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Economy

In your personal finance journey, you may or may not have come across peer-to-peer (P2P) lending platforms. The great news is, these have proven to be solid investments over the past few years, providing much higher returns than what you could earn on bank investments. But we have to wonder:  will P2P platforms continue to be reliable investments, particularly if the economy begins to weaken?

p2p

Since P2P lending only got its start in the early 2000s, we don’t have a particularly strong or reliable track record to fall back on. The first platforms only began coming on line as the last recession – the Financial Meltdown – was unfolding. So while they have been a picture of success since their inception, we don’t really know how they’ll hold up under pressure.

What Effect a Weakening Economy Might have on P2P Lending

In the absence of any substantial performance data from the last recession, we can only speculate what effect a weak economy will have on P2P lending. But we can rely on the general performance of loans in past recessions for strong clues.

When the economy declines, asset prices fall and unemployment rises. In turn, default rates on virtually all types of loans rise. Since P2P loans are unsecured and taken for a variety of purposes, they most closely relate to credit cards.

According to the Federal Reserve, credit card default rates were at 2.34% at the end of 2016. However, they hit a high of 6.77% during the second quarter of 2009, in the middle of the Financial Meltdown.

While P2P loans are priced to accommodate certain default levels, they are based on the most recent default experience. Should default rates rise to something close to what they were in 2009, P2P loans priced based on today’s default rates will likely suffer disproportionate losses in interest rate return.

The Flood of Institutional Money Might Weaken Lending Standards

The basic concept of P2P lending is simple. Individual borrowers come to lending sites in search of loans, which will ultimately be funded by individual investors. But as interest rates have continued low, institutional participation in P2P lending has grown, as banks and other large lenders seek higher returns. For example, Lending Club recently reported that banks funded 31% of loan originations in the fourth quarter of 2016, compared with 13% in the third quarter.

One of the concerns over increased institutional participation is loan quality. As institutions bring larger amounts of capital into the space, loan quality may decline. That can happen as P2P lenders lower underwriting standards in order to draw in a larger number of loans. As they do, the quality of those loans will gradually decline, eventually increasing the rate of default.

It remains to be seen if that will play out as a worst-case scenario. However, not only is the industry itself relatively new, but institutional participation is only very recent. That means that the impact of greater institutional participation has yet to be felt.

Lending Club’s 2016 Scandal

In May of 2016, Lending Club’s CEO, Renaud Laplanche, was forced to resign amid a scandal. A summary of the event disclosed that:

Lending Club conducted a review, under the supervision of a sub-committee of the board of directors and with the assistance of independent outside counsel and other advisors, regarding non-conforming sales to a single, accredited institutional investor of $22 million of near-prime loans. The loans in question failed to conform to the investor’s express instructions as to a non-credit and non-pricing element. Certain personnel apparently were aware that the sale did not meet the investor’s criteria…The review further discovered another matter unrelated to the sale of the loans, involving a failure to inform the board’s Risk Committee of personal interests held in a third party fund while the Company was contemplating an investment in the same fund.

Since Laplanche’s resignation, earnings have gone negative three quarters in a row. What’s more, the pattern of losses are expected to continue through 2017. The company is forecasting losses of $69 million to $84 million, on revenue in the range of $565 million to $595 million for the year. The company cites the loss of investors in the aftermath of last year’s scandal.

We should reasonably expect that Lending Club, as the largest platform in the P2P space, will recover. However the episode should serve as a warning that the development of P2P lending won’t necessarily be an elevator ride straight up. With the number of P2P lenders increasing steadily, there are bound to be more negative surprises.

Read More About Reducing Risk With Lending Club here.

That might make a strong case for spreading your P2P investments across several lending platforms.

The Nature of P2P Loans Themselves

Despite the positive overall performance of P2P lending over the past few years, the practice contains two built-in issues.

The first is the fact that the loans are largely comprised of debt consolidation loans. Though such a loan can potentially improve a borrower’s financial situation by lowering the interest rate and monthly payment that he or she is paying, it also holds the potential to borrow even more money.

For example, many borrowers engage in serial debt consolidation. They have a few credit cards, and then do a debt consolidation to lower the monthly payment. But one or two years into the debt consolidation, and they rack up more credit cards. Eventually, there’s another debt consolidation – and maybe even a third, and a fourth.

From a risk standpoint, the problem is that the borrower is never actually paying off debt. Often, the debt consolidation simply sets the stage for the next round of borrowing. As that cycle continues, the risk of default on the latest debt consolidation loan increases.

The second major concern is that most P2P loans are unsecured. Borrowers can typically take loans as high as $40,000, and for nearly any purpose, without having to put up any collateral. In the event of a loan default, there will be no assets to seize in order to satisfy the debt.

In an economy with low unemployment, low interest rates, and rising asset prices, neither issue is a major concern. But when the economy eventually weakens, both run more than a slight chance of becoming more pronounced.

Positioning Your P2P Portfolio for Leaner Times

All of this should be a reminder that P2P lending, like virtually all other types of investing, is not completely risk-free. And despite recent healthy performance, the situation could change — and change dramatically — in the event of an economic slowdown.

None of this is to discourage investing in P2P lending. Since the next recession is virtually inevitable, though, now is the time to prepare your investments for a change in circumstances.

Prepare Now: Sweat In Up Markets So You Don’t Bleed In Down Markets

How can you protect yourself?

  • As noted earlier, consider investing on several P2P lending platforms. That will minimize the risks associated with any one platform.
  • Don’t use P2P investing as a substitute for the fixed income portion of your portfolio. Instead, make it part of your fixed income investments, to offset and increase the lower rates paid on traditional but safer fixed income investments. You should have both P2P and traditional fixed income investments.
  • Invest across various risk grades, despite the fact that returns may be higher on the weaker grades. Lending Club’s Statistics page (“Loan Performance Details” chart) shows that default rates increase substantially with each lower credit grade.

In regard to the last item in particular, it’s important to realize that default rates are likely to increase more dramatically in the lower credit grades in the face of a bad economy. Those are, after all, the highest risk loans being made.

We don’t have much information available as to how well P2P investing performed in the last recession. But that makes it even more important, at this late stage of the current economic recovery, to make some reasonable assumptions about what’s likely to play out. This will allow us to best prepare for it.

How do you think P2P investing will do when the economy takes the next nosedive?

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If you’ve been paying attention to financial news, you’ve probably heard mention of the fiduciary rule. This rule was approved last year under the Obama administration, with the goal of increasing transparency within the investment realm. It was designed to force advisors to suggest investment products to their clients that were more affordable, rather than being able to suggest ones that instead provided these advisors with higher commissions.

While the rule has not yet been implemented (it was slated to go into play this April), it looks like its run may be short-lived. Today, President Trump signed an executive order that is likely to halt the implementation of the rule, along with ordering a widespread review of the Dodd-Frank Act.

fiduciary rule

This has many up in arms, as the fiduciary rule seems to be a matter of common sense and integrity. Forcing ALL advisors to offer their clients less expensive investment products, rather than higher priced ones that may result in bigger commissions, seems like a great idea. Transparency throughout any industry should be mandatory… so why nix the rule?

Yes, There Is Already a Fiduciary Obligation…

For almost 80 years, a fiduciary obligation — called the fiduciary standard — has been in place. This was implemented with the Investment Advisors Act of 1940, intended to affect most types of investment accounts. This standard implements an expectation that advisors need to place their client’s interests ahead of their own. The advisor is always supposed to act in the best interests of their clients, in every situation, whether the client is aware of it or not.

The reach of this standard is far and wide. An advisor cannot, for example, make trades on a client’s behalf that would result in higher commissions or fees for himself or his firm. An advisor is supposed to make all efforts to ensure that the investment advice given is not only accurate, but complete. They are bound to a “best execution” standard, while dictates that the purchase and sale of securities should be completed with the best possible combination of low cost and efficiency. Advisors are also prohibited from buying securities for themselves before they buy them (or advise their purchase) for their client.

Lastly, and perhaps most importantly, the existing fiduciary standard already prohibits the potential of conflicts of interest. In fact, if a potential conflict of interest is present, the advisor must disclose this to the client before any trades take place. Which begs the question…

Then, What Would the Fiduciary Rule Even Change?

As mentioned, the fiduciary standard already has provisions to avoid and prohibit conflicts of interest between advisors and their clients. This is, of course, the heart of the fiduciary rule… so why the new implementation?

Well, the difference primarily lies in the types of retirement account providers to which the existing rule applied.

As it stands today, the fiduciary standard does not technically apply to insurance reps, broker-dealers, and financial company reps (other than investment advisors). These individuals, instead, are bound by the suitability standard.

The suitability standard is much simpler and much less comprehensive. In a nutshell, it says that an advisor only needs to assess a client’s risk and tolerance before offering investment products and advice. Essentially, gathering a client’s preferences is enough, as long as the products the advisor subsequently recommends match those preferences. This opens up the possibility of a very large grey area… if an advisor simply believes that a product suits a client’s risk tolerance, it’s fair game.

The new rule, though, would make sure that everyone was bound to the fiduciary guidelines. Rather than having the freedom to pick financial products that simple lie below a client’s threshold, all advisors would need to first disclose the fees, limitations, conflicts of interest, etc. of the product. As of now, just the designated investment advisors are bound to such. The fiduciary rule simply hoped to expand this rule to anyone and everyone offering any sort of investment-related advice.

Why It’s Happening

Well, the argument seems to be that the fiduciary rule could actually harm many of the lower-income investors out there, in a number of ways. First, it would prevent advisors from recommending more expensive investment products to their clients when lower priced alternatives exist — even if the higher priced ones were a better match in the end.

Forcing advisors to be transparent about fees and compensation sounds like a great idea, unless the client then chooses their investment product based on this information alone. If an advisor puts three different funds in front of a client, with one having a noticeably higher rate of commission, the client is less likely to lean toward that fund. But what if it had a good chance of outperforming the others? To combat this, potential investors would need to take into account all components of a financial product, not just seek to avoid fees where they could.

Does limiting suggestions to lower cost financial products actually harm the client? Could narrowing their options actually be taking away their investment freedom, causing harm in the long run? Some fiduciary rule-protesters think so.

Another way that this rule could harm lower-income investors is through financial advisor services. Today, some companies are able to offer free or low-cost investment advice to their customers. The new regulations threaten to increase their fees for providing such, resulting in some of the smaller savers being denied advice or simply being unable to afford it.

The Impacts Overall

The fiduciary rule has also been challenged as detrimental to the smaller firms and dealer-brokers in the industry. The cost of compliance with the rule is expected to be high, with additional technology and compliance experts being an added, necessary investment.

As a result, we could expect to see many of these companies disband or be acquired. It’s actually already being seen, in the case of American International Group and MetLife Inc. brokerage operations. Both of these have already been sold off in anticipation of the fiduciary rule’s April 10 implementation date.

What does this really mean, though? Less diversity in the industry, for starters, as the independent companies disappear. Also, as the consolidation continues, it threatens to eliminate (or make difficult to find) advisors who will be able to offer smaller plans. Once again, this has the potential to greatly impact the lower-income investors.

It’s interesting to note that when the United Kingdom implemented a similar rule in 2011, their investment industry had exactly this response. Independent companies could not keep up or could not afford to comply with the technology and changes required. So, they forged paths with larger corporations. As a result, the number of financial advisors in the U.K. has dropped by a whopping 22.5% ever since, creating an even bigger guidance gap than had previously existed.

This effect makes it easy to see why the fiduciary rule has been referred to as “Obamacare for your IRA.” While the rule is necessary and important in many ways, its impact of narrowing the advisor industry down to fewer and fewer options is certainly a check mark in the negative column. Having options and healthy competition between companies is generally a big benefit for consumers.

All Hope Is Not Lost

For proponents of the fiduciary rule who are appalled to see its (likely) overturn today, I have some good news. Many of the financial services companies that were slated to be impacted by its April roll out are going to move forward with their new standards. They had already put new changes in place and believe that transparency is an important part of the advisor-investor relationship.

Companies like Morgan Stanley and LPL Financial Holdings, Inc. have both said that they still plan to move forward with the new standards that they have already worked to create. Hopefully, this idea of working in the best interest of the customer catches on and spreads, on its own, throughout the industry.

Until then, we wait and see.

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If you are a homeowner or have looked at buying a home in the near future, you probably know all about conforming loans. While the limits for these types of loans have remained stagnant for the past decade, steady increases in the housing marking have prompted this ceiling to rise for the first time since 2006. Beginning next year, a wider range of borrowers will now be able to access these types of loans. Rather than being limited to $417,000, conforming loans will now have an increased limit of $424,100 in 2017.

What is a Conforming Loan?

In the United States, mortgage loans are categorized based on whether they do, or do not, conform to the standards set for by Fannie Mae and Freddie Mac. One of these standards is the cost of the home. In order for a mortgage to be considered “conforming” – and be eligible for lower interest rates – it needs to be below the conforming loan limit.

Until this new change was announced for 2017, the conforming loan limit was set at $417,000 for many years. While a jump up to $424,100 isn’t an astronomical difference, it opens the homebuying door to many people who wouldn’t have otherwise been able to qualify for a lower risk, conforming loan.

If you want to buy a home that crosses this conforming limit threshold, your loan is considered non-conforming or jumbo. While these loans are certainly still available, they are considered much riskier to lenders and therefore are harder to obtain. Also, they typically involve higher down payments and a more intense scrutinization of your credit history and/or income. Because of this, they are seen more often with luxury homes, investment properties, or retail spaces.

Conforming loan limits vary by county, as it is relative to the cost of living in that area. The Federal Housing Administration is responsible for setting the national conforming loan limit (which is what will be increased for 2017), but some counties are deemed eve higher cost. As such, they have special higher limits.

In my county, for instance, the conforming loan limit is at the absolute max of $636,150 —  a whopping $212,050 above the standard national limit. Then again, the cost of living where I live is astronomical (Washington, DC area) and home prices stay high, so it makes sense that certain counties are able to get higher loans. If you want to check the conforming loan limits in your own county, Bankrate has a great chart that you can view.

conforming-map

What Does the Increased Limit Mean for Me?

If you are looking at buying a home that was toeing the $420,000 range, this increase may mean the difference between a basic loan and a jumbo loan for you. That equates to a lower down payment, greater chance of approval, and less headache.

Planning to buy your home with a VA loan? You would be obligated to purchase within the conforming limits of your county. A jumbo loan isn’t even an option with these (and other) government-backed mortgages, so the increase may open a few extra doors while finding the home of your dreams.

Why the Increase?

It’s a great indicator of the health and growth of our country’s housing market, that the limit is rising. After the US housing crash in 2007-2008, home costs are on the rise and expected to continue to grow. This is great news for our economy and for anyone whose money is invested in real estate, whether that be their home, rental properties, REITs, etc.

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While the cost of your home isn’t the only limiting factor between your mortgage being “conforming” or “non-conforming,” it’s a big part of it. Non-conforming, or jumbo, mortgages are harder to obtain and often involve more stringent credit/income guidelines, an intense application process, and higher down payments.

If you’re looking at a government-backed mortgage of any kind, you will need to stay within the conforming mortgage loan limits set forth by the FHA. Beginning in 2017, you’ll get a little extra wiggle room. Be sure to check for the actual limit in your county, especially if you live in a high cost area, and happy buying!

Have you ever had to walk away from a dream home because it would have meant a non-conforming loan?

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After a lull in the price of a barrel, we are seeing the cost of oil begin to once again increase. With it comes increased revenue and, in turn, money being pumped into both the stock market and the economy. So, is this good news for the average person? Well, the immediate answer is no, probably not.

It’s All Part of the Plan

Just a few weeks ago, the Organization of the Petroleum Exporting Countries (OPEC) — and even some countries who are not members of OPEC —  was able to create an agreement that reaches far beyond what many economists thought they could accomplish.  The goal? To reduce the supply of oil around the globe by at least 1.2 million barrels a day. Assuming the demand for oil remains unchanged (at least initially), the reduced supply will create a rise in price. This will, in turn, jump-start the oil industry.

As the price of oil continues to rise, it’s suspected that some of the countries involved will jump ship on the agreement. They may see the profits in front of them and begin pumping out more barrels than initially agree. So far, though, everyone is sticking to the arrangement and the price of oil has consistently risen since the start of the month.

No commodity is more discussed in the world of finance than oil. No commodity has more of an impact on your day-to-day personal finances than oil. Turn on any market-driven television channel, and I’m willing to wager that within 10 minutes, the analyst will have brought up oil at least five times. It’s a true driving force behind the global economy, and its shift in price can have drastic changes on you and your family.

Some economists are extremely bullish on oil predictions, saying it will reach $75/barrel before the end of the year. However, even the bears don’t see oil going anywhere but up (albeit slowly) for the next few months.

Now that the price of oil has stabilized and is steadily rising, is this good for your wallet?  Your future?

The Bad News

When the price of oil goes up, it affects the American buying consumer primarily in three negative ways:

The Price of Gasoline Rises – According to AAA, this week’s average price of unleaded regular gas is $2.21 per gallon.  This time last year, that price was $2.02. At its lowest point this year, the price was $1.62.  If you’re someone who takes an hour round-trip commute to work or drives the kids to football practice in the minivan, you will notice more money coming out of your wallet when you fill the tank.

Average Americans fill up w/ roughly 700 gallons of gas per vehicle, per year. Because of this, even a small increase of 25 cents per gallon will put you out an extra $200 or so per vehicle. You can mitigate this loss by owning a cashback credit card (some of which offer up to 5% rewards on gas purchases). Even after saving a little bit more there, though, rising gas prices are an inevitability of higher oil prices.

Price of Travel and Other Goods Rises – When the cost of gasoline goes up, the cost of goods also goes up. This is to coincide with businesses having to pay more money to get their goods to them.  And of course, that cost is passed on to you, the American consumer.

For example, a round-trip flight from LA to Chicago may be $110 today, but closer to $120 in two months when oil goes up another $5.  Truckers moving products across the country, grocery stores taking in daily shipments of produce… there is no shortage of consumer goods affected by a higher cost for oil.

Price of Heating Oil Rises – This is the one that impacts me the most, but overall impacts the fewest number of consumers.  I live in central Connecticut and every year, I buy between 700 and 800 gallons of oil to heat my home through the winter. My parents, who own a much older (and slightly smaller) home, purchase over 1,300 gallons of oil per winter. When oil prices go up, the price per gallon of heating oil also goes up.  The cost of oil is very similar to the cost of gasoline per gallon.

To combat these prices, I locked in a rate of $1.89 per gallon in July and prepaid for the winter. This should help me avoid having to pay inflated costs when the cold weather hits. However, I also lose the ability to pay lower costs should the price of oil go down.

The Good News

It’s not all bad, though, I promise.  When the price of oil goes up, there is a lot of good that comes from it, too.

Retirement Savings Accounts Increase – Because oil is a heavily traded commodity, it’s likely included in any retirement portfolio you own.  Whether it’s in a commodity mutual fund, or a direct stock ownership of Exxon Mobile, Chesapeake Oil, etc., higher prices in oil mean higher value in your portfolio.  As rising oil prices generally (and I say that loosely) means a stronger economy, it would also likely have an impact on the other investments you’ve made. So if the world is paying more for oil, and the demand for oil remains high, most investments are happy.

The Economy Grows – The oil industry is one of the largest in the world, and higher prices mean higher profits for oil companies.  These profits lead to the hiring of more employees to produce more oil (or expand the business in other ways, still hiring more employees). This means more jobs for not only American citizens but also abroad.

With more people employed, more money is spent inside the US economy. Goods that would not normally be purchased are now starting to move off the shelves.  My example is the most basic way in which the economy will see a positive effect of higher oil prices. However, there are countless other ways to quantify it as well. (For an added example of global wealth, Goldman Sachs provides perspective.)

The Government Doesn’t Get the Extra Revenue – When you see the price of $2.25 for a gallon of gas, you might assume that the money you pay the gas station stays with the gas station.  However, inside of that gallon is heavy taxes collected by both the US government and the state government.  Below is a map that shows just how much money you pay in “tax” when you buy a gallon of gasoline (as of January 2016).  The good news here is that these taxes are not based on a percentage of the gallon, but a flat amount. For example, the US government gets a flat 18.40 cents per gallon, no matter the cost of a barrel.  So, the added revenues earned by the gas station are revenues passed economically, without additional government taxes.

gas-tax-map

You’ll notice that the good news is very macro-themed while the bad news is very micro-themed.  When the cost of goods goes up, there’s just no way around having it immediately and negatively impact the day-to-day spending of the consumer.  So, whether or not the price of oil going up is good or bad for you likely depends on your current financial situation.

If you’re well-to-do with money in the bank, savings for retirement, and are secure in your employment (or your employment is oil pump-related), oil prices going up is a good thing.  It goes a long way to secure a stronger economy in the long-run and boost retirement savings.  However, if you’re currently struggling to make ends meet, and things like retirement seem like a dream versus a real goal, then higher oil only means less spending money in the near future. Either way, the rise in oil prices is likely to garner mixed emotions nationwide.

 

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Why Do You Feel Worse Off Financially?

by Luke Landes
Money

Gallup’s annual “Mood of the Nation” poll sampled 1,018 adults from across the United States earlier this year, and the results show that more Americans say they are worse off financially right now than they were a year ago. 42 percent of the respondents consider themselves to be worse off, 35 percent say they are […]

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JPMorgan Chase Settles SEC Charges Regarding Fraud in 2012

by Luke Landes
JP Morgan Chase

I would have thought that all the shenanigans within the financial industry ended when regulators began looking into causes of the Great Recession. Today, the SEC announced that JPMorgan Chase is settling the charges that lying to investors was part of the method of operation for the company as late as the first quarter of […]

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5 Keys to Full-Time Employment for Young People

by Luke Landes

The latest economic news from the Department of Labor paints a mediocre picture at best of the employment situation in the United States. It’s still difficult for young people to find full-time jobs. There may be some concern that this lower level of employment is going to be the new norm, and whether American society […]

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Mint.com Tracks Two Million Users to Create Spending Index

by Luke Landes
National Average Monthly Spending

When staff writer Sasha introduced Consumerism Commentary readers to Mint.com in 2007, I began to think about the power of massive consumer financial data. As more people signed up for this online service that connects directly to users’ credit card accounts and bank accounts, Mint.com, or any other similar services, would be able to analyze […]

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Raising the Minimum Wage to $9

by Luke Landes
Minimum Wage

In his State of the Union address to the United States Congress and the television-viewing audience around the world, President Obama called for an increase in the federal minimum wage as a way to reduce poverty. If you believe that business owners have a right to pay whatever the market will bear, minimum wages, whether […]

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$1 Trillion Platinum Coin: The Next Episode of Reality TV

by Luke Landes
$1 Platinum Coin

Political theatrics doesn’t stop. I’ve been ignoring the latest issue for as long as possible, but this is so ridiculous I couldn’t go on ignoring it. Now that pundits have stopped talking about the fiscal cliff, the discussion has turned to the debt ceiling, the artificial limit Congress has put on spending that they have […]

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