Troubled Times
How We Got Here, What May Lie Ahead
and What We Can Do About It
Ned C. Hill
National Advisory Council Professor of Finance
Fellow, Wheatley Institution
Marriott School of Management
Brigham Young University
March 2009
Outline
Prophetic warnings
Seeds of the economic crisis
14 suggestions on how we might deal with
the crisis
– Managing debt
– Building reserves for the future
– Protecting your family
– Building on what you have learned
President Gordon B. Hinckley
Priesthood Meeting, October 3rd, 1998
Story of Pharaoh’s dream of the seven fat cattle and the
seven lean cattle
“…I want to make it very clear
that I am not prophesying, that
I am not predicting years of famine
in the future. But I am suggesting
that the time has come to get our
houses in order. There is a portent
of stormy weather ahead to which
we had better give heed.”
“So many of our people are living
on the very edge of their incomes.
In fact, some are living on borrowings.”
President Gordon B. Hinckley (cont.)
“I urge you, brethren, to look to the condition of
your finances.”
“I urge you to be modest in your expenditures;
discipline yourselves in your purchases to
avoid debt to the extent possible.”
“Pay off debt as quickly as you can, and free
yourselves from bondage.”
“That’s all I have to say about it, but I wish to
say it with all the emphasis of which I am
capable.”
President Gordon B. Hinckley
General Conference, October 7th, 2001
“The economy is particularly vulnerable. We
have been counseled again and again
concerning self-reliance, concerning debt,
concerning thrift. So many of our people are
heavily in debt for things that are not entirely
necessary.”
“I urge you as members of this Church to get
free of debt where possible and to have a
little laid aside against a rainy day.”
Elder Joseph B. Wirthlin
April 2004
“Remember this: debt is a form of
bondage. It is a financial termite.
When we make purchases on
credit, they give us only an illusion
of prosperity. We think we own
things, but the reality is, our things
own us.”
“Some debt—such as for a modest home, expenses
for education, perhaps for a needed first car—may be
necessary. But never should we enter into financial
bondage through consumer debt without carefully
weighing the costs.”
Elder L. Tom Perry
November 2008
“We have been encouraged at almost every general
conference of the Church I can remember not to live
beyond our means. Our income should determine the kind
of housing we can afford, not the neighbor’s big home
across the street.
“President Heber J. Grant once said: ‘From my earliest
recollections, from the days of Brigham Young until now, I
have listened to men standing in the pulpit … urging the
people not to run into debt; and
I believe that the great majority of
all our troubles today is caused
through the failure to carry
out that counsel.’” (in Conference
Report, Oct. 1921, 3).
The Global Fixed-Rate Investment Market
Who Are These Investors?
Insurance companies, individuals,
pension funds, mutual funds,
governments, investment funds,
banks, municipalities, etc., etc.
2009
2000
$36 Trillion
$70 Trillion
Enter—New-fangled Mortgages
Mortgages from Start to Finish
Tranche 1
CDS (AIG)
Tranche 2
Tranche 3
Tranche 4
$70 Trillion
Fixed-Income Market
Factors Contributing to the Economic Crisis
Huge Global Demand for Fixed-rate Debt
The Federal
Reserve and
other Regulators
The
Housing
Market
(Easier
Qualifications)
Creation of
New
“Packaged”
Mortgage
Securities
Rating Agencies
Accounting Rules
Then the Inevitable:
The Housing Bubble Burst
August 2007, housing prices began to slip in key
markets like Phoenix, Las Vegas, California,
Florida, etc.
We had built 1M to 2M excess homes!
The actual risk of mortgages began to emerge.
No one wanted to buy mortgage-related “toxic
securities.” Very difficult to value.
Precipitous drop in the prices of these
securities—used to be “AAA” but now almost
worthless.
Accounting rules—write them down
We Can’t Have Huge Losses
What to Do?
Close or sell the institution
– Bear Stearns (1923) sold 3/2008 to JPMorganChase for $10/sh
(previous year was $133/sh)
– Countrywide Financial was bought by Bank of America (7/2008)
– IndyMac (Independent National Mortgage Corp.) seized (7/2008)
– Lehman Brothers (1850) sold to Barclays (9/2008) and Nomura
Holdings (10/2008)
– Washington Mutual seized by FDIC, assets sold to
JPMorganChase
Find a stronger institution to merge with
– Merrill Lynch merging with Bank of America (9/2008)
– Wachovia merging with Wells Fargo (10/2008)
Infuse more capital
– Government took over Freddie Mac and Fannie Mae
– Government is pumping $150B into AIG
Result—A Credit Freeze
No bank wanted to loan money—even overnight—to
another bank or anyone else. They’re afraid the
borrower might be “next on the chopping block.”
The economy runs on credit—even healthy companies
borrow frequently to meet short-term swings in cash
flows.
Consumer credit—dropped through the floor
We ran the risk of seeing the entire economy shut down.
We are connected to the rest of the global economy, too
– Iceland’s major banks fail—British savers lose $8B
– Some European banks failing
– Etc., etc.
Government Bailout Efforts—A
1. Federal Reserve Bank infused massive
amounts of cash into the banking system
and is assisting in mergers, sales and
rescues of troubled institutions
2. Congress passed “Troubled Asset Relief
Program” (TARP)—government
authorized Treasury to use $350B (done)
and $350B more (if authorized by
Congress) to buy equity in troubled
banks
Government Bailout Efforts—B
Recent stimulus package of $787B infuses
money into states, federal agencies,
consumers (through lower taxes), etc.
Plans to aid homeowners in danger of
foreclosure
What Are Possible Outcomes?
Worst case—prolonged depression similar to
the 1930’s (25% unemployment, no growth for
3-5 years, great personal hardship)
Best case—short recession (unemployment 68%, no/slow growth for 12-18 months)
Most likely case—serious recession
(unemployment 7-10%, no/slow growth for 18
months to 2 years)
Other Outgrowths of the Crisis
More regulation of securities industry
Restrictions on the mortgage/housing industry
Government may make a good return on much
of the bailout investments: buying toxic assets,
buying stock in troubled institutions, etc.
Eventually we will see higher taxes to pay for
bailout.
Inflation may be a problem in the recovery.
Some businesses (even whole industries) will
fail, stronger ones will eventually emerge.
How Individuals and
Families Might Deal
with the Crisis
14 Suggestions
Net Worth
Helps You Think About Debt
Net worth = Assets - Liabilities
Assets
– Market value (not purchase price)
– Real and financial
Liabilities
– Credit card and other consumer debt
– Mortgages
Why do this?
– Net worth helps you do stuff in the future
– Track over time--should be growing
– Identifies assets that could be used to reduce debt
Net Worth—A Picture
Liabilities
Assets
Net Worth
Impact of Credit Card Purchase
Stereo System
Credit Card Debt
Liabilities
Assets
Net Worth
Impact of Credit Card Purchase
Stereo System
Credit Card Debt
Liabilities
Assets
Net Worth
How do you balance this?
What Adds to Net Worth?
Stereo System
Assets
Credit Card Debt
Liabilities
Net Worth
Net Worth Must Shrink!
Suggestion 1
Avoid Unproductive Debt
It Makes Net Worth Shrink
Productive debt
Unproductive debt
Home
Consumer goods
Education
Vacations
Minimum
transportation
Business
Car
Most credit card debt
Origin of Most Debt Problems?
Spending Problems
Debt
Income
Expenditures
Suggestion 2
Control Your Spending
Step 1: Track past cash flows
– 1-3 months back
– Find all expenditures
– Determine assets and liabilities
Step 2: Agree on goals
– What do we want to accomplish?
– Agree on a budget for future cash flows
Step 3: Track ongoing cash flows--compare
budget to actual
– Use computer or any other method
Step 4: Review monthly
Step 5: Make adjustments
Why You Need a Spending Plan
Communicate with spouse and family
Find out what you are spending
Extract more money for saving and
investing
Get out of debt
Prepare for the future
Keep money from slipping through your
fingers
Remember the Pioneer Motto
“Use it up, wear it out,
make it do, or do without.”
Hugh Nibley story
~500%
Suggestion 3
Be Careful Where You Borrow!
Finance companies
Credit cards
Banks
Credit unions
Savings
Pay-day lenders
30
25
20
15
10
5
0
FC CC
B
CU
S
Suggestion 4
If You Have Debt, Reduce It
Plastic surgery
Reduce spending
Use assets to pay off debt
Reduce interest rate
– Careful of home equity loans!
– Use another lower cost source of
borrowing
Make a plan -- stick to it
Talk to a credit counselor if needed
Suggestion 5
Protect Your Family with Life Insurance
Term life -- pure death benefit
– No savings component
– About 1/10th the cost of whole
– Expires at age 65 (usually)
Whole life -- death benefit plus savings
– Builds cash value
– Does not expire
– Low but fixed rate
– Use for estate tax purposes
Insurance--Makes Up for Low Net
Worth Problems
If you have low or negative net worth?
– Heirs may have difficulties
– Severe cash flow problems
Insurance creates an instant estate--it becomes
an asset if you die
Assets
Liabilities
Net Worth
Cash from
Insurance
Added Net
Worth
What Kind and How Much?
Term insurance (6-10 times annual
income)
Consider convertible term
Group is least costly but what if you
leave?
Have some for non-employed spouse
Suggestion 6
Prepare for Retirement
Yes, Even When You Are Young!
Some Retirement Myths
“I’ll live on Social Security benefits”
– SS will replace only 24% of your pre-retirement
income
“Someone else will take care of me”
“Better be safe and invest conservatively”
Biggest regrets for retirees
– Didn’t take full advantage of tax deferred
investments
– Didn’t start earlier to save for retirement
Example
Bill starts saving for retirement at age 20
Joe starts saving for retirement at age 40
($2,000 per year at 8%)
1000000
900000
800000
700000
600000
500000
400000
300000
200000
100000
0
$903,800
20 Start
40 Start
$172,702
20
25
30
35
40
45
50
55
60
65
Bill has accumulated over 5 times what Joe did by 65!
How Does This Work?
Compound interest
Bill started earlier--compound interest has
more time to work its miracle
If someone had put $1 in an account back
in 1776 at 8% interest how much would
the account have in it today?
$61,000,000 !!
How Much Will I Need in Retirement?
Money Magazine Survey
People Estimate: 53%
Actual: 71%
One third of retirees support children and
grandchildren
Health care costs generally higher
You’ll want to serve missions, visit
grandchildren, etc.
So you may need much more than 71%
Suggestion 7
Save at Least 10%-20% of Income
Life Cycle Savings
700 (000’s)
600
Retirement
500
Save 20%
400
300
200
100
Save 10%
Borrowing
To heirs
0
-100 20
25
30
40
50
60
65
70
80
Age
Good Rule to Live By!
Pay Heavenly Commitments First—10%
Pay Your Future Self Second—10%
and then increase it to 20%
What Should I Invest In?
Important principle: risk-return trade-off
– High risk--high return
– Low risk--low return
What?
– Stocks -- ownership in a company (risky)
– Bonds -- loan to a company/government
(less risky)
– Deposit accounts -- (insured, no risk)
How should I invest?
– Mutual funds
– Tax-advantaged investing
Best and Worst Total Returns
(since 1926)
54%
Stocks: S&P 500
U.S. T-bills
20%
17%
15%
9%
0%
One year
holding
period
-43%
0%
-1%
10-year
holding
period
8%
3% 0.4%
20-year
holding
period
Chances of Beating Inflation
100
90
80
70
60
50
40
30
20
10
0
%
S&P500
Bonds
T-bills
One-year
5 Years
10 Years
Holding Period
20 Years
Chance of Loosing Money
30
25
20
S&P 500
Bonds
T-bills
15
10
5
0
One year
5 years
10 years
20 years
Question: When Was the Best 5-year
Period for Stock Returns?
#1: May 1932-April 1937
367% Return
Second Best?
#2: July 1982-June 1987
267% Return
Suggestion 8
Invest to Match Your Timing
Short period (5 years or less)—put your
money in less risky investments like
savings accounts and secure bonds
Longer period (10-20 or more years)—
put your money in a well-diversified
portfolio of stocks
Suggestion 9
Use Tax Deferred Investments
That means
You don’t pay taxes on that portion of your income
You don’t pay taxes on the income or growth of the
investments
UNTIL you take money out at retirement
How do you do it?
Individual Retirement Accounts (IRAs)
Roth IRAs (not tax deductible, but…)
401(k) (or 403(b)) -- retirement plans
– Employer may participate (match your
contribution)
– Loan provisions
Suggestion 10
Diversify!
Never put all or even most of your eggs in one
basket
Mutual funds can help
Index funds may be best for most of us
Suggestion 11
Consider a Trust
Estate taxes: about 50% of assets above
$2,000,000 per person (indexed)
Spouse may pass on unlimited amount to
surviving spouse
BUT…then only one gets the $2,000,000
exemption
If a couple has more than $2M, need A/B
trust
There is huge uncertainty in the future of the
tax law pertaining to estates!
Suggestion 12
Avoid “Get Rich Quick” Schemes
Case Study: the Ponzi Scheme
End of January, 2006
Student reports finding this
card in the Tanner Building
Reverse side claims:
Invest $6 to $6,000
Earn 44% over 12
days
New economic
paradigm!
What is the Annual Return?
(1 +
365/12
.44)
–1=
5,600,000%!
Ponzi Scheme—How it Works
Etc., etc.
KEY: Return comes from new investors
and not from any real economic activity.
How to Recognize Scams
Is promised return unusually high?
– Remember the risk-return trade-off
Is product significantly above or below
reasonable market price?
Does sale require pressure tactics?
Does seller emphasize “affinity”, e.g.,
BYU or Church connections?
Is most of the product purchased by end
users or by other distributors?
Protect Your Data
Identity theft is on the rise
– Shred financial documents
– Don’t give out account #, CC #’s, PINs, etc. over phone
(unless you originated the call to known party)
Be aware of phishing
Don’t fall for “awards” or any other gimmick in
which you have to send in a check
Protect your computer with anti-virus programs
Don’t give out SSNs
Keep informed—new scams are created every
day!
Multi-Level Marketing Tests
Is the product sold primarily to other
distributors or to actual customers?
Is the product really of value in the
marketplace?
Is the price reasonable for the product?
Are the real risks fully disclosed?
Where Should We Put Our Money?
Start-ups
Growth Stocks
Corporate Bonds
Corporate Bond
Funds
Government
Bonds
Specialty Funds
Growth Mutual Funds
Blue Chip Stocks
GARBAGE:
Speculative
Investments,
LPs,
Derivatives,
Gambling
Conservative Stock
Mutual Funds
Tax-Advantaged Retirement Funds: Growth Stock Mutual Funds
Insurance
Food Storage
Health
Life
MMMF,
Ins. Savings
Home
Checking
Account
Suggestion 13
Keep Track of Your Finances
Organize and know how to read your financial
documents (insurance, retirement, bank and
investment statements)
Create financial reports for your family
(assets and liabilities)
Know your monthly cash inflows and outflows
Use the Web for financial information
Develop a plan
Computers and the Internet Can Help
Excel
Internet
Online Banking
Suggestion 14—Most Important of All!!
Learn More about Managing Your Finances
For example, read Benna, et al, Managing Your
Money for Dummies
Tyson, Investing for Dummies, 5th Edition
Engel and Hecht, How to Buy Stocks, 8th Edition
http://providentliving.org/media/training/peacehe
art/main.html (lds.org > Home and Family >
Family Finances)
http://personalfinance.byu.edu/ (lds.org > Home
and Family > Family Finances > Other resources
> Personal Finance
Conclusions
1. Don’t panic—selling stock now may be the worst thing to do.
2. In fact, now may be a good time to buy—most stocks are at
“bargain basement” prices.
3. If you’re employed, become a very valuable employee,
sharpen your skills, dust off your resume.
4. Now may be a good time to go back to school.
5. Make sure your food supply is in good order.
6. Avoid/pay off unproductive debt.
7. If you can, give even more generously to fast offering, other
programs to help less fortunate
8. Teach your children and grandchildren these principles.
9. Wise financial management empowers you to serve more
capably: family, community, church.
10. Surely we will be held accountable for how we manage our
resources
President Boyd K. Packer
November 2008
“…in troubled times the Lord
has always prepared a safe
way ahead. We live in those
‘perilous times’ which the
Apostle Paul prophesied
would come in the last days. If we are to
be safe individually, as families, and
secure as a church, it will be through
‘obedience to the laws and ordinances of
the Gospel.’ ”