Question of the day: Ask the financial experts

KSDK -- In a new KSDK.com feature, local financial experts are answering questions related to today's economy.

As the economic rescue plan is retooled in certain areas, government officials say they want to focus on using some of these funds to free up money other places. How would consumers benefit most from these amendments to the plan? By lending money to banks, which they could in turn lend consumers? Or is there a better way to allocate these funds?

Bob Ferguson: There has to be some sort of coherent structure to this plan for it to have credibility to the markets. Consumers obviously need help with mortgage payments and credit card balances, but business also needs to be able to barrow money. The original intention of TARP was to get banks lending again and ease the strains in the credit markets. These sudden changes in Treasury policy do nothing but create more uncertainty in the markets. These are public funds that are being used. The taxpayer visa vie Congress, is going to demand better disclosure and hopefully the release of some type of concrete plan as to how this money is to be used. In my view the Treasury is risking the release of additional money by Congress with these seemingly random, whimsical changes in Fed policy.

Joe Terril: In general the consumer is best served by a banking industry that is well capitalized. However the government helps this to happen is good for the consumer.

Jeff Lapidus: It is clear that what we are being sold and what the desired outcomes are hidden. Clearly, the banking system was on the edge of collapse based on consumer confidence. That has now been reduced by capital injections and increased FDIC guarantees.

I was never an advocate of the initial "buy the toxic loans" from the books of the banks. The free market is required to determine what is the price of these securities. It appears at this juncture that the TARP assets will be used to consolidate the banking industry which is not a bad thing. Healthy banks will strive to attract depositors through higher interest rates on various savings instruments which is a good thing for consumers.

The ability to access credit has also tightened which will also be a good thing for consumers. Free and easy credit leads to excesses by many consumers who had questionable ability to repay their obligations. We are all better off in a healthy financial system.

As this recession deepens, many more people will lose their jobs. This is unfortunate but necessary for companies to become more cost efficient and profitable. Once this downsizing and realignment has occurred, the economy will have a stronger base and expand to greater heights in the future. This will have a positive effect on your checkbook, your 401(k), and your investment portfolio.

Rick Sharp: The bad part of the TARP revision is that markets and businesses hate surprises. Though changes may result from very real obstacles or improved analysis, they reduce the confidence and trust that is necessary for the market to function smoothly. Businesses are generally unwilling to commit their funds when the rules are constantly changing.

The good news is that the changes may be better for consumers. Treasury says they will implement "matching" programs where a firm's management must raise private capital to be matched with TARP funds, effectively doubling the new capital for the firm and increasing their lending power many times that.

They also intend to try to free up the securitization market. Many types of consumer debt (credit cards, student loans, and mortgages for example) are dependent on the ability of lenders to package the loans into securities to be sold to end investors. Without securitization loan volumes are restricted by the capital and liquidity on that specific bank's books. These limits disappear with a securitization process as the debt is passed through to investors worldwide.

With more people drawing unemployment benefits as a result of layoffs and job cuts, is the government at risk of running out of money in these unemployment accounts?

Joe Terril: In general, no. The account balances at state agencies that operate the unemployment claims will definitely go down. The state agency then increases the tax to employers to bring the balance back up.

Jeff Lapidus: eSimple economics says yes. However, all good and bad things must come to an end. What we need are our leaders to develop plans to get people back to work. To paraphrase, "give a man a fish and he will not be hungry for a day, teach a man how to fish and he will never go hungry." Since so much of our self-esteem is wrapped up in working and being productive- let's get America back to work!

Rick Sharp: My understanding is that the federal government is required to loan money to the state unemployment insurance trust funds so that they can continue to pay benefits. In turn, unemployment taxes on businesses would then be increased to recoup the money.

General Growth Properties, owners of the St. Louis Galleria, and Charter Communications have both made headlines lately for the value of their stock. (Both closed under $1 yesterday.) What does this mean for a company? GGP is discussing bankruptcy. Is a stock valued this low a sign that bankruptcy is coming, that a company is no longer profitable?

Bob Ferguson: A stock that sells below $1 per share is not necessarily headed for bankruptcy because it sells under $1. Nor is it an indication that a company is unprofitable although most companies in this price range are not financial Rocks of Gibraltar. The NASDAQ has the right to delist any stock that remains under $1 for 30 days, so it is definitely a problem for a company that seeks to remain traded on NASDAQ. Most firms generally will not allow stocks under a $1 to be margined. Also many firms cease research coverage of a stock whose price slips into the low single digits. An appropriate analogy might be this one: a person whose body weight slips significantly below normal, may not have a life threatening disease, but dramatic weight loss is usually a sign of some serious underlying health condition. This same applies to public companies and their stock prices.

Jeff Lapidus: Both companies are experiencing tough financial conditions due to a significant debt burden they carry on their balance sheets. Their stock prices reflect the expectation of future value and some question as to their continued viability to service this debt in the current economy.

Joe Terril: Almost always it is a sign the company is not profitable. It does not necessarily indicate the company is going bankrupt. One needs to look at the debt schedule to see how soon there is debt due. The low stock price prevents the company from raising equity to pay off the debt.

Economists have recently voiced the possibility that the economy is at risk of entering a deflationary period. What does this mean exactly, and what would the consequences of this be? Is deflation worse than inflation?

Bob Ferguson: Deflation is where the price of an entire category of assets falls in response to the drop in demand for that asset. Consumer's delay or avoid purchase and the price falls in response to this delay. This occurred during the 1930's after the stock market crash of 1929 and in response to the severe drop in economic activity in the United States that followed. In the case of deflation, assets such as common stocks, real estate, and commodity based assets decline in value. Only when the demand for the asset resumes does the price begin to go back up. Liquid assets such as cash are highly desirable at this time. Interest rates fall in response to the drop in demand. During the Depression and in Japan after their real estate bubble burst in the early 1990's, interest rates fell to near zero. Indeed the best performing assets of the 1930's were long US government bonds, high quality corporate bonds and preferred stocks. This was because investors were able to lock in high yields as rates fell.

Is it worse than inflation? The 1970's was a period of rapidly rising inflation which resulted in the United States being in recession off and on for 49 months during that period-roughly 1/3 of the time according to economist Timothy Taylor. While unemployment did not come close to the levels of the 1930's the real purchasing power of the consumer's dollar was drastically reduced. The stock market ended the decade pretty much where it began and long bonds were a disaster during that time. It certainly did not produce the levels of unemployment or poverty seen during the Depression, so it probably was not as bad. The hyper inflation Germany experienced after its defeat in World War I was something different. It ruined the fragile German economy and wiped out the economic stability of the German middle class. Hitler's rise to power was a direct result of effects of hyper inflation on the German economy and the German's discontent with their government.. In their extreme forms both are bad-very bad. The question is not is one worse than the other, but how do we avoid falling into either one of them?

Jeff Lapidus: A deflationary cycle occurs when demand drops for goods and services which is followed by a drop in prices. This is extremely bad. When supply outweighs demand, not only prices drop but employment is dramatically cut until demand returns.

Inflation is when too few dollars are chasing scares numbers of goods. Usually prices and wages rise. Therefore, deflation is extraordinarily bad while inflation can be painful but tolerable.

Rick Sharp: Deflation is the opposite of inflation as price levels on goods and services fall instead of rise. In a "deflationary spiral," consumers and businesses pull back their spending causing sellers to lower prices and cut expenses by laying off workers. As employment and therefore demand falls, prices are cut further and more people become unemployed, perpetuating the cycle. Business and consumers are afraid to buy, as they fear the price of the goods they are purchasing will fall. (Similar to what is happening now with home prices.)

Deflation is considered to be much harder to stop than inflation. To stop inflation, the Fed can raise interest rates repeatedly as Paul Volker did in the early '80s when he brought the inflation rate from over 13% to about 3%. But today the Fed Funds rate is only 1%; it can't be lowered below 0%. Should we enter a period of deflation, the Fed and Treasury would have to find other ways to stimulate the economy to encourage the purchase of goods and services in sufficient amounts to stop the downward spiral. These methods, forms of stimulus plans, are not as effective as interest rate changes and other traditional methods of regulating the economy.

As the volatility in the stock market continues, should consumers take funds they would otherwise invest and pay down their debt (credit cards, mortgages, etc.)

Rick Sharp: I think in general consumers should be paying their credit card balances in full monthly and also have six or so months of reserve cash in an accessible bank account before they begin to make investments in the market.

Remember that additional money paid down on your mortgage is not available to you in an emergency without re-borrowing it. If you lose your job, for example, it will not be possible to get that money back to use for living expenses because you won't qualify for a new loan. Also, once you pay your principal down IRS rules limit the amount you can re-borrow and still qualify for the mortgage interest deduction. So it pays to do some research before making significant additional principal payments on your mortgages.

Joe Terril: Yes. The consumer could do well by paying down outstanding debts. This is not absolutely mandatory, but it will not hurt.

Jeff Lapidus: It certainly makes sense to reduce credit card indebtedness as rates usually run 14% plus and the interest payments are not deductible. At the same time, committing large sums of capital to reduce mortgage debt where the capital is no longer for income purposes really needs careful consideration. That decision must also consider the ability to generate cash flow to make these payments.

Bob Ferguson: Given the economic slowdown facing us, the potential for layoffs in many industries and the general uncertainty facing us, consumers would be wise to reduce credit card debt if they have the available cash. Not contributing to a retirement plan or using excess funds to lower their mortgages involves more thought since both offer tax benefits to individuals. They should first check with their tax advisors to see if it makes sense for them since each situation unique. The person's amount of income earned, the size of their mortgage, the current interest rate on the mortgage and the years left to retirement, are all important considerations.

What is the biggest financial challenge facing President-elect Obama?

Bob Ferguson: In my opinion the biggest financial challenge facing President Obama is the dual task of getting the economy moving again while at the same time establish regulations in the banking and financial system that restore investor's confidence in the system. This will be a delicate task since too much regulation can keep credit tight and not enough will perpetuate the growing skepticism of the system's integrity. Mutual cooperation between Congress and the White House is essential for success here. President Obama will begin his term walking on the high wire of economic recovery while simultaneously juggling the balls if public opinion, congressional cooperation and as yet unseen problems.

Jeff Lapidus: The biggest problem facing our new president is finding the appropriate role of fiscal policy in getting the economy out of a potentially deep recession. The financial institutions have been provided a lifeline, but how do we get construction and auto industry out of dumps. Another stimulus package that is a handout and not targeted will be another waste of taxpayer dollars. I am hopeful that our new president will be able to take his impressive campaigning skills and translate them into leading this country out of a recession.