Wise Money Decisions

UPDATE — MAY 16, 2008:  Even more airlines have implemented a fee for checking a second bag.

UPDATE — APRIL 5, 2008:   More airlines have announced a $25 fee for checking a second bag.  Delta, Continental, and Northwest will begin collecting the fee during the first week of May. 

It’s been several months since I last flew on a major airline.  I don’t mind flying but I’m glad I don’t fly a lot.  It has become more of a hassle the last few years. 

Since I haven’t flown in a while I haven’t paid attention to recent airline rules changes.  If you’re a globe-trotter you may already be aware that some airlines have changed their baggage limits.

Checking Two Bags Will Cost You On Some Airlines

Starting May 5^th United Airlines and US Airways will charge $50 per round-trip for checking a second piece of luggage.  If you are a member of the business traveler programs (for example, United has the Premier, Gold, and Silver programs) then the fee is waived for the second piece.

I’ve never flown Virgin America, but I believe they already charge a fee for the second bag.

Three Separate Fees

The fee for an extra piece of luggage is separate from the overweight and oversize fee.  The overweight fee typically kicks in when a bag weighs more than 50 pounds.  The oversize fee applies when the sum of a bag’s height, width, and length is greater than 62 inches. 

Suppose you check a 2^nd piece of luggage on United Airlines that weighs 70 pounds and whose sum of dimensions is 80 inches.  You will pay all three fees.  There had better be something important in that bag because starting May 5^th it will cost you $225 each way, or $450 total - probably more than your round-trip ticket! 

If you have a connecting flight on another airline, you may be required to pay the fees for both airlines.

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A few weeks ago I wrote about how my parents and one other family handled allowance. 

Since then I’ve come across two allowance articles worth sharing. 

New York Times Article

Alina Tugend has an interesting 2006 article in the New York Times about the “slave wage” allowance she paid her kids.  It’s worth a read.  She mentions two studies that I found interesting.  The studies are a few years old, but I doubt much has changed in the world of allowance over the last few years. 

The first study:

“A 2005 survey of almost 1,500 children by Yankelovich, a research firm, found that the most common weekly allowance for 6- to 11-year-olds was $5 to $9, and $10 to $19 for 12- to 17-year-olds. Around 15 percent of 12- to 17-year-olds received $20 to $49.

“Forty-one percent of those surveyed said they bolstered their allowance by doing extra chores around the house or jobs like baby-sitting; interestingly, more than 40 percent of children in all age categories said they received no allowance.”

It says the most common allowance was $5 to $9 per week.  But 40% received no allowance, so actually it seems the most common allowance was zero!

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It’s been widely reported that Joe Lewis’ losses in the Bear Stearns collapse amount to $1 billion. 

However, investors that hold large positions in a company are able to use derivative instruments, such as forward contracts or swaps, to hedge their risk.  It’s possible he has lost significantly less than $1 billion.

I haven’t seen any reports on whether Mr. Lewis had a hedging strategy in place.  But I have to believe that every investment bank would have tried to sell him a hedge product after he bought up a large stake in Bear Stearns over the last several months or years.  After all, that’s what investment banks do.  They find someone with money and talk them into buying a product.  It’s good honest work (as long as it’s done legally and with the client’s informed consent).

I had never heard of Joe Lewis before yesterday.  But I’m learning a little more about him.  Here are a few interesting Joe Lewis facts:

• He had an estimated fortunate of $5.6 billion.  It’s a little smaller now.
• He made his fortune in foreign exchange.
• He is buddies with Tiger Woods and Sean Connery.
• He lives in the same Bahamas resort as Sean Connery.  I understand it is the setting for some scenes from the 2006 James Bond movie “Casino Royale.” 
• Besides his Bahamas property, he owns property in Orlando and Argentina.
• In 1999 apparently there was an attempt on his life in Argentina.
• He is the 369th wealthiest individual in the world according to Forbes magazine.
• He owns all or part of several European soccer teams.
• Apparently he avoids the spotlight.  He is well known in Britain because of his soccer teams, but he is not well known in the U.S. (until today).

I’ve never lived in Manhattan.  Long before I met her, my wife lived there for a short time.  During law school we mulled over a few offers from New York firms that would have taken us to Manhattan.  She would have liked to go back. 

Had we moved to Manhattan I may have known that the JPMorgan and Bear Stearns headquarters are next to each other in midtown Manhattan.  See the picture to the right.  Bear Stearns is on the left, JPMorgan Chase on the right.

Now that JPMorgan is buying Bear Stearns, I’m offering my consulting services to identify synergies, cut costs, and restore profitability.  My first suggestion for management:

• Hang a string between the buildings. 
• Attach one tin can to either end of the string. 
• When a JPMorgan employee needs to talk to a Bear Stearns employee, they put their ears to the can.
• Talk.
• Save on telephone bills.

It’s so simple that I predict no one will think of it.

Today it is being announced that JPMorgan will acquire Bear Stearns for $2 per share.  To provide a little perspective on the stunning collapse of Bear Stearns, you need to know where Bear Stearns has been.

A Little History

Bear Stearns is the country’s fifth-largest investment bank.  Its stock was trading as high as $172 in January 2007.  Last summer two of its hedge funds collapsed in the beginning stages of the subprime mortgage crisis that we are still going through.  Its stock began a downward slide that became a freefall last week as investors began to doubt its viability as on ongoing business. 

On Friday its stock plummeted nearly 50% and ended the day at $30. 

We Don’t Know the Extent of Bear Stearns’ Problems

Now we have the news that it is being acquired for $2 per share.  Clearly we have no idea of the seriousness of Bear Stearns’ problems.  JPMorgan is willing to pay only $2 per share despite help from the federal government in funding the deal.  We might suspect there was a fair amount of prodding from federal authorities to convince JPMorgan to do the deal.  Without federal intervention I suspect JPMorgan would have offered considerably less.

At $2 per share JPMorgan will be paying $270 million.  Bloomberg is reporting that the Bear Stearns headquarters in midtown Manhattan (pictured to the right) is likely worth several times that.  Reading between the lines, Bear Stearns’ problems are much deeper than we know.

Poor Billionaire

The second-largest shareholder in Bear Stearns is a billionaire named Joseph Lewis.  He paid as much as $150 per share as recently as September.  He obviously believed in the company and wanted to help it succeed.  His shares are now worth $2. 

I feel bad for him just a little.  But he’s still a billionaire.  He’ll be okay.

A week ago I discussed the large amount of news coverage about whether we’re in a recession.  I concluded that a recession should probably not change your investment strategy.

There is a neat interactive tool called “50 years of market swings” at the CNN Money website that supports my conclusion.  The tool is essentially a graph showing the relationship between recessions and bear markets over the last 50+ years.  Nearly every recession over the last 40 years was preceded by a bear market and was not followed by a bear market.

If you’d like, open up the tool and follow along as you read through the exciting history of recessions in our country.

Three Recessions During 1954-1962

The first three recessions on the chart occurred in the 1954-1962 timeframe during the Dwight D. Eisenhower years.  There was no bear market before, during, or after the first recession. 

There was a bear market directly before the second recession.  The bear market ended early in the recession.

There was no bear market before or during the third recession, but there was a bear market about one year after the recession.

Conclusion:  The stock market was not correlated with the recessions.  You would not have been able to predict the right time to exit the market based on the timing of the recessions.  Getting out of the market during the recessions would have been counterproductive.  The market continued to see gains during the recessions.

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Ten years ago the proud new owner of a Honda Civic brought his car home from the dealer.  Days later he totaled it.  It was salvaged, went through a few owners, and is now my wife’s primary mode of transportation.

After several years with the Civic it is time for my wife to upgrade.  Over the last few weeks she has been shopping, test driving, pricing, and looking for financing.  I’ve been helping.

Today she test drove a Toyota Camry.  She likes the quietness. 

New Versus Used:  The Conventional Wisdom

This week we are facing the “new versus used” question.  The conventional wisdom says new cars lose a significant amount of their value when you drive off the lot. 

On the other hand, we regularly see used Camrys for sale at prices not much lower than their new price.  For example, I saw a used Camry with 8000 miles for sale at 10% below its new price.  We regularly see Camrys with around 30,000 miles for sale at 25% off their new price. 

The Camry just doesn’t seem to lose much of its value when driven off the lot.  I’m working under the assumption that the conventional wisdom doesn’t apply to the Camry.

Since I don’t have the conventional wisdom to guide my thinking, how do I know whether to buy new or used?  I use math.

The Two Candidates

We have identified two cars that seem like good candidates.  One is new and the other used.  They have similar features and upgrades. 

The new car costs $5000 more than the used car.  If we buy the used car we plan to get financing through a credit union at 6%.  If we buy the new car we can get financing through the dealer at 4.9% or less. 

The new car costs $5000 more but has three advantages:

• The car is new.
• It has the full original warranty.
• We obtain financing at a lower interest rate.

The full warranty has some value, but for simplicity I’m going to ignore it.

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A few days ago I received a mailer from American Express.  They want me to pay my taxes using my Blue Cash card.  Apparently American Express doesn’t read my blog, because just last week I discussed why it’s a bad idea to pay your taxes by credit card.

The mailer focuses on the cash rewards I will receive from using the card.  The mailer helpfully reminds me that I can use the cash to buy certain featured items.  See if you can guess the items from AMEX’s descriptions:

First item: “A getaway to get away”

Second item: “Get a new perspective”

Third item: “A dazzling showstopper”

(Click below on “Read the rest of this entry” for the answers)

Remember, most people should not pay their taxes using a credit card.  Unless you’re on some kind of promotion with your credit card, your cashback bonus plus the time value of money from deferring your payment will not make up for the 2.49% “convenience fee.” 

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It wasn’t so long ago when we could buy two gallons of milk for $4.69.  Now two gallons set us back nearly $7.  That’s a 50% jump in the space of a few years.  It wouldn’t be so bad if my salary would also jump 50% every few years!

I’ve noticed it mostly with milk, but it turns out that many food products have seen big price increases lately.  According to this article from the Dallas Morning News, prices are up for:

• Chicken - up 10% in the last year
• Whole milk - up 20%
• Tomatoes - up 25%
• Bread - up 5.4%
• Eggs - up 30% retail and 60% wholesale
• Pasta - up 30%
• Fruits and vegetables - up 20%

We Spend Three Times More on Food Than Gas

According to the same article, food accounts for 13% of average household spending while gas accounts for only 4%.  Despite spending three times more on food, it seems that people notice the price of gas more than the price of food.  Perhaps we should pay more attention to food. 

I don’t know if my own household follows those averages.  I don’t keep track of our spending at that fine level of detail.  Spending three times more for food than gas strikes me as in the ballpark.  We may spend a little less on gas because my commute is only three miles.  And I bike it when the weather’s nice. 

Why Does Food Cost So Much?

So what’s causing the jump in food prices?  In no particular order, the article blames it on:

• Increasing demand for ethanol has driven up the price of corn.  As farmers plant more corn to meet the demand, they plant less soybeans and everything else, resulting in general price increases.  Cows eat corn, so the higher price of corn means higher meat and dairy prices.
• Increasing meat demand from China and India.
• Drought in Australia.
• Falling dollar.

What To Do?

What’s the wise money decision to deal with rising food prices?  Eat out less?  Shop at Safeway instead of the upscale corner market?  Be a more discriminating shopper?  Skip lunch?

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Just a few weeks ago it wasn’t clear that Freddie Mac and Fannie Mae would follow President Bush’s lead and raise their conforming loan threshold (click here for the background story).  But a few days ago it was announced that Freddie Mac and Fannie Mae raised the conforming loan threshold in 71 metropolitan areas and 21 rural counties. 

The threshold increase allows Freddie Mac and Fannie Mae to purchase loans as high as $729,750 (even higher in certain spots in Hawaii — for those of you lucky enough to be house shopping there!).  If you’d like the background on how Freddie Mac and Fannie Mae affect mortgage rates, click here.

The increase applies for the rest of this year (2008) and also applies retroactively to loans originated after July 1, 2007.  On January 1, 2009 the conforming loan limit reverts back to its previous amount of $417,000.

A few observations in no particular order:

As I discussed here, the threshold increase occurs on an area-by-area basis and depends on the median housing price in each area.  The threshold in each area is 1.25 times the median price, up to the maximum of $729,750.  Many areas increased to the maximum.  Other areas increased, although not to the maximum.  And other areas did not increase at all.  Here is the list of area-by-area limits.

Loans that were previously considered “jumbo” may be conforming loans now.  If you were shopping for a jumbo loan last week, you may be shopping for a conforming loan this week. 

According to this article it’s not clear when lenders will be able to offer loans using the higher limits.  Hopefully soon.   

If you currently have a jumbo loan and your house would now qualify for a conforming loan, watch mortgages rates to see if refinancing might be advantageous.

It is interesting that the change is retroactive to July 1, 2007.  If you took out a jumbo loan in late 2007, your loan may now qualify as a conforming loan.  Whoever holds your loan could presumably sell the loan to Fannie Mae or Freddie Mac. 

Something tells me you’re not going to get a lower interest rate, however.  If you’re in this situation, keep an eye on the rates to see if refinancing may get you a better rate.

I discovered that Silicon Valley has the highest median house price in the country at $845,300 as of the 4^th quarter of 2007.  Silicon Valley is even higher than the San Francisco-Oakland-Fremont area ($777,300), and blows Orange County ($657,400) and Honolulu ($625,300) out of the proverbial water.  If you want to see the numbers, open this excel file and sort Column J from highest to lowest. 

I have mixed feelings about living at the top of that list.  It’s nice to live in a popular area.  It’s not nice to pay the cost of living.  I would feel better if I owned a home big enough for kids.  I don’t.