The New Rules for Credit Cards

There's recently been a great deal of attention paid to the new Credit Card Accountability, Responsibility and Disclosure Act ("CARD Act").
Edward Yingling, president and CEO of the American Bankers Association, recently warned that now “less credit will be available generally, which means some consumers and small businesses will not be able to obtain credit cards at all, particularly younger people and start-up small businesses.” But Sen. Chris Dodd (D-Conn.), the driver behind CARD in Congress, thinks such claims sound “a little like Chicken Little.”
I am inclined to agree with Sen. Dodd and describle the industry's statements as exaggerations and a the banking sector's innate hostility to any further regulation; Most of the changes seem reasonable, with some slight exceptions. And, while I don't think this is much of a concern for our clients, this seems like a good time to review the changes that the CARD Act will bring as it's phased in over the next year:
Limited interest rate increases. If the credit card company wants to hike interest rates, it will now have to inform a customer at least 45 days beforehand and provide a written explanation.
New restrictions on retroactive rate increases. Under the new law, the interest rate on an existing balance cannot increase unless the customer is more than 60 days behind on a payment. Even if that happens, the credit card company will have to restore the prior, lower interest rate if they pay the minimum balance on time for the six months that follow.
Statements mailed 21 days in advance. This was a particularly sleazy practice by card issuers, but an irresistible temptation for larger entities. The new rules say that your monthly bill has to be mailed to you by the credit card company at least 21 days prior to the payment due date.
Pay before 5:00pm EST and you are on time. Another questionable practice that will go the way of the Dodo - Now all credit card payments made before 5:00pm Eastern Standard Time will be considered paid on that day. If your payment due date falls on a holiday, a weekend, or any day on which the credit card issuer is closed for business, your payment cannot be subject to late fees.
Borrowers can choose to attack the highest interest rates. Certain kinds of transactions could have different rates some credit cards. Under the new law, a borrower will be able to apply any payment above the minimum to your highest-rate balance.
More protection for teens and young adults. The new legislation bars companies from issuing cards to most people under age 21. Those younger than 21 will only be able to use a credit card under one of the following conditions:

• They can prove they have the means to pay the debt (or their parent or guardian promises to pay it off if they default)


• They are emancipated minors


• They are designated secondary cardholders on a parent or legal guardian’s account

Restrictions on cards issued to college students. College-age Americans will still be able to get credit, but within reason. Account limits will be either 20% of their annual income or $500, whichever is greater. So this market will grow less attractive for credit card companies.
An end to universal default. If you make a late payment to one credit card issuer, other issuers will not be able to hike your rate as a consequence.2
Cardholder permission for over-limit fees. Credit card companies now have to get your OK before they can process a transaction that would put your account over its limit.
Why are credit card companies crying? As I stated earlier on - all industries resist regulation as an innate response, but there's some reason to believe that it will hurt larger players in the card industry. Cut out all the nickel-and-diming, and credit card issuers will be left with lower revenues. So where are they going to get the money back? Think reduced rewards for cardholders, new and inventive annual fees and card services linked to balances held at depository institutions.

FTSE Launches More Environment Indexes

FTSE Group is expanding its FTSE Environmental Opportunities Index Series with the addition of nine new indexes designed to appeal to investors seeking to access the growing low-carbon economy.
We've had a number of clients express interest in low-carbon investment strategies that still provide a high level of diversification. This seems like a promising development for clients that want to play the "cap and trade" trade or who want to be "part of the solution" without over-concentrating...

California: After Pain, A Formal Feeling Comes

Please accept my apology for a somewhat gloomy entry today, but recent events have led me to be concerned about impact on the municipal bond market; California's financial situation is dire and will likely result in a significant deterioration in it's credit status in the near future. This presages tough choices to follow elsewhere.

With tax receipts falling way below expectations, California is facing a budget deficit that's likely in the $20-30 billion range for the current fiscal year's $111 billion budget. In order to prevent reductions in public services, the state legislature and the governor have implemented ballot initiatives that would allow for the redirection of mandated funds (Propositions 1A through 1F) to cover underfunded programs. However, it appears California voters are likely to defeat the initiatives. The

Should there be an adverse outcome on May 19th. The LA Times and the Wall Street Journal are reporting that the politically powerful public sector unions and the Administration are making matching funds conditional on no significant state government layoffs.

Likely, the explicit argument presented by the Administration and unions will relate to controlling unemployment (a powerful argument depending upon one's perspective on these things). The administration's opponents will argue that reductions in government spending are required. Both sides regard this situation as dramatically important.

It's reasonable to expect California to bend to the will of the unions regardless of the outcome of the ballot initiatives. In addition to their softer influence within government, their membership votes and their resources are formidable.  This will result in a combination of tax, fee increases (some of which are already coming as a consequence of budgetary issues that have plagued the state since 2001) and a downgrading of California's debt by the major ratings agencies. Whatever the outcome, the various accounting gimmicks that have been used will not substantially prevent significant downgrades in public services. 

It's realistic to expect that, barring the press exerting substantial pressure on Moody's or S&P, the rating agencies will be unwilling to anger politicians and public unions by initiating a ratings downgrade during the crisis, but they will certainly do so once the matter is resolved. This pattern was established earlier during the banking crisis. Barring some miracle, later this year, California will find itself firmly . This will cause bond prices to fall, the state's borrowing costs to increase and more unpleasant budget cuts to follow. Expect maintenance to suffer dramatically in most public buildings and services.

After Pain, a Formal Feeling Comes

The primary challenge facing California legislators is they stand between a rock and hard place. The rock,

Schwab Reduces Mutual Fund Expense Ratios

In an encouraging "Long Term Greedy" move I respect in companies, Charles Schwab has reduced it's expense ratios across several of it's funds, bringing the majority of it's equity index funds in line with the costs of previously cheaper ETFs. This should have the effect of allowing them to capture substanial index assets and make themselves competitive with Vanguard for younger customers.
As Schwab Institutional is our preferred custodian, the higher expenses of Schwab index funds had always irked me. It's nice to have improvement on that front and it makes me considerably more interested in using Schwab's funds as long term investments for clients of all sizes.

Extra! Extra! Stress Test Results Revealed!

Federal regulators have now released their “stress test” evaluations of America’s 19 largest banks. How many of the 19 thrifts are adequately capitalized? Which banks will be directed to boost their capital, and where might that capital come from? 

Information has been leaking for weeks and the Administration explicitly mentioned Citi (C)and Bank of America (BAC) and needing more capital. But, now we have the official report and the Federal Reserve’s opinion.

Nine banks won't be required to raise more capital. The banks in the best shape: American Express (AXP), BB&T (BBT), Bank of New York Mellon (BK), Capital One Financial (COF), Goldman Sachs (GS), JPMorgan (JPM), MetLife (MET), State Street (STT) and US Bancorp (USB). The government says these banks do not need to raise money from new investors.

Ten others need to raise capital or face effective nationalization. These banks need to raise new capital or bolster capital reserves by the following amounts: Bank of America (BAC) ($33.9 billion), Citigroup (C) ($5.5 billion), Fifth Third Bancorp (FITB) ($1.1 billion), GMAC LLC ($11.5 billion), KeyCorp (KEY) ($1.8 billion), Morgan Stanley (MS) ($1.8 billion), PNC Financial Services (FNC) ($0.6 billion), Regions Financial (RF) ($2.5 billion), SunTrust Banks (STI) ($2.2 billion) and Wells Fargo (WFC) ($13.7 billion). 

The only real surprise here was Wells Fargo, which as early as last weekend had Warren Buffet singing the company's praises at the annual Berkshire Hathaway investor meeting.

The government has given the banks that do need capital up to six months to raise it – and one month to come up with a plan to do so. June 8 is the plan deadline and November 9 is the deadline for raising money. Some may raise all the capital they need by converting government debt into private stock. But this will mean making the government a major or majority shareholder.

Under the conditions of the tests, the Fed wanted to see at least 6% of their assets in in the most liquid ("Tier 1") capital and at least 4% in common equity by 2010 under the two economic scenarios posed. Tier 1 capital includes common shares, most types of preferred stock, and TARP funds. 

The worst case scenario assumed a fairly high rate of foreclosure, but also expected high levels of profitability by the banks through a worsening climate, which is a somewhat controversial position. What is probably the most compelling criticism of the tests though is that the different risk management models of the banks themselves (which were presumably pretty flawed to begin with) are what have been relied upon to reveal the expected capital position of the banks in these two scenarios. 

Ultimately, the great weakness of the Treasury's approach is that, if the last year has taught us anything - attempts to model a realistic "worst case scenario" for anything over a very short period is virtually impossible. This is not what the Stress Tests really are about anyway - they are an orchestrated effort to restore investor confidence and change sentiment. It is apparently, so far, effective, in that it has substantially reduced bank debt interest rates in the private markets.

Banks that need to thicken their capital cushion can do so by 1) selling selected assets, 2) raising new common equity from current shareholders or new investors, 3) applying any earnings that top analyst expectations toward their capital bases, or 4) converting preferred shares into common stock. Step 4 is actually a cash conservation move – converting the preferred shares wouldn’t actually boost overall capital, but it would allow banks to eliminate preferred stock dividends.

Consolidation is likely. Several analysts project the smaller banks among the 19 – thrifts such as SunTrust, Fifth Third, Regions Financial and KeyCorp – could end up merging with larger banks.

The Treasury is the lender of last resort. The government has instructed the banks to go to the private sector first before asking for any more federal money. Treasury Secretary Tim Geithner projects the “vast bulk” of thrifts needing more capital can capably raise it “through private sources”. The still-developing Public-Private Investment Program (PPIP) could offer a way. But, its reasonable to expect that Citi and Bank of America will find it very challenging to raise significant capital in this environment and will likely have to accept strong US government influence on their boards.

Stress tests have occurred for years in the banking world; the findings of such tests are commonly kept private. The government revealed these results with the goal of maintaining the public’s faith in the banking system – as if to say, “Here is the open book and here is how we are directing the banks to make things better.” 

Some analysts wonder how credible the results are. After all, what would the government have to gain by saying a big bank was in big trouble? Investors would flee, and the Treasury would have to shell out more TARP money. Other analysts note that generating capital and bettering the balance sheet doesn’t address the problem of removing toxic assets from the books of these banks. 

On the other hand, the announcement of the stress tests did lessen the anxiety among investors this winter, when Wall Street fretted about the possibility of bank nationalization. The announced results do not look as negative as some investors had expected. Interviewed May 6 on Charlie Rose’s PBS program, Secretary Geithner noted that there are “very significant cushions in these institutions today, and all Americans should be confident that these institutions are going to be viable institutions going forward.” 

The Tax Man Cometh (And Right Soon)

In February, the President introduced his plan for the federal budget – a budget created with the vision of expanding government and inching towards a universal health insurance for all Americans, and with consequences for estate and income tax for affluent Americans. Since his campaign, he has also repeatedly committed that taxes will not increase for families making less than $250,000 annually.

Given this situation, the question becomes: How to plan for the implications of this new policy direction? If taxes won’t rise for the middle class and working class, where will the money come from? The all-but-certain answer: through increases in corporate income taxes and increases in the top tax rate.

In the President’s budget, the sun would set on tax cuts given to high-income earners during the Bush years. Families earning more than $250,000 and individuals earning more than $200,000 would have tax rates they faced during the Clinton administration.

Taxes are slated to go up in 2011. The 2001 and 2003 tax cuts would expire and the highest two tax brackets would return to 36% and 39.6%, and the capital gains tax rate would head back up to 20%. The administration believes this could raise $637 billion over the coming decade.

Estate taxes will likely increase. 2010 was to be the year of 0% estate tax – the great reprieve before estate taxes as high as 55% would hit in 2011. That was what was supposed to happen but now it may not. President Obama wants the estate tax picture to remain as it is now, with estate tax rates of up to 45% kicking in above a $3.5 million exemption (which would be indexed to inflation for future years). In late April, a Senate proposal aimed to lower the estate tax rate and raise the exemption, but this fell by the wayside in budget negotiations with the House. So it appears the estate tax is here to stay, but it will apparently not reset to 2001 rates.

Corporate taxes will increase. Among the ideas being considered: a requirement that investment partnerships (i.e. Hedge and Private Equity Funds) pay regular income tax rates rather than capital gains tax rates; revoking methods of inventory accounting that can help to cut business taxes; and further restricting corporate options for automatic deferral of federal taxes on overseas income. Treasury Secretary Tim Geithner has claimed that planned tax increases would only affect only about 2% of filers with business profits; the nonpartisan Joint Committee on Taxation puts the figure at 3%.

Legislators will compromise. On April 29, the House and Senate approved a $3.5-trillion outline of the proposed federal budget, but it did not include all of what the President wanted. (No Congressional Republicans voted for the budget resolution, and among them, Sen. John McCain denounced it as “generational theft”.)

An important tax-linked question wasn’t answered: how to pick up the cost of making quality healthcare accessible to more Americans. The President wants to leave more money for that mission by capping tax deductions at 28% for families earning more than $250,000 a year, as opposed to the current 33% value. Charities and homebuilders would hate that idea, and figure to lobby Congress if it advances.

The Obama administration also wanted to remove subsidies to farms with annual sales of more than $500,000, and have the opportunity to bill insurance companies for treatment of injuries linked to military service. Neither idea survived budget negotiations in Congress.

Under the budget blueprint that was approved, the $400/$800 “Making Work Pay” tax credit – which Obama wanted to make permanent – would disappear after 2010.

Changes call for conversation. This is an excellent time to consider what might happen to your financial picture as a result. Let us coordinate with your tax advisor to discuss this.

Tax Season Follow-Up: Overwithheld? Underwithheld?

Did you owe tax on your 2008 federal income tax return? If so, you might want to consider increasing the amount of federal income tax that's withheld from your paycheck by completing and filing a new Form W-4 with your employer. (If you're self-employed, you'll have to bump up your quarterly estimated tax payments.) Not having enough withheld can result in more than just a cash crunch at tax time--it can mean penalties and interest.

On the other hand, receiving a large federal income tax refund can be an indication that you should adjust your withholding as well. Why? A large refund essentially means that you're providing Uncle Sam with an interest-free loan during the year. Think of it this way: if you received a $4,000 refund, in 2008 you paid approximately $333 more each month to the federal government than you had to. Sure, you get that money back in the form of a refund when you file your federal income tax return, but the government doesn't pay you interest on those funds.

If you had taken that $333 every month and instead invested it in an account that earned exactly 3% annually, you would have an extra $80 by the time your return was due. And, depending upon how you invested the funds, you would be able to access those dollars during the year if you had the need.

If overpaying the government during the year is the only way that you can force yourself to save, go right ahead. Just recognize that there's an opportunity cost when you overwithhold. Consider investing those dollars instead; if your employer provides a 401(k) plan, think about increasing your contribution to the plan. Alternatively, you might be able to use payroll deductions to make IRA contributions. Like withholding, these contributions would come directly out of your pay; unlike withholding, though, the funds would be working for you instead of for Uncle Sam.