Liquidity! It Affects Everyone, Not Just Big Banks

Image from https://www.treasuryandrisk.com/

You might have heard about the markets having “liquidity” problems, but to the average Joe, this could sound like technical mumbo jumbo.  I mean, how does liquidity in the markets affect you?  Believe it or not, it can massively affect you.  Besides inciting panic in the stock market, which probably has affected your investments since late February, lack of liquidity means there is less cash out there to lend.  For a few weeks, this made it difficult for people already in a home purchase contract to close on the deal without paying a premium interest rate for their new mortgage. 

Most conforming loans are made by a mortgage lender who fully intends to sell your loan on the secondary market, typically to a real estate investment trust (REIT) that takes capital from investors, ranging from ordinary people to big funds owned by the likes of Vanguard or Fidelity.  The REITs also take out loans from big banks to buy more loans.  Then, when people pay their mortgages, the cash from those payments flows through the REITs to pay off principle and the interest is distributed to shareholders as dividends.  The principle in reinvested into new mortgages, and the cycle of life continues.  The main investor draw to REITs is their high dividend yields.

In March, something crazy happened related to the Coronavirus crisis.  Some of those big banks called the loans made to the REITs.  Why?  The banks were worried and wanted to get some cash to act as a safety net in case cash flows from operations waned significantly.  The REITs didn’t envision being so unstable that the banks would ever call the loans due.  At the same time, stocks like AGNC and MITT dropped by as much as 80%.  MITT could not come up with enough cash to pay back the called loans, and many feared default.  Lucky for the REITS, their knight in shining armor, A.K.A, the Fed rode in on their shining horses and bought up some of the REITs’ holdings at a discount, potentially staving off a wave of bankruptcies.  This also shored up the mortgage market for future loans.  This situation is a case-in-point on how delicate the economy is.  Liquidity is everything. 

Without the government providing free capital to all of these REITs and banks, mortgage rates would go much higher.  This was the case for many years.  I remember in the 2000s, a 5.50% interest rate was fantastic.  A good rate in the mid-1990s was 9%.   I also remember earning 4-5% on my ING savings account.  I would be elated for rates on my savings like that now.  I keep chasing a 1.40-1.70% yield on savings and the banks keep dumping the rates because they can get cash for less from the Fed.  Banks make their money on the margins of what they pay out in interest and what they charge on loans and credit cards.  When you deposit your money in a bank, the bank keeps a mandated reserve and can loan the rest.  If they fall below this threshold at the end of each business day, they take an “overnight loan” from the Fed at the low, low rate that you hear about in the news constantly.

Liquidity makes the capitalist market ebb and flow.  Many may talk badly about day traders or big fund managers, but the cash coming into the markets is what keeps prices real.  If they were not there, trading every day, you would never be able to sell investments out of your 401(k) and retire.  Everyday traders keep things going, even though some view Wall Street as criminal, the reality is most are out there working hard so that those who put money into the markets get a healthy return over the long term and can make their dreams come true.  The alternative is Social Security, which we know isn’t enough on its own for most to live a comfortable life in retirement.

So, all hail liquidity!  It’s essential for a smooth-running economy and stability for you and me.  To work, it needs a good balance of those who want to lend or invest and those who want to borrow and pay back the principle and interest, as scheduled. 

Check out my other blog posts and follow me on Twitter!  Thanks for checking out today’s read.

Disclaimer:  William owns AGNC and has recently traded MITT.  He also owns shares of SRET, an ETF that holds a range of REITs.  This article is not intended as investment advice.  Please consult a licensed investment broker for complete investing advice that aligns to your risk tolerance.

If You Want to Retire, It Takes Money to Make Money

Everyone has different ideas on how they should spend (or not spend) their money and that is fine.  If we all did the same thing, our economy would be vastly different and highly predictable.  However, I hear a great many people say they can’t get ahead or can’t afford to save, whether for a rainy day or retirement.  My question back to them is how can you not afford to save? 

Image from learn.stashinvest.com

In an earlier post, I talked about how difficult it was to save and all the mistakes I made.  It was difficult for me to get started as well.  I did not start contributing to my 401(k) plan at work until I was 25 years old.  I always had an excuse, yet when I lived in Southern California, I always had designer clothes from Abercrombie & Fitch and was eating out quite often.  Keeping up appearances and going out was my thing back then and my income was much lower that it is today.  So many people, especially younger ones, spend to keep up with their friends, coworkers, and even strangers they are somehow trying to impress for no known reason. 

There is always something to spend on, but you have to make saving a priority.  Most who don’t save likely don’t budget.  Having a clear vision, or some kind of long-term idea, of what you want to see happen with your money over time is the first thing on the saving to-do list.  You don’t just save for the heck of it!  Life is short and you really need to have goals set.  Retirement may seem like it will never come when you’re younger, but trust me, you will wake up at 35 or 40 and suddenly remember your 10th or 20th birthday.  You are now 20 or 25 years away from 60, where you could retire on a 401(k) or Individual retirement account if you had enough saved.  Time will march on and you need to be ready.

If you can only save for one thing, save for retirement.  Social Security is not enough for most to live on today, and according to the Social Security Administration, benefits will likely erode over the coming decades.  Health care will likely need to be a larger part of your budget as you get older if you want a good quality of life or to live a long life.  I have learned from my mother and her recent change to Medicare still requires a supplemental plan to not have prescription drug costs and other procedures wipe out her savings over time.  While the plan is affordable, it is an additional line item many don’t have today. 

For those who make it to their golden years and have issues with retiring due to income, the problem isn’t whether they invested in mutual funds, stock index funds, or some other diversified way of building wealth, it’s that they didn’t put money aside to grow.  That is why this article is called It takes money to make money, because if you do not put anything aside, just like if you don’t plant seeds in the spring, you will not have a harvest to reap later on. 

Make a small sacrifice of three to five percent of your income and your older self will thank your younger self in your elder years.  It’s never easy to cut back or see your take-home-pay shrink, but you are actually just delaying pleasure.  That money will be there in the future, except it will have grown much more than what you originally contributed.  If something happens to you before retirement, you will be leaving a legacy for your spouse, kids, or whomever you designate as a beneficiary.

What was your turning point?  What made you start saving for retirement?  Was is being automatically signed up for your employer’s 401(k) plan, or did you make the decision consciously?  If you aren’t saving, what is your reasoning?  Please leave me a comment.  Thanks for reading!