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Archive for December, 2010

In my post today, I decided to reflect on “another day’s useless energy spent.”  (For those who recognize it, they are lyrics from one of my favorite bands, The Moody Blues, which I saw in concert from the lawn seats at Great Woods before it became known as the Tweeter Center.  Now how’s that for dating myself?)

Part of this reflection is because we are approaching another year-end and turn of the calendar. Partly it’s a reaction to the ongoing cram session known as the “lame duck” Congress which, like other times during the political calendar, is filled with lots of speeches, interviews, talking heads (not the band unfortunately) and hot air in general that is probably doing as much to contribute to Global Climate Change as any coal-fired power plant.

It’s also because as I sit here contemplating another post – staring at that taunting, blinking cursor, I wonder if anyone is getting any benefit from this exercise (I mean, besides my own ego, I suppose).

Then it sort of dawned on me as I was trying to get Spencer (the cute one on the right hand margin of this page) into his sneakers and snow suit and car seat.  This was an opportunity for a life lesson for the future heir to all that I possess (or at least my family name – which is more important than anything else in the long run, I think).

As Spencer squirmed and wailed in protest to the limits on his personal freedom I was imposing, I reminded him that he might want to get used to the simple fact that the universe simply is absorbing his energy. And after all is said and done, the gnashing of teeth, spilling of tears and biting of lip (all on Spencer’s part, mind you), we’re back to where we started and we’ve just gotten a bit older.  In Spencer’s case, this is sort of a routine that we’ve gotten into as summer turned to fall and now winter.  (It was much easier when we didn’t have to put on so much restrictive outer gear.)

So his wailing reminded me of all the things that we do throughout our days.  Hustling here and there.  “Deadlines and commitments” as Bob Seger (another BIG TIME favorite of mine) would say in another favorite song.  All of this made more stressful by the holiday with its artificial consumer-driven shopping spree that is upon us.

And after all is said and done, we are, in the end, left with nothing – just ourselves.  This could be a bit Buddhist in outlook.  And that’s not bad as a life lesson either.

So what should matter in the end?  We work; we play; we sound off about all sorts of major and minor grievances (‘how dare that guy take my parking space at the mall’ sort of thing).

But what matters in the end is who we are left with.  We are left with ourselves and all the energy spent is sort of like a furnace used to mold the metal that makes us up.  Sometimes the fire can burn us up and other times makes us stronger. (Remember the old line: “What doesn’t kill us, makes us strong” or maybe your dad telling you that “it builds character.)

So as life lessons go, I’m hoping that Spencer will one day understand it.

For the rest of us in the here and now, I go back to my favorite holiday movie “It’s a Wonderful Life” with Jimmy Stewart (in black and white of course).  George Bailey feels like a failure and a disappointment to his family.  But in the end he realizes how rich he really is and how rich life is with him in it. (Thanks for the lesson, Clarence).

That’s another life lesson I hope that Spencer understands someday.  For the rest of us, I hope we can understand that now.

When I first started this post today, I wondered whether anyone really cared about what it is that I say or think.  Then, I remembered George Bailey.  And if just one person gets something valuable out of these reflections on reflections of mine, then maybe it’s not a whole lot of sound and fury but maybe it really does signify something.

So if anybody’s out there, thanks for stopping by.  And don’t be a stranger. Let me know what you’re thinking and are looking for when you next stop by.

Best wishes to you during this season of peace.

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Girish asks, “I have heard people talk about ‘taking advantage of’ or ‘minting money from’ a recession. How does one do it?”

If you have cash you can find great bargains in almost any market or asset class – whether it is a stock, bond, mutual fund, buying tax liens or judgments or even real estate.  This is the classic sort of value investing espoused by Benjamin Graham and practiced masterfully by Warren Buffet.

Certainly, when stock prices are down you can pick up shares in companies with strong brands, franchises, marketing and cash flow but which may be temporarily out of favor because of investor fear.  This is certainly what happened during the Great Financial Meltdown.  Those who had the stomach for it and the cash to back it up could buy up many companies at bargain prices.

The key is having the cash and not being over-leveraged. There are lots of stories (most recently in BusinessWeek) about developers who are mortgaged to the hilt and unable to maneuver now as they are caught in a foreclosure squeeze.   Liquidity is really the key to crises.

If you have the cash and the stomach for the risks, you can buy into distressed areas of the market: tax liens, providing capital as a loan with equity kicker to an operating business that may be short of cash because banks are too timid to lend, real estate to fix up and rent (and later on use as a vacation property if you properly structure a 1031 exchange for example.

Some of these tactics can be done with non-qualified money. But one can even consider doing it through a self-directed IRA. Not every custodian is set up to allow this but there are some specialized non-bank custodians that will help set up such accounts. (One such custodian is PENSCO Trust). And the income that may be generated can be tax deferred allowing for more capital to be available for investment or to compound longer.

This is not a substitute for a broadly diversified investment portfolio but a supplement; you could call it the “opportunity” or “tactical” bucket.

The key is cash and an understanding of your personal risk profile. And most require a time horizon longer than a typical day trader’s.

Sure, the key to investing success is to buy almost anything low and sell it higher later.  But don’t limit yourself to just stocks.  There are opportunities beyond just stocks where astute and risk-tolerant investors can take advantage of what arbitrageurs call “information asymmetries.” And they may even be in your local market.

This is where a good financial adviser can help.

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Lately, the media has been dominated by the compromise on US federal tax policy that has been brokered by President Obama that will lead to an extension of current income tax rates, lower estate and payroll tax rates and an extension of unemployment benefits.  It is very likely to pass almost intact and free up the logjam that has hampered this lame duck session of Congress.

Uneven Recovery

From the point of view of a resident of Main Street, the economy is still ailing.  Consumer demand is still off.  A stubbornly high unemployment rate persists.  Real estate values continue to drop in most markets and at best have settled in at levels not seen in nearly a decade. In general, it’s not a pretty picture.

On the other hand, business profits, productivity and cash (now sitting at about $2 Trillion) are up. And this has been reflected on Wall Street by a healthy rise in most major indices.

So the prescription for getting out of this funk is a familiar one: Low taxes leads to growth.  Sometimes, though, conventional thinking can be dangerous.

Economic Theory

From a purely economic theory point of view, there are really only three participants in the economy who can spur demand and ultimately growth: consumers, businesses or government (at all levels).

With consumer spending hampered by unemployment and nervousness about what assets, income and jobs that they may have, you can’t really expect consumers to be leading us to growth.

While businesses have the cash and the profits, they seem to be in wait-and-see mode “keeping their powder dry.”

So that leaves governments at the local, state and federal level. Unfortunately, most local and state governments don’t have the resources or the legal authority to continue deficit spending so that leaves us dependent on the federal purse to help spur the economy.

Tax Package as Stimulus

The tax package compromise as proposed is not perfect.  Like any piece of legislation, it is a mash-up (though the versions seen on Glee are usually much more fun to watch).  It certainly provides the potential for much-needed economic stimulus.

By putting cash in the pockets of the persistent unemployed, it will help keep households running and bolster their local economies when cash is circulated.  By reducing payroll taxes on those who are working, it will also lead to direct spending in much the same way that the under-reported stealth “middle class tax cut” of 2010 did.

By patching the Alternative Minimum Tax (AMT) for another year, more than 21 million households were protected from an unexpected hike in their personal tax burden (estimated at around $3,000 to $5,000 for each family) which might have choked off funds available to circulate in the rest of the economy for goods and services.

The big question will be whether the upper income brackets will use their tax breaks on income and estate taxes to pump up the economy.  Certainly, it could help with high-end consumer goods, vacation homes, and furnishings.  But as much as these purchases will help jewelers, real estate agents, car salesmen and clothing retailers, there’s only so many shoes, watches, cars and homes that someone can consume.

Good Politics May Make for A Bad Economy Long-Term

But will this create jobs?  How quickly can an expected $100,000 cut in income taxes for the richest 1% of Americans translate to business investment that creates jobs?  And at the end of the day, does this potential added economic activity keep us on track for growth?

These are the kinds of questions that probably prompted credit analysts at Moody’s Investor Service, a credit rating company, to put out a cautionary note about the possible negative impact on federal finances with its ultimate impact on consumers.

From a purely political point of view, this may be a good deal.  From a short-term economic stimulus point of view, it provides some benefits.  In the long-term, though, there is a real risk that the nation’s strained finances will take a hit to its credit rating leading to higher borrowing costs for the government directly and for all consumers seeking credit as well.

The Rich (And The Government) Are Different

Why?  Well, ask any mortgage borrower.  When you have pristine credit, it’s easier to borrow money at the most favorable rates.  Over the long-term, borrowing $200,000 at 6% will cost you more than borrowing the same amount at 4.5%.

On the other hand, when a borrower’s credit score is lower – even by a little – then the options available can dry up or cost more.

This is what may happen as we move forward and digest the impact of this tax plan.  It ultimately is kicking the can down the road for others to deal with.  The estimated price tag on the plan is between $700-billion and $900-billion to be added on top of a trillion-dollar plus federal deficit. And the proposals for cutting the deficit prompted much gnashing of teeth and proclamations of lines in the sand indicating that there is no likely easy compromise on their recommendations especially in a grid-locked Congress next term.

US Credit Score on Watch List

Is there an immediate problem?  No.  As long as we still have investors who are confident that they will get paid back on the money that they lend us through their purchase of our government’s debt.  Unlike the mortgage borrower in my example, the government can vote to increase its credit limit and authorize the printing of cash. Not something that your typical consumer or state government can do.

And investor’s in the marketplace seem to be OK with that as seen by the cost of insuring against default through derivatives. An insurance contract to protect $13.-million worth of U.S. government debt currently costs €41,000 a year, according to data from credit-information firm Markit Group. That is down from €59,000 in February of this year, and far less than in early 2009, when it cost €100,000.

But this can turn on a dime.  Ask those folks in Greece.  They are painfully aware what can happen when investors and banks lose patience and pull the plug and the credit line.

Yes, Greece is not the US, which has the benefit of being the world’s reserve currency.  But that should not lead us to complacency and hubris.  We need more than conventional thinking and political party maneuvering.  We need the kind of shared sacrifice that the Greatest Generation exhibited which won the peace in a global conflict and pulled us out of the other greatest global economic calamity of the last century.

Either we need to make the tough choices now while we can or we will be forced to pretty much at gunpoint down the road.  That’s not a pretty picture nor a way to grow in the long-term.

Maybe we can get the folks from Glee to work on a musical mash-up of sorts that will make this happen.

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Divorce is emotionally traumatic on everyone involved especially if there are children.  While it may seem mundane, dealing with the money and tax issues that arise from the unwinding of a life together is as important for both psychic and fiscal sanity.

In the big scheme of things, there are more important things than money.  And many who are faced with this kind of life-changing event will cope by simply ignoring the details, shutting down trying to avoid confrontation and more emotional pain. The personalities of each person involved (including family, friends and lawyers) will come out to wreak havoc.  And if someone was a submissive person, then they may become more withdrawn from the process.  Someone who was more dominant in the relationship will likely be more so.

If I’ve learned anything from years of working with people and their money, it is that money is emotionally charged.  And while it may seem satisfying to try to extract some sort of revenge for the pain by attaching a price tag to impose on the other spouse, it is more important to get to closure and strike a deal which best positions each person for moving ahead.

I’ve often said that life is a journey.  And along this journey we’ll each encounter all sorts of things.  A divorce, like any other sudden, life-changing event, is just another part of the journey.  And while we cannot plan perfectly for this or anything else, we can prepare.

So it is with divorce.

I’ve written in the past about the critical mistakes that divorcing couples will make that can set them up for financial failure now and as they start the next stage of their new life.

Dealing with the Family Home in Divorce

For many the key to the settlement is the home.  While each may want to keep the home, it may be wiser to consider other options. For some, there may be sentimental reasons for keeping the home or emotional reasons and bad memories prompting one to put physical and emotional distance between themselves and the home.

For many, the main reason to keep the home is to avoid further disruption especially if there are kids involved which might entail changing schools or at the very least dealing with a move while school is in session.

Financial Triage

Despite the pain, you will need to step up and deal with these issues.  Otherwise, there is a greater risk that the financial foundation put in place for your post-divorce journey will simply not stand up.

At the very least it is important to make sure that all legal documents properly reflect who is responsible for the debts and bills associated with the property going forward.  This means contacting the utilities to change the name on the account.  In the event that the marital home was a rental, then make sure that the landlord changes the name on the lease. Get confirmation in writing.  Otherwise, there is the risk that an unpaid bill may end up in collection and lead to a black mark on your credit report.

The same can be said for credit cards.  It’s in everyone’s best interests to contact the credit card issuer to freeze the account to any new charges.  Don’t forget about old credit cards that you may not use or can’t find the actual plastic card.  To help with this get a copy of your credit report and make contact with each listed creditor appearing on it.

For property that is owned or mortgaged, this becomes a little more tricky.  The mortgage company won’t simply release someone from the debt not even with a valid final divorce decree.

In this case the only way to get this liability off your back is to sell the property or through a cash-out refinance by a spouse who will then assume the ownership and debt solely.

And as long as you are both on the deed, then the property tax liability and even water, sewer or other municipal charges will be the responsibility of each of you.  Only when the property is sold or refinanced will these liabilities be behind you.

Keeping the Home: Will It Make Sense?

A lot of my divorce financial planning practice centers on this very question.  Now if someone insists on keeping the home, I’ll spend a lot of time modeling the impact on near-term cash flow and long-term financial security.  It is not a guarantee that keeping the property is the best option.

It may not make sense at all.  There are the costs of running a home now on one source of income.  Even if one is receiving alimony to supplement this, it may not last long.  There are the added costs for maintenance that may need to be done by outside vendors that were once done by the spouse “for free” before such as snow removal, lawn care, repairs or house cleaning.

And while there may be support payments expected as a source of cash flow to cover these costs, what happens when or if your ex-spouse is unable to pay or simply decides to stop paying? Sure, there are legal remedies.  But these take time and cost money.  In the meantime, the bills may pile up and risk not only your credit.

In some cases, an ex-spouse may continue to provide help in these areas.  But they may want to negotiate the classic side deal: Do the repair and deduct it from the support owed.  This isn’t proper and will not help your long-term cash flow. In some cases, the ex-spouse will try to claim the funds used for these repairs as part of alimony so that it can be a tax-deductible expense.  This is also flat-out wrong and distortion of the tax and divorce rules.

Selling the Home May Make the Most Sense

It may be easier and wiser to simply sell the home, split the proceeds, pay off outstanding debts, fund the emergency reserves and start off fresh without the added burden of running a home.

And while not seeming to be critical in a time of depressed real estate values, by keeping the home you risk losing out on a very valuable capital gains exclusion on the sale of property.  As long as you’re married when you sell your home, the first $500,000 in gain above the original purchase price and subsequent costs of improvements will be exempt from any capital gains taxes.

Once you are divorced this exclusion drops to only $250,000.  For those couples who bought homes several years ago before the huge run up in values, this may be a critically important consideration.

Seek Professional Guidance

Dealing with the many tax, financial and real estate issues related to a divorce can be complicated.  You may want to seek advice from someone specifically trained to handle such issues.  Not all CPAs, attorneys and financial planners are qualified or set up to help clients through this type of life-changing event.

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The clock is running out on this session of Congress.  While far from a sure thing, at least there is movement on the tax front.  Whether that movement is progress or a step back will depend on your point of view.

It’s been said many times:  Two things you don’t want to see being made are sausage and legislation.

This go-around with the recently negotiated tax bill is just such an example.  In the spirit of the holidays, there is just about something for everyone in this proposed compromise: tax cut extension, cut in payroll taxes, a fix to the AMT exemption, extension of unemployment benefits.

While the full impact is yet to be digested, it is certain that the debate is far from over.  And it is almost equally certain that in its present form it will likely add considerably to the federal budget deficit.

Since we are still in fragile economic territory, demand stimulus is still needed.  And at least this proposal, while far from perfect, will provide that in the form of funding for unemployment benefits, lower payroll taxes and

Now that there will be “tax certainty” let’s see if the job creation will follow.

I’m happy to see that there is a patch for the AMT so that millions of families won’t be unexpectedly hit by a stealth tax increase.  Unfortunately, a permanent fix of the AMT is not on the radar and we’ll be doing this again next year as well.

And from an estate planning point of view, there will finally be some certainty on this front – at least for now.

While ‘stimulus’ is a bad word, at least there will be some economically beneficial parts to the proposal.  The most direct positive impact on the economy and aggregate demand is having more cash in the hands of average consumers.  On this point, the extension of unemployment benefits, in addition to being just morally right, will put cash in the pockets of millions who will immediately circulate it for payment of needed goods and services – not to mention paying the mortgage to help avert more foreclosures.

I’m no fan of trickle down economics and don’t think that we can afford tax breaks that for the most part will not lead to job creation in the near term.

Now we’ll see how the proposal will fare in Congress.  In any event, let’s hope that the sound you hear in the background is only the clock ticking down to the end of the session and not the timer of a not-t00-distant debt time bomb counting down to a nasty explosion.

 

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The Wall Street Journal reports that efforts to pass an extension of the Bush-era tax cuts have failed in the Senate.

If these politicians are serious about getting rid of “tax uncertainty” and reducing tax liabilities on the vast majority of Americans, then they should be dealing with a relatively simple and uncontroversial thing – patching the AMT tax exemption. Otherwise, more than 21 million families will see their tax bills go up next year. But like the estate tax, these are for the most part great stealth taxes. No one has to go on the record about voting for higher taxes because it just will happen.

As a nation we cannot even afford to extend the Bush-era cuts temporarily much less permanently if we are serious about tackling the deficit. And the tax cuts are far from being stimulative in this economic environment.

More stimulative options would include payroll tax holidays and extensions to unemployment benefits.

Instead we will be left with the “tax uncertainty” of the AMT and the estate tax. And every other thing that is the serious province of government will be held hostage.

On second thought, there really is no tax uncertainty. The Congress has had nearly nine years to come up with solutions for the estate and Bush tax cuts. We know that the rates on both will be going up on January 1. And we know that AMT will, too.

So now that we have certainty, can we please move forward and do some other stuff that really needs doing?

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Shakespeare was right.  In Hamlet, one character, Polonius, counsels his son “neither a lender or borrower be.”

While not entirely realistic, then or now, it does have a grain of truth in it.  Too much debt limits one’s flexibility and options.  If you borrow too much, you are forced to service that debt with resources that can’t be used for other things.  If you lend too much, you are at risk of never seeing your money again (or being forced to take less when your borrower defaults).

Cash Flow Impacts Personal, Corporate and National Choices

This is as true for individuals as for sovereign nations and corporations. You can’t eat your shoes or your car.

You may have assets but without cash flow, the grease that keeps the system running smoothly, you can only keep going for so long.  Just ask your neighbor who has lost a job and run out of unemployment benefits.  While the house, car and stereo all are assets with value, unless he can turn them into cash he can’t use them to eat. And when you’re forced to sell them, don’t expect to get the same sort of cash money price for them. Boon to the buyer but not to the seller.

Debt Crises and Dominoes

Earlier this year, the banking crisis in Greece occupied the top spot in the headlines.  While a loan from the EU backed by the Eurozone’s largest and most healthy economy so far, Germany, placed a bandage over the immediate crisis, structural problems persist.  This has led the Greek government to roll out a number of stringent and very unpopular austerity measures.

At the time, the open question was how would this crisis in Greece impact the rest of Europe.  No country in the developed world has been spared by the current global recession and slow down.  Would this create a domino effect where weak economies lost the faith of the markets and were forced into their own crises?

The Story of the PIIGS – Scarier Than the Bedtime Story

The targets to watch were the PIIGS of Europe:  Portugal, Ireland, Italy, Greece and Spain.

Each of these economies have structural deficit issues and are the weakest links in the Eurozone chain.

Just like the children’s tale, these little PIIGS are threatened with being gobbled up but in this case by the firm hand of the market in the form of higher interest rates and loss of investor confidence needed to keep their debts financed.

Sure, there is the potential for bailout from other Eurozone members. While Germany continues to be a relatively strong economy, it alone cannot support all of these economies.

So Ireland is the latest victim to the excesses of easy credit.  Now their economy and banks are saddled with real estate loans gone sour and no one to buy the leftovers. Even Great Britain, not part of the EU, has its own issues that they are trying to tackle by implementing severe cuts in their social services, government programs and employment.

Cash Flow and Jobs Closer to Home

Looking back to 2008, the loss of faith in the financial system by nearly everyone cut off the money lifeline to otherwise solvent businesses.  Companies with lots of assets (real estate, machinery, equipment and workers) lacked the cash to continue operations.  Typically, a business (and governments, too) finance themselves from short-term borrowing to cover operational and payroll costs while waiting on the collection of accounts receivable.

But when the faith in getting repaid dried up so did the credit forcing many to the brink.

Eventually, here in the US we saw the Fed and the federal government step in to provide the needed liquidity to the system.

Now while other economies are being forced to make unpleasant choices about their economic structure and priorities, we in the US continue to avoid any real adult discussion about our own issues.  Since market investors continue to buy up our public debt, we continue to run as if nothing has changed.

As the world’s primary reserve currency, we continue to benefit from the world’s use of the US dollar as a safe haven.  But as has happened to Greece, Ireland and companies like Lehman Brothers before them, a flick of a switch can change investor sentiment and the near-term financing needed to keep our economic engine running can be shut off.

Whether or not this will lead the political classes to do what is right in the long-term (beyond the next election cycle) to get our finances in order is another open question.  The President’s debt commission has come out with a number of laudable, if not popular or pleasant, options that offer ways to share the pain to make sacrifices that will keep us on track for continued economic growth and national security. Unless we follow through and take up the hard choices that have otherwise been forced on other nations, we risk our own crises more nightmarish than we have seen as we are forced to make bad or worse choices with limited options.

Let the adult conversation begin.

 

 

 

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