Financial Regulation...What It Means to You and America

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

As expected, financial regulation recently was passed in Congress and President Obama has signed that into law. As I discussed in Politicians Run Amuck… Again, my overall view is that something is better than nothing, but this bill is far, far from perfect. Historically, sweeping reform often comes with unintended consequences and this bill, just like health care reform will have its fair share.

To be clear, I have not read the almost 2000 page bill. My conclusions are drawn from a variety of research and commentary from both sides of the political aisle. I don’t want to rehash most of what I already wrote about, but there will be a few repetitive comments. First and most importantly, shame on Congress for totally and unequivocally kicking the can down the road on Fannie Mae and Freddie Mac. That is appalling! Two of the main ingredients in the financial crisis are passed over? Is Congress kidding, scared of what they may find or helpless?

President Obama pounded the table that “too big to fail” is over and we will NEVER again use taxpayer money to bailout failing institutions. Does anyone really believe that to be the case? You mean to tell me that if J.P. Morgan was on the brink of failure and needed a government backstop, the administration wouldn’t step up? That’s beyond naive to accept. We all know that Uncle Sam, whichever party is in control, would kick and scream but still come to the rescue.

I know what’s in the bill, giving the Fed and FDIC new and extraordinary powers to orderly unwind a failing institution (something I totally favor), but I just don’t buy it in times of crisis. There is no way, in my opinion, that anyone in government could have safely unwound Lehman Brothers to protect the system. And while a “bailout fund” may be created from this bill, who do you really think will end up paying for it? The banks may cut the checks, but that will certainly result from higher fees and charges to us!

The bill does address derivatives, by requiring banks to spin off certain groups under their control and move some trading to exchanges and clearing houses. Longer-term, I have to agree with this as it removes one element of potential financial Armageddon. But it does not come without cost. By spinning off these departments, banks will be required to capitalize (inject money) the new entities, further straining their own capital and reducing the amount of money to lend. That is called credit contraction, something we’ve been unsuccessfully fighting for three years. Less and tighter credit in the system will negatively impact economic growth in the short-term until the banks replenish their capital base.

The bill also limits banks from investing more than 3% of their capital in hedge funds and private equity. This provision was interesting as it suggests that somehow the hedge funds and private equity shops were a cause or accelerant in the crisis, something that is simply not true. I don’t really care if this is law, but like most major changes, it should be phased in over a period of years. I do believe it will end up hurting bank earnings.

FDIC insurance was raised to $250,000, something that I applaud and makes perfect sense. That should help keep or increase customer deposits in banks (CDs, money markets, etc.), adding revenue and strengthening their base.

A new consumer protection agency/department is being created under the Fed as I understand it. Folks, we have enough governmental agencies, units and departments to last 100 lifetimes. We need another one like the Pacific Ocean needs more water! This country will never fully recover from our economic malaise until government begins to shrink and the private sector starts expanding. Interestingly, although auto dealers originate 80% of auto loans, they were exempted from this bill. That’s somewhat dubious from my seat!

I was surprised that few people talked about one of the root causes of the crisis, leverage. Over the years, the banking and mortgage industry have created all sorts of non conventional, fancy, outside the box products that few, if any, really understood or knew how to use. If Congress really wanted to prevent another housing bubble and fix the current problem for the long-term, they should have considered requiring 20% down on all mortgages. Yes, I know that many people could not afford it, but that’s exactly what used to be the norm before we decided that owning a house was part of our right of passage in this country.

In the short-term, it would further depress an already depressed sector, but it would also begin to create a very long-term, stable and constructive housing market for decades to come. Like addressing Fannie and Freddie, this would not be politically popular (so probably very smart!) and therefore not interest the vast majority of politicians only interested in reelection, pandering to the media and special interest.

As I said, overall, the bill is something and it’s probably better than nothing, but by no means the final answer. I believe it is deflationary in the short-term and will lead to further credit contraction and harm to the economy. Financial institutions are creative, cagey and shrewd, employing some of the smartest minds on earth. Longer-term, they will likely adapt and adjust, find loopholes to make up for lost profits. I just hope that we don’t drive too much business to other shores.

I am scheduled to be on CNBC’s Worldwide Exchange this Tuesday, July 27th, from 5:35am to 5:55am.

Feel free to email me with any questions or comments at Paul@investfortomorrow.com.

Until next time…

Paul Schatz
Heritage Capital LLC
http://www.investfortomorrow.com/
http://RetirementPlanningConnecticut.com/

Health Care Bill Not So Healthy

(Editor's Note: Paul Schatz, President of Heritage Capital, LLC, in Woodbridge, will be contributing to Fi$callyFit every Friday. Read his biography here)

Although the political wrangling continues over the legality of the health care bill, for all intents and purposes, it's law, like it or not. On the one hand, it's a positive that we've gotten at least something done on this issue. But, this bill is FAR from being great in my humble opinion.

This morning, I had a conversation with a client whom I routinely disagree with. We always have very spirited political, social and economic discussions. Sometimes he makes a good point that causes me to reassess my position, like today, and other times I do. And sometimes, we agree to disagree.

From my seat, that is good and healthy debate; always respectful, never personal. Two individuals from different sides of the political spectrum and from different generations. The question is... why can't our elected officials in Washington behave like this?!?!

Getting back to health care, one of the problems with reform is that we're not dealing a straight social or free market issue. Think of yourself as the CEO of a health insurer whose top priority is to deliver results to the shareholders. That's your fiduciary responsibility. The more times your company says "no", the more profits in the corporate coffers.

As a customer of that insurance company, you pay significant premiums to cover you in case of health issues. You expect a "yes" when the time comes. You expect life to be preserved. The problem is that health insurance companies are a hybrid and cannot be a straight capitalist/free market model. There must be regulation to "insure" life and protect the insured as another client (physician) offered at lunch today.

I am NOT in favor of government run health care, but I think we all know that without the proper oversight, the insurance companies become the sector of "no" to maximize profits. It's a social and free market issue that doesn't seem to have a good compromise. The health care bill does have some pluses, such as added coverage for meds, subsidies for lower income families to buy insurance and hopefully a small business tax credit.

Socially, I am 100% in favor of fixing the preexisting condition problem. But I do know that shareholders are hurt by that. I am not in favor of requiring everyone to buy health insurance. I don't know our forefathers personally, but I have a hard time believing that they would be in favor of this. I also don't think they would have too much respect for Nancy Pelosi who believes that "pursuit of happiness" means forcing citizens to buy a product.

If you don't want to buy auto insurance, you don't have to drive. If you don't want to buy homeowner's insurance, don't buy a home or buy one without a mortgage. Since smoking and obesity are huge burdens on the healthcare system, is Congress going to mandate our weight or outlaw smoking to protect the system? Will they pass a bill forcing us indoors during peak sun hours because of skin cancer danger?

I've seen the Congressional Budget Office (CBO) estimates on what the bill is going to do over the next 10 years in deficit reduction. Wonderful. It's primarily through tax increases and this insane idea that the government can find hundreds of billions in savings from Medicare waste and fraud. If it was so easy, why hasn't anyone done it before???

And while the CBO is an independent group, who ever said they were correct or even good? Show me ANY of their previous long range forecasts that have come true. You can count me as a skeptic here. I don't buy it.

And the tax increases are the crowning point of not only this bill, but additional increases coming online in 2011. Have we not learned ANYTHING from FDR's great mistake in 1937 when he raised taxes and removed fiscal stimulus, causing Great Depression Part Deux?

The folks at Casey Research recently penned a piece entitled, "Help! I've Been Taxed and I Can't Get up!" The general premise of the article is HOW we are going to pay for all this spending. If you don't know, by doing nothing, taxes are going up in 2011 to the pre-Bush cut levels. That's a huge increase during a very fragile recovery.

Forget about income tax levels for a minute where the top rate is going from 35% to 39.60%, dividends and interest are going from 15% to ordinary income levels. To rub salt in the wounds, the new health care bill adds the Medicare tax of 3.80% to capital gains, interest and dividends beginning in 2013.

Add another 0.90% tax on all income earners above $250,000 and you have the recipe for slow economic growth at best, another recession or two at worst. It's not a pretty picture. The Casey folks also point out that it's possible for the 3.80% Medicare tax to hit you when selling real estate for a gain, even the lower income brackets. Additional tax increases are seen in raising the deductible medical expense threshold from 7.50% to 10%.

There are other less widespread taxes starting in 2013 that are almost certain to raise various medical costs, but I think you get the picture. I feel like a politician saying this, but I am for lower taxes and smaller, less interventionalist government. Boy, do I feel like the odd man out!

Please feel free to email me with any questions or comments at Paul@investfortomorrow.com.

Until next time…

Paul Schatz