Payday Lenders and The Post Office

Did you know that the average rate on a payday loan is around 600%!?!

Payday lenders and pawnshops both fit into the category of financial intermediaries. They are just as much a part of the financial system as your bank on the corner. Like banks, both make money by lending money. Unlike banks, they don't have depositors. Instead, their lendable cash comes from investors.

Pawnshops make loans that require collateral-- take in Grandma's wedding ring and get some ready cash based on its value. The buyback will be more than their purchase price, meaning your interest charges are built into the transaction. Of course, if you default on the loan, they sell the ring! A win-win for the pawnshop guys.

Payday lenders don't require collateral, only a post-dated check. Because there is no collateral, the implicit interest rate on these loans is, generally, higher than the pawnshop. Both are designed to be short-term loans.

Each state sets the rules for payday lenders operating within their borders. Four states don't allow payday lending: Arizona, Arkansas, Georgia, and North Carolina (interesting that 3 of the 4 are southern states). One state, South Dakota, has a no holds barred policy on these institutions.

In Mississippi, the limit on the total anyone can have at any one time in a payday loan is $500. Average cost for this cash advance loan is around $20 per $100 borrowed. Write a check for $500 and get $410 in cash. Later, the lender puts the check through to collect the full $500 ($410 for the loan and $90 for interest).

The small dollar amounts make them seem trivial, but the short-term nature makes this an expensive way to go. Do the math on the dollar fee and the term of the loan, and you'll see how you can get to 600%!

Lenders will time deposit of the post-dated check to match your next payroll cycle. If it bounces, they are only allowed to charge one $30 NSF fee.

Is this predatory lending? Well, they serve a purpose in the marketplace. There are folks who need money but have no access to banks or credit cards. The problem is that many become serial borrowers and get caught in a never-ending cycle of high interest loans. Payday lenders justify the high rate by pointing to the risk and high default rates among this population. What's the answer?

There is a proposal to go back to the old Post Office banks to serve this segment of the public. These would be government-sponsored banks that would offer loans to high-risk customers at more reasonable rates than the payday lenders. For an ailing P.O., this could be a win-win!

realized political risk

MSCI classifies Ukraine as a frontier market, that is, an underdeveloped, underinvested, 'more emerging than emerging' market economy. This keeps it out of most indices and funds and off of most investors' radar. Lately, however, Ukraine has been in the news over large anti-government protests that reached a dramatic crescendo as the olympics died down.

Since the collapse of the USSR, Ukraine's economy has struggled. It used to have a large and diverse manufacturing base, but failure to invest since 1991 has led to declining output. Poverty and corruption are also a big problem in Ukraine, leading to a large underground economy. Bribery and onerous regulations make it hard for legitimate businesses to emerge. In the capital, Kyiv, this underground economy is in plain view in markets right alongside the high-end shopping and restaurants that dominate the center of the city. Enterprising individuals offer their cars as taxis or open up stalls to sell clothes straight from factories or simply sell food on the curb. 

While the economy has declined, it's underpinnings are still valuable. Current economic problems stem largely from underinvestment and the drag of corruption. The potential for growth and investible business is immense here.

This corruption also highlights the great political risks of investing in a country like Ukraine. The former president Viktor Yanukovych strenghened ties with Russia by borrowing money and getting subsidized fuel in order to try and prop up the struggling state. This took an explicit turn away from trade agreements with the EU. Protests erupted over this and other aspects of his government, resulting in Yanukovych fleeing Kyiv to Crimea - a semi-autonomous region with much deeper ties to Russia than the rest of Ukraine. Crimea is home to a Russian naval base, and Russia has moved troops on the ground, ostensibly to protect Russian citizens there. It appears that the region is on the brink of actual war -  Russia has a history of inserting troops into former SSRs, and Ukraine is clearly no exception.

Political risk be realized in dramatic instances like this, but it's true cost is much more insidious. Political risk leads to economies being underproductive and investments being undervalued. For countries that are moving towards a more open, fair economy, the opportunity can be great.  As the drag of corruption eases, these economies can grow closer towards their full potential. Generally optimistic, I see frontier markets as an overwhelmingly positive long term investment opportunity.

the long term

Investment Advisors like to talk about returns in the long term. By long term I generally mean somewhere between "more than 10 years" and "pretty much forever." We talk about the long term for good reason. In the short term, stock investments can swing in any direction - from the dark days of 2008 (S&P 500 down 37%) to the bounce the next year (up 28%) to a boring 2011 (barely up 2%) to the puzzlingly exhuberant 2013 (roaring up over 32%!). It just doesn't make sense to talk about what might happen in the next year or two. Looking back further the S&P 500 is generally cited to have average returns of about 7% a year (that happens to be bang at where returns have been for the past 10 years). But again, we don't know what will happen in any given year, only that the long term has been good.

We also talk about the long term because your biggest financial decision is a long term decision - retirement. The decision to end your income and rely on what you have saved is a huge decision that you can look forward to from your first paycheck.

It is also the long term that is your greatest helper when trying to reach that goal.

Returns can vary year to year, but thanks to compounding, having a positive return for a longer period is always better than that same return over a shorter period.

For example, at the oft-cited 7% return, $1 saved up for 20 years would turn into $3.87. If that is short of your savings goal, you need to adjust one of two things - the return or the time. To double this in the same time period, you would need a return near 11%. While the stock market has had plenty of 11%+ years, the long term average is still only 7% and you are unlikely to find 4% of outperformance that persists for 20 years.

The easiest way to double your money is just to wait. At the same average return on 7%, waiting another 10 years - or better yet - starting 10 years earlier, would turn your original $1 into $7.61. Chasing higher returns not only improbable, but is probably risky as well - but fortunately, time is on your side.

So there you go - the easiest way to double your money is just to wait. The more time you give yourself to save, the more you will have. Get started saving and investing as soon as possible!

paying off debt

Last week I paid off the last of my student loans. I did not have a lot to start with, so finally getting rid of them after only 4 years was not a difficult task.

Paying off debt can be a huge emotional relief. It seems like it would be a financially savvy move too - but that is not always the case. Let's look at when it makes sense, and when it does not. The general rule of thumb is that you should pay off debt when the interest rate is as high as, or higher than what you could earn on that money elsewhere. For a point of reference, I generally look at long term investments earning 6% or more (over 10-20 year periods).

Mortgages are the biggest debts Americans owe. These are very long term debts and money is cheap right now! With my mortgage at 3.5% I am in no hurry to pay that off, as I expect my long term investments to earn a premium over that. However, even at these low rates, there are special cases. There are various thresholds which may benefit the homeowner to be under:

• Paying a little extra off before you refinance may help put you under a threshold to get a better rate. Namely, prime rate mortgages generally require 20% equity or more, so if you owe $121,000 on a $150,000 home, paying an extra $1,000 might translate into big savings on interest. 
• Certain loans may have Mortgage Insurance Payments which go away once you hit a certain threshold. For instance, FHA loans typically require 22% equity before the mortgage insurance payment goes away. The insurance payment will vary with the program, so check with your mortgage servicer to see where your threshold is.
• Refinancing. If interest rates are lower than when you got your mortgage, look into refinancing. Though the monthly payment may be higher, a shorter term loan may have a lower interest rate, and the faster amortization will mean you pay less interest overall.

Credit Card debt is a big problem. While this is some of the most flexible debt you can obtain, you pay dearly for that flexibility.

• Check your interest rate. Rates on credit cards are typically variable and if you carry a balance, will probably only rise. Average APR right now is over 15%, though cards with rates from 20-30% are not uncommon. With an interest rate of 18%, every $66 you owe translates to about a dollar of interest a month - that's money you never benefited from.
• Many cards come with an introductory 0% APR. If you need to, take advantage of this, but you will want to pay down the balance aggressively before the interest rate shows up.
• Lower your total credit utilization. This is a question of thresholds again. Your utilization ratio is your total balance outstanding to your total credit available. This total is from all of the cards in your name - 50% would mean that the sum of all of your balances is half of the sum of all of your credit limits. The recommendation is to keep the ratio under 30%, but the lower you go, the better. This accounts for almost a third of your FICO credit score, so it may be worthwhile to pay down even a low or 0% interest card if you need your credit score to drift up.

Student loans are in the headlines in very scary ways lately. Rising use of student loans has been in a vicious cycle of being needed to pay ever higher tuition while also making it easier to bid up the cost of said tuition. In general, student loans are a great idea - it is some of the easiest debt you can get, and you expect to earn enough to comfortably pay for it when you graduate. The problem now is that people are not getting payed quite what they expected. Government program loans are typically fixed rate and for a 10 year term while private loans are have variable rate options and different terms. The lowest rates are for undergraduate loans, but graduate and parent loans are a much higher rate that may usefully be paid off early. There are repayment programs available to help ease the cost of the loans when you first start paying them back.

Debt can be intimidating, but that doesn't mean it can't be useful as well. The decision to pay off debt is just as important to consider carefully as the decision to take the debt on in the first place.

A CBO Report To Crow About!

While everyone was screaming and drawing battle lines over the latest CBO report on the Affordable Care Act, I was reading another CBO report—“Budget and Economic Outlook:   2014 to 2014.” You can find the report here http://www.cbo.gov/publication/45010 . It’s quite uplifting.

Since the Financial Crisis of 2008, growth in our economy has been tepid, coming in below 3% each year. In our office, we carefully follow the release of each piece of economic data. We noted the slow improvements in our economy since 2010 and saw a pick up in activity in 2013. It seemed that we were back on track. Our view is that this would continue into 2014. After the auspicious beginning in markets this year, our projections seemed too optimistic. Nice to know the CBO agrees with us!

According to the report, GDP growth is expected to be 3.1% for years 2014, 2015, 2016, AND 2017. While still not setting the world on fire, 3.1% is a healthy rate. Four years of this pace will be good for business!

Buried in the report is a comment about the improvement in state and local budgets. They are healing from the huge losses of the past few years and are finding themselves with more cash than expected. The result is that these state and local governments should begin spending again. More spending here means more economic growth.

And maybe some of their spending will involve hiring more people. THAT will be a welcome change, since 2/3 (TWO-THIRDS, you read that right!) of the job loss over the last five years has come from the government sector. The CBO projects the unemployment rate will stay above 6% until 2016. A turnaround in this trend will help with our stubborn unemployment situation.

And guess what else?

The federal deficit continues to shrink!! Much of that is due to improvements in tax revenue with an improving economy. The CBO expects a further reduction of $514 billion in 2014 and $478 billion in 2015. In 2016, they expect us to start losing ground again since we refuse to address the real problems in our budgetary process. In fact, with the exception of Social Security, healthcare programs, and net interest, all other government programs are seeing declining expenditures.

And inflation? Meh.

Don’t expect anything beyond 2.0% for the next few years.

I was all smiles until I got to the part covering 2018 and beyond. They are projecting a return to the snail’s pace for our economy at that point. I’ll be like Scarlet O’Hara and worry about that tomorrow! For now, I’m looking at the glass half full.

With all this positive news, why didn’t THIS report make the headlines?!?