Today at TILE, we asked the question…Where Did The Money Go? It seems hard to believe that a few states, including California, are threatening to “shut down,” “declare bankruptcy,” or make payments with “IOUs” instead of cash.

States, unlike the Federal Government, don’t have the authority to print money. Thus, just like an individual, they create a budget – and some states are required by law to keep a balanced budget. This means that the sources and uses need to be in sync. In other words, you can’t spend more money than you have!

So, how does a state make money? States source money from income taxes, sales taxes, investments, and the Federal Government. If the sources shrink, then the spending on programs such as parks, education, roads, and infrastructure must also shrink.

For example, if a state’s population generated $100 in earnings and was taxed at 5%, that means the state made $5. If today, with 10% unemployment, the population only generates $90 in earnings, a 5% income tax leaves the state with just $4.50.

The same theory applies to sales taxes – the less people buy, the less revenue to the state.  If $100 in purchases last year was taxed at 5%, the state got $5 in tax revenue. But if this year there was only $90 in purchases, the state only makes $4.50.

On the investment front, states earn a lower return on the money they hold.  Today, they can only earn a few percentage points.  So instead of 5%, or $5 earned on $100 in investments, there is only $1 of investment income.

Finally, the Federal Government is also losing money and having to shrink the amount it gives to the States.

Add all this up and our hypothetical state which had $115 in Sources last year only has $60 this year. That means there is a lot less money to go around and state legislatures have to make tough decisions about which programs to cut. While borrowing is an option, it’s not always affordable or available. States, like companies, are having a hard time raising money in this market.

In terms of the TILE community, we can think about our sources and uses too. The more we track our expenses and the economic landscape, the more we can make informed choices. The money we have often comes from sources such as jobs, investments, and family. If your sources were cut in half, would you purchase less? Would you go out to eat less often? Could you get another job?  How is your investment portfolio doing? If it is earning less, does that mean you have less to spend?

In a perfect world, we can ask for more money or a bigger allowance. The reality is we all have budgets to balance! It’s not that the money is gone, but when less is generated, there’s less to play with.

- Amy

Today at TILE we asked the question, “Has anything really changed for the banks since the financial crisis?” If you were ever punished by your parents or a teacher for misbehaving, did you really see the error of your ways and change? Or did you just go back to doing what you did before (and hope not to get caught next time?)

The Federal Reserve introduced “Stress Tests” to measure: 1) How much more money could banks lose if the economy got worse? and 2) How much more capital would they need to sustain a worst-case scenario? The worst-case scenario assumptions include unemployment rising to 10.3% (versus 8.6% today) and a 22% further decline in housing prices (as compared to a 29.1% decline since 2006.) Looking at the 19 largest banks, the Fed estimates they could lose up to $600 billion if things get worse and the banks will need to raise another $75 billion to get to a “comfort level.” For example, they estimate Bank of America could lose another $137 billion in a worst case scenario and they’ll need an additional $34 billion in capital to get to a comfort level. The table below gives you the details for each bank reviewed. (click the image for an interactive version)

The objective of the Federal Reserve (and the government, in general) is to make sure that the U.S. financial system is sound – that banks have enough capital (or resources) so that your deposits are safe and that they have enough capital to start lending again. Confidence and action together help the economy grow. For example, if you feel confident that your money will be safe, you will put it in the bank. Using your deposits, the bank can then lend to others. If the banks use leverage (e.g. for each dollar on deposit, they can lend out 10x that), then even more money circulates in the economy.

So, after these Stress Tests and after the big banks raise more capital… are we really in better shape? We know they lost a lot of money in the first place by making bad decisions (e.g. bad loans, bad trades, and poor risk management). We know they raised or are raising more capital. We know that the government says a Tier 1 Capital Ratio of 6% should give us confidence (this measures Available Common Equity as a percentage of Risk Weighted Assets – in other words Do you have enough money to cover your “bets”?) We know that people and markets are feeling upbeat lately – after all the S&P is up almost 26% since the beginning of the year.

What we don’t know is if the banks have really changed their ways. Are we providing taxpayer and investor dollars just so they can lose it again? Are decisions at these firms being made any differently? Beyond having less money to trade, lend, and invest, are there any new “checks and balances” in place? In the 1600s there was a tulip bulb craze in Holland where people were willing to pay $76,000 for a single tulip bulb! This is probably the best example of a “bubble” which inevitably burst – today we think it is silly for happening. Unfortunately, more bubbles have happened – the Internet Bubble in 2000, the Telecommunications Bubble in 2001, and the Real Estate Bubble of 2008. The banks were involved with all of them – so can we really believe they’ve learned their lesson this time?

What does this mean for the TILE Community? Well, if your bank failed their “stress test” you may want to watch to see if they raise the extra capital they need. Even if they didn’t fail the test, banks may still be reluctant to lend money for a while (for fear of failing in the future.) If you failed a Physics 101 test, you’re probably going to be a little reluctant to sign up for Advanced Physics next semester.

Even if your bank passed the test, pay attention to what they do and not just what they say. Is it easier or harder for you to get a credit card? A loan? Are they paying you more or less interest on your deposits? Is the service level higher or lower? Probably faster than the government, you will know how the banks are doing – just by how they interact with you!

- Amy

Today at TILE Financial, we talked about the US Government’s announced details on the Stress Test that banks will need to undergo. The results of the Stress Test will provide an indication of the financial well being of the bank and the need for added Capital (aka money) to make it healthy.

New York Times: Government Offers Details of Bank Stress Test

In essence the stress test is like a medical exam. If the doctor says you are deficient in Vitamin X, you then need to take special supplements to bring you back to a “good range”.

The Stress Test tries to illustrate what the Bank’s balance sheet will look like in a hypothetical/ worst case scenario (Some aren’t sure if that scenario is tough enough and others say it is too stringent). Assumptions include:

- the economy shrinks by 3.3% in 2009 and doesn’t grow in 2010

- housing prices fall by 22% in 2009

- unemployment rate grows to 10.3% by 2010

After carrying out the analysis, banks will either need to “Raise Capital” (aka money) themselves or go to the government for a capital injection (aka shot of money). In exchange, if using tax payer dollars, the US government would get an ownership share in the company.

The goal is to give people confidence that the banks have enough “money in the bank”/equity on the balance sheet to be healthy in tough times. Using the medical example, you want to make sure you take extra vitamins if you know you are going to be facing a stressful situation (e.g. maybe you try to get more sleep or eat better during final exams?).

For the TILE community, this has two implications. First, you may want to see how your financial institution did on the Government’s stress test. Does the test suggest the bank is healthy or at risk. If it needs more capital, how much is it receiving from the government? Some people are concerned that if the government owns too much of a bank, the bank will be less able to compete when the markets get better.

Second, watch the total amount of money the government “invests” in financial institutions. Right now they have already used $350 billion of the $700 billion rescue package. The more they use, the more they are creating a deficit (the governement owes more than it can pay) – and a future burden for future taxpayers (That is you!). If it can’t be paid back by normal means, your tax rate may increase. In essence the government is spending your future money to make the banks healthy today.

The TILE Community, more than anyone, has a stake in what is being done today – because you will be the large taxpayers in the future.

- Amy