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MARICOPA COUNTY MEDICAL SOCIETY - VOLUME 54, NUMBER 5, MAY 2008
PRESIDENT’S PAGE
TH E C OMM ON TH REA D
SERVES YOU RIGHT®
FRONTLINE POWER OF INFLUENCE
LEGAL UPDATE:
MEDICARE
APPEALS PROCESS
SPECIAL REPORT:
The Impaired Physician
in Your Group
FINANCE - A BROADER PERSPECTIVE:
FEDERAL RESERVE IN THE SPOTLIGHT
AS KEEPER OF THE ECONOMY
FINANCE
A Broader
Perspective:
Federal Reserve
in the Spotlight as
Keeper of the Economy
by Mike McCann, CFP, AIF
Increasing costs at the grocery store and the gas pump,
news of falling home prices, and the recurring ups and
downs of the financial markets seem to be taking their
toll on the collective American psyche.
When asked to name the most important problem facing
the nation, 35 percent of Americans participating in a
March 2008 Gallup poll simply said “the economy.”
More than half (55 percent) mentioned some aspect
of the economy, such as fuel and oil prices, unemployment and the high cost of living. As recently as
October 2007, only 22 percent of Americans mentioned some aspect of the economy as the most
important problem.
To counteract this negative consumer psychology and improve public understanding of monetary
policymaking, the Federal Reserve has recently stepped up the frequency and expanded the content of
the economic projections it releases to the public. This increased communication, along with unwavering
coverage by the media, appears to be keeping economic concerns top-of-mind for many.
“It certainly does seem like the economy has slowed down considerably compared to what it was a couple
of years ago,” said Stephen Happel, Ph.D., a professor of economics at Arizona State University’s W.P.
Carey School of Business. “But the question is, how much is this stoked by negative media reporting?”
“I don’t want to sound like some right-wing fanatic, but the media does tend to over-emphasize the
negative aspects. You’re hearing about job losses. You pick up the paper and read about foreclosures. And
this is the stuff people are talking about in the presidential debates. Naturally people are going to become
more sensitive to it,” he said.
Meanwhile, the Bush Administration proposed in late-March the most sweeping overhaul of the U.S
financial system regulatory structure since the Great Depression. The plan, unveiled by Treasury Secretary
Henry Paulson, would merge several existing regulatory agencies and give the Federal Reserve (commonly
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FINANCE
called the Fed) broader power
over financial market stability.
The plan could take a few years
to fully implement, but it
continues a trend that has been
evolving for decades – increasing
responsibility for the Federal
Reserve as keeper of the
U.S. economy.
“It certainly does seem like the economy has
slowed down considerably compared to what it
was a couple of years ago,” said Stephen Happel,
Ph.D., a professor of economics at Arizona State
University’s W.P. Carey School of Business.
“But the question is, how much is this stoked by
negative media reporting?”
AN EVOLVING FED
Throughout the 19th century,
the United States teetered on
the brink of crisis under a fragile
banking system with financial
“panics” occurring roughly every
20 years. These panics occurred
when Americans would lose faith
in their paper currency and “run”
on the banks to convert the
paper to gold.
To deal with recurring panics,
Congress created the Federal
Reserve System in 1913. Initially,
the primary role of the Fed was to
serve as a banker’s bank, a lender
of last resort. If the banks did not
may 2008
have sufficient funds to cover a
bank run, the Fed would loan
them enough to cover it.
The responsibilities of the Fed
have expanded through the
decades and now include
fostering a sound banking system
and a healthy economy. Under
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FINANCE
that directive, the Fed writes
regulations and supervises banks
to help ensure the banking system is sound and able to respond
to a financial crisis; it also offers
financial services to banks
and promotes competition,
innovation and efficiency in the
marketplace. With regard to a
healthy economy, the Fed is
charged with managing the
nation’s money supply to keep
inflation low and the economy
growing at a sustainable rate.
“Economists like myself argue
that really what the Fed ought to
be doing is just making sure that
inflation is low and that growth
will kind of take care of itself,”
said Happel, who follows the
free-market doctrine of noted
economist Milton Freidman. “But
the Fed is sometimes caught
between a rock and a hard place
because Congress always wants
the Fed to keep growth going.
Congress wants growth. It wants
low unemployment, even if it
means big-time inflation.
Congress doesn’t get upset
by inflation as much as we
free-market economists do.”
The Federal Reserve is comprised
of three parts: the board of
governors, the reserve banks
and the Federal Open Market
Committee (FOMC).
The board of governors, located
in Washington, D.C., is the Fed’s
centralized component. It consists of seven members appointed
by the President of the United
States and confirmed by the
Senate. The Fed’s 12 reserve
banks are the decentralized component of the system, meaning
they operate somewhat independently but under the general
oversight of the board. These
banks lend their expertise and
knowledge about local economies
and regions, while contributing
to national policy discussions.
The FOMC is comprised of
the board of governors and
the reserve bank presidents,
and it determines national
monetary policy.
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FINANCE
MANAGING
THROUGH CRISIS
A financial crisis is what led to
creation of the Federal Reserve
roughly 100 years ago; and averting financial crisis seems to be
the Fed’s primary charge today.
The Fed has three tools at its
disposal to accomplish monetary
policy goals. The discount rate,
reserve requirements and open
market operations each influence
the amount of funds in the banking system. The discount rate is
the interest rate reserve banks
charge banks for short-term
loans. Reserve requirements are
the portions of deposits that
banks must hold in reserve, either
in their vaults or on deposit at a
reserve bank. Open market operations is the most frequently used
tool; it involves the buying and
selling of U.S. government
securities, as well as adjustment
of the federal funds rate.
Approximately every six weeks,
the FOMC meets to deliberate
and vote on options that would
best promote economic growth
and control inflation. A directive
is then issued to the New York
Fed’s domestic trading desk with
the committee’s objective –
essentially, whether to ease,
tighten or maintain the current
policy. The desk then buys or
sells in an attempt to achieve
that objective.
“Monetary policy works with a
lag. Therefore, our policy stance
must be determined in light of
the medium-term forecast for real
activity and inflation, as well as
the risks to that forecast,” stated
Fed Chairman Ben Bernanke
may 2008
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FINANCE
during his semiannual monetary
policy report to the Congress in
February 2008. “The FOMC will
be carefully evaluating incoming
information bearing on the
economic outlook and will act
in a timely manner as needed to
support growth and to provide
adequate insurance against
downside risks.”
The FOMC has paid particular
attention to the federal funds
rate and made an atypical number of changes to it this year. On
January 22, the Fed announced a
three-quarter percentage point
rate cut, the largest since 1982.
Just eight days later, it reduced
its benchmark interest rate by
another half a point to 3 percent.
Additional adjustments were
made again in March.
In early April, Bernanke
addressed Congress, stating that
the Fed does not expect the gross
domestic product (GDP) to grow
20
during the first half of 2008 and
that a “recession is possible.”
GDP measures the value of all
goods and services produced
within the United States. Several
economic indicators are considered when declaring an official
recession; six consecutive months
of declining GDP is one of them.
That said, Bernanke remained
optimistic about the government’s $168 billion stimulus
package and the Fed’s aggressive
reductions to a key interest rate.
“Much necessary economic and
financial adjustment has already
taken place, and monetary and
fiscal policies are in train that
should support a return to growth
in the second half of this year
and next year,” he said.
ENCOURAGING NEWS
FOR INVESTORS
What does all this mean for one’s
investment portfolio? Recession
or not, stay the course.
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“Stock markets are discounting
mechanisms,” wrote Liz Ann
Sonders, chief investment strategist for Charles Schwab, in the
January 2008 issue of Schwab
Investing Insights. Sonders noted
that the market suffers in anticipation of recessions, but then
surges during and after slowdowns. Looking at past recessions, the average maximum loss
before and during a recession is
about 23 percent, but the average
maximum gain during a recession
and soon after is 42 percent.
What’s more, occasional market
volatility and recessions are to
be expected.
“You’re always going to have
periodic problems in the financial
sector, because somebody is
always coming along with some
kind of new way of investing,”
said Happel. “Bankers are always
going to be looking for ways to
make more money and leverage
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it. And when you have big time
leverage effects, you can have the
economy turn down.”
Investors who tune out the daily
media reports and stick with a
well-planned investment strategy
typically see better long-term
results than those who try to
predict the ups and downs of a
volatile market.
A recent article by Heartland
Funds, a mutual fund company
out of Wisconsin, noted that
from 1983 to 2003 the average
equity mutual fund returned 10.3
percent annually. In contrast,
during this same time the average
mutual fund investor returned
only 7.9 percent annually. Why
the disparity? According to
Heartland, it comes down to two
simple factors: fear and greed.
Typically, investors are fearful of
putting their money into Bear
markets when there is often good
value to be gained over the long
term. Conversely, investors often
become greedy and invest too
heavily during rising markets
when the true growth potential is
slowing and coming to a close.
An example of this is the tech
bubble of the late 1990s that not
only pulled a lot of investors in
too late in hopes of getting extraordinary returns, but also made
them nervous and kept them out
of the stock market after the
detrimental burst when other
equities were taking off.
Other independent studies have
shown an even larger disparity in
results. For example, DALBAR’s
Quantitative Analysis of Investor
“You’re always
going to have
periodic
problems in
the financial
sector, because
somebody is
always coming
along with
some kind of
new way of
investing,”
said Happel.
“Bankers are
always going
to be looking
for ways to
make more
money and
leverage it.
And when
you have big
time leverage
effects, you
can have
the economy
turn down.”
Behavior study reports that equity
mutual fund shareholders have
held their funds for only about
two years; as a result, they have
earned less than inflation. The
average equity investor earned
only 2.57 percent annually since
may 2008
1984, compared to 3.14 percent
inflation and the 12.22 percent
the S&P 500 index earned
annually for the last 19 years.
Simply put, emotions can get the
best of investors and keep them
from achieving the full potential
of the stock market in the
long-term.
“Successful investing is difficult,”
wrote economist and former Fed
Chief Alan Greenspan in The
Age of Turbulence: Adventures in a
New World, published last year.
“Some of history’s most successful
investors, such as my friend
Warren Buffet, were early to
understand the now well-documented anomaly that the rate of
return on stocks, even adjusted
for risk, exceeds that on less-risky
bonds and other debt instruments, provided one is willing to
buy and hold equities for the very
long run. “My favorite holding
period is forever,” said Buffet in
an interview. “The market pays a
premium to those willing to
endure the angst of watching
their net worth fluctuate….”
A solid investment plan can go a
long way in maintaining that
endurance. According to two
surveys conducted by the CFP
Board, people who have a written
financial plan report that they are
more satisfied with how they plan
and manage their financial affairs
(55 percent) than people who do
not have a written plan (35
percent). In addition, those
without written plans are more
likely to be worried about being
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FINANCE
financially prepared for
retirement than those with plans
(51 percent versus 40 percent).
Working with a trusted and
disciplined advisor to create a
personal financial plan and
investment policy statement can
help investors keep their emotions in check and stay the
course, even in challenging
economic times.
Mike McCann
is an
investment advisor and founder
of Perspective Financial Services,
LLC, a preferred vendor for the
Maricopa County Medical
Society. He offers a 20 percent
members-only discount to
MCMS physicians.
To learn more, visit his website at
www.MoneyAZ.com/MCMS.htm
A Certified Financial Planner
(CFP) and Accredited Investment
Fiduciary (AIF), Mike has worked
in the financial services industry
since 1991. He advises on a wide
range of portfolios with a diverse
group of clientele and speaks to
groups on a variety of topics,
including charitable planned
giving, asset allocation,
retirement planning and tax
management. He earned his
Bachelor’s degree in finance
from Arizona State University.
Perspective Financial Services
1440 E. Missouri Ave.,
Suite 250
Phoenix, AZ 85014
602-281-HELP (4357)
[email protected]
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