I've been talking a lot lately about how our country is on a collision course with fiscal disaster. We're borrowing money like crazy. We're spending trillions we don't have. Our budget deficit is exploding, with red ink spewing as far as the eye can see! Longer-term threats to government programs like Medicare and Social Security are getting graver by the day.
Meanwhile, the Federal Reserve is adding more and more garbage to its balance sheet every week. It's trying to reinflate the last bubble by pumping massive amounts of money into the economy and slashing interest rates to the bone. And it's expanding its tentacles into every corner of the credit markets. This is undermining the Fed's independence and virtually guaranteeing that future rate decisions will be compromised by politics.
More worrisome: We could be staring down a significant wave of dollar devaluation and inflation, delivered by the Fed and sanctioned by academia. Heck, just this week two prominent economists ? former White House adviser Gregory Mankiw and former International Monetary Fund chief economist Kenneth Rogoff ? encouraged the Fed to let inflation get out of control. Rogoff suggested the Fed adopt a whopping six percent inflation target!
Are these guys nuts?
Look, we can't control everything Washington does. But we can take steps to keep OUR finances from imploding, even if Washington insists on torpedoing its own. So this week, I'd like to share my suggestions on how to gird yourself for tough times ahead ...
Step #1: Save More ...
I'll warn you right up front: This Money and Markets column will make liberal use of the "S" word. No, not that one. I'm talking about "savings!"
The Fed is doing all it can to destroy your savings. It's taking steps that could crush the purchasing power of your dollars. And by driving interest rates to practically zero, it's making it so your ultra-safe funds can't generate much of anything in interest.
You can do one of two things:
Take the Fed's bait and shovel your money into risky junk bonds or high-yielding CDs being offered by troubled banks. That could theoretically increase the yields your savings generate.
But doing so exposes you to significant principal risk if your deposits are uninsured or if junk bond prices fall. Is that really the best option?
Increase the amount of money you save to offset the loss of future interest income. This isn't the "fun" way to confront the Fed's assault on your savings. It takes dedication and a willingness to tone down your discretionary spending. But it'll help fortify your balance sheet against the risk of a deeper economic recession ? and give you the peace of mind so many folks are lacking today.
Mainstream economists would have you believe the second approach is almost un-American. They talk in Ivory Tower language of the "paradox of thrift" ? the economic collapse that a widespread increase in savings would supposedly bring about.
I say you tell those guys to take a hike, and start saving more! We can't keep living beyond our means as a country ? or individuals ? without consequences, no matter what those pointy-eared economists keep telling us.
Step #2: Borrow Smart ...
I'll be the first to acknowledge that savings can't fund every purchase you need to make. Sometimes, you're just going to have to borrow money. But here too, you have to make sure you don't take the Washington approach. You know: Piling on more and more debt ... spending more and more money you don't have ... and demonstrating absolutely ZERO concern for the potential consequences.
The Treasury may be able to get away with this for a while, though even that's debatable. After all, the Treasury bond buyers we've always counted on to pony up to the bar are bidding less aggressively and extracting higher interest rates on newly issued debt.
What's more, as an individual borrower, you don't have the same market power as Uncle Sam. If you run your cards up to or near their credit limits, or you max out your home equity line of credit, chances are it'll hurt your credit score. That, in turn, will lead to a re-evaluation of your creditworthiness. It'll prompt existing creditors to cut your credit lines and new potential creditors to shy away. They might even offer you less money or charge you higher interest rates.
And don't get me started on home loans ...
Nowhere did borrowing get more out of control in recent years than in the mortgage arena. Borrowers let their appetites get the better of them. They borrowed too much money to buy too much house on too risky terms. As a result, foreclosure rates are exploding higher and people's financial lives are being ruined.
If there's anything good to come out of this whole sorry affair, it's a lesson that serves as a warning to future borrowers. I hope you listen ...
Simply put: If you can't qualify for a 30-year fixed, fully amortizing mortgage ... save up for a down payment of at least 5 percent or 10 percent ... and restrict yourself to a monthly principal, interest, tax, and insurance payment that eats up no more than 28 percent of your gross monthly income, then I've got news for you. You should NOT be buying a home!
Greedy bankers will always try to find a way to subvert these rules so they can pad their own pockets. Don't take the bait!
The same goes for loading your home up with other debt, such as second mortgages and equity lines of credit. These tools can have practical uses ? such as home improvement, where the money you're borrowing can possibly help increase the home's value. But charging pizzas or trips to Aruba on your HELOC is a sure-fire way to get yourself into serious debt trouble, especially in a market where home prices are still tumbling.
I know this may not be exactly what you want to hear ... but hear it you must. Because in these days of Washington insanity, the best thing we as individuals can do is take charge of our own finances ? before they take charge of us!
Until next time,
Harry
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