By John W. Schoen
updated 4/26/2004 12:00:20 PM ET 2004-04-26T16:00:20

January 30, 2004

This week's high-profile trial of domestic diva and former stockbroker Martha Stewart has Jonnye in Pennsylvania wondering why the government doesn't believe her story about a controversial stock trade. Meanwhile, Chandna in Virginia, who is worried that housing prices may be about to crash, is not alone.

As always, if you'd like to write to us, please include your first name and hometown.

Timing is everything
Why wouldn't Martha Stewart request her broker to enter a "stop order" for her shares of ImClone? She was a stock broker and should know what a stop loss order is.
          Jonnye C. -- Doylestown, Penn.

She very well may have. But, given the suspicious timing of the trade, she now has to prove that she did.

As you point out, professional investors frequently make arrangements with their broker to sell a specific stock when it hits a certain price. These “stop loss” orders are designed to impose discipline and help overcome the natural tendency we all have to hang onto a once-promising stock (like ImClone) even as it keeps falling.

And, yes, it may be pure coincidence that the $60 stop loss order that Ms. Stewart claims she had with her broker just happened to kick in right before bad news about ImClone’s promising cancer drug sent the stock plunging to $15 within weeks. Or maybe they find the stop loss order story hard to swallow because the stock hit $60 two months before she sold -- after it had doubled in the prior eight months. (ImClone founder Sam Waksal, who the government says tipped Ms. Stewart, has admitted that he dumped his shares based on inside information about the drug’s approval problems; he’s taken up residence in a Pennsylvania prison.)

We’ll know more about just what happened if and when a young man named Douglas Faneuil testifies in the case, an appearance that was postponed at the eleventh hour Thursday as both sides tangled over procedural issues. The government is hoping that Faneuil, the assistant to Ms. Stewart’s former broker, will explain that the alleged stop loss order was cooked up after the fact. (To prove this, they’re expected to try to show, among other things, that the $60 figure set down in the order was written with a different ink, implying that it was added after the stock was sold.)

What’s missing from this “insider trading” case is a charge of insider trading. While a separate SEC complaint makes that claim, the current criminal case stops short of doing so. Instead, the Feds have accused Ms. Stewart of securities fraud because they say she tried to conceal her alleged ImClone stock trading shenanigans from shareholders of her own company, Martha Stewart Omnimedia. The theory is that bad news about Martha would hurt those shares, and that, by covering up her alleged misdeeds, she defrauded her own shareholders.

Even the judge in the case has called that a “novel” argument; the government's case could very well fall apart. But if prosecutors can convince the eight women and four men sitting in the jury box that her story doesn't add up, Ms. Stewart may soon be taking up housekeeping behind bars.

Housing crash?
Do you think housing market will crash and prices will go down? If so, what time frame do you suggest?
          Chandna J. -- Norfolk, Va.

The simple answer is: No, we don't think house prices will crash. (Full disclosure: We own a house.)

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But you're not the only one who's worried about whether the housing market is another "bubble" ready to burst. An exhaustive report by the Congressional Research Service last spring (you'll be exhausted when you finish reading it), looked closely at possible causes but, you'll be shocked to hear, came to no definite conclusions. So here's the Answer Desk summary:

Yes, it's certainly likely that — at some point — housing prices will stop rising as quickly as they have been recently and may even fall somewhat. in the five years ended Sept. 30, 2003, U.S. house prices are up 38 percent, according to the government's House Price Index. In some red hot markets on the east and west coasts, they've risen twice as much.

But earlier dire predictions of an impending housing crash in recent times — the period shortly after the stock market Crash of '87 comes to mind — haven't come about. True, housing prices fell slightly in the early 1990s, but the declines were much less than some had feared. And, unlike the stock market crash then and in 2001, the housing market gave up only a small portion of the big gains homeowners had already seen.

One reason a “crash” is unlikely is that the housing market is structured much differently than investment markets like stocks or commodities. A "selling panic," for example, is much less likely in the housing market because most houses are primary residences. If everyone wanted to sell at once, where would we all live? (This is less true for second homes, which is why prices in those markets tend to be more volatile.)

The impact on average prices also tends to be gradual because housing price trends are very local; a lot has to do with how the supply of housing in a given area compares to demand. In some markets, where the local economy is in decline and everyone is leaving, house prices can and do fall. But in areas where the economy is strong and there’s little space for new construction — prices will most likely continue to rise. There are plenty of doomsday scenarios out there: A prolonged, steep  recession could eventually bring steep housing prices declines. A sharp rise in interest rates would likely cool demand for houses and force prices lower — because potential buyers would qualify for smaller mortgages. But many homeowners have locked in low rates and wouldn't feel the impact of higher rates on their monthly mortgage payments.

January 23, 2004

This week's State of the Union speech by President Bush called for big cuts in the federal deficit, after we'd just gotten used to the idea of huge budget surpluses. But Gary in Wisconsin wants to know: Just how realistic were those surplus projections anyway? Meanwhile, Dave in North Carolina wants to know if the 100 percent-financed, variable rate mortgage is too good to be true.

Were budget surpluses real?
It's seems like only yesterday that economists were worried that the national debt was going to be erased and that the Federal Reserve wouldn't have any monetary "levers" to use to adjust the economy. But when I was looking at a few articles regarding the surplus and where it went, I was struck by the impact of the enormous capital gain taxes collected by the federal and state departments of revenue from 1997-2000, that, combined with overstated earnings of corporations during this period a la Enron (resulting in huge but illusory corporate tax payments), would seem to have accounted for a lot of the "vanished surplus" and a good deal of the problems that the states are wrestling with. Got any insight here?
          Gary V. -- Madison, WI

The now widely-cited 10-year government budget projections are about as accurate as 10-year weather predictions -- regardless of which party is making them. Even if you factor out the political haze that inevitably obscures these numbers, there are just too many “unknowables” that will inevitably scramble projections made that far into the future. (That’s why corporate CEO are loathe to forecast the next 10 months, let alone ten years.)

Still, politicians persist, in large part because spreading financial ups and downs over ten years tends to smooth them out and make them easier to take credit for -– or hide from.

But there's no question that 90s bubble balanced the federal budget, and the resulting economic hangover brought the fiscal fallout that is now washing state and federal budgets with red ink. The big question -- one that likely will be the centerpiece of this year's presidential campaign -- is whether current deficits are the result of state and federal governments spending too much or taxing too little.

Most state governments are in a very different situation than Uncle Sam for a very simple reason: They're not allowed to run deficits. Though they can sell bonds to make up tax shortfalls, they at least have to make the books look like they’re balanced every year. As the good times rolled in the 90s, so did state spending. Now that those bubble-induced, capital gains windfalls have evaporated, the required budget-balancing spending cuts are painful.

But the federal government has an easier solution: It just raises the debt ceiling and borrows more money. This is roughly the equivalent of your bank letting you raise the spending limit on your credit card every time you binge at the mall. Why bother paying it off when you can just raise your limit?

The answer, of course, is that eventually people will become reluctant to do business with you when they learn how you're managing your personal finances. The worry for Uncle Sam is that investors begin to balk at buying the blizzard of Treasury debt used to fund U.S. budget deficits. If that happens, interest rates go up, which makes it harder for people to buy homes and business to expand, which further slows the economy, which further cuts into tax revenues, which makes the deficit grow -- and round and round we go.

In his State of the Union speech this week, President Bush laid out a different scenario that he'd prefer we all think about: that recent tax cuts will stimulate economic growth, which will create more jobs, which will then generate more taxes (without raising rates), which will cut the deficit in half in five years, etc. It sounds plausible, but so far, it hasn't happened. Unless the economy starts producing more jobs in the next six months, Bush and his economic team may soon be checking the “unemployed” box in the government’s monthly surveys.

As for the dire predictions about the perils of doing away with Treasury debt, there will always be plenty of borrowers out there (corporations, state and local government, other countries, etc.) to keep the bond market going.

But think of the government savings – from the billions of interest payments made every year – if the federal debt ever were reduced. And consider another major lost opportunity now that federal budget surpluses have evaporated. Some, including former Treasury Secretary Paul O'Neill, had proposed using the extra money to phase out Social Security once and for all in favor of expanded private, individual retirement programs. Imagine how much easier it would be to balance the federal budget without having to pay the ongoing costs of that gigantic, untouchable spending program.

Scared of variable rates?
My wife and I are first time homebuyers, and we think we've found a good loan - 100% financing with 5% interest rate. The interest rate is variable, however, so I'm worried that this rate will go up to 7 or 8% by the end of the year. Should I be scared of the variable interest rate?
          Dave C. -- Durham, NC

Variable interest rates can make a lot of sense to first time home buyers like you -- especially if you plan to move well before the loan is paid off. While there's no need to be scared, you're right to be careful about the fine print. You need to ask a few questions: what, exactly are the terms?

Mortgages come in more flavors than ice cream, so it's impossible to generalize. Many "variable rate" loans actually fix the rate for a year or more, giving you the best of both worlds. If you plan to move to another house within, say, 5 years, look for a "variable rate" loan that promises you a flat rate for those first five years. You'll get the benefit of a lower, variable rate loan but enjoy the peace of mind of knowing exactly what you'll owe for those five years.

Even if your rate if variable, it should tied to a market rate-- like a six month T-bill -- which needs to be spelled out in the mortgage offer. That means the lender can't arbitrarily jack up your payments (the way credit card lenders can -- and do).

And before you jump at that 100 percent financing, take a good, hard look at your total borrowing costs. If the upfront fees (points) are too high, you might better applying a bit of your own money as a down payment and going for fewer points. And remember that if you do move in a few years, you'll still owe most of the principal on that mortgage. If for some reason you can't sell the house for what you paid for it (like, say, interest rates go up and the housing market cools off), you'll still owe the lender the full amount you borrowed, so you'll have to come up with the difference. 


January 16, 2004

This week's plea bargain by a key player in the Enron scandal has left Phil in Nevada wondering: Will investors who were scammed by Wall Street fraud ever get justice?

Send them packing
While there has been ludicrous thievery going on in the investment world, I can't help wonder that nothing of any consequence will ever come of it. I hate to sound pessimistic but money talks and BS walks. It is my sincere wish that all, and I mean all, of those found with their hands in the pockets of others are brought to court, found guilty and severely punished. It would be my hope that their entire net worth be brought to zero. I would be glad to start them back in business with a tin cup and a dozen Ticondoroga #2 pencils. That is way more than was given to their investors by them. What contempt.  What GREED! Let's not let any of them off the hook. What in your best guess will actually happen?
          Phil M. — Nevada

Our personal opinion is: Some will go to jail, some will get off, and many more will never be caught or charged.

The problem is that it’s a lot harder to catch a chief financial officer setting up hundreds of complex, offshore “special purpose entities” that it is to snap a picture on a security camera of a guy holding up a convenience store. The security camera is cheap. The army of forensic accountants required to sift through thousands of financial documents costs a lot more money.

But take heart. Last week’s Enron plea bargain was a major “high five” for the good guys. Building a case against truly sophisticated thieves takes months – sometimes years – of painstaking prosecution. Document by document, junior accountant by junior accountant, the government seems to be working its way up the food chain to the management suite. Last week’s guilty plea – and cooperation -- from Enron’s chief financial officer makes it much more likely that top management will ultimately be held accountable for the widespread pain they inflicted on millions of individual investors.

That’s not to say Enron investors will ever see a dime of their losses. You may derive some satisfaction from seeing millionaire managers escorted in handcuffs to eight-by-ten concrete cells. But the much publicized “restitution” you may have read about – where individual investors get their money back – is even more difficult to pull off. Even when financial fraud is discovered and successfully prosecuted, it’s a lot harder to unscramble the egg and return the money to those who were defrauded. Politicians and regulators have promised to do so, but we aren't holding our breath waiting for that check in the mail.

January 9, 2004

It's been a while since we answered one of those "sample" questions above -- why interest rates are so low -- and Blair in Miami wants a fresh explanation. (Hint: anyone remember what inflation is?) Speaking of inflation, Lance in Texas wants know why retirees' cost of living adjustments haven't kept up with the historical pace of inflation.

Low rates
Your "intro" says: Why are interest rates so low? But I cannot find the answer. Billions are being spent in Iraq and the deficit is in the billions. Does the government borrow at zero percent rate?
          Blair D. -- Miami. Fl.

No, unless it's buying a new car from Ford or General Motors, the U.S. government can't borrow at zero percent interest.

The rate it pays is set every time it sells new Treasury securities at auction. That auction determines how much interest the government will pay during the life of the note -– until “maturity.” That fixed rate is called the “coupon rate” -- because you used to have to clip coupons from the original bond and mail them in to get your interest payment.

But you can also buy, say, $1,000 worth of T-bills or notes in the open market – from someone who bought it at auction. But if, say, rates have fallen since the last auction, you'll pay more than $1,000 for that higher coupon rate -- because it's paying more. So the amount you get for every dollar you invest -- the "yield" -- will be different than the coupon rate, unless you pay exactly $1,000 -– or "par. (Still with us?)

These yields keep rising and falling long after the coupon rate is fixed, which means that, at any given moment, investors will get roughly the same return for each dollar they invest in debt with the same maturity. The differences in the price makes up for the differences in the coupon. (Market rates are different for different maturities, but that's another column.)

But the mechanics of rates say little about why they go up or down, and there are a number of forces that move rates. The ups and downs of interest rates are a lot like the weather -- much easier to explain reliably after the fact than to forecast what's coming next.

One big reason rates are low these days is the supply of cash available to buy all that government debt. If the Treasury gets lots of bids at its auction, it can get away with offering a low rate -– just like you can lowball bid on eBay these days for one of those singing Big Mouth Billy Bass contraptions up for sale.

Mostly, all that cash comes from the Federal Reserve, which is why the Fed has so much control over rates. But if it pumps too much cash into the system, the Fed risks pushing inflation higher; too much money out there means each dollar is worth less. For the past few years, inflation hasn’t been a problem. The minute that changes, expect rates to go higher.

You’re quite right to be concerned about government borrowing to pay for the war in Iraq. If too much cash gets sucked up by government spending, there’s less to go around for other borrowers -– like home buyers. That means they have to bid more (pay a higher rate) to borrow.

The same happens if investors around the world stop letting the U.S. borrow their money. That’s why some people worry that if the dollar keeps falling, the flow of dollars from overseas investors could dry up. The U.S. government would have to pay more (in the form of higher rates) to keep sucking up all those dollars.

To keep investors interested, the Treasury came up with a new type of paper called “inflation-protected” securities. The idea is simple: If you buy these notes, you’re guaranteed you won’t lose money if inflation rises. Because the government bears the risk of higher inflation, it’s able to sell the debt more cheaply than conventional debt -– where investors demand an inflation “risk premium.” 

For more on indexed bonds, check out this article from the Phildelphia Fed.

Keeping up with inflation
If inflation has historically averaged 3 percent per year since time began, then why have retiree cost of living adjustments not kept up? Seems over the last ten years none have come close.
          Lance R. - Texas

As I recall, inflation was quite a bit higher than that in the Pleistocene Age. But let's not quibble; economic statistics from that geologic period are notoriously unreliable.

In any case, your recollection over the last 10 years is correct. The Social Security Administration's annual cost of living adjustment -- designed to help retirees keep up with rising prices -- has average 2.38 percent over the past ten years. Since the annual COLA was first instituted in 1975, it's averaged about 4.3 percent -- from a high of 14.3 percent in 1980 to a low of 1.3 percent in 1986 and 1998.

There's no question that inflation can tear a big hole in your paycheck. To buy $5.36 worth of 1913-era goods, for example, you'd need $100 in 2003 dollars. (Check out the government's inflation calculator to see how much inflation has eroded your buying power over the years.)

Keep in mind that the adjustment, made every year in early October, is based on last year's inflation rate. So when inflation is lower than average (which is it these days) so, too, is the COLA. The theory is that, if prices are rising slowly, so should your Social Security payments. If a pair of shoes at Wal-Mart cost the same this year that they did last year, the argument goes, you don't need more money to pay your bills.

But it's also true that the COLA is based on government figures that likely don't represent your true cost of living. This year's increase was 1.2 percent -- but some costs are rising much faster. College tuition is rising at closer to 8 percent a year; health care costs more like 7 percent.

In the meantime, the only way to keep up is to keep bargain-hunting.

January 2, 2004

Is saving more money good for your country? That's what Dave in Michigan wants to know. He's puzzled by economists who blame the growing U.S. trade imbalance on America's low savings rate. And he should be. Francisco has a more basic question: Are deficits, in general, good or bad?

A saving deficit?
In a recent issue of the Economist magazine an article stated that our huge trade imbalance with countries like China and Japan are due to America's extremely low savings rate. I fail to see this connection and hope you can explain to me why the Economist magazine editors think this is true.
          Dave M., Bay City, Mich.

There are lots of economists out there who fail to see the connection, too. But then, as the old joke goes, if you lined up all the economists in the world end-to-end, they still couldn't reach a conclusion.

For the dismal science of economics, explaining the causes and impacts of the U.S. trade deficit is definitely a work in progress. The last time the subject reached the current level of hang-wringing was the mid-80s, when the value of the dollar was cut in half relative to the then-dominant currencies, the Japanese yen and the German mark. The U.S. trade deficit from 1980 to 1987 shot up nearly ten-fold. (For more on that period, check out this essay by Martin Feldstein, chief economist during the Reagan administration.)

Despite dire predictions then that the sky was falling, the global economy defied the gloomiest computer models. The U.S. economy is still standing, and the reasons why are still subject to some spirited debate.

But the textbook explanation goes something like this: The U.S. trade deficit has two components, how much we import from other countries and how much we export back to them. When we pay more for imports than we get back from selling exports, there’s a deficit.

One way the low savings rate could expand that deficit is that people who don’t save money will then spend more on goods and services that they wouldn’t otherwise. And these days, those goods are more likely to be made in China than in Michigan. So those purchases worsen the deficit on the import side of the ledger.

The other side of the ledger is a little fuzzier, but the basic idea is that a low savings rate produces less capital for American businesses to borrow, so they wind up borrowing more from foreign investors. Among other negative impacts, that tends to depress the amount of money used to support U.S. exports, which further worsens the deficit. (The flow of capital is measured by the “current account” deficit – another number that some economists watch for worrisome trends.)

But there are a few problems with blaming the U.S. trade deficit on our low savings rate. For one thing, the statistic itself is the subject of some debate. For example, the number doesn’t include capital gains from investments like stocks or homes – which form a big part of many Americans' savings. Worse, there are lots of other forces moving the trade deficit that likely have a much greater influence than the size of your bank account. The rise in energy prices, for example, has had a big impact on the cost of U.S. oil imports. On the export side, lower foreign wages have pushed much U.S. manufacturing offshore, which has hurt U.S. export volumes. But the profits from many of the goods made offshore still flow to American companies and investors. (Discussion question: Is that good or bad for the U.S. economy?)

Still, it’s entirely possible that the expanding trade deficit -- which ran $418 billion last year, up from $38 billion in 1992 -- will “catch up with us.”  If a long, slow slide in the dollar convinces foreign investors that U.S. stocks and bonds are a bad deal, it will be harder and harder for American companies (and consumers) to find money to borrow. That means interest rates go up – no matter what the Fed decides. And that makes it that much harder for the U.S. economy to grow. In the past 20 years, we’ve become accustomed to U.S. economic growth as a cyclical thing – if the economy weakens, we all just wait it out. But there have been periods in U.S. history, and there are economies abroad (think Japan), where the pain is deep and protracted.

But while a long-running, and growing, trade deficit could produce such a result, it’s pretty unlikely that economists will ever be able to agree on exactly why.  

Deconstructing deficits
I would like to know your opinion about deficits generally speaking ( governments, states, cities, people, etc.)
          Francisco L.

When it comes to my own bank account, I’d always prefer to have a surplus than a deficit.

For governments, the question is not as clear cut. In the U.S., until recently, the question was mainly academic. The government had run deficits for so many years that most people had all but given up on the idea of balancing the budget. But thanks to a remarkable alignment of political forces – and a booming economy and stock market – the U.S. budget swung to a significant surplus as the new Millennium approached.

The U.S. government still owed trillions of dollars to investors who hold U.S. Treasury bonds (the national debt, which is the accumulation of years of budget deficits). But as long as the budget ran a surplus, that extra cash could be used to pay off that debt. You might think that was a good thing – kind of like have enough money left over every month to pay off your credit card debt.

But the current government (White House and Congress) have taken a different view. The thinking is: If the government is taking in more in taxes than it’s spending, then taxes are too high. So thanks to one of the biggest tax cuts in U.S. history – along with the unexpected cost of fighting wars in Iraq and Afghanistan – the U.S. budget is running big deficits again. The talk now is of cutting that deficit, but no one seriously believes we’ll see a surplus again any time soon.

For states and cites, the situation is somewhat different. Though states can issue bonds, many require that their budgets balance every year, which means raising taxes or cutting spending – or both. States like California are feeling the effects of a big drop in tax revenues (after the Internet bubble burst) and now face painful choices as a result. And because a part of their financial well-being depends on contributions from the federal government, states don’t entirely control their own economic fate. This is even more the case for budgets of major cities, which often cover the cost of services enjoyed by people who don’t live in the city and, therefore, don’t have to pay taxes to pay for those services.

So generally speaking, I suppose the ideal circumstance would be neither deficit nor surplus but a balanced budget based on tax revenues that rise very slowly. But unless and until Goldilocks is in charge, I wouldn’t count on that happening.


Ever wonder what a P/E ratio is and why it's so important? Are you confused about the official definition of a recession? And just what the heck is a derivative? We're here to give you the answers.'s weekly feature "The Answer Desk" helps you make sense of business, the economy and investing. So send along your questions to and we'll try to get you the answer. (Please include your home town with your question; we'll only include your first name if we use your question.)

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