The Common Sense Fix

A friend forwarded a common sense plan aggregated by Dave Ramsey, a Tennessee based nationally syndicated radio talk show host. Ramsey is also the author of a best selling book called Financial Peace, a book I have read more than twice personally and have handed out on more than one occasion.

To be transparent, he and I don't see perfectly eye to eye on everything from a personal finance perspective which many of you have heard me say, but 90% of the time we are in step with each other. On the issue of this $700 Billion bail out plan, I agree with him.

Many of you have asked me what I think should happen. This is along the lines of my thinking.

The Common Sense Fix:

Years of bad decisions and stupid mistakes have created an economic nightmare in this country, but $700 billion in new debt is not the answer. As a tax-paying American citizen, I will not support any congressperson who votes to implement such a policy. Instead, I submit the following threestep Common Sense Plan.

I. INSURANCE

a. Insure the subprime bonds/mortgages with an underlying FHA-type insurance. Government-insured and backed loans would have an instant market all over the world, creating immediate and needed liquidity.

b. In order for a company to accept the government-backed insurance, they must do two things:

1. Rewrite any mortgage that is more than three months delinquent to a 6% fixed-rate mortgage.

a. Roll all back payments with no late fees or legal costs into the balance. This brings homeowners current and allows them a chance to keep their homes.

b. Cancel all prepayment penalties to encourage refinancing or the sale of the property to pay off the bad loan. In the event of foreclosure or short sale, the borrower will not be held liable for any deficit balance. FHA does this now, and that
encourages mortgage companies to go the extra mile while working with the borrower—again limiting foreclosures and ruined lives.

2. Cancel ALL golden parachutes of EXISTING and FUTURE CEOs and executive team members as long as the company holds these government-insured bonds/mortgages. This keeps underperforming executives from being paid when they don’t do their jobs.

c. This backstop will cost less than $50 billion—a small fraction of the current
proposal.

II. MARK TO MARKET

a. Remove mark to market accounting rules for two years on only subprime Tier III
bonds/mortgages. This keeps companies from being forced to artificially mark down
bonds/mortgages below the value of the underlying mortgages and real estate.

b. This move creates patience in the market and has an immediate stabilizing effect on failing and ailing banks—and it costs the taxpayer nothing.

III. CAPITAL GAINS TAX

a. Remove the capital gains tax completely. Investors will flood the real estate and stock market in search of tax-free profits, creating tremendous—and immediate—liquidity in the markets. Again, this costs the taxpayer nothing.

b. This move will be seen as a lightning rod politically because many will say it is helping the rich. The truth is the rich will benefit, but it will be their money that stimulates the economy. This will enable all Americans to have more stable jobs and
retirement investments that go up instead of down.

This is not a time for envy, and it’s not a time for politics. It’s time for all of us, as
Americans, to stand up, speak out, and fix this mess.

The Federal Reserve Cuts Rates .75%

Tries to stave off a larger decline in the stock market The Federal Open Market Committee (FOMC) held an emergency meeting last night to determine how to address the sharp sell off of stocks from around the world yesterday and the impending sell off US stocks today. It was the first special meeting since 9/17/01 and the largest one day cut since 1984. They decided to cut the Fed Funds Rate (FFR) to 3.5%. Here's an updated chart showing the Fed Funds Rate, the Prime Rate and the National 30 yr. Fixed Rate average. For more information about this story click here... To learn more about how Fed Rate cuts affect mortgage rates, check out our blog entry from Jan. 15, 2008... Cashflow Coach

The Fed Cuts Again

The Federal Reserve Cuts Rates .50%

And leaves the door open for more cuts if necessary

The Fed met yesterday and today to discuss inflation and the economy. They decided to cut the Fed Funds rate (FFR) by .50% to stimulate a slowing economy. There's a lot of debate as to whether we're in a recession or not. Some pundits say that if the Fed starts to talk about a potential recession that usually means we are already in one.

What does this mean for interest rates?


If you have a loan with a short-term interest rate or a rate based on the Prime index, your rate will be declining. The Prime rate is simply the fed funds rate plus a margin of 3%, currently at 6%. Most home equity lines and some credit cards are based on the prime rate.

Other short term indexes like the 1 month, 3 month & 6 month LIBOR rates will also likely decrease. The decrease may not necessarily be by the same .50% FFR reduction and not as quickly. The 1 month LIBOR typically follows the FFR over time.

For long-term interest rates like the 15 yr. and the 30 yr. fixed rates, these rates will most likely be increasing. The last four rate cuts resulted in higher fixed rates in the subsequent days and weeks. For more information on why this happens read my previous post on Fed Rate cuts.

If Goldman Sachs' predictions are correct, then we may see a few more cuts from the Fed to stimulate the economy even more.

What does all of this mean to you? It means you should schedule your annual review call with us, if you haven't already. Interest rates may rise or they may decline, there are so many factors that go into the supply and demand for long term bonds. Make sure you're ready for the next interest rate decline. Stay up to date with by subscribing to our cashflowcoach blog and attend our next Total Wealth Workshop. We want to be your source of valuable information and financial education.

Thank you for your loyalty and your business!

the Cashflow Coach

FED Rate Cuts: How Low Can They Go? part II

After yesterday's emergency .75% rate cut by the Federal Open Market Committee (FOMC), I have received numerous calls and questions as to how low will the FED go and how low will Fixed Rates go? If you read my previous post on the FED Rate Cuts, you know that the two rates don't always move in the same direction, in fact they more often than not, move in opposite directions.

The FED has tried to be as transparent as possible, especially under the leadership of Ben Bernanke. The goal of transparency is to limit "surprises" in what the FED does and says. In some ways the Fed has met this objective by releasing their notes from their scheduled meetings on a timely basis. The challenge arises when the voting members don't agree with each other on policy.

If you want to learn how to guage the direction of interest rates, here are some basic guidelines that I learned from Jim McMahan, a Mortgage Broker in Texas. These are some guidelines that the FED tends to follow:

1. The FED's goal is to keep Core Inflation (C.I.) at 3% or less. (the PCE is currently at 2.16%)

2. Everytime we've had a recession, the FED has taken the Real Interest rate to a negative number in order to stimulate growth:

Real Interest (R.I.) rate = Federal Funds Rate (F.F.R.) - Core Inflation (C.I.)

(1.34% = 3.5% - 2.16%)

3. Real Interest rates have never increased 8 quarters in a row unless inflation (C.I.) was present at 4.5% or greater.

4. Mortgage Rates in the U.S. have been at or below 7.5%, 85% of the time in the last 80 years.

5. Mortgage rates tend to gravitate towards Core Inflation (C.I.) + 3.5% (2.16% + 3.5% = 5.66%)

If the FED continues to follow these guidelines, we could see fixed rates in the 5.6% range.

Cashflow Coach

Copyright © 2008 the Cashflow Coach | All Rights Reserved

FED Rate Cuts: How Low Can They Go?

Will Fed Rate Cuts Equal Lower 30 yr. Fixed Rates?

The Federal Reserve will be meeting on Jan. 29^th & 30^th to discuss the state of our economy. Will they cut rates and if yes by how much? Will the rate cuts lead to decreasing or increasing mortgage rates?

There's a lot of confusion about the Fed Funds Rate (FFR) and the typical 30 yr. fixed rate. Do these rates move in the same direction or are they inversely related?

First, let me provide a simplistic definition. The Fed Funds Rate is the rate the Federal Reserve charges other banks for overnight deposits. It is also the rate the Fed uses to control inflation. If inflation starts to rise above the 1% - 2% "neutral" zone, the Fed will usually increase the Fed Funds rate to slow down the economy. If inflation starts to decrease below the 2% level then the Fed will usually start to cut the FFR stimulate the economy.

A Fannie Mae 30 year fixed rate mortgage is actually a bond, also known as a Mortgage Backed Security (MBS). If you are a bond holder (investor), the worst thing for your bond investment is inflation. If inflation is rising, then the value of your bond (30 yr. Fixed rate) is declining, so as an investor you would require a higher rate of return to compensate for the inflation. Here's an example to help you understand.

Bond Holder/Investor: willing to lend $100,000 to a home owner for 30 yrs. expecting a rate of return (interest) of 6% because inflation today is only 3%.

Borrower/homeowner A: willing to finance the home purchase with a loan of $100,000 for 30 yrs. at 6% interest rate.

Let's say a month from now, inflation jumps to 5% from 3%.

The Bond Holder/Investor is still willing to lend $100,000 for 30 yrs. to borrower/homeowner B but because inflation is 2% higher, the investor will charge 7.5% or 8% to compensate for the loss of value of what that note will be worth in 30 yrs.

This is a simplified example, but the point is that normally when the Federal Reserve decreases the FFR, they are trying to stimulate economic growth which means that inflation will eventually start to rise. The 30 yr. fixed rates will start to rise as inflation starts to rise with the economy.

This is not always the case and we are seeing the exception in today's interest rates. The last few FFR cuts led to declining 30yr. rates and part of the reason is that we may be heading into a mild recession. There's an interesting article from Goldman Sachs anticipating that we will have a recession in 2008 and that the Fed Funds Rate will be cut to 2.5% by the third quarter from 4.25% that we are at today.

If this comes to pass and the FFR rate is reduced to 2.5%, we will most likely see 30 yr. fixed rates in the 5% range.

A number of analysts are expecting a .50% rate cut at the Jan. 30^th meeting. This will reduce your Prime based interest rates like your home equity line and some credit cards. The Prime rate is just the FFR plus 3%.

Stay posted, because I believe that 30 yr. rates will continue it's trend down and should help homeowners qualify for an inexpensive mortgage to take advantage of the tremendous real estate bargains. Let's help move inventory off the market and get our home values back on the rise.

But Wait There's More:

Jim McMahan, a Mortgage Broker in Texas taught me some guidelines that the FED tends to follow:

1. The FED's goal is to keep Core Inflation (C.I.) at 3% or less. (the PCE is currently at 2.16%)

2. Everytime we've had a recession, the FED has taken the Real Interest rate to a negative number in order to stimulate growth:

Real Interest (R.I.) rate = Federal Funds Rate (F.F.R.) - Core Inflation (C.I.)

(2.09% = 4.25% - 2.16%)

3. Real Interest rates have never increased 8 quarters in a row unless inflation (C.I.) was present at 4.5% or greater.

4. Mortgage Rates in the U.S. have been at or below 7.5%, 85% of the time in the last 80 years.

5. Mortgage rates tend to gravitate towards Core Inflation (C.I.) + 3.5% (2.16% + 3.5% = 5.66%)

Cashflow Coach

Copyright © 2008 the Cashflow Coach | All Rights Reserved