"We now know that the readings of last month were not a fluke or some temporary aberration that could be marked off as something related to the weather. There is quite obviously some serious financial stress manifesting in the data and this does not bode well for the growth of the economy going forward." - National Association of Credit Management report for March 2015
The Credit Managers' Index (CMI) is an index put together by the people paid to spot trouble early. Credit managers are the people that approve or reject applications for credit. Furthermore they are the same group that try to collect on the debt once it is issued. So this group has a very keen understanding of the health of the economy which is why I like to follow the index closely.
To give you a better understanding of the index it is based on a scale of 50. Anything that is higher than 50 means that the indicator is showing signs of health; a reading therefore less than 50 shows signs of strain. Back in 2008 the reading plunged from roughly 55 to 50 in a couple of months before then falling to 40 in the midst of the recession. Once again this reading has fallen from 55.1 to 51.2 in two months, a sever contraction not recorded since right before the previous recession. Prior to February the index had hovered around 55 for the past 5 years with moderate fluctuations but nothing serious. So in February when the index tested its lower boundary it was a concern but now that it has bust the bubble it could mean trouble is coming at a very rapid clip.
Digging into the numbers shows that while the number of applications for credit is rising, the number being rejected is growing faster. This means that the companies requesting the credit are struggling and are not strong enough financially to handle the additional credit so they are being turned away. Companies that could be given credit lines are not taking on more debt so the number is falling. This is creating a financial squeeze similar to that which occurred right before the previous contraction. With this type of financial squeeze going on it is only a matter of time before a number of bankruptcies are announced but for now this is one number that has yet to fall into the negative category.
The ripple effect of these bankruptcies will be felt throughout industry as these debts that were previously recorded as either performing loans or accounts receivable will have to be written off creating an overall contraction of credit and a strain on company and bank cash flows. The problem this time around is that the Federal Reserve has already spent $4 trillion getting us nowhere so announcing another round of quantitative easing while more likely than not, will not help alleviate the stresses caused by a weak business environment. What it could do is once again ignite the currency warfare and drive not only Europe but the rest of the world into a recession.
Keep your eyes on this indicator as it does not normally flash red unless there is a real danger ahead.
Friday, April 24, 2015
Friday, April 17, 2015
A $2 Trillion Hand Brake
"I couldn't repair your brakes so I made your horn louder." - Unknown
In a fascinating article in the Economist Magazine entitled "The paradox of soil", the authors put forth that the cost of strict land regulation in major metropolitan areas around the world is like a hand brake on economic growth. In the United States it is estimated that the lost GDP is around 13% a year or $2 Trillion. This is a very large number and unlocking this blockage would result in significant benefits to society and economic growth.
In the past restricting land development, particularly in large metropolitan areas, was thought prudent due to the inherent slums and poor living standards that urban sprawl created. Through the years land development controls were put into place to restrict development so that these problems were eradicated. Fast forward to today and these controls have now moved far past the median and are creating enormous drags on economic growth. Removing or streamlining a significant portion of these over burdensome controls is the key to unlocking significant economic gains.
In the past it was thought that technology would make cities obsolete. Workers would be able to work anywhere so there would be a tendency to relocate out of the cities to cheaper more remote places. It turns out that the opposite is true. Major metropolitan areas create brain pools that cannot be replicated elsewhere. People living in these brain pools are stimulated by their peers in ways that cannot be replicated moving away. For this reason cities like London and San Francisco continue to attract people while the outlying areas remain a backwater.
Furthermore it is shown that due to the concentration of people in the metropolitan areas a large swath of wealth inequality occurs in these cities as landlords receive a larger proportion of income on their land holdings that those who own similar tracts of land outside of these areas. The impact is even larger when you consider that as the rent rises the poor are pushed further from the city center, away from the brain pool and this further out of the main stream. This inability to partake in the activities of the main stream expands the inequality and forges a barrier to entry.
In addition, as the cost to living in these cities increases people that are living on the margin of prosperity leave the city in search of a better quality of living elsewhere. As we have seen above, leaving the brain pools reduces their productivity thereby slowing economic growth and pulling harder on the economic hand brake.
I have to say that I am living through the nightmare that is city planning and development in that I have spent the past 4 years trying to get a 22 unit parking lot built downtown San Diego. Now I will be the first to admit that this is not the type of expansive land use that the authors of the article are promoting but when you consider that after 4 years I still do not have the necessary permits issued you can see immediately the drag on economic growth. Were it easier to obtain permitting I would have considered building an apartment complex (which is exactly what the authors think will lead to greater economic growth) but who knows how long that would have taken and how much it would have cost.
So while I believe that some land development restrictions are required to ensure green areas and healthy living standards for all, loosening the strangle hold that is strict developmental control and allowing development to occur would have an immediate and direct impact on the economic outlook to not only the city but the nation as a whole and that should be a high priority in all cities across the globe.
In a fascinating article in the Economist Magazine entitled "The paradox of soil", the authors put forth that the cost of strict land regulation in major metropolitan areas around the world is like a hand brake on economic growth. In the United States it is estimated that the lost GDP is around 13% a year or $2 Trillion. This is a very large number and unlocking this blockage would result in significant benefits to society and economic growth.
In the past restricting land development, particularly in large metropolitan areas, was thought prudent due to the inherent slums and poor living standards that urban sprawl created. Through the years land development controls were put into place to restrict development so that these problems were eradicated. Fast forward to today and these controls have now moved far past the median and are creating enormous drags on economic growth. Removing or streamlining a significant portion of these over burdensome controls is the key to unlocking significant economic gains.
In the past it was thought that technology would make cities obsolete. Workers would be able to work anywhere so there would be a tendency to relocate out of the cities to cheaper more remote places. It turns out that the opposite is true. Major metropolitan areas create brain pools that cannot be replicated elsewhere. People living in these brain pools are stimulated by their peers in ways that cannot be replicated moving away. For this reason cities like London and San Francisco continue to attract people while the outlying areas remain a backwater.
Furthermore it is shown that due to the concentration of people in the metropolitan areas a large swath of wealth inequality occurs in these cities as landlords receive a larger proportion of income on their land holdings that those who own similar tracts of land outside of these areas. The impact is even larger when you consider that as the rent rises the poor are pushed further from the city center, away from the brain pool and this further out of the main stream. This inability to partake in the activities of the main stream expands the inequality and forges a barrier to entry.
In addition, as the cost to living in these cities increases people that are living on the margin of prosperity leave the city in search of a better quality of living elsewhere. As we have seen above, leaving the brain pools reduces their productivity thereby slowing economic growth and pulling harder on the economic hand brake.
I have to say that I am living through the nightmare that is city planning and development in that I have spent the past 4 years trying to get a 22 unit parking lot built downtown San Diego. Now I will be the first to admit that this is not the type of expansive land use that the authors of the article are promoting but when you consider that after 4 years I still do not have the necessary permits issued you can see immediately the drag on economic growth. Were it easier to obtain permitting I would have considered building an apartment complex (which is exactly what the authors think will lead to greater economic growth) but who knows how long that would have taken and how much it would have cost.
So while I believe that some land development restrictions are required to ensure green areas and healthy living standards for all, loosening the strangle hold that is strict developmental control and allowing development to occur would have an immediate and direct impact on the economic outlook to not only the city but the nation as a whole and that should be a high priority in all cities across the globe.
Friday, April 10, 2015
When will the Bull market end?
"As a bull market continues, almost anything that you but goes up. It makes you feel like investing in stocks is very easy and safe and that you're a financial genius." - Ron Chernow
I am repeatedly asked when I think the Bull market will end so it was interesting when I read a blog article today written back in November 2013 by Manley Market Insight where he answered the question by pointing to three reasons for a possible decline: 1) the Federal Reserve adopts a restrictive monetary policy; 2) sales and earnings decline sharply without prompting from the Federal Reserve; and, 3) valuations become too high and collapse on their own weight.
I completely agree with him but it appears to me that we do not only have one of these problems but all three. Right now we have a Federal Reserve that has stopped printing money and is hinting at raising interest rates (restrictive monetary policy); corporate sales have been declining for a while and the US Commerce Department announced that in Q4 2014 corporate profits fell 3% and are on pace to decline again in the first quarter of 2015; and no matter what market metric you look at the market is way overvalued. In fact the market is at its second highest level in its history. With trading volumes dropping and the length of the bull market at six years already almost twice as long as the average bull market, it appears to me that we may have a triple play brewing.
A lot of the cause of this is the recent strength of the US dollar. The vast majority of the fortune 500 rely on expansion and growth in markets outside of the Untied States and with weakness in foreign currencies and countries, sales growth and profits are being hit. Even the benefit of the lower oil price is muted as consumers are not only saving the extra cash but they have not really felt the full impact as prices at the pump have risen by almost 20% during the last two months. Volatility is also picking up with the most 1% daily moves since Q4 2011 right before the last 10% correction.
With all of the poor economic news coming out of Europe, Asia and South America I cannot imagine that the Federal Reserve will be dumb enough to raise rates any time soon. In fact the one thing that no-one is talking about is the next round of quantitative easing from the Federal Reserve. Personally I expect more easing before any type of interest rate increase. In fact I expect that this year there will be a 10% plus correction in the market that will force the Federal Reserve to inject more stimulus into the economy. Unfortunately the type of stimulus that they are akin to use has never worked and hence it will be more futility and cause a larger problem later, however it will have the effect of stimulating the market to possibly new highs.
As I have mentioned above the market is on a seriously rocky road and the stimulus is not a fix but rather a larger problem. If you are looking for a place at which to sell, this might be a good time to diversify out of the market and head to distant shores.
I am repeatedly asked when I think the Bull market will end so it was interesting when I read a blog article today written back in November 2013 by Manley Market Insight where he answered the question by pointing to three reasons for a possible decline: 1) the Federal Reserve adopts a restrictive monetary policy; 2) sales and earnings decline sharply without prompting from the Federal Reserve; and, 3) valuations become too high and collapse on their own weight.
I completely agree with him but it appears to me that we do not only have one of these problems but all three. Right now we have a Federal Reserve that has stopped printing money and is hinting at raising interest rates (restrictive monetary policy); corporate sales have been declining for a while and the US Commerce Department announced that in Q4 2014 corporate profits fell 3% and are on pace to decline again in the first quarter of 2015; and no matter what market metric you look at the market is way overvalued. In fact the market is at its second highest level in its history. With trading volumes dropping and the length of the bull market at six years already almost twice as long as the average bull market, it appears to me that we may have a triple play brewing.
A lot of the cause of this is the recent strength of the US dollar. The vast majority of the fortune 500 rely on expansion and growth in markets outside of the Untied States and with weakness in foreign currencies and countries, sales growth and profits are being hit. Even the benefit of the lower oil price is muted as consumers are not only saving the extra cash but they have not really felt the full impact as prices at the pump have risen by almost 20% during the last two months. Volatility is also picking up with the most 1% daily moves since Q4 2011 right before the last 10% correction.
With all of the poor economic news coming out of Europe, Asia and South America I cannot imagine that the Federal Reserve will be dumb enough to raise rates any time soon. In fact the one thing that no-one is talking about is the next round of quantitative easing from the Federal Reserve. Personally I expect more easing before any type of interest rate increase. In fact I expect that this year there will be a 10% plus correction in the market that will force the Federal Reserve to inject more stimulus into the economy. Unfortunately the type of stimulus that they are akin to use has never worked and hence it will be more futility and cause a larger problem later, however it will have the effect of stimulating the market to possibly new highs.
As I have mentioned above the market is on a seriously rocky road and the stimulus is not a fix but rather a larger problem. If you are looking for a place at which to sell, this might be a good time to diversify out of the market and head to distant shores.
Friday, April 3, 2015
Rethinking Bonds
"He behaved like an ostrich and put his head in the sand thereby exposing his thinking parts." - George Carman
Plenty of investors have portfolios with a large allocation to bonds. It is the part of the portfolio that is considered safe and the base for creating a sustainable retirement. With rates at historic lows the main issue with a bond portfolio is reinvestment risk. This is the risk that some of your longer dated higher coupon bonds are maturing. The proceeds, if they are reinvested into similar longer term bonds, yield next to nothing. The reinvested dollars yield a very low amount creating havoc with a retiree's income.
In the modern world where financial companies are constantly trying to show the world that retirement is easy, millions of people are pouring billions of dollars into target dated funds, The idea is a nice one (and I use nice in its true sense meaning a fair idea with limited merit) but the problem is that it automatically shifts the needle on allocations more heavily into bonds as you age. This is creating a lower overall portfolio return and is not producing the desired returns impacting the ability to retire.
Rather than blindly following the herd pull your head out of the sand and survey the investment scene. First thing to do in a low interest environment is to look for places where there is yield. When you find it make sure that you are not accepting too much risk for the return. As most high yielding (and I am thinking in the neighborhood of 6% and higher here) investments are fraught with danger there are limited opportunities in this market to find the safe haven required by your retirement funds.
Assuming that you are unable to find a safe investment yielding anything of significance the next thing to do is to invest in shorter term bonds. I would not look out much further than two or three years. I know that you will be giving up some yield as short term rates are lower than long term rates but the difference is marginal. One or two percent difference will have a powerful impact on your portfolio over the long run due to the power of compounding however if rates start to rise then the drop in value of the long term bond would mean you are either stuck in that low interest investment or you have to take a far larger hit to your portfolio by selling the bond at a large loss. This to me means that you should rather earn a lower rate for the short run in order to participate in a larger rate of return later in the cycle.
The last thing you can do is reduce your allocation to bonds and focus on other parts of the market that can provide the boost your portfolio needs. One place to look is the stock market and this is touted by the "experts" as the only place to look but finding high yielding stocks is not easy and most of these stocks come with a double dose of risk; possibly cutting the dividend in poor times and/or falling precipitously from their current highs. To me this risk is the same as the higher yielding high risk bond investments. So you will have to look further afield to find returns and yields that match the requirements of your portfolio. One of these places is the property market where there are some parts of the country that can produce relatively high returns on investment with the safety of a free and clear property. Outside of this keeping this part of your portfolio secure while mitigating risk is becoming ever more difficult but one thing is for sure you will need to take some responsibility and control of your investments as we all know what happens when the blind lead the blind!
Plenty of investors have portfolios with a large allocation to bonds. It is the part of the portfolio that is considered safe and the base for creating a sustainable retirement. With rates at historic lows the main issue with a bond portfolio is reinvestment risk. This is the risk that some of your longer dated higher coupon bonds are maturing. The proceeds, if they are reinvested into similar longer term bonds, yield next to nothing. The reinvested dollars yield a very low amount creating havoc with a retiree's income.
In the modern world where financial companies are constantly trying to show the world that retirement is easy, millions of people are pouring billions of dollars into target dated funds, The idea is a nice one (and I use nice in its true sense meaning a fair idea with limited merit) but the problem is that it automatically shifts the needle on allocations more heavily into bonds as you age. This is creating a lower overall portfolio return and is not producing the desired returns impacting the ability to retire.
Rather than blindly following the herd pull your head out of the sand and survey the investment scene. First thing to do in a low interest environment is to look for places where there is yield. When you find it make sure that you are not accepting too much risk for the return. As most high yielding (and I am thinking in the neighborhood of 6% and higher here) investments are fraught with danger there are limited opportunities in this market to find the safe haven required by your retirement funds.
Assuming that you are unable to find a safe investment yielding anything of significance the next thing to do is to invest in shorter term bonds. I would not look out much further than two or three years. I know that you will be giving up some yield as short term rates are lower than long term rates but the difference is marginal. One or two percent difference will have a powerful impact on your portfolio over the long run due to the power of compounding however if rates start to rise then the drop in value of the long term bond would mean you are either stuck in that low interest investment or you have to take a far larger hit to your portfolio by selling the bond at a large loss. This to me means that you should rather earn a lower rate for the short run in order to participate in a larger rate of return later in the cycle.
The last thing you can do is reduce your allocation to bonds and focus on other parts of the market that can provide the boost your portfolio needs. One place to look is the stock market and this is touted by the "experts" as the only place to look but finding high yielding stocks is not easy and most of these stocks come with a double dose of risk; possibly cutting the dividend in poor times and/or falling precipitously from their current highs. To me this risk is the same as the higher yielding high risk bond investments. So you will have to look further afield to find returns and yields that match the requirements of your portfolio. One of these places is the property market where there are some parts of the country that can produce relatively high returns on investment with the safety of a free and clear property. Outside of this keeping this part of your portfolio secure while mitigating risk is becoming ever more difficult but one thing is for sure you will need to take some responsibility and control of your investments as we all know what happens when the blind lead the blind!
Friday, March 27, 2015
Maximizing Your Retirement Dollar
"The quality, not the longevity, of one's life is what is important." - Martin Luther King, Jr.
I don't think I have ever said that my blog is a must read but if you are approaching, planning for, or in retirement then this blog is a must read. Trying to make our retirement dollars last through our remaining life expectancy is one of the most important considerations that we have. Not running out of money before you die has to be a priority and therefore maximizing your retirement dollar is critical.
In an excellent article in the Financial Analysts Journal by Kirsten Cook, William Meyer and William Reichenstein, the authors present a methodology for extending your investment portfolio without changing your investment strategy or the amount that you have invested but by simply using the tax code to your advantage. Now some of my international readers may think this does not apply to them but I am sure that reading this article will spark some ideas that you can use at home to assist your portfolio.
The common rule of thumb is that in retirement you should first exhaust your taxable investments (TI), then your tax deferred investments (TDI) and finally your tax exempt investments (TEI). The authors of the article point out that if the tax rate is flat there is no difference between the TDI or the TEI, It is only when there is a progressive tax structure (such as the one in the United States) where a difference exists. In a flat tax environment whether you have a TDI or a TEI account will result in the same net amount. You can try it on a calculator if you like but believe me placing an amount net of tax into a TEI and growing it at a set interest rate for any amount of time will give you the same result as placing the whole amount into at TDI and withdrawing the total amount and deducting the same tax rate as before. In this environment it makes no difference which tax protected account you withdraw from first. The only way you can extend your dollars is by drawing down on your TI portfolio first.
Turning to the progressive tax environment results in a completely different equation. As before drawing down on your TI first is a must but after that things get interesting. The first thing to determine is the total amount that can be withdrawn before you trigger the next higher tax bracket. Once you have these amounts you can start to plan and it is surprising to discover that the optimal tax strategy may be to withdraw amounts from your TDI before it is required. The authors in fact discovered that the optimal strategy is one where you convert two or more blocks of your TDI portfolio into TEI investments. This is allowed as a Roth conversion in the United States. Each block needs to be placed in its own separate account. The accounts are opened and funded at the beginning of the year with investments from the TDI portfolio. Each allocation amount is the maximum allowed in the lowest (or second lowest depending on the size of the portfolio) tax bracket. So for example in the United States in 2013 an individual could have placed $47,750 and only triggered the second tax bracket of 15%. At the end of the year the converted TEI with the highest value is left as a TEI and the others are reconverted back to the TDI therefore only one conversion is taxed. Doing this throughout the portfolio extended the life of the portfolio by an average of 6.5 years!
So you may be asking why even have a TDA why not invest everything into a TEI? The answer is that there are benefits to the TDA in that you should be able to fund it with more money as you did not need to pay tax on the money before funding and this larger amount will grow tax deferred therefore growing to a larger ending balance than the TEI. The key then is trying to minimize the tax burden on the withdrawals from this investment and I have shown you one clever technique above. A second technique is to maximize the withdrawals on this account in any year where you have large expenses such as medical bills that will offset the tax paid on this withdrawal. Doing this will also extend the life of the portfolio.
So while I do not typically like to delve into taxes this is an excellent way to stretch the life of the portfolio and this could be critical to some of us. Furthermore having investments in TDI and TEI investments can be beneficial so do not steer everything away from the standard TDI investments as these can provide a higher value and if planned for correctly should not cause you too many tax nightmares. In the meantime as I have now stretched out your portfolio I think you and I better start limbering up our bodies so that we can enjoy the extra years.
I don't think I have ever said that my blog is a must read but if you are approaching, planning for, or in retirement then this blog is a must read. Trying to make our retirement dollars last through our remaining life expectancy is one of the most important considerations that we have. Not running out of money before you die has to be a priority and therefore maximizing your retirement dollar is critical.
In an excellent article in the Financial Analysts Journal by Kirsten Cook, William Meyer and William Reichenstein, the authors present a methodology for extending your investment portfolio without changing your investment strategy or the amount that you have invested but by simply using the tax code to your advantage. Now some of my international readers may think this does not apply to them but I am sure that reading this article will spark some ideas that you can use at home to assist your portfolio.
The common rule of thumb is that in retirement you should first exhaust your taxable investments (TI), then your tax deferred investments (TDI) and finally your tax exempt investments (TEI). The authors of the article point out that if the tax rate is flat there is no difference between the TDI or the TEI, It is only when there is a progressive tax structure (such as the one in the United States) where a difference exists. In a flat tax environment whether you have a TDI or a TEI account will result in the same net amount. You can try it on a calculator if you like but believe me placing an amount net of tax into a TEI and growing it at a set interest rate for any amount of time will give you the same result as placing the whole amount into at TDI and withdrawing the total amount and deducting the same tax rate as before. In this environment it makes no difference which tax protected account you withdraw from first. The only way you can extend your dollars is by drawing down on your TI portfolio first.
Turning to the progressive tax environment results in a completely different equation. As before drawing down on your TI first is a must but after that things get interesting. The first thing to determine is the total amount that can be withdrawn before you trigger the next higher tax bracket. Once you have these amounts you can start to plan and it is surprising to discover that the optimal tax strategy may be to withdraw amounts from your TDI before it is required. The authors in fact discovered that the optimal strategy is one where you convert two or more blocks of your TDI portfolio into TEI investments. This is allowed as a Roth conversion in the United States. Each block needs to be placed in its own separate account. The accounts are opened and funded at the beginning of the year with investments from the TDI portfolio. Each allocation amount is the maximum allowed in the lowest (or second lowest depending on the size of the portfolio) tax bracket. So for example in the United States in 2013 an individual could have placed $47,750 and only triggered the second tax bracket of 15%. At the end of the year the converted TEI with the highest value is left as a TEI and the others are reconverted back to the TDI therefore only one conversion is taxed. Doing this throughout the portfolio extended the life of the portfolio by an average of 6.5 years!
So you may be asking why even have a TDA why not invest everything into a TEI? The answer is that there are benefits to the TDA in that you should be able to fund it with more money as you did not need to pay tax on the money before funding and this larger amount will grow tax deferred therefore growing to a larger ending balance than the TEI. The key then is trying to minimize the tax burden on the withdrawals from this investment and I have shown you one clever technique above. A second technique is to maximize the withdrawals on this account in any year where you have large expenses such as medical bills that will offset the tax paid on this withdrawal. Doing this will also extend the life of the portfolio.
So while I do not typically like to delve into taxes this is an excellent way to stretch the life of the portfolio and this could be critical to some of us. Furthermore having investments in TDI and TEI investments can be beneficial so do not steer everything away from the standard TDI investments as these can provide a higher value and if planned for correctly should not cause you too many tax nightmares. In the meantime as I have now stretched out your portfolio I think you and I better start limbering up our bodies so that we can enjoy the extra years.
Friday, March 20, 2015
Helping or Hurting?
"The biologist and intellectual E.O. Wilson was once asked what represented the most hindrance to the development of children; his answer was the soccer mom. But the problem is more general; soccer moms try to eliminate the trial and error, the antrifragility, from children's lives, move them away from the ecological and transform them into nerds working on preexisting (soccer-mom-compatible) maps of reality. They are now totally untrained to handle ambiguity." - Nassim Taleb from his book Antifragile
While the quote above is directed at soccer moms I personally think that it could just as easily have been directed at modern day dads or parents as a group. As parents we love to give our kids a helping hand and mostly this is fine but often times the giving is taken too far and for too long and not only does this jeopardize our retirement but it also gives our kids a false sense of entitlement and security (they become fragile) and this is bad for the parents and their offspring. A study showed that the average retiree in the United States has $111,000 in their retirement account at retirement age. A rule of thumb is that you can fund your retirement with roughly 4% of this balance each year meaning that the average American can only draw $4,440 a year or $370 a month from this balance. This is hardly enough to pay the groceries for a month let alone service the mortgage, car payments, taxes, medical care and any form of meals and entertainment. However regardless of this 1 in 3 parents are providing financial assistance to adult children. In comparison only 1 in 5 provides support to their parents so the argument that your kids will support you holds little water.
Well I am certainly not saying pull the rug out from under your children's feet but I would definitely make sure that you can afford the support that you are giving. I have numerous examples of couples in the retirement age bracket that continue to work 50 plus hours a week to not only maintain their life style but the life style of their grown kids. This is crazy. Not only does this hurt you but it also hurts the kids. It hurts you because you are unable to put aside the amount required to retire and it hurts your kids because you are teaching them to live a life beyond their means so when the day finally does arrive where you can no longer work both of you instantly have the rug pulled out from under you.
My thought is to allocate spending on your kids in ways that benefit them *(make them antifragile). Our job as parents is to give our kids the best chance to succeed and so for example spending on a child's education is certainly one way that can achieve this goal. On the flip side paying their rent, buying them chic clothes or a flash car is tantamount to feeding animals in the wild. It is detrimental to both of you - in the wilds not only does the animal become dependent on the handouts but it becomes aggressive attacking people when it becomes hungry. Now I am not opposed to the odd handout at say their birthday but making monthly payments to support a life style that neither they nor you can afford is completely ridiculous.
It appears that parents are doing everything possible to protect their kids from the evils of the world including making sure that when they leave the house that their baby is taken care of financially so they can live like they did at home. While an admirable goal it is foolish and does not help them in the long run. Worse still if you empty the piggy bank you are now a huge burden on them (assuming they actually help you which as the earlier paragraph shows is a long shot) and their income so you actually end up dragging everyone down with you. This I am certain is not what the intention is so in order to help everyone in the family make sure you are setting aside enough to remove this potentially huge burden. Help yourself to help them and who knows in the end they may receive a nice handout when you die and they find that the coffers are not empty. Now that would be far more beneficial to all!
While the quote above is directed at soccer moms I personally think that it could just as easily have been directed at modern day dads or parents as a group. As parents we love to give our kids a helping hand and mostly this is fine but often times the giving is taken too far and for too long and not only does this jeopardize our retirement but it also gives our kids a false sense of entitlement and security (they become fragile) and this is bad for the parents and their offspring. A study showed that the average retiree in the United States has $111,000 in their retirement account at retirement age. A rule of thumb is that you can fund your retirement with roughly 4% of this balance each year meaning that the average American can only draw $4,440 a year or $370 a month from this balance. This is hardly enough to pay the groceries for a month let alone service the mortgage, car payments, taxes, medical care and any form of meals and entertainment. However regardless of this 1 in 3 parents are providing financial assistance to adult children. In comparison only 1 in 5 provides support to their parents so the argument that your kids will support you holds little water.
Well I am certainly not saying pull the rug out from under your children's feet but I would definitely make sure that you can afford the support that you are giving. I have numerous examples of couples in the retirement age bracket that continue to work 50 plus hours a week to not only maintain their life style but the life style of their grown kids. This is crazy. Not only does this hurt you but it also hurts the kids. It hurts you because you are unable to put aside the amount required to retire and it hurts your kids because you are teaching them to live a life beyond their means so when the day finally does arrive where you can no longer work both of you instantly have the rug pulled out from under you.
My thought is to allocate spending on your kids in ways that benefit them *(make them antifragile). Our job as parents is to give our kids the best chance to succeed and so for example spending on a child's education is certainly one way that can achieve this goal. On the flip side paying their rent, buying them chic clothes or a flash car is tantamount to feeding animals in the wild. It is detrimental to both of you - in the wilds not only does the animal become dependent on the handouts but it becomes aggressive attacking people when it becomes hungry. Now I am not opposed to the odd handout at say their birthday but making monthly payments to support a life style that neither they nor you can afford is completely ridiculous.
It appears that parents are doing everything possible to protect their kids from the evils of the world including making sure that when they leave the house that their baby is taken care of financially so they can live like they did at home. While an admirable goal it is foolish and does not help them in the long run. Worse still if you empty the piggy bank you are now a huge burden on them (assuming they actually help you which as the earlier paragraph shows is a long shot) and their income so you actually end up dragging everyone down with you. This I am certain is not what the intention is so in order to help everyone in the family make sure you are setting aside enough to remove this potentially huge burden. Help yourself to help them and who knows in the end they may receive a nice handout when you die and they find that the coffers are not empty. Now that would be far more beneficial to all!
Friday, March 13, 2015
Too Big to Save
"There aren't enough lifeboats. Someone is going to die. So you might as well enjoy the champagne and caviar." - Jamie Dimon, CEO of JP Morgan Chase to his staff the night before Lehman filed for bankruptcy
In the argument over banks being too big to fail it seems that there are a few key missing pieces of information. First off is that one of the large banks will fail again at some point in the future regardless of what regulations are put into place. I am certainly not saying that it will happen tomorrow but it will happen, there is no question about this. Why am I so sure? First history has a tendency to repeat itself and second bankers by their very nature are intent on maximizing profits. In order to maximize profits risk has to be taken and leverage is often used. Normal banking leverage is already high when compared to the rest of society (10 to 1; even your riskiest stock broker will only give you 2 to 1) and this level pails into insignificance when taken up to the derivative trades made off balance sheet. In fact when you look off balance sheet you find trades with leverage in the magnitudes of 1,000s of times the global GDP! One small shake of this stick and everything collapses but that is for a different blog post. The point to the argument is that one or many major too big to fail banks will at some point in time collapse.
The second problem is that as global trade becomes more and more interrelated and borders are crossed at will by large corporations, they will require banks that can manage the complexities associated with each countries regulators. If you were the CEO or Treasurer of Apple for example would you want to have a new bank account at a new bank in each country where the company's products are sold or would you rather go to JP Morgan and have them open a branch next to your satellite head quarters in each country, consolidate all the cash balances in one statement and provide you instant access to monitor the situation in any branch around the globe? Of course you would choose the second option meaning that big banks are not only here to stay I expect them to get bigger.
So it really is not a question of creating regulations to make banks smaller but to me trying to ensure that should a large bank fail that it does not impact the lives of ordinary citizens. A simple solution is to regulate banks so that their growth is restricted based on their chosen types of operations. So for example let's say that bank one provides our Apple Treasurer with everything that he needs and remains a plain vanilla bank that operates in a multitude of countries. One could argue that as the bank is not involved in trading or underwriting or derivative transactions that the risk of the bank failing is limited. In this case holding a 10% reserve requirement seems reasonable and should protect investors and the globe against the fallout should the bank fail. The bank is still huge and could be considered too big to fail but the impact should it fail should be minimal.
On the opposite side of the equation bank two provides not only the normal banking functions but behind the scenes is anything but a a bank (in its true form) but is rather a banking hedge fund where the majority of its results are derived from trading and other gambling style investments. This bank obviously has a higher level of risk associated with its survival and should therefore not only hold significantly higher reserves but should also have to show regulators how the pipes that connect them to the rest of the banking community will continue to operate should they vaporize. Assuming that the pipes will continue to operate without them then the systemic risk is relieved. Now this is really easy to put into print and virtually impossible to do right now but in reality if the penalties were such that if the bank cannot show a way to allow the rest of the banking world to function without them then it would be a relatively easy job to raise the level of reserves required by the bank until such time as they can show this ability. One thing I do know is that if the tables are turned, the bank will work out a solution.
So instead of regulators running around in a desperate attempt to reign in something they will never keep abreast of and forcing a size constraint on an operation that is required to keep the global economy functioning and growing; I believe that it is time to turn the tables and create a simple solution of too big to save. Any bank that falls under this heading (and they are not hard to spot) has a simple choice, raise the reserve requirements to unheard of levels or off load those operations. These banks would then be left to fail next time around. The funny thing is with the safety net removed I would not be surprised to see banks change their colors pretty quickly. As an example, if a banks operations make it risky and the face value of its derivative portfolio are larger than 20% of global GDP then it becomes too big to save. At this point the bank must either tone it down or post 30% reserves with the IMF or the Federal Reserve. Once it can control its greed then it can go back to business as normal. The current discussions on too big to fail are failing themselves, wasting tax payer money and will not result in a solution to the problem for the simple reason that, as has happened throughout history, the regulated problems of the past will be superseded in the blink of an eye as the banks will have morphed into something new and unregulated.
It is time to move on from too big to fail and realize that regulations should be designed around too big to save!
In the argument over banks being too big to fail it seems that there are a few key missing pieces of information. First off is that one of the large banks will fail again at some point in the future regardless of what regulations are put into place. I am certainly not saying that it will happen tomorrow but it will happen, there is no question about this. Why am I so sure? First history has a tendency to repeat itself and second bankers by their very nature are intent on maximizing profits. In order to maximize profits risk has to be taken and leverage is often used. Normal banking leverage is already high when compared to the rest of society (10 to 1; even your riskiest stock broker will only give you 2 to 1) and this level pails into insignificance when taken up to the derivative trades made off balance sheet. In fact when you look off balance sheet you find trades with leverage in the magnitudes of 1,000s of times the global GDP! One small shake of this stick and everything collapses but that is for a different blog post. The point to the argument is that one or many major too big to fail banks will at some point in time collapse.
The second problem is that as global trade becomes more and more interrelated and borders are crossed at will by large corporations, they will require banks that can manage the complexities associated with each countries regulators. If you were the CEO or Treasurer of Apple for example would you want to have a new bank account at a new bank in each country where the company's products are sold or would you rather go to JP Morgan and have them open a branch next to your satellite head quarters in each country, consolidate all the cash balances in one statement and provide you instant access to monitor the situation in any branch around the globe? Of course you would choose the second option meaning that big banks are not only here to stay I expect them to get bigger.
So it really is not a question of creating regulations to make banks smaller but to me trying to ensure that should a large bank fail that it does not impact the lives of ordinary citizens. A simple solution is to regulate banks so that their growth is restricted based on their chosen types of operations. So for example let's say that bank one provides our Apple Treasurer with everything that he needs and remains a plain vanilla bank that operates in a multitude of countries. One could argue that as the bank is not involved in trading or underwriting or derivative transactions that the risk of the bank failing is limited. In this case holding a 10% reserve requirement seems reasonable and should protect investors and the globe against the fallout should the bank fail. The bank is still huge and could be considered too big to fail but the impact should it fail should be minimal.
On the opposite side of the equation bank two provides not only the normal banking functions but behind the scenes is anything but a a bank (in its true form) but is rather a banking hedge fund where the majority of its results are derived from trading and other gambling style investments. This bank obviously has a higher level of risk associated with its survival and should therefore not only hold significantly higher reserves but should also have to show regulators how the pipes that connect them to the rest of the banking community will continue to operate should they vaporize. Assuming that the pipes will continue to operate without them then the systemic risk is relieved. Now this is really easy to put into print and virtually impossible to do right now but in reality if the penalties were such that if the bank cannot show a way to allow the rest of the banking world to function without them then it would be a relatively easy job to raise the level of reserves required by the bank until such time as they can show this ability. One thing I do know is that if the tables are turned, the bank will work out a solution.
So instead of regulators running around in a desperate attempt to reign in something they will never keep abreast of and forcing a size constraint on an operation that is required to keep the global economy functioning and growing; I believe that it is time to turn the tables and create a simple solution of too big to save. Any bank that falls under this heading (and they are not hard to spot) has a simple choice, raise the reserve requirements to unheard of levels or off load those operations. These banks would then be left to fail next time around. The funny thing is with the safety net removed I would not be surprised to see banks change their colors pretty quickly. As an example, if a banks operations make it risky and the face value of its derivative portfolio are larger than 20% of global GDP then it becomes too big to save. At this point the bank must either tone it down or post 30% reserves with the IMF or the Federal Reserve. Once it can control its greed then it can go back to business as normal. The current discussions on too big to fail are failing themselves, wasting tax payer money and will not result in a solution to the problem for the simple reason that, as has happened throughout history, the regulated problems of the past will be superseded in the blink of an eye as the banks will have morphed into something new and unregulated.
It is time to move on from too big to fail and realize that regulations should be designed around too big to save!
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