One investment “rule of thumb” that has traditionally developed is smaller investors are usually late to the game…and thus expose themselves to higher levels of risk when a market bubble leaks, bleeds, or bursts. Such a time could easily be approaching in regard to the purchase or continuing ownership of bonds.

Tens of thousands of smaller investors have grown frustrated with the dismal overall performance of most stocks (also known as equities) during the past decade. Many of these investors in the past would have simply shifted some of their investment funds to financial institution savings accounts and certificates of deposit.

Many investors like the ability to sleep at night, knowing that deposits of up to $250,000 are guaranteed by the FDIC. Most recognize that while interest rates are extremely low, inflation pressures are also historically low.

For other investors, the low interest rate on such savings accounts and CDs has led them to seek higher returns. Bonds…especially U.S. Treasury notes and bonds…have been extremely popular, whether owned as individual securities or as part of a bond fund.

The Investment Company Institute reports that from January 2008 through June 2010, outflows from stock mutual funds totaled $232 billion. During the same time period, bond funds saw an enormous $559 billion inflow (The Wall Street Journal).

For those who shifted money into bonds or bond funds earlier this year, the returns have been attractive. For those who are considering such an investment now, the risks are extremely high.

The Other Risk

Human nature suggests that thousands of average investors who bought bonds earlier this year have boasted to their families and friends about the attractive returns they have generated by buying longer-term U.S. Treasury notes or bonds. As their buttons are bursting from their chests, they also note that these returns have been generated from investments that are U.S. Government guaranteed…

…They are somewhat correct

…and they are woefully misinformed

For example, an investment of $100,000 into the 2.625% 10-year maturity U.S. Treasury note due on 8/15/2020 (bought at face value or par) is guaranteed by the U.S. Government as to semiannual interest payments of $1,312.50 on February 15 and August 15 of each year. In addition, you will receive back your $100,000 principal investment on August 15, 2020.

This security has no “credit” risk. Believe it or not, debt issued by the U.S Government to finance enormous budget deficits is still considered the safest, most liquid (marketable) investment in the world. It is this assurance that helps people sleep at night.

However…and this is a BIG however…the investment is still subject to “market” risk. The value of the bond fluctuates daily, based on the general movement of interest rates.

Since the 1950s

The 10-year U.S. Treasury note yield (investment return) at mid-day on Tuesday, August 24 was 2.53%. The 30-year U.S. Treasury bond yield was 3.62%. With the exception of a few weeks very late in 2008 and very early in 2009 at the height of the global financial crisis, current yields are the lowest in more than 50 years, since the 1950s! The same is true for 15- and 30-year fixed-rate conventional mortgages, which averaged 3.90% and 4.42%, respectively, last week.

Long-term interest rates have fallen sharply in recent months because of high anxiety about slowing global and U.S. economic growth, as well as high anxiety about possible default by Greece and other southern European nations. Possible deflation in coming years, as well as stocks going nowhere in recent months have also contributed to rising bond prices…and lower yields.

Barring another global economic or financial meltdown, or other major hits to the U.S. and global economies, such long-term interest rates are not likely to move much lower. Yes, some suggest we could see a period of deflation in the U.S. economy, as discussed in last week’s issue of the Tea Leaf. Under such a scenario, long-term interest rates could move even lower.

The Party’s Over?

However, most economic forecasters and financial market professionals suggest that the amazing and largely unexpected decline in long-term interest rates has about run its course. They would suggest that the primary direction of long-term interest rates later this year and throughout 2011 is to somewhat higher levels. They point to the fact that while the U.S. economy has definitely slowed down in recent months, the odds do not favor a return to recession.

Note: We do know that the first U.S. Commerce Department estimate of a 2.4% real (after inflation) annual growth pace during 2010’s second quarter could be roughly cut in half when the first revision is released on Friday of this week. The consensus forecast for U.S. economic growth during 2010’s final quarter and for 2011’s first half is near a 2.5% annual growth rate.

Forecasters might note that there have been 33 official recessions since 1850, and only three times has the economy fallen back into negative growth within a year, according to the National Bureau of Economic Research, the official scorekeeper for the U.S. economy(www.Bloomberg.com).

…but I digress

The point is that a meaningful rise in long-term interest rates in coming months or quarters—when and if it does occur—will lead to sizable investment losses for many previous (and especially) new investors into direct bonds or bond funds.

Two Risks

Financial market emotions can turn on a dime. At some point, high anxiety about $1,000,000,000,000 and larger annual budget deficits could (or will) return. All of this excessive government spending must be met with borrowed money…much more borrowed money. Longterm interest rates could easily rise.

For example, if 10-year U.S. Treasury note yields were to rise one percent in coming months, simply back to the still low 3.53% level of last Spring, an investor buying notes or bonds today would have a 9% loss of principal should they need to sell…a loss of $9,000 on a $100,000 investment.

A similar 1.00% rise in the 30-year U.S. Treasury bond yield to a still low 4.62% would create a principal loss of nearly 20% for an investor buying the long bond today and needing to sell later…a loss of nearly $20,000 on a $100,000 investment! An investor in a long-term bond fund would see similar losses, while an investor in a shorter maturity bond fund would lose less…

Understand that a U.S. government guarantee applies to credit risk only…

…market risk is a whole ‘nother animal.

Jeff Thredgold is an economic consultant to Zions Bank

Featured in the 24 August 2010 issue of Jeff Thredgold’s Tea Leaf newsletter.

The Federal Deposit Insurance Corporation (FDIC) approved the payout of the insured deposits of Centennial Bank, Ogden, Utah. The bank was closed March 5, 2010 by the Utah Department of Financial Institutions, which appointed the FDIC as receiver.

The FDIC entered into an agreement with Zions First National Bank, Salt Lake City, Utah, to accept the failed bank’s direct deposits from the federal government, such as Social Security and Veterans’ payments.

The FDIC was unable to find another financial institution to take over the banking operations of Centennial Bank. As a result, checks to the retail depositors for their insured funds will be mailed on March 8, 2010. Brokered deposits will be wired once brokers provide the FDIC with the necessary documents to determine if any of their clients exceed the insurance limits. Customers who placed money with brokers should contact them directly for more information about the status of their funds.

As of December 31, 2009, Centennial Bank had approximately $215.2 million in total assets and $205.1 million in total deposits. At the time of closing, the bank had an estimated $1.8 million in uninsured funds. This amount is an estimate that is likely to change once the FDIC obtains additional information from these customers.

Customers who have questions about today’s transaction can call the FDIC toll-free at 1-800-889-4976. Customers with accounts in excess of $250,000 also should contact the toll-free number to set up an appointment to discuss their deposits. The phone number will be operational this evening until 9:00 p.m. Mountain Standard Time (MST); on Saturday from 9:00 a.m. to 6:00 p.m. MST; and on Sunday from noon to 6:00 p.m. MST; and thereafter from 8:00 a.m. to 8:00 p.m. MST. Interested parties also can visit the FDIC’s Web site at www.fdic.gov/bank/individual/failed/centennial-ut.html.

Beginning on Monday, customers of Centennial Bank with deposits exceeding $250,000 at the bank may visit the FDIC’s Web page “Is My Account Fully Insured?” at www2.fdic.gov/drrip/afi/index.asp.

Centennial Bank is the 26th FDIC-insured institution to fail this year and the second in Utah since Barnes Banking Company, Kaysville, was closed on January 15, 2010. The FDIC estimates the cost of the failure to its Deposit Insurance Fund to be approximately $96.3 million.

Congress created the Federal Deposit Insurance Corporation in 1933 to restore public confidence in the nation’s banking system. The FDIC insures deposits at the nation’s 8,012 banks and savings associations and it promotes the safety and soundness of these institutions by identifying, monitoring and addressing risks to which they are exposed. The FDIC receives no federal tax dollars – insured financial institutions fund its operations.

FDIC press releases and other information are available on the Internet at www.fdic.gov, by subscription electronically (go to www.fdic.gov/about/subscriptions/index.html) and may also be obtained through the FDIC’s Public Information Center (877-275-3342 or 703-562-2200).

Under the terms of an agreement with the DINB and FDIC, Zions Bank will provide operational management of the DINB. All 10 former branches of Barnes Bank will open on Saturday, January 16, 2010 at 9 a.m. as branches of the DINB of Kaysville for an interim transition period, after which the new bank will be closed. Direct deposit, checks, ATMs and debit cards will work normally for former customers of Barnes Bank during the transition period.

Zions Bank has also received approval from the Office of the Comptroller of the Currency to operate temporary branches inside the 10 former Barnes Bank locations, allowing Zions Bank to accept funds from former customers of Barnes Bank and assist them in opening deposit accounts with Zions Bank.

“We’re really here to help. Barnes Bank has a legacy of providing quality service to families and businesses in the community since 1891, so we want to help their former clients through this transition,” said Scott Anderson, president and CEO of Zions Bank. “This is an extremely difficult situation for everyone, but we are prepared to answer questions, provide support and comfort, and assist former Barnes Bank clients into new banking relationships.”

“We are honored to be asked to assist the FDIC with their efforts and continue to support our fellow Utahns through challenging times,” added Anderson. “Our goal is to ensure that former Barnes Bank clients have as smooth a transition as possible during such a stressful time.”

The FDIC has arranged for Nevada State Bank to assist in managing the deposit accounts. Direct deposit, checks, ATMs and debit cards will work normally. All twelve former Community Bank of Nevada branches will be open Monday, August 17 as branches of the new Deposit Insurance National Bank of Las Vegas for an interim transition period, after which the new bank will be closed. Nevada State Bank will oversee the new bank in providing banking services to former Community Bank of Nevada customers.

“We’re really here to help. This is an extremely difficult situation for everyone but we are prepared to answer questions, provide support and comfort, and assist former Community Bank of Nevada clients into new banking relationships,” said Dallas Haun, president and CEO of Nevada State Bank. “We are honored to be asked to assist the FDIC with their efforts and continue to support our fellow Nevadans through troubled times.”

He adds that, “this was not a situation where Nevada State Bank bid for the assets or deposits of Community Bank of Nevada, but rather we were asked to provide services to help facilitate depositors in this transition period. Nevada State Bank acquired two other failed institutions in the past 12 months—Silver State Bank in September of 2008 and Great Basin Bank in April of 2009, and we feel that our experience working in similar cases will help us provide a smooth transition for Community Bank clients. Indeed, our goal is to ensure that former Community Bank clients have as smooth a transition as possible during such a stressful time.”

Source: Press Release, dated 14 August 2009.

Image from + pAula + [ AnnieMate ] under Creative Commons License BY-NC-SA 2.0

While benefits of FDIC insurance can be debated, especially in this economic climate, insurance on certificates of deposit (CD) and bank accounts provides needed relief to the individual investor. Created in 1933 in response to the bank losses suffered during the Great Depression, FDIC insurance guarantees individuals’ bank deposits, currently up to $250,000 for each deposit in a single bank. Today, an individual can use the insurance to buy a CD knowing that their money is protected up to $250,000 until December 2013.

In addition to bank deposits, FDIC insurance carries over to some of the more conservative investment options as well. FDIC-insured CDs are a great alternative to low-interest-rate savings accounts. CDs are easy to open and produce a higher rate of return, usually much better than an everyday savings account.

Those looking to give up FDIC insurance in exchange for typically higher interest rates—without getting into higher-risk investments—might also consider senior notes. While not insured by the FDIC, senior notes historically have less risk than other types of unsecured debt because in the event that the issuer goes bankrupt, holders of these investments are generally paid before any other creditors.

Despite the current economic situation, there are ways to invest that will keep your risk low. Zions Direct offers one of the most popular FDIC-insured CD auction platforms, and, as mentioned in April’s Wall Street Journal article, investor usage in this platform has continued to “accelerate as the recession continues to affect consumers’ investment decisions.” Zions Direct has also recently sold Senior Notes on its auction platform as well, giving investors an easy, transparent way to get investing.

In Part One of this series, Zions Bank Senior Vice President Paul Hansen offered an overview of some key considerations when planning for retirement. In Part Two, Hansen reviews IRAs, the building blocks of a retirement plan.

“After some Zions Bank clients expressed concerns about keeping IRAs open, I realized there was confusion out there,” Hansen says. “An IRA, or Individual Retirement Account, is a vehicle for saving. It’s not the investment itself. IRAs can be used to invest in stocks, bonds, mutual funds, Certificates of Deposit, money market accounts and other investment vehicles such as real estate. When investing in an IRA through a bank, clients can put their money in CDs and money market accounts covered by FDIC insurance for up to $250K.” (Check the FDIC website for details about insurance coverage limits as the coverage limits for certain types of accounts will change back to $100,000 at the end of 2009.)

“In the current economic climate, clients might want to think about CDs and money market accounts,” Hansen continues. “But they should definitely continue to save toward retirement whenever possible.”

Zions Bank offers a number of IRA plans, including three FDIC-insured IRA options. All plans are offered in both traditional and Roth flavors. Because it can be difficult to know which is best for one’s individual situation, Hansen provides some guidance.

The first consideration, Hansen says, is eligibility. Both types of IRAs have certain restrictions. Individuals who are 70.5 or older can only contribute to Roth IRAs, for example, but Roth plans have certain income caps that don’t apply to traditional IRAs.

The main difference between the two types of IRAs is how they’re taxed. Contributions made to traditional IRAs are eligible for a tax deduction when the contribution is made. Contributions to Roth IRAs don’t get the tax benefit when the money is put into the account. However, withdrawals from Roth IRAs aren’t taxed, whereas withdrawals from traditional IRAs are.

For individuals who are eligible for both types of IRA, Zions has outlined some guidelines:
• For investors who want a deduction now, a traditional IRA may be the way to go.
• Those who want tax-free earnings should probably consider a Roth IRA.
• If you expect your tax bracket to go down at retirement, a traditional IRA is probably best.
• Those whose tax bracket will remain the same or increase at retirement might try a Roth IRA.
• Traditional IRAs have required minimum distributions that kick in at 70.5. For those who don’t want mandatory withdrawals imposed at that age, a Roth IRA will be the better option.
• Individuals looking to lower the effect of estate taxes by reducing an estate should consider a Roth IRA.
• The further you are from retirement, the greater the advantage of choosing a Roth IRA.

If all this still sounds confusing, that’s probably because it’s hard to make blanket recommendations about investing for retirement. Some investors may even benefit from contributing to both kinds of IRAs. Hansen recommends sitting down with a financial planner to review both your current situation and your expectations for the future. Remember, your retirement plan should be as tailored to you as are your retirement dreams.

Please note: The preceding article is offered for informational purposes only, and should not be construed as tax advice or as pertaining to specific factual situations. Consult a tax adviser concerning your own needs and circumstances and to obtain any tax advice with respect to the topics discussed in the article.

Featured in the March/April 2009 issue of Zions Bank’s Community magazine.

*Artwork from Felipe Skroski under Creative Commons license at Flickr.com.

Nevada State Bank officials announced April 17, 2009 that the bank has agreed, in a whole bank transaction, to acquire the banking operations of Great Basin Bank of Nevada in a transaction facilitated by the Federal Deposit Insurance Corporation (FDIC).

Branches previously owned and operated by Great Basin Bank of Nevada, headquartered in Elko, Nev., will reopen on Monday morning as branches of Nevada State Bank, Nevada’s oldest state-chartered bank. All Great Basin clients will automatically become clients of Nevada State Bank, said Dallas Haun, president and chief executive officer of Nevada State Bank.

The acquisition is effective at the close of business on Friday, after state regulators declared Great Basin Bank of Nevada insolvent and named the FDIC as receiver. The FDIC Board of Directors then approved the whole bank acquisition of Great Basin Bank by Nevada State Bank, which includes all loans, deposits and assets.

“Our first order of business is to welcome Great Basin clients to Nevada State Bank and to assure them that their deposits are safe, sound and readily accessible,” Haun said. “Nevada State Bank is healthy, with a strong balance sheet and capital ratios, as well as a history of serving our Nevada communities. We look forward to welcoming our new clients when we open our new Nevada State Bank branches for business as usual on Monday morning.”

Clients of Great Basin Bank should continue to use their existing branches, checks, ATM or debit cards. If former Great Basin Bank clients have any questions regarding their accounts involved in this transaction, they should continue to use the same channels as they have in the past, including contacting their local branch.

Much like last fall, when Nevada State Bank acquired the insured deposits of Silver State Bank in Southern Nevada, Haun said this is an opportunity for Nevada State Bank to ensure that communities in Nevada continue to be served by a locally managed, community-focused bank. He said it also enables Nevada State Bank to expand its reach and network of freestanding branches throughout the state, especially in rural Nevada.

“Being the successful bidder to acquire this bank speaks volumes about the financial strength and success of Nevada State Bank,” Haun added. “Such growth reinforces our commitment to provide personalized services to businesses and consumers in this state for at least another 50 years.”

Before this acquisition, Nevada State Bank, a wholly owned subsidiary of Zions Bancorporation, operated 54 branches statewide and listed assets of more than $4 billion. As new clients of Nevada State Bank, Great Basin Bank clients will have full access to a wide array of deposit and loan products once consolidation occurs.

Great Basin Bank of Nevada operated five bank branches, all in Northern Nevada. They include two branches in Elko, one in Spring Creek (southeast of Elko), one in Fallon and one in Winnemucca. The transaction includes approximately $220 million of deposits and $238 million of assets, including the loan portfolio of Great Basin Bank.

“Under the terms of the transaction, the FDIC will make an initial payment to Nevada State Bank and assume 80 percent of the first $40 million of credit losses. Any credit losses in excess of $40 million are borne 95 percent by the FDIC,” Haun said.

*Artwork from s337c under Creative Commons license at Flickr.com.

IMPACT ON CONSUMER SPENDING AND GDP |

Housing, poses enormous risk to the U.S. economy through its impact on financial markets, financial institution solvency and consumer confidence and spending. Key will be what happens to housing prices and the extent to which falling prices affect expected losses on mortgages and other linked financial instruments and the extent to which declining wealth affects consumer spending. Prospects are decidedly negative on all fronts as housing price declines continue unabated.

The linkages between housing wealth, price changes and consumer spending are imprecise and have been hotly debated. As the evidence comes in the debate is being resolved. Unfortunately, it appears increasingly that the resolution is in the direction of those who believe that housing had a substantial impact in stimulating consumer spending during the bubble phase and will have a commensurate negative impact now that the bubble is unwinding.

Part of the difficulty in tracing cause and effect is tied to transmission lags between changes in household wealth and consumer spending. These lags are long. My modeling indicates that falling housing prices will place considerable downward pressure on GDP growth during 2009 and 2010. Table 2 shows the timing and size of impacts of housing on GDP growth, which captures consumer spending, residential construction and other linked effects. Note that my Severe Recession scenario projects a -12.1% additional cumulative decline in nominal housing prices over the next two years (from 2008 Q3 through 2010 Q3), while the S&P Case-Shiller CME 10-city futures project a -14.7% decline over the same time period.

The Severe Recession GDP scenario indicates that non-housing GDP growth has been weak for several quarters. It turns negative during the fourth quarter of 2008 as recession deepens.

During 2009, the lagged impacts of cumulative declines in home prices have a very negative effect on GDP, which is offset by recovery in the rest of the economy beginning in 2010. The risk is that the recovery in the rest of the economy will be less than forecast because of negative feedbacks from housing (see Chart 1).

Table 3 includes the effect of $700 billion in additional stimulus in 2009 and 2010 on quarterly GDP forecasts. While stimulus has no effect on the housing component of GDP, it has a very favorable effect on non-housing GDP, beginning in late 2009 and gaining momentum during 2010. But, what is also clear from Table 3 is that it will take a very long time to overcome the drag on GDP of negative housing wealth effects and this will keep GDP on a slower growth trajectory for years to come.

GDP Growth Prospects Post Recession

You should note in Chart 1 that GDP growth post recession does not recover to the pre-recession level. Both of the last two recessions have been followed by prolonged periods of sub-potential GDP growth. Not only is this likely to be repeated in 2010 and 2011 but there is cause to expect sub-potential growth to be worse and extend for a longer period of time. Even the massive $700 billion in fiscal stimulus assumed in the Fiscal Stimulus scenario only manages to boost GDP growth to about 2%. I calculate that real GDP non-inflationary growth potential is currently between 2.50% and 2.75%. This is lower than in recent years due to slowing labor force growth and lower productivity gains. GDP growth is likely to remain below potential and that will add to an output gap that is already headed toward -6% to -8% by 2010 according to various estimates. Large output gaps are highly deflationary.

In past cycles aggressive monetary and fiscal policy eventually stimulated recovery, primarily through consumer spending. But there was a consequence. The saving rate resumed its secular decline and consumer debt to income ratios eventually climbed to new highs. Recovery was also assisted by expansion in household wealth.

The era of steadily rising household leverage is over. We have entered a new trend toward greater saving and less reliance on debt. By definition, a higher saving rate means that consumers will spend less out of current income. This will translate into slower GDP growth until the saving rate stabilizes. Moreover, housing wealth will not be an engine of consumer spending for a very long time. Once the housing price correction has run its course, a return to real rates of growth in housing prices of about 1.2% annually seems likely. How much this eventual return to rising real housing prices translates into consumer spending will depend importantly on the rate of inflation, which I expect to be near zero or negative (deflation) for a considerable period of time.

This is part 4 of our four part series of Bill Longbrake’s review of 2008 and the ongoing credit crisis. Bill Longbrake is the former Deputy to the Chairman and CFO of the Federal Deposit Insurance Corporation and Vice Chairman of Washington Mutual. He is currently on the Board of Directors for First Financial Northwest.

Originally published as Bill Longbrake MEMORANDUM, December 15, 2008, RE: Economic Commentary – Massive Negative Demand Shock Threatens Worst GDP Performance Since the Great Depression; Specter of Pernicious Deflation Lurks.

*Artwork created by Iron Man Records under a Creative Commons license at Flickr.com.

MANAGING THROUGH “INTERESTING TIMES” |

“May you live in interesting times,” often referred to euphemistically as the Chinese curse, is reputed to be the English translation of an ancient Chinese proverb and curse. If ever we were living in interesting times, it would be now.

To say that the current economic times are challenging might seem like an understatement. With the unprecedented events in the market over the past several months, people everywhere are concerned about protecting and preserving their money. While this uncertainty can leave all of us feeling uneasy, it can also bring forward the need for all of us to be proactive about our personal finances and manage our money with care.

Since early in 2008, the President’s Advisory Council on Financial Literacy has been working to develop policies and programs to promote financial literacy. Their goal is to provide substantive guidance and resources that can help people make smart financial choices during both good times and bad.

Last month, the council offered a series of tips for managing your money in challenging times. I offer a few of these tips below, along with information on additional available resources.

1. Understand how your deposits are insured. As we’ve discussed in previous articles, the FDIC insures all deposits at insured banks up to at least $250,000. In addition, Zions Bank is participating in the FDIC’s voluntary Temporary Liquidity Guarantee Program. This program insures 100 percent of deposits that are held in noninterest bearing deposit transaction accounts at Zions Bank (including NOW accounts with interest rates of 0.5 percent or less), regardless of the dollar amount, through Dec. 31, 2009. For additional information on how to maximize your FDIC insurance coverage visit zionsbank.com.

2. Understand how your investments are protected. Brokerage firms are required to be members of the Securities Investor Protection Corporation, which insures customer securities accounts up to $500,000, including $100,000 in cash claims, when a brokerage firm fails. To learn more about these protections, visit www.sec.gov/answers/investoralert.htm.

3. Protect your credit score. Only put on your credit cards what you can afford to pay back. For other hints on improving your credit score, visit www.controlyourcredit.gov. Also, to protect against identity theft, get a free copy of your credit report at www.annualcreditreport.com.

4. Make sure you have a rainy day fund. Keep an emergency fund worth three to six months of your monthly expenses in an insured account. If you don’t have an emergency fund, try to start one. Visit “Managing Your Money” at the Zions Bank education center to access budgeting calculators, savings calculators and more.

5. If it sounds too good to be true, it probably is. Watch out for scams trying to take advantage of all of the recent changes in our nation’s financial markets. Educate yourself at www.FTC.gov.

As we begin 2009, we can all feel a little more secure in our financial situation as we become more proactive in managing our personal finances.

Zions Bank continues its commitment to helping you through these “interesting times” with innovative products and services, as well as the financial advice and information you need to make informed decisions. We haven’t forgotten who keeps us in business, and together we will weather this storm.

A. Scott Anderson is President and Chief Executive Officer of Zions First National Bank

Featured as “The Last Word” in the January/February 2009 issue of Zions Bank’s Community magazine.

*Artwork from Rob Sheridan under Creative Commons license at Flickr.com.