front of the line that was inevitably forming. And a few people hastening through the financial district could soon turn into a full-blown stampede.

Today you can demand your money back with a click of a mouse, so you don’t need to form a line outside the bank. But many people still do, assuming that the bank will have hard cash in its vault. But whether people are lining up in person or demanding withdrawals online, it can cause big problems for the bank involved. Most banks only have a small proportion of their total deposits on reserve. To get more cash, they need to sell, or liquidate, investments. That can take time, and the bank may end up taking a loss.

Bank runs have happened so many times in the US that Hollywood has made movies about them, from It’s a Wonderful Life in 1946, to Too Big to Fail in 2011. So many banks have failed, in fact, that the government has created an insurance plan to deal with the problem. In 1933, following the great stock market crash of 1929, the government formed the Federal Deposit Insurance Corporation (FDIC). The FDIC insures accounts, up to a certain amount, held in banks that have signed up for the plan. It’s what banks call a backstop, and it’s there to bolster your trust in the bank’s guarantee that your money is safe. Which is why most financial advisors recommend banking in places that are part of the FDIC program.

The government created the FDIC, but in the event the program has to make a payout to customers, the cash comes solely from the dues paid in by the banks in the plan. The FDIC insures our money, not the banks’, but the fact that the government saw a need to protect banks from any crisis in consumer confidence shows how important it thinks the banking system is.

Excerpt from Man vs Markets Economics Explained, Plain and Simple. Available at Amazon, or wherever books are sold.


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The Cyprus “Special Assessment”

If you’ve every owned a condominium, an apartment in a co-op building, or a home in a homeowners association, you’ll be aware of the term “special assessment.” Such an innocuous phrase, but one that strikes fear into the heart of owners across the nation.

As a good member of the community, you pay your HOA/condo/co-op fees every month, along with your property tax and your mortgage. You’d think that should be enough, right? But one day you get a note in the mail from the Board. Usually this crowd of  underworked, overfed frustrated megalomaniacs sticks to penning irritating rules banning consumption of food in the common areas.  But this time, it’s a big deal. It turns out there’s a huge problem with the HVAC system, and if it’s not fixed immediately, we’ll have no heat or A/C and our property values will drop 50% overnight.

Normally, we’d cover the cost with money from the reserve fund. Except the fund’s empty. We had a couple of million in there last year, but it’s gone. No, we’re looking into it. Yes there’ll be an election next year, but we need to sort the HVAC problem out now!

Special Assessment! Every member of the Association has to pay $100,000 to fix the HVAC.

That’s what’s going on in Cyprus. All those solid Cypriot citizens, who’ve socked away their money over the years and trusted in their government, have effectively gotten a letter from the Board telling them the roof of their economy is falling in and they’re going to have to pay a special assessment for the repairs. Depositors with more than 100,000 Euros in their accounts have to give 9.9% of it to the government. That may mean taxing a bunch of rich Russians who’ve been using Cyprus as a place to sock away cash…but depositors with less than EUR100,000 also have to pay some money – 6.7% of their holdings. That’s regular Cypriots, many of whom will be depending on that money for their retirement.

If you live in a housing association, co-op or condo, you know that a special assessment is a possibility, but you cross your fingers, pay your fees and hope that the board and the management company stay on top of things so that an assessment never becomes necessary. If you’re the citizen of a country, you pay your taxes and you trust your government. You don’t think that the equivalent of a special assessment might be a possibility; that you might get a letter in the mail from the government ordering you to hand over a chunk of your savings to help bail out the nation.

Turns out, it’s not just a possibility; it’s a reality.


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WaPo makes Brill’s Bitter Pill explainer easier to swallow

I’ve read Steven Brill’s excellent report on costs in the US healthcare system twice now. The first read through nearly gave me a heart attack. The second wasn’t quite so stunning, but it left me feeling pretty queasy.

At 26,000 words, it’s not exactly a succinct explainer. In fact it’s so big that it rather undercuts itself: many people are so infuriated by the time they get half way through that they stop reading altogether. So distilling Brill’s reporting on why services cost so much and why healthcare CEOs are paid so much is a tough task.

Over at the Washington Post, Sarah Kliff has an interesting one-line take. She says the reason we pay so much is quite simply because the government doesn’t set rates in this country. In other words, we allow medical companies to charge as much as they like. So they do.

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Everything you need to know about Germany’s gold.

Back in the days of the Soviets and worries about a Red Army invasion west of the Iron Curtain, Germany made a decision to hide the family jewels outside German borders. Well, the family gold, anyhow.

Germany has the second largest reserve of gold in the world — after the U.S. — but for years it has stored most of it in vaults in New York, France and London, rather than at home.

But the Soviet Union doesn’t exist anymore. Why’s the gold still there?

Germany’s version of the Federal Reserve, the Bundesbank, says it wanted to keep gold in overseas money centers so that if it needs to buy foreign currency, it has immediate access to collateral. 

Where did the gold come from?

Quite simply, from German taxes. Germany didn’t have any gold in reserve until 1951. The Bundesbank says it first bought gold in October of that year, paying 2.5 million deutschmarks for 529 kilograms.

How much gold are we talking about here?

Germany has gold reserves worth 3,396 metric tons, worth about $200 billion. It is stored in the form of 27,000 gold bars — 45 percent of which are held in the Federal Reserve Bank of New York; 13 percent of which are in the Bank of England in London, and 11 percent of which are in the Banque de France, in Paris. The remaining 31 percent of the gold is kept in Frankfurt. Once the Bundesbank repatriates 300 tons of its gold from New York and all of the 374 tons of gold that it keeps in Paris, exactly 50 percent of Germany’s gold reserve will be stored in Frankfurt. Thirty-seven percent of the reserve will remain in New York.

So what’s Germany doing with the gold now?

With fears of the Soviet menace now a distant and unpleasant memory, Germany has decided it wants its gold back — or some of it. The Bundesbank announced this week that it will repatriate some of the gold that it keeps in the U.S., and all of the gold that it keeps in France.

The announcement follows a government audit, which ruled that oversight of the reserves by the Bundesbank wasn’t rigorous enough. The audit said the Bundesbank has never actually verified the holdings in a proper inspection. The decision also comes on the heels of a heated internal debate in Germany about whether its gold is safe in other countries and should be moved home in case of domestic or international strife.

A Bundesbank spokesman acknowledged this in in interview with Forbes, saying the relocation “is in case of a currency crisis.”  

Is this a snub to the U.S.?

The French might take the move as a snub, but the fact is, they hold the same currency as Germany, the euro, so there’s no real upside to holding gold in a Paris bank. As you read earlier, the Bundesbank said it wants to hold gold in New York and London — and will continue to do so — so that it can use it as collateral for dollars and pounds sterling, if needed.

How will they get the gold back to Germany?

They can truck it back from Paris, but the getting 300 tons of gold back from New York is fodder for movie scripts. Forbes says the gold will have to be flown back to Germany, probably in 3- or 5-ton shipments, as that’s the maximum that insurance companies will cover.

Isn’t that risky? Are thieves planning a heist?

Germany has done this before. The Bundesbank shipped about 850 tons of gold from London to Frankfurt between 1998 and 2001. But this is a big chunk of gold to move in a short time. It’ll take between 60 and 100 flights to transport the gold. And this at a time when thieves in Germany are getting quite innovative. Robbers in Berlin recently dug into a Berlin safe deposit vault via a 100-foot tunnel, and got away clean.

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So what is the debt ceiling …

The debt ceiling – or the debt limit, as the Treasury calls it – is, quite simply, the amount of money that the government is allowed to borrow.

Every year, the Congress decides how much it’s going to spend – that’s the budget. And depending on what it puts in the budget, the government gets a load of bills in the mail every month. Just like every other American. It has to pay its employees; it has to pay its contractors; it has to pay for the stuff that its buys; and it has to pay the interest on its debt.

The arm of the government that makes those payments is the Treasury. It uses all the money that it gets in taxes to pay the bills. And if it hasn’t got enough money, then it borrows some more to make up the difference.

But the Treasury’s only allowed to borrow up to a certain amount. It’s got a credit limit, called the debt ceiling, which is decided by Congress. If it needs to borrow more, it has to get permission to do so.

That’s right – it’s Congress that decides the amount we can spend, and it’s Congress that decides the amount we can borrow. Right now, those amounts aren’t matching up. And if Congress can’t get them to match, then some of those bills aren’t going to get paid.

And that’s a problem.

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Explainer: how to choose a financial planner

Here’s a question we get asked a lot on Marketplace Money: what’s the best way to choose a financial planner.

There’s no easy answer to this – a lot depends on your net worth and your needs. But the first step is to understand what’s out there in the financial planning world. Recently we invited Louis Barajas on the show. He gave us perhaps the most succinct breakdown of the financial planning world that we’ve heard yet. You can listen to his explanation here, or read on….

There are three kinds of financial advisors.

1.    Commission based

These advisors may not charge you a fee, but instead, they are paid commission on the products that they sell. In other words, they have a conflict of interest – the more commission-based products they sell, the more they get paid, so they have an incentive to sell you products, and the bigger the commission that comes with the product, the more they make. That’s not to say that the products they’re selling are necessarily bad, just that you should be aware of how your advisor gets paid, and who the advisor is really helping when he or she sells you on one of these products.

2.    Fee based

These people both sell you commissionable product AND charge you a fee to manage your money. So there’s less incentive to put you into a commission-based product.

3.    Fee only

These advisors don’t sell products; they don’t get paid commission; they don’t get referral fees for referring you to other agents. In other words, they don’t have any conflicts of interest. They tend to charge by the hour, although some may have different payment structures, depending on how you want them to help you, and what areas you need help with, such as taxes, real estate or legal issues.

Fee only advisors are a bit like the Holy Grail of financial helpers. There aren’t that many of them out there, and they can be tough to find. Start with NAPFA, the National Association of Personal Financial Advisors, but also ask around – a personal referral is always good to get.

OK, you’ve got a name (or names). Now what

1.    Check their credentials

Is your advisor a Certified Financial Planner? They should be. They should be able to show you a certificate, but if they don’t, and you’re too shy to ask, you can check their bona fides by checking on the CFP Board of Standards website. The Find a Certified Financial Planner feature allows you to search by name. You’ll find out first if the advisor is registered as a CFP, and secondly if there have been any compliance issues with them.

But just because her or she is a CFP doesn’t mean they’re qualified to give good advice. So ask your advisor whether he or she is a Registered Investment Advisor. You can check them out with the financial industry’s regulatory body FINRA. Run a brokercheck search at and it’ll allow you to confirm your advisor has the requisite qualification, and whether they’ve had any compliance or other issues you’ll need to worry about.

2.    Get references

A good advisor will not be afraid to provide you with names of other clients. Call them, and grill them. Ask how responsive the advisor is; how punctual; how much of a stickler he or she is when it comes to timekeeping; how good they are at running the basics of their own business (you don’t want to go with an advisor who can’t even run their own business properly).

3.     Determine whether they’re a good fit for you

Your financial advisor is about to get to know you very well indeed. You’re about give him or her some of the most intimate details of your life. Are you cool with that? Take a long look at the person across the table from you. She’s all good on paper; she has a good track record; she looks 100 percent. But how does your gut feel about her? Is she irritating? Overbearing? Is she a little scatter-headed? Or too much of a people-pleaser? Is she too risk-averse, or too willing to take risks? Are you going to be comfortable discussing your money issues and taking advice from this person? Be honest. If your instinct tells you this is not going to be a relationship you’re comfortable with, then look elsewhere. After all, you’re about to embark on a highly intimate partnership with another human being; perhaps one of the most important partnerships you’ll ever have.

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