The Santa Claus Syndrome: Where Things Come From

Interest Starvation

One key reason consumer spending is down and depressing the economy is interest starvation. If you had saved $100,000 expecting that, at worst, you could earn four or 5 percent by putting it into safe government securities you would have expected $4,000 or $5,000 a year in income. But if this turns out to be only a few hundred, you certainly can't spend the interest you didn't earn. You probably aren't going to spend the few hundred either since you don't know what is coming next.

As late as five years ago, even the most conservative financial advisor would have calculated that you could earn four or five percent fixed income on top grade investments, even government securities. Nobody predicted that a lunatic would get control of the Federal Reserve and lend banks vast sums for nothing.

    As a CPA, I know that debits have to equal credits. This is as certain as the law of gravity in physics. This means that when the Federal Reserve lends vast sums to banks for virtually no interest, others can't earn anything when they put money into what were once called fixed income investments: bonds, CD's, money market funds

    In practical terms, those who did the right thing and saved their nickels and dimes for 40 or 50 years so they would have some investment income in retirement instead of relying solely on government benefits or help from family members find themselves stranded.

    You might have little sympathy for old people with money but how are you going to be able to persuade young people to save for their own retirement if they see this happen to those who did? People now speculate that Social Security won't be around when those who are now young get ready to retire. But what if there was no way for them to earn anything on their investments? There needs to be an incentive for people to keep investing. In the long run, we need an economy where capital comes from investors, not new money printed by the government.

    I recently noticed at least one commentator say that a good thing about low interest rates is that it encourages people to spend instead of save. While this could have some purpose in a short run, in the long run it leads to ruin and generations of old people with nothing but government services to live on.

    Even the low rates don't seem to be stimulating the economy that much. If you are a business considering a loan, you have to look at the prospects of earning enough money from the loan to pay the principal as well as the interest. If you don't think you can earn enough to pay the principal, it doesn't matter what the interest rate is.

    All the emphasis is on making cheap loans. But this starves those on the other end of the transaction. I'm hearing ads on the radio about home loans for under 3% for a ten year loan and not much more for a longer loan. This is another disaster in the making. It can only be done by creating money through government action. What if these loans are securitized and sold to investors?

The Fed gets away with this in the short term because people are more concerned about their principal than earnings. So they buy government securities that pay virtually nothing. But in the long run, this isn't going to work. In 5 or 10 years, interest rates will go up and these securities will drop in value relative to those with higher rates.

    Throwing the future away to pretend we are fixing the present is what we did wrong in the first place. Lending to anybody willing to take a mortgage certainly boosted the housing and lending market and boosted prices. But when it became clear that many of these borrowers couldn't pay, the whole thing collapsed and it will take years for the system to digest the mess.

Bernanke’s Interest Starvation

Why is one of the most important reasons people aren't spending being ignored? Low interest rates from the Federal Reserve is the problem. Few retirement planners anticipated this risk: A lunatic would get control of the Fed and give the banks all the money they wanted for free. This means that people who saved their nickels and dimes for forty years and have some money to invest are getting virtually nothing for it. Even if you had a million dollars, at the rates you can get on CD's, money market funds or bonds, you would only earn a few thousand a year, only a sliver of what even conservative planners expected. Many will be forced to invade principal which is the worst thing to happen when you are beyond your working years in that it's going to reduce your future earning ability even more.

The Fed has poisoned investment markets which no real benefit and some real negatives. I can't spend interest I never earn and won't spend what I do earn if it appears to be dwindling. It's hard for even consumers with some money to gain confidence in these circumstances.

No matter how cheap money is, people won't borrow if they don't believe they can make a return on it. Whether rates are 2%, 4% or 12%, if you don't think you can employ it in something that will make money, borrowing is a bad idea. Lowering interest rates in the current economy is of little value. If rates were in the staggering, double digits of the Carter Administration, lowering them would remove a barrier but the rates now aren't the problem.

The current Fed policy reduces the value of capital to virtually nothing. In the long run, this is a problem. I mean real capital involving people saving money to invest, not fictional money created by the Fed. Nothing good can come out of this. Salvation will not come from the Fed, and wherever it comes from, it won't be soon. The economy won't perk up until people have money to spend and making a little on investments is one way to get money to spend. When you are starving for interest, you aren't spending.

Home Mortgage Deduction Over

If we are ever going to eliminate the home mortgage interest deduction the time is now. The deduction provides a discount of the interest rate resulting in a lower monthly payment in some cases. The elimination is just as if the rates went up a point or two. So with rates at record lows and home prices dropping, now it the time that the elimination would have the least impact.

This big factor in eligibility for a mortgage is the monthly payment which is based on the rate and the mortgage balance. Not only are rates low, prices have dropped dramatically in most markets so monthly payments have also. Anyone who is reasonably financially able to manage home ownership should be able to do it now.

As interest rate increases always eliminate potential buyers at the margins; this will too. But we know there is a risk with those who barely qualify so this will increase the margin and reduce that particular error. We are realizing that home ownership isn't a good idea for everyone.

In some cases, the deduction isn't such a great benefit anyway. For 2009, singles were eligible for $5700 standard deduction and couples for $11,400. Unless you have a pretty big mortgage and it's fairly new, you may be getting very little benefit, if any, over what you would get with a standard deduction, especially for a couple. The first few years of a mortgage, most of the payments are deductible interest but in the later years, the interest element diminishes rapidly.

Since this is one of the larger deductions for some people, it can't be overlooked in any review of the tax system. The real estate industry will fight it since it will reduce their market by a small amount and reduce what others can spend on houses but it's not nearly as big an issue as it was when interest rates and prices were much higher. It's now or never on this one.

Poor Millionaires?

    Nobody knows what rich and poor mean anymore. Of course the majority of us are neither, just part of the vast unheard majority in between. 

    The only way you can measure the value of an amount of money it to relate it to something else. You can’t say whether $500 is a lot of money without some reference point. It is a lot of money to pay for a hamburger but not much to pay for a new car. 

    So how can we decide if the millionaires are rich or poor? One way is to look at what sort of income they might earn on this and relate that to average income. Remember, having a million dollars is a lot different from spending a million dollars. When people describe what they would do if they had a million dollars, they often describe how they would spend it. Usually they would spend it immediately and several times over. This should be a clue as to why they will never be in that position. 

    Let’s describe someone who could be a typical millionaire. I’m using total net worth to define “millionaire.” Some like to use a definition that only includes investable assets so excludes the value of their home. This is important to investment advisors looking for clients because they are looking for what they could earn a commission on. For the rest of us, the total is fine. 

    Let’s assume a case of someone who accumulated a net worth of a million dollars over 30 or 40 years of running a small business, say a couple of dry cleaning stores or maybe a couple of drugstores. Let’s say our millionaire is 70 years old and no longer working. So how are things going in this situation? 

    Many investment advisors say that it is safe to spend 4% annually of your savings in retirement. Of course with the low investment incomes now, you might have to cut back. And say our millionaire has $200,000 of his net worth invested in a home. You can’t spend that as you go along and you aren’t going to be getting any income from it unless you are renting out a room so we should take that amount out of consideration. If you spent 4% of the remaining $800,000 it would only amount to $32,000. 

    Then let’s assume a Social security payment of $20,000, fairly typical. You would have a total income of $52,000 a year, very close to the actual median income. Our millionaire is not poor but is a long way from rich. Depending on the cost of living in your location, he could be on the lower end of middle class. You could just plunge in and spend more of your capital but those who think like that aren’t likely to accumulate much anyway. So it’s good to remember this example when you hear the media discussing millionaires.

Democrats Against Obamacare

Roy Barnes, former Georgia governor and the Democrats’ nominee for this year, is campaigning against his party’s health care bill that so many of them are so proud of.  An AJC/AP story published yesterday points out that while Democrats favor the plan, he will need votes of Independents and moderate Republicans to get elected and they are highly suspicious.

            Barnes criticized the plan as “financially devastating” to the state without a plan to get Medicaid costs under control.  He is concerned that in 2014 when the federal government cuts back to their normal Medicaid contribution, it will impose staggering new costs on the state.  He sees the current Medicaid tab for the state going from the current $2 billion a year to as much as $5 billion a year.  This is while the state is going through a big reduction in every program because of lowering tax revenues.  (No, the state isn’t likely to raise taxes either.)

            One of the biggest shortcomings in Obamacare is that it focuses on health INSURANCE costs instead of healthCARE costs.  In many cases it will increase costs. Just the Medicaid issue will probably bankrupt a few states.  (Maybe that’s why many of them are suing the federal government to stop the plan.)  It imposes increased employment costs on small businesses that are already having a hard time paying their employees.  

Many small businesses have dropped health insurance not because they thought people didn’t need it but because of the cost.  So what is the Obamacare solution?  Force them to pay! 

So even some Democrats see the problems with this plan. As the features go into effect over the next few years, and the bills start to arrive, they will become more obvious.  But can we stop the monster before it sinks us?  The November election results will give a sign. 

It’s What’s and How’s Season

Like many other places, we are having a primary election in Georgia and are being swamped with political ads.  But as is often the case, they are mostly about what’s and short on how’s. 

            On a TV debate our former governor, who is running to get back in, was promising to reinstate regional crime labs and talked about how important they are.  I agree that they are important.  But the reason that they were cut back is a shortage of funds that isn’t getting better anytime soon.  

            It’s easy to promise all sort so things people might want or think they deserve.  Paying for them, especially when everybody is already broke is another matter.

            It’s not just the poor and ignorant who are voting for anybody who promises a free lunch, but they are certainly there.  Maybe a lot of others are living with a lot of wishful thinking.

            It seems like politicians usually run by promising a lot of things that are going to cost money.  I guess the hope that the voters don’t realize that all that money is coming out of their pockets.  Of course there are some voters who pay little in taxes and hope to gain much more in benefits.  When this group gets big enough, it can sink the ship of state. 

            In any case, when these politicians take office, they will have a list of things they have promised to do and no money to pay for them.  Serves them right. 

 

The Poison of Free Money From Government

    No, not for you, for the banks.  That’s what the Federal Reserve is doing supposedly to stimulate the economy, loaning the banks money at virtually no interest 

            There are a couple of things wrong with this policy that at the same time take money out of your pocket and put the economy at risk.  Of course the first only applies if you have a little money in your pocket.  If you have done the right thing and saved your nickels and dimes for 30 or 40 years so you could take care of yourself instead of being completely dependent on the government, you are getting robbed.  When you are retired, you need income from your investments to live on and you need to move away from the ups and downs of the market so you are going to be putting your money into certificates of deposit, bonds and money market funds.  But as long as the government is lending money for nothing, banks and investment companies aren’t going to pay you anything either.  My money market account is paying such a small fraction of one percent that I doubt they could afford the postage to send me a statement to tell me about it.

            Some of this is supposed to stimulate the real estate market but house prices have dropped 30% to 40% in most markets.  How much stimulation do people need if they really have an interest in buying?  If a 40% discount doesn’t get them moving, they aren’t really going to move. 

            Another thing is that all this money may end up going into low risk government investments which allow banks to make money for doing nothing or into higher risk investments just because it’s available.  

            One the main causes of our recent problems was vast amounts of easy credit from the government or created by government. So they are doing it again. 

            We need higher interest rates to stimulate saving as well as to pay people who are doing the right thing.  Putting unlimited supplies of money out inevitably leads to some sort of bubble.  It may be a sweet tasting poison but it kills just the same.

Hail the Soda Tax

    What could be better than putting a tax on soft drinks?  Why should they escape tax?  It would provide needed money to balance the state budget and get people to drink less harmful soda.  This is the “Double Do gooder scheme:  They take your money and say you are better off for it.

            This is the plan in New York State, among others, which has a bit of a budget shortfall.  New York is talking about a cent per ounce tax.  You would hardly notice.  But on the other end it would add up.  But on a 12 ounce drink, you would pay 12 cents.  Of course they do things big in New York, at least where money is involved.  Last fall I was there for couple of days and the hotel vending machine charged $2.50 for a 20 ounce drink, just add another 20 cents.  I went out to a grocery store and bought a 2 liter bottle for about $2 which is high but not that high.  But these guys would add 66 cents to it. 

            People don’t like naysayers but there is a lot of “nay” to say about this.  Like most taxes, it will generally come out of the same pockets as the other taxes, just from another angle.  It isn’t like it would apply to some new group of people who are paying no taxes at all now.

            The big “nay” on any new tax is the overhead.  You have to come up with a scheme to collect the tax.  You have to find a way to make sure people pay and pay the correct amount.  You have to make sure the money doesn’t get diverted.  You have to hire new people to do all this.  If you increase an existing tax, you just have to change the rates.  This costs little but may be more noticeable. 

            Another big nay is that it is another step in the direction where we get nipped from every direction and can’t have any control over the situation. If there are a small number of visible taxes, the people have some control.  When it’s a little here and there, it is much harder.

            But at the end, the vast majority of taxes are paid by the same middle class lump of people.  The poor pay little on a tax like this.  There aren’t enough rich to drink enough sodas for this to matter.  So it’s us again.  

Wrong Culprit in Healthcare Debate

As the Democrats healthcare bill, designed to turn health insurance on it head, is percolating in Congress, I decided to look into the situation.  The government has savaged the health insurance industry as if they were just a bunch of looters, taking all the money and leaving their customers high and dry.  Much of what the Democrats are working on is designed to put the squeeze on the insurers.  But they are looking at the wrong thing!

As a CPA, I like to look at the numbers. I have been reviewing the financial results of Wellpoint, the largest insurer with 35 million members and 42,000 employees.  They are the Blue Cross franchisee in a number of states.  If the health insurance industry is getting rich, it should show up here.  Their financial statements are available on their website for anybody to see.  

The 2009 results aren’t available yet but 2006 to 2008 are there. So did I find vast bundles of profits?  If I had, I would be buying their stock instead of writing this.  In fact, I was not moved at all towards that.  Annual reports are designed for potential investors so put an optimistic a face as possible on things. 

I would not buy into this industry.  Their profits as a percentage of revenues are nothing special and Nancy Pelosi is trying to grab that. 

It is clear that where the money is going is to the healthCARE industry, not the health INSURANCE industry.  Of Wellpoint’s 2008 gross revenues of $57 billion, $48 billion went straight through to healthcare providers: hospitals and doctors.  By the time they paid their administrative costs (salaries for 42,000 employees), taxes and drug bills, they were down to $2.5 billion which is only about 4.4% of the gross.  With Nancy Pelosi hell bent on grabbing as much of that as possible, nothing good can come of this. 

If the government is to reduce healthcare costs, they need to go where they are actually occurring, not after the industry doing the paying.  They can beat up the health insurers forever and it will never touch health care costs.  When you have the wrong people analyzing the wrong thing, they will get the wrong answer. 

Christmas at the Obama White House

        Nancy Pelosi and Harry Reid are handing out the presents and all is right with the world.  Or is it?  They are just putting the final ribbons on the biggest present, the new healthcare package, all the hundreds of pages of it.  It will take time to sort out just who gets what and what the cost will really be but it seems like if your U.S. Senators are Republican, look for switches and ashes.  If you have the other guys, the sky is the limit.

            I had not planned on a Christmas blog since my basic theme in my Santa Claus Syndrome book is that there isn’t really a fat guy in a red suit who is going to pay all our bills.  But Obama and his elves in the Congress are trying to prove me wrong.  The NY Times is reporting that deep in the bill there are lots of specific provisions inserted by Harry Reid to get the votes of specific senators.  There are reports of millions for this, hundreds of million for that.  All presents designed by senators for some specific need:  To get a vote here, a vote there to get to the magic 60.            

        Some of these benefits have very specific criteria and only fit a few circumstances.  Those who wrote these provisions may be the only ones who know the intended beneficiary.  How can anybody vote for something like this?  They seem to be just looking at the specific benefits to their own constituents and turning a blind eye to the costs to the whole government.

            Another big factor is the expected cost savings.  Like many government plans, they say they have devised ways to save money but instead of implementing the plans to see if the savings actually appear, they are going to spend the whole bundle first.  Wishful thinking is an important legislative tool.  One of the major savings they allege is by paying less to Medicare doctors.  These are the same doctors who are turning down Medicare patients now because of the low payments.  This is pure fantasy.             

            There may be a political urgency for the proponents of this plan but for those of us who might be on the paying end; a little more thought would be a big benefit.  In fact, they need to defer this plan for a year, not just for more study but to implement the cost savings schemes and see if the money really rolls in before they spend it.

            So while everybody is settling in to enjoy their new presents, remember there is a bill as big as the moon headed for somebody.