Misery Index, Zappos and Expensive Loans

I'm catching up with some reading because I've been busy with work lately. Here are some interesting articles I liked:

Hedonically-Adjusted, Well-Spun, Nominal Misery (The Big Picture) - Are the reported inflation and unemployment numbers artificially low compared to what were reported years ago? Maybe. But what can you do about it?

Credit/Debit/ATM Cards and Foreign Exchange (FlyerGuide Wiki) - All you want to know about spending money and getting cash when you are in a foreign country.

Why Zappos Pays New Employees to Quit And You Should Too (Harvard Business) - Zappos sells shoes online. I've always had great service from them. Although their prices are not always the lowest, unless they are much more expensive, I always choose Zappos. Great service is worth a few bucks.

The End of Entitlement (Newsweek) - Be prepared to deal with the new economic reality.

Why Is This Legal? (Credit Slips) - How do we strike the balance between consumer choice and consumer protection? Should expensive loans be illegal? What about other expensive stuff? Should we regulate prices?

In 2028, 1.40% EE bonds will earn 50% in one day (Savings Bond Advisor) - The 1.4% EE bonds are a rip-off. Why is this legal?

Debt Collector, Universal Default and Home Sales Data

Here are some interesting articles I found last week.

Debt Collection Done From India Appeals to U.S. Agencies (New York Times) - It shouldn't be a surprise. When you call customer service, you talk to someone in India. When they send you to debt collection, they call you from India. I wonder if people can pretend they don't understand what they are being asked.

Credit the cardholder (Atlanta Journal-Constitution, via Payments News) - Consider this. Suppose you lent money to someone. You heard from other people that your borrower started paying late or stopped paying those other people. Are you concerned you may be next? Should you not be able to raise your borrower's interest rate or cut their credit line?

Tracking NAR Spin (The Big Picture) - Nice chart of home sales data with corresponding quotes from the National Association of Realtors. Note the chart shows the number of homes sold, not the average selling price.

Specific share identification mutual fund redemption at Vanguard (IndexTown) - indexfundfan shows how to do specific share identification for selling mutual fund shares at Vanguard. Of course this is only applicable to taxable accounts.

Never Pay a Late Fee Again

Ranking above overdraft or NSF fees from the banks, late fees from credit card companies are probably the most hated fees. Even finance blogger and business executive Shadox who is usually on top of these things is sometimes caught by a late fee. If you ask them nicely, as in Shadox's case, the credit card companies will sometimes reverse the late fee. It would be much nicer if you don't have to spend the time begging them. I wrote previously about how to avoid overdraft or NSF fees from the banks. This time I'm going to share a few tips about how to avoid the late fees from credit card companies.

1. Use a card that doesn't charge a late fee. Not all cards charge a late fee. Some cards actually advertise it as a feature which distinguishes themselves from other cards. If you hate late fees, use one of those cards that don't charge a late fee. If other cards begin to see that they are losing customers because of late fees, they may stop charging late fees too. Clear from American Express is a card that doesn't charge late fees or over the limit fees. I don't personally use this method because I have a better approach. Read on.

2. Reduce the number of cards you use. The fewer accounts, the fewer payments and due dates to worry about. I have only 3 cards: one for business travel, one for gas, groceries and drug store, and one for everything else.

3. Schedule an automatic payment of $100 every month using your bank's online bill payment function. Set it to a date between your credit card statement closing date and your payment due date. It's a one-time setup. Then you don't have to worry about being charged a late fee. I heard this tip from someone else. The minimum payment for most cards is 2% of the statement balance. $100 should cover the minimum payment in most cases. If you charge a lot, make it $150 or $200 or whatever amount that will always cover the minimum payment. With a minimum payment coming in automatically before the due date, you will never be charged a late fee. You can make up for the rest of the bill by your normal due date. Even if you are occasionally late with your second payment, you may be charged a small finance charge, but you won't pay a late fee.

4. Let them auto debit. This is what I use now. I turn over the responsibility for making the correct payment on time to the credit card companies. All my cards offer auto debit. If you don't see it offered online, call up customer service and ask for an enrollment form. I signed up all my cards for it. I let them debit my bank account for the full statement balance on the due date. This way *they* are responsible for making sure my balances are paid in full on time every time. It works perfectly. A side benefit is that I have my money in my bank account for a few extra days. When I was making the payments myself, I usually leave about a week of cushion for possible delays in processing. Now the credit card companies always debit on the exact due date.

This setup also solves the problem of due date creeps. Sometimes credit card companies reduce the grace period and therefore change the due date. If you didn't pay attention and always pay on the same date, your payment may be late. Now if they are doing auto debit, they are responsible to tracking the due date changes.

What if you have to dispute something? Letting them auto debit doesn't mean I don't read the statements. If I find something not right, I can still dispute it. If the amount isn't high, I'm OK with paying it while disputing it. That just makes it much cleaner. If I win the dispute, I get a credit back. If I lose, I already paid it. Unless it's an unauthorized charge or a duplicate billing, the credit card protection probably isn't as strong as they make you believe. In all these years using credit cards, I only had one dispute and it was denied.

Related Posts:

• How To Avoid Overdraft/NSF Fees
• Why Banks Push Debit Cards

TFB's Stumbles: Week Ending April 11, 2008

Here are some food for thought for this week:

My Very Own Risk-Based Repricing Experience (Credit Slips) - A law professor wrote about his experience with disputing a billing error on his credit card.

And It All Comes Down to This ... (Wall Street Journal) - After writing more than 1,000 columns, Jonathan Clements is leaving WSJ. He distilled his advice down to eight simple suggestions. No surprises.

Lenders Swamped By Foreclosures Let Homeowners Stay (Bloomberg) - Borrowers who don't pay their mortgage get to live rent-free for six months. That's a sweet deal.

The real reason borrowers default (Business Week) - And why do those borrowers not pay their mortgage? A recent study from Boston Fed says it's because they are upside down. They stop paying even if they can keep making payments if they really have to. It would be a different story if home prices are going up, not down. "Heads I win, tails you lose ..."

Better never than late (Enough Wealth) - See how homeowners in the U.S. are spoiled. Mortgage rates in Australia are 9%. And it looks like you can fix your rate for maximum 5 years. Perhaps they don't have Fannie Mae there.

And tell me why the U.S. government is contemplating giving billions of dollars to delinquent mortgage borrowers? What a strange world.

TFB's Stumbles: Week Ending March 21, 2008

Market volatility continued. The Fed cut interest rate by 0.75%. The market wanted a 1% cut. For the first time, the Fed dared to give the market less than what they demanded. I added some money to my stock funds last Friday. The shares I bought are up 3% already. Not bad for a short week. We will see what happens next week. I still haven't decided whether I should go beyond my 60/40 allocation. So far I'm just adding to the stocks side to keep up with the market.

These are the interesting articles I came across this week:

Countrywide suspending equity lines of credit (QueerCents) - Proof that a HELOC can be pulled unilaterally by the bank, sometimes right before you need it the most.

Commodities lifeboat being swamped in rush to safety (Financial Times) - A sober reminder for those who believe commodities are the next sure thing. I don't have any money in commodities. I missed the boat on commodities because I didn't want to get on it.

A tale of Stock Mergers and Schedule D (The Financial Engineer) - One more reason for keeping it simple and not investing in individual stocks, at least not in a taxable account. Otherwise get ready for some math exercise.

Jeremy Siegel on Bear Stearns, Rate Cuts and the Looming Threat of Inflation (Knowledge@Wharton) - Even the forever bullish Wharton Professor Jeremy Siegel is concerned about the Fed not doing enough on inflation. Interesting quote about Bear Stearns and Long-Term Capital Management (LTCM):

"The truth is, had they had the liquidity to hold on, the Bear Stearns positions might have turned out to be very profitable. [It's] just like Long-Term Capital Management ten years ago -- had they been able to hold on, those positions became profitable. But they weren't in both of these institutions, and as a result, without liquidity, this is a major risk."

John Meriwether's Bond Fund Loses 24% on Credit-Market Plunge (Bloomberg) - Speaking of LTCM, its former chief is still at it. He's probably going to be able to hold on to his positions this time. From the article:

"Relative-value funds try to profit from price changes between related bonds. They rarely make outright bets that a specific bond will rise or fall. Investors in these funds expect to make about 1 percent a month."

1% a month is pretty decent from bond trading, isn't it? We only hear about it when he loses money. He must have made a lot of money for his clients in the last 10 years. Or else where did the $1 billion come from?

Closing Oldest Credit Card Did Not Hurt My Credit Scores

I wrote about canceling my oldest credit card in July last year. At that time, I said:

"I don't see myself borrowing any money in the foreseeable future. The rate on my mortgage is fixed. I don't think there is any chance for refinancing unless we have another recession."

Although I'm not sure whether we have a recession now, the opportunity for refinancing knocked on my door last month. Because I'm refinancing my mortgage, my mortgage broker pulled my credit reports and credit scores. He sent me a copy and here are my scores:

Agency	Model	Score	Range
Equifax	FACTA Beacon 5.0	803	300-850
TransUnion	FICO Classic (04)	797	300-850
Experian	Fair Isaac (Ver. 2)	780	300-850

 

The scores show that canceling my oldest credit card didn't really hurt my credit. Perhaps my scores were higher before I canceled the oldest card, but who cares. If there was an impact, it was minimal and/or temporary. I didn't have any problems qualifying for the lowest rate on my mortgage refinance with these scores.

I'm Refinancing My Mortgage

Among the stock market chaos, the bond market had a rally, which brought down the mortgage rates. I'm refinancing my mortgage. I already locked my rate but I don't have time to write it up as a detailed blog post yet. If you think you might also benefit from a mortgage refi, you can read these threads on the Bogleheads forum:

• Will mortgage rates drop?
• Refinance a 30 yr. mortgage to 15 yr. if paying off soon?

Looking Inside a Credit Card Portfolio

I was searching for some information about my credit card the other day and I accidentally stumbled upon a collection of interesting documents. They are the offering documents for Bank of America's borrowing backed by its credit card receivables. Bank of America lends money to credit card holders. It borrows the money from the capital market for the funding. The instruments they issue for the borrowing are the so-called Asset Backed Securities (ABS). While I'm not interested in or qualified for purchasing these particular securities, the offering documents offer a great under-the-hood view of a credit card receivable portfolio.

There are many documents. I'm just using a recent prospectus for BAseries Class A(2007-13) Notes as an example. It's a huge document, 232 pages. Most of the interesting data start on page 24. Here are some of my observations:

- 55 million credit card accounts owe Bank of America $94 billion. The average balanced owed is $1,719. 60% of the accounts don't carry any balance. Another 28% of the accounts have balance under $5,000. The average balance owed for accounts which carry a balance is $4,311. (p. 29)

- 5% of accounts, carrying balances over $10,000 each, are responsible for 50% of the balances owed. I'm sure there are some App-O-Rama participants in there, but most of these 5% are probably paying good interests to the bank. (p. 29)

- Cardholders on average pay back 17% of the principal owed in any month. This "principal payment rate" actually increased from 13.6% five years ago. (p. 27)

- The bank writes off 5% of the portfolio every year because the cardholders are more than 6 months late, declare bankruptcy, die, or are fraudulent. Prosper.com lenders should be prepared for at least this level of credit loss. (p. 25)

Contrary to what people might think, it's not easy to be a credit card lender. Funding costs the bank LIBOR + 22 basis points, currently about 5.25%. Charge-offs cost another 5%. That means the bank has to charge at least 10% interest before covering fixed costs.

What Did the Appraisers Do Wrong?

Early in November, the New York state Attorney General Andrew Cuomo accused home appraisal company eAppraiseIt of yielding to pressures from lenders like Washington Mutual and appraising the home values too high. According to the news report, Mr. Cuomo said

"consumers are harmed because they are misled as to the value of their homes, increasing the risk of foreclosure and hindering their ability to make sound economic decisions."

This sounds a little odd to me. Perhaps you can help me figure out how an allegedly inflated appraisal hurt the consumers.

If I understand correctly, here's the sequence of the events related to a home purchase:

(1) The seller lists a home for sale. The buyer looks at it.
(2) The buyer likes it and makes an offer to buy the home.
(3) The buyer and the seller haggle. They finally agree on a price and terms. They sign a sales contract. The buyer gives the seller 3% of the contract price as "earnest money."
(4) The buyer applies for a mortgage with the sales contract attached.
(5) The lender hires an appraiser.
(6) The lender approves the mortgage application.
(7) The buyer accepts the mortgage by signing the mortgage papers.

The purchase price is negotiated between the buyer and the seller in step (3). The buyer comes up with a value of the home they are buying before an appraiser is involved. In a mortgage refinance, the process starts with step (4). The appraiser is called in after the fact by the lender. The lender wants an appraisal to see if the risk is acceptable if it lends the money. The appraiser works for the lender. If the appraisal comes in too low, the buyer will have to look for another lender. Every loan has an application form. If the lender approved a loan which was more than the home's value, it's because the buyer applied for that much. I just don't see how the appraiser hurt the buyer. There was a willing buyer and a willing seller. They struck a deal. Our public officials should stop blaming everybody else when the deal didn't benefit one party as much as they wanted.

Take the Bait On No Interest Financing?

No interest, no payments for 12 months! That's a typical financing offer by furniture and electronics stores. I noticed recently some airlines started offering the same type of financing. For example United Airlines has a United Travel Card which offers no interest or payments for 90 days on qualifying purchases. American Airlines' credit card offers 6 months no payments, no interest on purchases from aa.com. These cards are specific to the airline. They don't have a Visa or MasterCard logo. You can't use them for other purchases. If there is no other discount for paying now, should you take the no-interest financing?

Mathematically, maybe. If you keep your money earning interest, and you pay the same amount X months later, you come out ahead, although you don't earn a cash or miles rebate on these. It's the same as the 0% credit card balance transfer game you may have read somewhere.

Of course the stores or the airlines making the financing offer are not foolish. They use the financing offer as an incentive for you to buy from them. The actual financing is usually outsourced to another company. For example United uses Chase and American Airlines uses Citi. The financial company banks on the percentage of people who can't pay in full when the bill comes due. That's when the fun starts. Interests are silently accruing on the side during the no interest, no payments period. If you can't pay off the entire balance before the due date, you owe interest retroactively. And we are talking about interest rates up to 25% a year.

To be fair, the retroactive interest is disclosed. From the American card:

"FINANCE CHARGES accrue on a promotional balance (which includes the promotional purchase and related fees for optional credit protection) from the transaction date and all accrued FINANCE CHARGES for the entire promotional period will be added to your account if the promotional balance is not paid in full by the end of the promotional period or if you fail to make a required payment on your account when due. "

So they show you both the bait and the trap. If you are careful, you can take the bait without being trapped. If you are not, you will be sorry. I think most people should say no to the bait. It's not worth the aggravation.

Opt Out of Credit Card Convenience Checks

It's getting close to the holiday shopping season. I have received several convenience checks from my credit cards. These convenience checks are usually treated as cash advance which carries a fee. They also make the grace period on purchases disappear. I usually just shred them.

I called my credit card company about something else yesterday. While I had the agent on the line, I asked her if they can stop sending me those checks because I will never use them. To my surprise, she said yes. They don't advertise it but they do have an opt-out list. They can exclude you from the convenience checks mailings only if you ask. Perhaps not all credit card companies have a list like that, but if you hate those convenience checks like I do, it's worth a phone call.

For the record, the company I called is FIA Card Services. If you have success doing the same with your credit card company, please put the name of the company in the comments. We will make a list of companies which allow opting out of convenient checks mailings.

Moral Hazard: Deposit Insurance and Subprime Bailout

Moral hazard refers to the fact that if people don't have to face the consequences, they tend to take on more risk than they should. I learned a great deal of this from the book The Greatest-Ever Bank Robbery. In the 1980s savings and loan crisis, some banks were widely known for losing a lot of money, yet people still continued to pour in large sums of money to them through brokered CDs because they offered higher interest rates than other banks, and because the deposits were insured by the federal government. The troubled banks were gambling with the deposits on high risk loans or stealing them outright. If they won, the bank owners would profit. If they lost, the deposit insurance would pick up the tab. But because the deposits were insured, people didn't care whether the banks would lose them or not. The crisis became much larger than it otherwise would have been. 

The typical means of offsetting the moral hazard is via insurance limit, deductible, and coinsurance. Suppose if the deposit insurance in the U.S. is set up similarly to what's in the UK, the first $4,000 is covered in full, and the next $66,000 is covered for 90%, people would be much more careful about where they place their money. If they used a bad bank, they'd lose 10% of their money over $4,000. Therefore they'd choose carefully who they bank with and not jump on whoever offers 0.1% higher interest rate. FDIC estimated that the NetBank shutdown would cost it $110 million. If the FDIC insurance had a coinsurance component, NetBank would not have been able to attract as much asset, and its closure wouldn't have cost as much. I think the deposit insurance system in the UK is designed much better than that in the U.S.

Fast forward 20 years to our recent residential real estate market. People with poor credit bought houses using zero down, interest only loans with teaser rates. They were gambling that the house prices would continue going up 15%, 20% a year. If they won, they'd profit handsomely. If they lost, well, the lender can  take the house back. Here the moral hazard plays out again. Because there is no downside risk, people took on more risk than they should.

Now we hear President Bush and some senators talking about helping the homeowners who cannot pay their mortgages [Bush video, Sen. Dodd video on YouTube]. That will exacerbate the moral hazard problem. If people get to profit if they win, and receive federal subsidy if they lose, they will take on even more risk. People taking on more risk than they should've is exactly what got us into the current situation. What should be done is the opposite of what Bush and some senators proposed -- discourage the moral hazard. For example,

• Require a 10% down payment on all mortgages. If people can't pay their mortgages, they'd lose their down payment. This way they will not bid up the house prices wildly.
• Require recourse and loss recovery. If a mortgage is foreclosed, the borrower should be required to make up the difference through other assets or future income. If people know that they'd also have their paychecks garnished if they defaulted on their mortgage, they will not take on risky mortgages as easily as they did. If they sell a different property in the future, some of the gains should go to the lender they previously defaulted on.

These measures will put the risks back into buying a house. Buying a house is a huge undertaking and it should be. In the last few years responsible savers couldn't compete with no-risk gamblers. While the responsible savers were diligently saving for their down payment and shopping for houses within their means, they were priced out of the market. If the speculators are driven out, house prices should fall back to more rational levels. The interest rate will be lower too because lenders would become more comfortable with a large down payment and loss recovery. Both lower prices and lower interest rates will benefit the responsible buyers. Our markets should reward the qualified responsible buyers, not the speculators.

Book Review: Your Credit Score

Today I'm reviewing the book Your Credit Score by Liz Pulliam Weston.   

The author Liz Pulliam Weston is a columnist at MSN Money. I picked up this book from the library when I browsed for new personal finance titles.

I hear a lot of buzz about the credit score and I don't understand what the hype is about. After reading this book I still don't understand why people think everybody should care about what their credit score is and everybody should manage their financial affairs around how the credit score is calculated.

The book gives information on what the credit score is, how it is used, what factors influence the credit score calculation, and how to improve your credit score if you have a bad one. Then it also says:

"You don't need to have the very highest score to get good credit. Any score over 720 or so is going to get you the best rates and terms with the vast majority of lenders. You'll have all the credit you need, and then some."

Bingo. 720 is the average credit score for all population in the United States. I think it's worth repeating: if you have an average credit score, you will be able to get the best rates and terms with the vast majority of lenders.

It turns out that people who have above average scores don't have to worry. Use a few credit cards if you want to. Pay your bills on time. Don't carry any balance. Use common sense. That's it. I don't know how much money is wasted by consumers who are scared into buying their credit score from the credit bureaus.

Final verdict: ** (fair) If you have below average credit, read it, otherwise, skip. You won't miss much.

Related post:

• Canceled Oldest Credit Card

What Type of Bank Is Your Bank?

No, it's not a trick question. While most people think a bank is a bank is a bank, the financial institutions we usually call a "bank" actually come in many different flavors. Some are organized under federal laws, some under state laws. Some are a special kind called thrift, savings and loan or savings association. Some are members of the Federal Reserve, some are not. Depending on the types, they are regulated by different entities. I learned these from the book The Greatest-Ever Bank Robbery which I reviewed a few weeks ago. Here are some categories of banks in the United States:

1. National Bank. These institutions are organized under federal laws. Their primary federal regulator is The Office of the Comptroller of the Currency (OCC). All national banks are required to be members of the Federal Reserve. Their names typically (but don't have to) include the word "national" or end with "N.A." which stands for National Association. For example Zions First National Bank and Bank of America N.A. are national banks.

2. Federal Savings Association. These institutions are organized under the federal Home Owners' Loan Act. They are required to do a substantial amount of business in mortgage lending. Their primary federal regulator is a different branch of the Treasury department called The Office of Thrift Supervision (OTS). They are NOT members of the Federal Reserve, but are instead members of a parallel Federal Home Loan Banks system. Their names often (but not always) include the word "savings" or end with "FSB" which stands for Federal Savings Bank. For example Washington Mutual Bank and ING Bank, fsb are federal savings associations.

3. State Member Bank. These institutions are organized under the state laws but they chose to become members of the Federal Reserve. Their primary federal regulator is the Federal Reserve. For example SunTrust Bank and Fifth Third Bank are state chartered banks which are also members of the Federal Reserve.

4. State Non-Member Bank. These institutions are organized under the state laws but they are NOT members of the Federal Reserve. Their primary federal regulator is FDIC. For example Bank of the West and GMAC Bank are state chartered banks who are not members of the Federal Reserve.

5. State Savings Association. Like their federal counterpart, these institutions also do substantial amount of business in mortgage lending, except they are organized under state laws. Their primary federal regulator is FDIC. For example Emigrant Bank is a state chartered savings association.

	Charter	Is Thrift?	Primary Regulator	Example
National Banks	Federal	No	OCC	Bank of America, Zions
Federal Savings Associations	Federal	Yes	OTS	Washington Mutual, ING
State, Fed Member	State	No	Federal Reserve	SunTrust, Fifth Third
State, Fed Non-Member	State	No	FDIC	GMAC Bank
State S&L	State	Yes	FDIC	Emigrant Bank

 

Finally, a credit union is not a bank at all. Credit unions are not insured by FDIC. They are supervised and insured by a different federal agency NCUA.

How do you find out what type of bank yours is? If you use an online savings account, sometimes they use a trade name and you may not even know who's behind the service. My previous post Online Savings Accounts and Their Backers has a list of popular online savings accounts and the real names of the banks behind them. Then use FDIC's Find an Institution search form. Type in a name and you will see its Bank Charter Class. For example, NetBank, which was shut down by the OTS last week, was a Savings Association.

 

As a customer, should you care? Today both banks and savings and loans offer pretty much the same array of services. They are all FDIC insured. That's probably why most people don't even know they are different under the hood. Yet who regulates them may make a difference. During the 1980s the banking regulators in some states and the predecessor of OTS had looser rules, which contributed to the massive savings and loan crisis. However as long as the banks were insured by the federal government, the customers didn't care whether they were run in a safe and sound manner. They dumped large sums of money to the troubled banks because the troubled banks offered higher interest rates. This phenomenon is called the moral hazard.

The customers are still doing the same today. The Wall Street Journal reported that Countrywide Bank is attracting $50 million a day with its higher interest rate. Customers are not concerned about Countrywide's negative publicity because their deposits are insured.

In my opinion, as a customer, you should care how your bank is run, even if the deposits are FDIC insured. There's a moral aspect to your decision. If chasing the highest yield resulted in a FDIC payout, it means you are taking money from other depositors who may be less well off than you are. Doing that intentionally is wrong.

Related Posts:

• Online Savings Accounts and Their Backers
• What Happens When a Bank Goes Out of Business

Should the Fed Cut Interest Rates?

Everybody on Wall Street is waiting for what the Federal Open Market Committee will do to interest rates when they meet on Sept. 18. The Federal Funds Rate options market now implies a 50% probability for a .50% cut and a 30% probability for a .25% cut. The probability for the Fed Funds Rate remaining unchanged is less than 10%.

[Source: Federal Reserve Bank of Cleveland, as of Sept. 9, 2007.]

Should the Fed lower interest rates? I think they shouldn't.

First of all, the Fed stated again and again in the past they wanted to curb inflation. They can't declare victory yet. Inflation isn't low. The Consumer Price Index in December 2006 was 201.8. It was 208.299 as of July 2007, the latest available data point. This means for the first seven months of this year, inflation was 208.299 / 201.80 - 1 = 3.22%. 3.22% inflation in seven months is terrible. If this trend continues, we will have annual inflation rate above 5%. That's simply too high. Inflation isn't under control yet. The Fed shouldn't let their guard down.

Second, the economy is doing fine. GDP growth is healthy. Unemployment is low. The latest jobs number is a one time glitch. Except for the mortgage market, the rest of the economy is doing well. Apple's iPhone still sells like hot cakes, which means consumer spending isn't weak. The economy is doing fine on its own. It doesn't need stimulating. There's no need to cut interest rate.

Moreover lowering interest rate now will send the wrong signal. Wall Street wants a rate cut so their risky subprime mortgages will be worth more because bond prices go up when interest rates go down. Cutting the interest rate now will let the subprime lenders off the hook easily. We can't have the Fed come to the rescue every time there is a stock market sell off. Or else they will just take on more and more risks and expect to be bailed out by the Fed. Many people believe that the Fed's lowering the interest rate all the way down to 1% during the most recent bear market planted the seeds for the housing market bubble and the current subprime problem. I agree with that assessment. The Fed panicked. They cut the interest rate too low and raised it too slowly after the short recession was over. For a great article on how the Fed's policy led to the easy credits and today's subprime problem, please read How Credit Got So Easy And Why It's Tightening from the Wall Street Journal.

Will the Fed cut interest rate in their September 18 meeting? Given that the market predicted a less than 10% probability of the rate not changing, I'd say they probably will cut it. The market participants collectively are usually a lot smarter than anybody else. But I'll be very disappointed if the Fed caved in to pressure from Wall Street. Even if the Fed thinks the economy needs some boost, they should wait until their October meeting. Waiting merely one month won't hurt the economy. But it will send a strong signal to Wall Street and politicians that the Fed makes its decisions independently. The Fed is responsible for the economy. It's not responsible for putting a floor under the stock market. They should make that point very clear.

Most Valuable Bank In the World

Which bank is the most valuable in the world, measured by its market capitalization? Is it Citigroup? Bank of America? HSBC in the UK? UBS in Switzerland?

None of the above. According to this August 23, 2007 article from Reuters, it's a bank in China, called Industrial and Commercial Bank of China Ltd (ICBC).

"Last month ICBC overtook Citigroup as the world's biggest bank by market value and is worth more than US$280 billion. Citi is valued at around US$239 billion."

According to my rough calculation using data from Reuters, ICBC earned about $6.6 billion net income in 2006. Citigroup earned $21.5 billion in the same period. Hmm ... 1/3 of the earnings, 20% more market value.

And which life insurance company is the most valuable in the world? It's not a Chinese company yet. AIG is still #1, but China Life is #2, larger than the French company AXA, the German company Allianz and the Dutch company ING. The earnings story is the same. The Chinese company has much smaller earnings but it has higher market value than the global giants.

It just shows how out of whack the Chinese companies' values have become. Yes the Chinese economy is growing fast, but having the world's No. 1 bank and No. 2 life insurance company? I don't think it's rational. Back in May I thought China was in a bubble. The bubble just became a lot larger. The Shanghai stock exchange index rose another 40% in 4 months since May 2007, or how about up 220% in one year? The P/E on the other Chinese stock exchange reached 70 [source]. Scary stuff.

What Happens When Your Mortgage Lender Goes Out of Business

Since we had the subprime problem, many mortgage companies went bankrupt. The largest mortgage lender in the country Countrywide Financial (CFC) announced today that they drew down their entire $11.5 billion credit line. The analogy for this move in personal finance is like a person who normally uses credit cards only for convenience all of sudden maxing out ALL of their credit cards. It's a signal of distress. The credit lines are supposed to be a backup. They are there but you are not supposed to use them unless there's something seriously wrong. There's talk of bankruptcy. Usually before someone goes bankrupt, they draw down all their credit lines. WorldCom did the same to their $2.65 billion credit line in 2002, about 2 months before it filed for bankruptcy. The credit line draw down from Countrywide today is more than 4 times as large as what WorldCom did.

I'm not saying Countrywide will go bankrupt. I don't know that. But one can't help but ask what happens when your mortgage lender goes out of business. I wrote about what happens when a bank goes out of business in February. That was from a depositor's point of view. What if you are a borrower?

First the bad news. You will not be let off the hook on your mortgage. Even if the lender goes out of business, you are still responsible for paying your mortgage. Someone else will take over the bankrupt company's assets (the loan to you) and demand payments from you. If you don't pay, they will take your house. Sorry, you are not going to get a reprieve.

Now the good news. Your loan term will not change. If you have a fixed rate mortgage, your rate will remain fixed. If you have an ARM, it will adjust according to the index and the original schedule. You may have to send your payment to a different place, but as long as you pay by the original loan terms, nobody can change the terms on you and force you to pay more. Nobody can call in the loan and force you to refinance either.

In the end if your mortgage lender goes out of business, it'll be a non-event for you for the most part. You will not benefit from it. Nor will you be negatively impacted financially. Tax reporting may get a little messy. The bankrupt company may not issue the 1098 form timely. Your loan may get punted from one place to another. There's not much you can do about that. Just keep your eyes on payment notices. Keep paying your mortgage and send your payments to the right place.

Credit Card Dispute Against Priceline

This is an update to my credit card dispute against Priceline. When I went on vacation a few months ago, Priceline gave me a bad hotel. I'm usually not very picky. But this time it was bad enough for me to file a dispute with my credit card company against Priceline. It was the only dispute I ever filed against anybody. Just as I predicted, my dispute was denied. I received a form letter from my credit card company, which said:

"We have thoroughly reviewed the details of your dispute, and based on the information we have received, we are unable to issue a credit for the disputed amount(s). We understand that you were not satisfied with the outcome of the service provided by the merchant. Unfortunately, the merchant has the right to receive payment for services that were rendered. At this time we consider this dispute closed and the full amount now due."

So basically as long as *some* service was provided, no matter how crappy it was, no matter whether it was misrepresented or not, there is NO protection from the credit card company.

I was not alone in complaining about Priceline's misrepresentation. Many other travelers left negative comments about the same hotel right on Priceline's website. Here are few of them:

"You can tell just from looking at the outside of the [...] Hotel that the building is old, and the rooms are just as shabby with old or cheap furnishings, a tiny television, and ceilings that are in ill repair. It really seemed more like an old Holiday Inn or similar budget hotel, and not a three star establishment."

"I was very disappointed even with the reduced price. The A/C was on its last legs."

"Very poor! Not a 3 star hotel--dirty chairs with large stains. Dirty curtains. Slow room service. A clock radio that was broken. And a very noisy room--both from road noise and hallway noise. I've traveled for years for work--and this was not a 3 star hotel!"

Yet Priceline continues passing off that hotel as a quality hotel.

I didn't have high hopes for the credit card company. I always thought the credit card protection is a myth. Now it has become very clear to me. Choosing a reputable company for your business is the best defense against unsatisfactory experience. I learned my lesson.

APR or APY, It Doesn't Matter

It's very strange. I see a lot of people reaching my blog when they search for information on converting APR to APY or vice versa. They end up on my post last year Interest Rate: APY and APR which mentioned two Excel formula: EFFECT which converts APR to APY, and NOMINAL which converts APY to APR. While it's nice to know that 5% APR is 5.13% APY and 5% APY is 4.88% APR, I think they are missing the big picture. The difference between APR and APY is not a big deal.

If someone is carrying a car loan at 4.99% APR and the interest rate on an online savings account is 5.30% APY, is this person better off keeping the money in the savings account or paying off the car loan? Do I need to convert one to the other and compare the numbers? Not really. The difference between APR and APY is so small you can pretty much ignore it. What makes a much bigger difference is taxes. You have to pay federal and state income taxes on the interest earned in a savings account. There is no tax deduction for the car loan. Therefore, before taxes, 5.30% APY and 4.99% APR are about equal; after taxes, 5.30% APY is much smaller than 4.99% APR.

So, if anyone comes to this post again searching for converting APR to APY or converting APY to APR, please stop. Forget it. It doesn't matter. Look at the effect of taxes instead.

Carnival of Personal Finance #110

Carnival of Personal Finance #110 is up at Fat Pitch Financials. My entry in the carnival is Out of the Market and Meaningless Stats. The following articles in this carnival stood out for me:

* Car-free Living Is the Path to Financial Independence by A Canadian and Her Money. Owning and operating a car is expensive. By my calculation it costs about 40 cents per mile if you include all vehicle operating costs.

* How Dumping TV Allowed Me to Quit My Job, Create an Online Business and Fund My Retirement Account by SavingAdvice.com. I didn't realize how much commercials take up in a typical TV hour until I watched TV in a hotel when I traveled on vacation. I cut my cable subscription 2 years ago and I never regretted it.

* How Much Is Your Privacy Worth by Chief Family Officer. I think this is the best article in this week's carnival. When you open accounts for the sole purpose of earning the signup bounty, you are basically selling your private information, social security number and everything. It's funny people say they value their privacy highly but they won't hesitate for a minute giving out everything when there's a signup bonus dangling in front of them or when a new bank offers 0.05% higher interest rate.