I received this question from a friend today, with regard to banks, lending (or the lack thereof) and the credit crunch:

Wasn’t the point of the bank bailouts originally to keep the credit markets going? And if so, a) why are banks still not lending even after receiving the money and b) at the very least, why are they calling in all these huge debts and putting all these companies out of business?

A lovely point! Everything that has been done, from emergency loans to TARP to the latest bank rescue plan from Timothy Geithner has been aimed at trying to free up capital so that banks will start lending — especially to consumers. Unfortunately, as you may have noticed, this hasn’t necessarily translated into loans for the rest of us. Here are some of the reasons that banks aren’t really that interested in taking the taxpayer money that is supporting them and lending it back out (with interest, of course):

1. Banks just don’t want to lend. One reason banks aren’t lending is because they don’t want to. They’d rather use that capital to shore up their books. Plus, they’ve been burned by their horrible decisions. Of course, the argument could be made that they are over-reacting, going too far the other direction. Technically, though, banks are lending — just not to you or me. Insider lending, to executives and directors, is going on right now.
2. Banks still have to cover toxic assets. Many bank still have toxic assets on their balance books, and they are using some of the money to balance that out. Also, foreclosures and credit card loan defaults are still expected in the coming months, so banks are hoarding cash to get to that point.
3. Banks owe money to others. Consider AIG: Most of the money it has been getting, rather than going to junkets or bonuses (as outrageous as that is), has been funneled to its own creditors, like Goldman Sachs. Other financial institutions are also paying off their debts.

As far as calling in debts, banks are just trying to get what they can, as quickly as they can. They are hoping to get lump sum capital — as much of it as they can.

Bottom line: Our leaders may have wanted banks to lend to us, but unfortunately have taken a “trickle down” approach. And we know how well that’s been working. Banks have just been holding on to the capital because they don’t really need worry about it. All they have to do is yell about how if they fail the whole economy goes down and everyone panics and agrees to give them more money.

Perhaps it would have been more effective for our leaders to buy our consumer debt. It would have cost less (more than $11 trillion — most of it for financial institutions — has been spent on economic stimulus so far). And it would have had a positive effect on bank balance sheets and automatically boosted everyone’s ability to borrow more. Even if more consumer lending is not the best thing, it’s our leaders’ stated goals. What they’ve done so far hasn’t even brought them to a point to where that is feasible.

It’s the first reader question of the New Year:

I have a credit card with a $6700.00 balance,with an interest rate of 14%, have a CD which I can cash in to pay this down, CD will yield about $5600.00. Should I use the CD to pay down the credit card?  CD is paying about 3.6%

Personally, I am inclined to take the money in the CD and pay down the credit card. The 14% interest that you pay on the credit card more than cancels out the 3.6% you are getting on the CD. Indeed, you will be paying a great deal more in interest than you could earn on the CD. Savings rates are dropping rapidly in a variety of categories, including high yield savings accounts and CDs. It’s what happens as the Fed rate heads lower. In this climate, it might be best to pay down debt while you can, doing your best to free yourself from obligations. Get the credit card paid off, and then start rebuilding your savings.

My only concern is whether or not the CD has reached full maturity. You may have to pay a penalty for cashing the CD in early if the entire term of the CD has not run its course. Do a cost-benefit analysis. Even with the penalty, you may still be saving more by getting rid of the interest payments on the credit card.

Readers: Do you agree with my assessment? Would you pay off the credit card or keep the CD?

I got this email from a reader not too long ago. And I think it deserves some attention. And your help as well:

We make $ 95,000.00 per year before taxes. Husband and wife both work.  Have excellent credit.
We have a $102, 000 remaining on 20 years left on mortgage.
We have a $ 7,600 Home equity loan.
We have a  $ 13, 500 Car loan.
We have $8,000 in our savings/emergency fund.
We or our Daughter will need to borrow $17,000 for College next year for fall of 2009 College.

Should we:

Pay off the Home equity.
Pay a chunk of Car loan.
Don’t pay either,  because we won’t get a 17K loan next year, so we’ll need the 8K for college.

This is an interesting question. First, I’ll let you know what I think. And I hope that Yielding Wealth’s readers will add their two cents.

First of all, it’s great that you appear to be in such good financial shape. I assume that you don’t have credit card debt, since you did not mention it. I also assume you are able to make all your payments, since you seem to be in a good place.

My main question is where this 8K is coming from. Are you planning on raiding your emergency fund in order to pay something off? In these economic times, I actually think you should build your emergency fund further, since you never know what could be happening.  My first suggestion would be to not use the the money in your emergency fund to do any of what you are considering.

Kids and college

Personally, I believe that kids should cover their own tuition expenses. I don’t know whether the $17,000 is tuition + other expenses. In any case, kids can cover their own tuition through scholarships, part-time jobs or even loans. But I’m biased, because that’s what I did. My parents paid my rent and my car insurance (I bought the car), and I took care of the rest. I recommend that you let your daughter take care of tuition. Even if she has to do loans, she will have much longer to pay them back, and you don’t want to put your retirement at stake.

Paying down your consumer debt

Next, if you have leftover money (again, I do not think it is a good idea to raid your emergency fund) after making sure you are funding your retirement account and emergency fund and helping in a small way with your daughter’s college costs, I suggest that you start paying down your other debt. Start with the highest interest debt. In your cases (assuming you don’t owe on credit cards), it appears that your car loan probably has the highest interest rate.

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I’ve been thinking about my parents a lot lately, since they are approaching retirement age. My husband’s dad retired last year, and his mom expects to retire this year. So I’ve been contemplating their situations. I also had a brief email conversation with Patrick over at Cash Money Life in which he wondered how many people are considering putting off retirement because of the current economic issues. So, really, it is no surprise that over this past weekend I’ve received a few emails to this effect:

I’m a couple of years away from retirement. Should I put it off for a couple more years?

Over the past couple of decades the concept of “retirement” has been changing. We have largely shifted from a pension-based retirement society to one that relies more on personal investment accounts like 401(k)s and IRAs for retirement income. This has also been resulting in earlier retirement ages. However, WREX news points out that an AARP poll shows that some are thinking about putting off retirement now, due to the economy.

With the stock market doing what it’s doing, many people are experiencing statement shock as they see that their retirement accounts are losing money. But, as Patrick points out, withdrawing money from your retirement account really isn’t the best solution. And, it may not be in your interest to retire just yet, either.

You should look at your personal finance situation to see where you are at. Chances are that the stock market will recover in the next few years, so if you can work for a couple more years, it might actually be beneficial for you to put off retirement. That way you can still earn an income while you wait for your retirement account to recover. Additionally, it you might consider continuing your retirement account contributions. Your money will buy more while it’s cheap, and that could benefit you later — provided you have chosen solid investments that are likely to recover.

Disclaimer: I am not an investment professional. This should not be construed as investment advice. All investment carries the risk of loss. Before investing, do your own research and/or consult with an investment professional.

I have a few people that email me every now and again wondering about the state of the U.S. dollar. These are folks that are interested in it for investing purposes, because they expect to travel overseas in the next year or so, or are just concerned about the dollar’s standing in the world.

Lately, I’ve been getting questions about how the $700 billion bailout is likely to affect the U.S. dollar. In the near term, the bailout has been helpful, since the dollar has been rallying on the assumption that the economy is likely to recover as a result of this measure. But the Forex Blog is not so sanguine, and warns about taking things right now at face value:

The consensus- unchanged from when the plan was first unveiled- is strongly negative, especially as far as the Dollar is concerned. When combined with the government’s other initiatives, the bailout will add nearly $1 Trillion to America’s national debt. Additionally, the Federal Reserve Bank would have to print money to bridge a shortfall in the government’s borrowings, thereby stoking the fires of inflation. Ironically, the Dollar’s best chance to avoid a continued decline is if the bailout plan fails in its stated aim, and the American economy implodes, pulling the global economy down with it.

I found this a very interesting analysis. But it seems in line with everything else about this bailout and with efforts at “economic stimulus.” Everything done so far seems to have little value beyond the surface, and does little to promote long-term stability and prosperity.

What do you think the effects of the $700 billion bailout will be?

image credit: sxc.hu

We’ll take a little break from all bailout all the time to answer a reader question:

Three years ago my husband and I were talked into purchasing permanent life insurance policies as a means to eventually supplement our retirement.  This was in addition to my husband’s 401k but at the time was my only contribution to retirement of any kind.  We are both 33 now and my question is was this a really bad decision?  What is your opinion of using your cash surrender value for retirement? Should we get out while we can and put the money in our IRA or wait until the cash value is greater than our premiums paid (5 years from now)?

First of all, I don’t like life insurance as a form of retirement income. Especially with cash rates what they are right now. Inflation is likely to eat up any returns. My husband and I have small universal life insurance policies to supplement the term life (because you do need life insurance to secure the finances of loved ones), but we don’t consider them sources of income. We plan to use the cash value on a small trip to celebrate retirement.

I’m actually inclined to say “cut your losses” and get out. If you are having trouble affording the premiums, then the current economy could make things tight. On top of that, if you use the money to beef up your tax-deferred retirement accounts now, you can get more bang for your buck as the market recovers in the coming decade. In the long run, that will accumulate better than putting up premiums for cash value for another five years.

Do any readers have any suggestions or thoughts on this?

I received this interesting question from a reader last night:

I’ve been hearing a lot about inflation lately. But now I’ve started to hear about deflation. What is deflation?

An excellent question! At its most basic, deflation is a fall in prices. It is the opposite of inflation. In the sense of this economy, deflation is most connected with the stock market and with housing prices — both of which are falling. (Consumer prices haven’t quite reached a state of deflation, so it’s not very helpful to household budgets.)

One of the biggest worries right now is that the economy will enter a deflation spiral. This is a great fear on the stock market, as there is a pullback in investment as  stock values (especially in the financial sector) fall. If you have a retirement account, or if you have stock investments that act as passive income, this sort of deflation is going to affect you.

Another concern is the continued fall in home values. As less equity is available in homes to provide support for spending, less spending happens. And this can create deteriorating economic conditions. Deflation also brings liquidity problems. Money does not flow as easily, and banks are not willing to lend to each other — or to you.

Inflation: the solution to deflation

As a result of deflation fears, the Federal Reserve authorized central banks around the world to release dollars into their economies (the Bank of Japan, for example, is now offering loans denominated in U.S. dollars) in order to increase liquidity. The idea is that by releasing more cash into the market, inflation will result in order to battle the deflation.

Don’t ask where the money for all this liquidity injection comes from, though. Because, basically, it comes from the promise of future returns on debts owed to the Federal Reserve. And some of it is, in fact, just being created out of thin air.

image source: Wikimedia Commons

I love me some questions from readers, and I thought this one, in light of my recent adventures in banking, was a great one:

Is overdraft protection worth it?

One of the things I love about personal finances is that they’re, well, so personal. Really, it depends on your habits. First, though, a little background on overdraft protection.

What is overdraft protection?

Overdraft protection is a loan. It is a line of credit that you are allowed (usually between $1,000 and $10,000, depending on what you are approved for) to use when your account goes into the red. The idea is to help you avoid the hefty fees that come, per transaction, when you overrun your account.

There are, however, fees associated with overdraft protection as well:

• Interest charges (usually in the neighborhood of 13% to 18% APR).
• Annual fee (around $25).
• “Advance” fee (somewhere between $5 and $7 per transaction, if you don’t move the money from your credit line yourself and the bank has to do it for you after you go negative).

Is overdraft protection worth it?

Now we answer the question. If you occasionally go into the red due to cash flow realities, carelessness or for some other reason, overdraft protection can be worth it — especially if you know the money will be replaced almost immediately. Fees on overdrawing your account can range from $34 to $45 per transaction (my bank charges $38), putting you ever deeper in the hole. Each $4 coffee that you buy results in a hefty fee once you go negative.

Even at the relatively high interest rate, overdraft protection can be worth it, since, as a revolving line of credit, the interest is only charged while you are negative. Just one transaction that puts you negative could make overdraft protection worth it. If you feel that it will ease your cash flow, it is worth considering. But remember: Overdraft protection is a loan.

If, however, you are very scrupulous about your account, and if you stay out of the red all the time, with adequate padding, there is no reason to get overdraft protection. It’s just so much extra cost.

image credit: sxc.hu

As the new school year approaches, many people turn their thoughts toward school costs. And this includes college costs.

Here is a question I received from a reader about college costs:

My oldest daughter will be starting college in three years. What can we do now to prepare for saving money on college costs?

First of all, kudos for thinking ahead. Like many other life expenses, college costs are something that you need to plan and prepare for. Here are three things you can do to prepare for saving money on college costs:

• Research scholarships, and consider steps that can be taken in order to get them.
• Tax advantaged college savings plans like 529 and Coverdell.
• Think about a state university or starting at a community college.
• Consider encouraging your child to get a part-time job.

Encouraging your child to help pay college costs

Especially in these economic times, it is a good idea to have your kids help pay for their own college costs. Not only does it teach them responsibility (in a personal finances capacity), but it can aslo make things a little more affordable for you. Many parents are considering raiding their retirement accounts to help for college, and this — honestly — isn’t a very found decision for your personal finances.

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