Consider the Depression Generation. So scarred was it by insecurity that, forever after, its members borrowed no money and took no risks. They mistrusted the prosperity that swelled around them because they “knew” it wouldn’t last.
Now consider the Inflation Generation who came of age in the 1960s and 1970s. They saw in a flash that a dollar saved was a dollar lost because inflation ate it up. A dollar borrowed was a dollar saved. You could use it to shop before a price increase.
The Inflation Generation felt sorry for the codgers who saved so arduously and lost so much. The value of their low-interest bank accounts, fixed pensions and insurance policies eventually fell apart.
Now the question is whether the Inflation Generation can change its approach to money any better than the Depression Generation could. Time turned traitor again in the 1980s, deflating the strategy of borrow-and-spend. Yet large numbers of Americans still behave as if real-estate values will always rise, loans will be repaid in cheaper dollars and salaries will go up forever. To act otherwise goes against their generational grain, even though the 1990s demand an entirely different response.
The immediate economic pain - the mass layoffs - will end when the recession does, a time most analysts put at anywhere from this spring to this fall.
But beneath the recession a longer process is underway: a wringing out of personal and corporate debt; a slump in commercial construction until all the empty office buildings finally fill up; a shortage of credit, as the banks concentrate on covering their losses instead of greasing the next expansion. Even when the downturn passes, “a subpar economy will linger for a couple of years,” says Allen Sinai, chief economist for the Boston Co. For individuals, that means slower growth in job openings than is typical in an economic recovery, slow or no growth in standards of living, undependable housing values and wages rising too slowly to cover the interest on too much debt. The flip side of a lazy economy is bargain pricing, slower inflation, lower interest rates and - if the Inflation Generation can take it - a turn to the old-fashioned virtues of saving and thrift. Here’s your guide to the siege ahead:
You cannot rely on gains in the value of your house to substitute for the money you’re not saving yourself. Those gains may not come. As backup, you need a regular savings program - either automatic payroll savings at work or automatic monthly transfers from your checking account into savings or into a mutual fund (any fund can arrange this).
Assuming that the recession deepens, interest rates will fall further. The savings you keep in a floating-rate money-market account will earn less and less. Consider reinvesting the funds that you don’t need right now in certificates of deposit or Treasury securities. Treasuries can be purchased, at no sales charge, through any Federal Reserve bank or branch (ask your own bank where the nearest Fed is). For the highest CD rates in the country, take a $34 trial subscription to the publication “100 Highest Yields,” 860 Federal Highway One, N. Palm Beach, Fla. 33408. Some of the institutions it lists are near collapse but others carry top safety ratings. Among the latter, all recently paying about 8 percent on one-year CDs: First Trade Union Savings and the Mercantile Bank, both in Boston, and American General Financial Center in Midvale, Utah.
The traditional reserve - three months’ income on tap - is not a sufficient safety net for the freshly disemployed white-collar class. Jobs don’t come easily to a banker or broker out on the street. You should aim for enough ready cash to support yourself and your family for a year, in addition to whatever severance deal your company offers. What makes up a suitable reserve? Cash savings, readily salable investments like stocks and mutual funds and some borrowing power on credit cards or a home-equity line.
As a group, the funeral-home stocks outperformed all other industries in 1990, which pretty much defines the kind of year most investors had (table). Stocks today are up 8.5 percent from their low of last October. The bulls believe the worst has passed; the bears predict another downdraft. Any serious long-term investor should be buying this market - downdraft or not - by putting in money every month. If you’ll drive for miles to a factory outlet to buy a coat at a half-price sale, how can you not buy stocks or stock mutual funds when they’re on “sale?” That’s the only way to make money. If you don’t buy in recessions when prices are down, you shouldn’t bother buying stocks at all.
That is, unless you’re in the Doomsday camp. Walter Stone of the investment firm Kanon Bloch Carre & Co. in Boston sees an agonizing 1930s-style crash, lasting until mid to late 1992 and dragging down the Dow Jones industrial average to 1000 to 1200, from about 2565 today. If he’s right, buyers will become longer-term investors than they had intended. By contrast, Anthony Tabell of Delafield, Harvey and Tabell in Princeton, N.J., almost yawns while pronouncing this “a perfectly normal, run-of-the-mill bear market,” which he thinks might end as early as March.
The banks’ cost of funds from the Federal Reserve started dropping in April 1989 and so did the rates the banks pay on savings deposits. But not those charged on consumer loans. They’re stuck to the ceiling, reports the Bank Rate Monitor, which surveys interest rates at banking institutions. Over that period the Fed funds rate slid by 3 percentage points - yet rates on auto loans fell an average of only 0.25 points, unsecured personal loans rose 0.4 points and credit-card rates rose 0.75 points. Making the burden even heavier, taxpayers who itemize have now lost the last sliver of their consumer-loan interest deduction.
If you do have high-interest loans and own a home, consider switching your debt to a home-equity line of credit. Interest rates (which generally float along with market rates) now run in the area of 10.5 to 11.5 percent. What’s more, interest payments are still tax deductible on loans up to $100,000. Three risks:
(1) Once your credit cards are clean you might run up consumer debt all over again. To minimize this possibility, the Goldome thrift based in Buffalo, N.Y., requires borrowers to cancel all the credit lines and cards that they’re paying off with money borrowed on their home-equity line.
(2) Your four-year auto loan, once transferred to a home-equity line, might turn into a 10-year loan at twice the cost because you’re not forced to repay faster. When you consolidate, work with your banker to budget your payments, so you won’t inadvertently stretch out your loans. Alternatively, take a fixed-payment fixed-term loan. This loan has the added attraction of shielding you from a rise in rates.
(3) If your house drops in value, and you’re behind on your payments, your banker may force you to repay some principal. That’s exactly what’s happening to nearly 5 percent of the home-equity borrowers at First Federal Financial Services in Rutherford, N.J. “We try to make the payments as palatable as possible,” says vice president Mark Sussman although, he adds, “If they don’t have it, you can’t get it.” To minimize the risk that part of your loan will be called, borrow no more than 50 percent of your home’s value.
Donald Trump isn’t the only one who can bargain with his bankers. Virtually every lender will restructure a loan if you can’t make your current monthly payments. Some arrangements are temporary: you might make partial payments for a few months or skip some payments altogether. Or the entire loan might be refinanced. You should not be reported as delinquent to the credit bureaus if you’ve reached an agreement with the lender and live up to it. Don’t make the mistake of ducking your creditors. They’ll work with anyone who calls but sic a collection mastiff on anyone who doesn’t.
(wiped-out urban professionals): Bankruptcy is a rotten choice for anyone who can possibly avoid it. The siren song of “starting fresh” may especially tempt the Yuppie class, which in its heyday, had so much credit shoved into its pockets. But life after bankruptcy isn’t the breeze that many a lawyer makes it sound. The blemish sticks to your credit history for 10 years - and forever, if you’re being checked for a mortgage, an insurance policy or a job paying more than $50,000. “Employers look at credit reports and see them as signs of character,” says Jay Muzychenko, vice president of the National Foundation for Consumer Credit. “It might cause you a credibility problem.”
Bankruptcy doesn’t liquidate student loans, tax liabilities or child support. It will probably block you from any future job that requires bonding and may cause a landlord to reject you as a tenant. You’ll need a high down payment to buy a car (maybe 50 percent or more) and won’t get other credit easily, now that lenders are tightening up.
If you have no option but bankruptcy, start with the wage-earner plan (chapter 13 of the Bankruptcy Code). You negotiate reduced payments on your loans rather than dump them altogether. Homeowners, in particular, will be helped by the “cramdown” - a new form of court-ordered debt relief truly crammed down the lenders’ throats.
In the past, chapter 13 bankrupts in most states had to make their full mortgage payments or lose their homes. But courts in several states have chopped the size of the mortgage loan when the house is worth less than the sum you borrowed. The remaining money owed becomes an unsecured loan, none of which may ultimately be repaid. “The whole idea is to pay what the lender would have gotten at a foreclosure sale, but let the borrower keep the home,” says Oklahoma City attorney Mark Farmer who has pleaded several of these cases for lenders.
If one spouse goes bankrupt, can the other spouse protect his or her credit record? Usually yes, if the debt is just in one name. “But depending on state law, the credit generally needs to have been separate for at least six months before the bankruptcy filing,” says Paul Richard, executive vice president of the National Center for Financial Education in San Diego. “And even then, the lenders might challenge.” If one spouse’s unincorporated business goes broke, the assets of both could be on the table. Both are also responsible for any cosigned loans. Furthermore, the judge will look at both incomes when deciding whether to grant a bankruptcy petition or what the couple can pay on a wage-earner plan.
Mobile young people looking for their first or second job should curl up for half an hour with the results of the 1990 census. The areas of the country with the strongest population growth will probably recover more rapidly than those that are stagnant or losing population.
Over the 1990s, the Bureau of Economic Analysis sees tepid growth in New England and parts of the Mideast (New York and Pennsylvania), the Great Lakes states and the Middle West. The states with the strongest projected growth in population and employment: Delaware, Florida, Georgia, Virginia, Arizona, New Mexico, Colorado, Utah, California, Nevada, Washington and Hawaii. Personally, I’m making a side bet on parts of the Middle West. The old rust belt should turn into a chrome belt, as America’s manufacturing plants increasingly tool up for customers abroad.
Prices are weak and mortgage rates falling - a window that rarely stays open for long. Lower rates bring out buyers and prices start up. Adjustable rate mortgages (ARMs) average 7.9 percent for the first year (including teaser rates that can rise by as much as 2 points in the second year), according to HSH Associates in Butler, N.J. Thirty-year fixed-rate loans, at 9.7 percent, are around the lowest in four years.
This past summer, ARMs adjusted to the 10.5 percent range. It might pay you to jump to a new low-rate ARM, depending on the upfront costs. In general, the switch makes sense if your lower monthly payments will recoup your closing costs within two years. If you’d rather switch to a fixed-rate loan, you might want to gamble on even lower rates by March or April as the recession rolls on. A good rate to aim for: 9 to 9.25 percent.
Some economists as well as stock-market pessimists see a far harder row to hoe than most people imagine. But the odds are against a true rerun of the 1930s. Back then, the government let the financial system collapse. This time, it is bailing out S&Ls, maintaining banking stability and preventing the sudden and devastating liquidation of overindebted corporations. Economist David Levy of Industry Forecast in Chappaqua, N.Y., calls it a “contained depression” - with liquidations proceeding in an orderly rather than a chaotic way. The huge government deficits will keep the economy stimulated, Levy says, but not by enough to allow a true recovery from recession. His view of the 1990s is darker than that of some of his colleagues but his theme is the same: growth will be frustrated for some years.
The old assumption that war spending helps the economy is not widely held with respect to a war in the Persian Gulf. The spending beefs up a few sections of the country that specialize in military manufacture, like southern California. But war would drive up oil prices, interest rates and the inflation rate, and divert money away from pressing domestic needs. “We cannot have guns and butter this time,” Allen Sinai says. If a war lasts any longer than just a few days, buy short-term Treasuries and wait.
Over the past 12 months, investors lost money on almost everything but cash and government securities.
Investment 1990 Return
One-year CD +7.9% Money-market funds +7.8% U.S. government bond funds +6.0% Private homes -1.9% U.S. growth funds -5.5% Junk bond funds -11.9% International stock funds 12.8% Gold funds -24.6%
SOURCES: BANK RATE MONITOR; LIPPER ANALYTICAL SERVICES; NATIONAL ASSOCIATION OF REALTORS
