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Solving the nation’s debt problem with I.O.U.S.A.

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 This is a contribution from Bud Hebeler who runs Analyzenow.com


Last night  I went to the movie I.O.U.S.A. followed by live commentary from Warren Buffett, Pete Peterson, Dave Walker (headed GAO and was Controller General), William Novell from AARP, William Niskanen from the CATO Institute and an Economist whose name I can’t remember.  You’ll have to pardon the errors in this because I was taking notes in the dark and found later that it’s almost impossible to read them.

 

The commentary that followed was handled by Becky Quick from CNBC’s Squawk Box show who fielded questions from the audience.  The movie was loosely based on the book, Empire of Debt, and was actually exciting—quite a surprise for a financial show.  It even got our local movie audience clapping and laughing.  The show was financed by the Peterson Foundation and starts out with a lot of material from the Concord Coalition.  It was non partisan.

 

The more I think about the conclusions of the experts (Buffett, Walker, Peterson, et.al.) at the conclusion of the movie I.O.U.S.A., the more I wonder about their almost universal opinion that the main solution would be to increase the federal tax rates and moderate Social Security and Medicare payments to solve the $53 trillion government obligation problem.  Nowhere did they mention the other main debt problems:  personal debts, business and financial firm’s loans, State obligations including unfunded public employee pensions, and the sorry state of our transportation infrastructure.  These have to be satisfied as well.  As bad as the national condition was portrayed, our share of the total obligations was far understated.

 

One position that was mentioned was a mandatory savings program although the small percent cited would do little to solve our huge savings problem.  After all, Social Security costs us 6.2% plus another 6.2% from our employer—and that isn’t enough to keep the program solvent.  Further, as I have cited in Getting Started in a Financially Secure Retirement, the savings rate (not including Social Security) has to be well over 20% for the next two decades just to make up for the lack of savings in the past two decades of consumerism.

 

There are those that would only tax the rich, but as much as I dislike the extreme over-compensation of the top executives in major companies, those people eventually have to spend their money, and in so doing enrich the rest of us.  They and their children may live what we consider (or wish we could achieve) obscenely ostentatious lives, but their incomes (less taxes) eventually come into the economy.

 

On the other hand, government spending and wealth redistribution do little to increase productivity.  In fact all of the paperwork, additional government employees, even more private sector employees to respond to government regulations, and the imposition on our personal time all hurt productivity.  That’s not to say that some innovation doesn’t come from government sponsored research in medicine, military and space activities, but there is lots more that comes from the private sector where competition and necessity are the stimulus for invention.  This is well illustrated by the modern examples of nations that have converted from pure welfare states.  Russia and China now have booming economies by comparison with their past under totally controlled economies.

 

Higher taxes and increased savings have to reduce economic activity.  Some other alternative solutions are particularly unappealing:  Government bankruptcy, revolution, and hyperinflation.  Bankruptcy destroys much of the world’s economy with it.  Revolution ends the way of life we and few others know.  Hyperinflation puts those on fixed incomes into poverty.  Yet, in my view, a little of each of these horrible extremes is the medicine that might be necessary to at least end up in some reasonable equilibrium.

 

How about some real government changes to same money?  The Congress should start by setting the example and cutting its overgrown and bloated staffs by 50%.  Then it should act to change all federal pensions, including their own, to fixed pensions like all of those in the private sector.  (Only one in five private sector employment earns a pension, and they don’t have cost-of-living-adjusted pensions like federal and most state pensions.)  Stand up to your unions.  Let them strike.  That would reduce cash outflows too.  Then deny state largess from the federal coffers unless the states do likewise.  Don’t stop there.  Demand IRS 1040 simplification so that the IRS can cut its work force in half and we don’t have to use accountants and computer programs to do our taxes.  Simultaneously, get Medicare to do the same thing so that both government employees and the private medical facilities can cut their own staffs with less paper to handle.  Then sell off the excess office buildings.  Give up your perks.  These are the kind of things we have to do in the private sector in order for a business to survive.  You’ve got to save a country—that’s even more important!

 

This is not “change” as envisioned by current political parties.  Current political “change” is aimed at things that increase government spending and control.  In my view, change should be moderately more inflation than now considered acceptable, reduced bailouts of industry and financial firms, meat-ax reductions in government personnel, and much increased foresightedness in Congress and personal financial planning –together with some tax increases and entitlement reductions.  We all have to consider much longer horizons than hours or days in financial markets or a few years as in elected office terms.   We even have to think in terms longer than decades as we did in our Boeing planning.  We have to think in terms of generations and life-expectancies, just as in the insurance business.

 

Everyone is going to get hurt, but we all have to understand that a little pain now is a lot better than a lot of pain if we wait longer to take our medicine.  Perhaps the only Congress and Administration people willing to take such long range positions might be those nearing retirement, but certainly not the others and especially their supporting staffs which provide all of the advice and “smarts” on which government officials depend.  These all need their jobs to feed their families, and most are terrified of leaving their jobs to seek private sector employment and much lower benefits than the government provides.  Further, they have demonstrated that they have no interest in solving the additional problems of personal savings to replace debt, business debt, State obligations including public pensions and the sorry state of our transportation infrastructure. 

 

That said, here are my notes from the movie, I.O.U.S.A., and the comments from some of the more powerful people in financial circles and former government executives.  I feel all citizens should hear this message—and consider some of the points I have made above.

 

 

Of course, the movie is mostly about debts this country has incurred to date as well as the history leading up to our current situation.   Before the movie began, they had a digital display showing the current national debt as it was actually changing.  It was increasing by millions as we watched.   The only time this country was out of debt was 1830.   At the time the movie was made the total unfunded obligations of the country were $53 trillion or $175,000 for every man, woman and child in the US.  By 1/1/09, it will be $55 trillion and $184,000 for each person.

 

$10 trillion of this will be the national debt at the end of the year.  44.5% of our debt is owned by foreigners, principally China.  The other time the country reached levels of national debt to GDP like we are now was at the end of WWII, but that debt was owed to ourselves, largely as savings bonds.  Unlike now, the people were willing to make great sacrifices because they had experienced the Great Depression and had come out of the War where most things were rationed.  So much of the debt got paid.

 

One of the few periods in modern times when the government was not outspending its income was in the Clinton administration supported by a Republican Congress.  The movie came down hard on President Bush for not containing spending, especially for approving Medicare drug assistance with Part D.  It showed clips of Secretary O’Neill who was very upset about being fired for his disagreements with President Bush.

 

All commentators agreed that the current problem was largely due to excessive consumption.  Our national savings rate is now -2.9%.  The graphics showed the highest savings, about 23%, occurred during WWII.  Most of the time savings rates in the past have been about 9% to 10% through good times and bad.

 

There was a considerable amount of material on inflation with laudatory comments about Paul Volker raising the interest rate to 20% to combat what had occurred in the Carter years.  There were also clips of Ron Paul railing the government for printing money.

 

Social Security was highlighted in the movie as well as the commentary.  Various solutions were suggested such as raising the full retirement age from 66 to 70 or doubling the Social Security tax on the work force.  After 2017, without action, the Social Security Trust Fund will no longer be able to support cash flows for things other than Social Security as it does now because the trust funds won’t be there.  As most of us already know, the trust fund is a fiction.  It’s full of IOUs from the federal government.  One person said that the trust fund is neither a fund, nor can it be trusted.

 

The movie showed street interviews with ordinary people.  It was shocking how little they knew not just about the country’s financial conditions, but even simple financial terms like deficit.  The movie and all commentators (except Warren Buffett) felt it was grossly unfair to have our children and grandchildren and following generations have to pay for our current excesses.  Buffett felt that the ingenuity of our people would come up with things to solve the problems so that our children would actually have better lives than us.  The movie and commentators showed how poor our schools were compared to all other developed countries.  We are particularly deficient in math and science.  After seeing the movie, I’d add that they are even worse in teaching basic finance and money management.

 

The movie also made some dramatic points about the trade deficit.  It showed a US scrap yard where the manager said the majority of his scrap was being sold to Japan and China who were manufacturing things to be exported back to the US.

 

Foreigners that hold our debt hold it in dollars, so if they sell it to another foreigner, the other foreigner will have the same debt in dollars.  It’s like a tar baby.  The risk is not the foreigners dumping the debt; the risk is the interest rate and being able to get them to take on more of our debt.

 

Walker pointed out that one of the things that made the debt problem so intractable is that 68% of the national budget is on autopilot (e.g., automatically adjusted for inflation) and only 32% is for the things originally intended by our founding fathers to be what the federal government was supposed to do—like defend us.  Also, Congress was supposed to be a part-time job where the congressmen went back home to their regular jobs the rest of the year.  Now, congressmen work to preserve their congressional jobs and have a very short term perspective directed at whatever it takes to get reelected.

 

Most of the commentators agreed that the solution to our problem relies on national leadership—and it just isn’t there.  Politicians are campaigning with programs advocating more government spending, not less.  Medicare is currently the largest single unfunded liability—and it looks like the finance problem not only will not get solved—it will get worse with all of the add-ons.

 

The $53 trillion debt and unfunded liabilities is made up (as I recall the numbers) with $10 trillion national debt, 7 trillion Social Security, $26 trillion Medicare parts A and B, 8 trillion Medicare part D and some miscellaneous items.  I don’t remember how they accounted for the trade deficit, and there was no mention of State debts or industrial debts which must exacerbate the problems.

 

If you get a chance to see a replay, I’d urge you to see it yourself.  It has a very compelling message that should be understood by all citizens including those in high-school.  We need better government leadership and we must greatly increase personal savings.

Hidden government costs

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This is a contribution from Bud Hebeler who runs Analyzenow.com

Hidden government costs FAR exceed that which we think we pay in sales and income tax.  See the illustrations below:

So you may think you are only paying income, property and sales tax.  Wrong!  You are paying for the government labor to administer and collect the taxes.  You are also paying for all of the taxes on the materials used to get you the final product.  And you are paying for the additional effort required by the retailer to administer and collect the taxes.

 

The additional administrative costs problem may be the worst in the medical field where medical offices now employ many more people than the professional staff in order to handle the bookwork of Medicare patients.  Of course the major exceptions to this are those medical professions where Medicare doesn’t cover the costs, i.e., dental, hearing and eye care.  Still they require some effort to cover those things covered by private insurance, but they don’t have to provide all of the incremental labor associated with submitting the bills to Medicare, waiting for a reply, resubmitting the result to a Medigap insurer, waiting for the insurer’s reply, and then finally billing the patient for the incremental cost that’s left.

 

Our family and retired friends have found that many times, the interval between the visit to the doctor’s office and our final bill can exceed a year.  Since all of the medical staff and their suppliers must be paid before the doctor’s office finally gets the checks from Medicare and the Medigap insurer, your medical bills have to include the cost of borrowing the money in the interval.  Throughout this process we get a number of reports on what’s allowable and what’s not–almost always aggregated with other items still in progress in a mess that’s virtually impossible to untangle.  I remember that my father used to just throw all of these reports unread in his top drawer and discard them when the drawer got full.   This used to drive my sister nuts, but it probably was the most practical thing to do.

 

Medical costs may be the least problem to you who are young and healthy.  You don’t get off scot free from hidden government costs though.  Let’s first look at sales taxes.

 

We only see the sales tax on the retailer’s bill.  However, the retailer must pay sales (or “use”) tax on the goods it sells.  The retailer pays sales tax on the goods it buys from the wholesaler.  The wholesaler pays sales tax on the goods it buys from the manufacturer.  The manufacture pays sales tax on the goods it buys from subcontractors.  The subcontractor pays sales tax on the materials it uses.  And so on down to the point where the basic material comes from the ground—and property taxes are due.  Actually, property taxes are involved in every step of the way, but we’ll leave those out to simplify the results.

 

In a product area where the labor costs and profit are a small part of the costs, say only 10% of the total cost, then a 9% sales tax like we have in our area really is a 24% sales tax when considering the product passes through only four hands on the way to your home.   A 5% sales tax translates to a 13% sales tax in the same situation.

 

On the other hand, a product that has a high labor content, say 50%, at each of the four steps with a 9% sales tax would really cost you 12%.  If the labor content was 50% and the sales taxes were 5%, the net sales tax to you would be 7%.

 

How do income taxes come into this?  You pay income tax on all of the labor that went into the product at each step along the way.   Suppose the labor content was 50%.  If the average income tax of the workers was 20% and the profit was 10% at each of four steps, you would be paying 14% of the price for income tax along the way.  If the income tax was 10%, you would be paying 7% of the price for income tax.  Remember that the income tax includes that of the top bosses, administrators, and hands-on labor.  Also remember that we haven’t accounted for Social Security and Medicare.

 

So, leaving out property taxes, Social Security tax and Medicare tax, if the sales tax is 9% and income tax is 20%, we are paying 24% tax for a low labor product and 26% for a product that averages 50% labor and profit at each of four steps.  At the other extreme with 5% sales tax and 10% income tax, we are paying 13% tax for a low labor product and 19% for a product with 50% labor and profit at each step.  Of course these are just rough figures because everything we buy is going to have different net taxes.

 

One of the main ways that the federal government has to reduce taxes is to push responsibility down to the state level.  Medicaid is a primary example of this, but it also applies to many other areas including education and law enforcement.

 

The main point is that actual taxes on the things we buy are far greater than that sales tax number we see printed on the receipt.  By analogy, the same is true of our property tax rates.  So when someone says that the federal government is going to increase its services but not income tax for the average person—Watch out!  The average person will pay for it one way or the other.

 

The other point to keep in mind is that increased government services and regulations can have a far greater effect than the increase in government payroll.  This in itself is costly because both the average pay and retirement benefits for government workers far exceed the averages for those in the private sector.  But the greatest effect is on the increase in labor needed in the private sector to satisfy the government requirements and administrative effort.  The medical profession is a prime example of this, but it’s not the only one.  I worked for thirty three years in the military and space fields.  For every government oversight person assigned, we had to employ many more of our own employees to respond to the government’s questions.

All of these things are hidden costs.  It’s impossible to find out the total, but almost anything we buy has hidden sales tax, income tax, Social Security tax and private sector overhead costs that far exceed that which we think we are paying in that simple sales tax number!

We’re going to pay for all of this with our taxes

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This is a contribution from Bud Hebeler who runs Analyzenow.com

How would you like to have retirement resources that will provide about the same income in retirement as when working and be inflation protected? Answer: Go to work for the government. Oregon has one of the richest pension plans. After 30 years of employment, pensions equal or exceed their working compensation per 1999 rules. (Statesman Journal, April 20, 2003) Add Social Security which may provide another 40%.

The baby boomers with government pensions will exceed the number of baby boomers getting pensions in private industry if current trends continue. Consumer Reports Money Adviser (May, 2008) cites Boston College research showing that while 36% of the private sector employees had defined benefit plans in 1992, only 19% have such plans now. That translates to about 22 million private sector employees (19% of 116 million) who get pensions. Virtually all of the 23 million government employees get pensions. This does not count those in the military who also get pensions, and I believe does not count postal service employees or those in similar government sponsored corporations like the Pension Benefit Guarantee Corporation that’s supposed to save pensions for the rest of us.

Most federal pensions have inflation protected cost-of-living-adjustments, COLAs. Many state pensions also have this rich benefit. Practically no private sector pensions have COLAs. At 65, a pension with a COLA has a funding obligation about 50% more than a fixed pension assuming future inflation is only 3%. So if you’d go to buy an inflation adjusted immediate annuity with regular monthly payments like a pension, a COLA annuity will cost about 50% more than a fixed payment annuity. Said another way, a $1,000 a month COLA pension will pay $1,810 after 20 years of 3% inflation while a $1,000 fixed pension will still pay $1,000.

So we are paying into a pension plan that’s not our own even if we personally will not get a pension. That’s because we are paying for the federal, state and local government retirement plans with our taxes. As government increases in size, we’ll pay more—and even more with the COLA adjustments. Although politicians run for office on the basis of reducing government spending, it practically never means reducing the government payroll. Every addition for oversight or a function adds people. And it’s almost impossible to reduce the staff size in a government job. I can remember when congressmen had only 4 people on their staff while ten times that much is not uncommon today.

That’s not all. The percentage of retired people is increasing relative to the number of working people, perhaps 10% to 20% more in the next couple of decades. That means that an ever smaller working force is going to have to support an ever increasing number of aged people. This is not just for the government pensions. It also covers everyone’s Social Security (also inflation adjusted) and Medicare. Medicare is not only increasing from inflation—it’s increasing because of the increasing number of aged and faster-than-inflation growth of medical expenses of almost every kind.

It also means that over 17% to 20% of the work force will be in the government excluding the military and other quasi government workers and the unstoppable growth of government. That’s a powerful voting block. Government employees will always vote to keep their jobs.

Federal employees have subsidized health insurance in retirement as do many state and local government retirees. Very few private sector employees have this benefit. This is huge. A retired couple from the private sector pays about $700 a month for Medicare and Medigap policies, and that doesn’t cover drugs, uninsured costs and care of eye sight, hearing or dental work.

Government employees have 403(b) savings accounts with provisions similar to the 401(k)s in the private sector. But, in the case of the private sector, these savings plans are rapidly replacing pensions, not in the government sector. The public sector is better subscribed because many of those in the private sector opt out, even when the employer offers matching funds.

The average government employee now makes about 50% more than the average person in the private sector. USA Today (2/1/08) reports that “State and local government workers now earn an average of $39.50 per hour in total compensation …Private workers earn an average of $26.09 an hour. . . From 2000 to 2007, public employees enjoyed a 16% increase in compensation after adjusting for inflation compared to 11% for private workers.” In large part, many government workers can thank their very powerful unions and public shy politicians afraid to confront a large part of their voters.

So there you have it. We’ve grown a government that not only pays its employees better than the private sector, we give them better benefits. We’ll pay for those employees not only while they are working, but at an ever increasing rate while most of the rest of us in private sector retirement see our incomes cut by inflation.

General Motors, move aside. There’s another entity that is going to pay more dearly than you for all the retirement promises it has made. Ah, but it’s a sovereign power that has the ability to tax. Sorry about that GM. You have to manage better to catch up. The government doesn’t.

Bud

Is there a way out of this mess?

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This is a contribution from Bud Hebeler who runs Analyzenow.com

The current economic mess:

 

Debts

 

“Households have used 30% or more of their available credit –considered a risky percentage by the industry– has risen to more than one-quarter of all card users.

Average revolving balance is $9,890, up from  $8,069 just four years ago.

US households now hold an average of 2.8 cards—compared with 2.4 cards four years ago.”  Bottom Line Personal, Feb. 1, 2008, p. 15.

 

“The past 10 years will go down as one of the greatest consumer-lending sprees ever.  Adjusted for inflation, consumer debt – including mortgages – rose an average 7.5% per year since 1997, far faster than the 4.2% rate of the previous 10 years. . . If Americans had kept borrowing at the pre-1997 pace, they would have had about $3 trillion less in debt.”  Business Week, 2/4/08,  p. 27.

 

“the average debt-to-income ratio for middle-class Americans now stands at 141%, double what it was in 1983. . . the U.S. hasn’t faced a credit crunch like this in 25 years.”  Business Week, 2/18/08, p. 34, 36.

 

“Eighteen percent of workers had a loan outstanding from their retirement plan in 2007, up from 11% in 2006….[T]he average unpaid balance at the end of 2006 was $7,300 according to  the Employee Benefit Research Institute.”  Wall Street Journal, 2/18/08, p. D1.

 

Surprise retirement costs

 

“Caring for parents can cost children: …People who don’t prepare to care for their sick and aging parents could fall victim to what economists call “negative inheritance.”.. It is when costs to children caring for their relatives outstrip any gifts or bequests they might receive in return.”  Wall Street Journal, Personal Finance: “When Inheritance is Negative.”

 

Public employees enjoy security at our costs.

 

“Public jobs see pay gains. ..State and local government workers now earn an average of $39.50 per hour in total compensation …Private workers earn an average of $26.09 an hour. . . From 2000 to 2007, public employees enjoyed a 16% increase in compensation after adjusting for inflation compared to 11% for private workers. . . The nation has 20 million state and local government employees [+ 2.7 million federal workers not including the military or supporting contractors].  About 116 million people work in the private sector.”  USA Today, 2/1/08, p. 1.

 

“public pension funds have $3 trillion in assets but unfunded liabilities of $440 billion…An economic slowdown would only aggravate the situation for many funds…” Wall Street Journal, 2-28-08, p. C1.

 

 

Medical costs increase naturally as we age—but so does the unit cost.

 

“The survey of 1,000 Americans over the age of 65, conducted for Medco by Directive Analytics, found that one in three retirees say medical and drug costs far outpaced expectations. Results also showed that one in four retirees spend 10% or more of their monthly retirement income on medications alone.”  Reported 2/13/08 on FoxBusiness.com.

 

Taxes

 

“Eliminating the 75-year Medicare deficit would require an immediate 122% increase in the 2.9% Medicare payroll tax, a 51% cut in benefits, or a combination of the two.”

American Academy of Actuaries quote from USA Today 1/17/08, p. 3B.

 

“Daunting future for Medicare.  Spending will soar from 3% of gross domestic product now to 8% of GDP in 2040, according to Boston College’s Center for Retirement Research.  By 2040, income tax rates will need to rise by 20% to cover the government’s Medicare costs, and out-of-pocket costs will devour more than half of the average Social Security benefit.”  Kiplinger’s Retirement Report, January 2008, p. 9.

 

“If today’s tax rates remain in place, 76% of all federal income tax revenue in 2050 [vs. 8.6% in 2010] will be soaked up by [Social Security and Medicare] –before a penny is spent on defense, national parks, health care for the poor or haircuts for congressmen.”  Money, 3/08, p. 88.

 

“Senior benefits costs up 24% [above inflation in last 8 years.]  The average Social Security benefit per senior in 2007 was $13,184…The [total] cost of government benefits for seniors soared to a record $27,289 per senior in 2007, according to a USA TODAY analysis.”     USA Today 2/14/08, p. 1.

 

Inflation

 

“If you start measuring inflation after the Great Depression, inflation has been 4%, not 3%.  Long periods of recent history had over 6% inflation.  My father retired in 1965.  He lived to 96.  During those years his purchasing power declined 80%!  In the first ten years of my own retirement, my fixed pension lost 30% of its purchasing power–and that was in a time of supposedly low inflation.”  Inflation Can Destroy Retirement, www.analyzenow.com, Helpful Articles by Henry K. Hebeler.

 

Retirees inflation greater than the CPI

 

“By 2017, total health care costs will double to more than $4 trillion a year, accounting for one of every $5 the nation spends…The 6.7 percent annual increase in spending – nearly three times the rate of inflation – will be largely driven by higher prices and an increased demand….That [$4.3 trillion] would be about 20 percent of the U.S. gross domestic product….In 2006, people and the government spent …an average of $7,026 a person.  In 2017, health care spending will cost an estimated $13,101 a person.”  Seattle Times, 2/26/08, p. A4, referencing report from Centers for Medicare and Medicaid Services.

 

 Investments

 

“Corporate Earnings.  Yes, there’s been a profit boom in recent years….But here’s an unfortunate truth – the profit surge has been mainly in one area, financial services.  Financial institutions have benefits from the consumer credit boom, the proliferation of new financial instruments, and relatively low rates.  By contrast, the earnings of nonfinancial companies over the past decade have averaged …about the same since the mid-1980’s.”  Business Week, 2/4/08, p. 27.

 

“In 2003, 10 big Wall Street firms paid $1.4 billion in fines and penalties to settle civil charges by securities regulators that they issued overly optimistic stock research to win investment-banking business from companies they were supposed to analyze separately.”  WSJ, 2/16/08, p. B1.

 

Your home as an investment

 

“As baby boomers retire, home markets will hurt. . .The math is simple:  79 million boomers have driven up housing demand.  That trend will reverse itself when boomers are age 65 to 75;  there will be three sellers for each buyer.”  Dowel Myers, Prof. of policy, planning and development, USC.  USA Today, 1/16/08, p. B1.

 

Count on energy problems

 

“Our energy problems will not go away—at least in our lifetimes.  Our dependence on foreign oil is too great and our political process too weak to permit mobilizing solutions. It is virtually impossible to develop domestic oil fields, increase refineries, build dams, construct power plants, lay pipelines, string high power lines, open coalmines, dispose of urianium, and the like.

 

“Industrial and commercial growth has always demanded more energy.  We have seen it here, and we are starting to see it in developing countries.  China by itself is going to be a massive user of energy—even bigger than the United States.  India is going to add to the problems.”  Getting Started In A Financially Secure Retirement, Wiley & Sons, 2007.

 

The average person can’t recover.

 

It’s important to understand the history of national savings rate, that is, the percent of disposable income (gross income less income tax).  During the Great Depression, savings rates were about 4% and dipped below zero for only two years.  The Great Depression was followed by World War II.  During the war, the national savings rate was its highest value ever averaging about 25%.  After World War II and until 1985, the national savings rate was generally between 8% and 10%.  The exceptions were the couple of years immediately after the war when the savings rate was only about 5% to 7%.  That was when people once again had an opportunity to buy automobiles and previously rationed items.  Still, the savings rate was not negative, and debt was a bad word.

 

The fuse to our financial disaster was lit about 1985 when national savings rates started an abrupt decline until savings became virtually non existent from 2005 on. Consumption increased at a mad pace as men, women and children raced to get the latest electronics, large houses and vacation expenses far beyond their means.  Debts increased as well as people stretched to borrow on the remaining assets to be like their friends and the “Jones” across the street.  Grade school kids had to have cell phones.  High school kids had to have cars.  Mom and Dad had to have a bigger TV and cable connection to the internet.

 

“The financial industry, intent on keeping an image of ever upward growth, makes one excuse after another to minimize the importance of national savings. At one time, financial “experts” said people didn’t have to save because they were going to inherit so much.  When the stock market was booming in the late nineties, these same experts said people don’t have to save because what they have already saved had grown so much.  Then the next excuse was that people have made tremendous savings from the growth of their home equity.  After watching all of these theories fall apart, these experts must have crawled into the woodwork, because their silence is deafening after the tide has turned in each instance.

 

“So, how much would people have to save in the future to make up for lost savings over the past 20 years?   To get this answer, we have to calculate what they would have accumulated with 9% savings over both the past 20 years plus the number of years ahead when they will retire.

 

“Let’s first assume that they have 20 years ahead to save.  Over the past 20 years plus the future 20, they would have accumulated what amounts to 10.9 times the final year’s after-tax wages—if they could get a consistent return as high as 8% in a deferred-tax account and preserve 3% wage growth over the entire period. (10.9 times final wages might finance a retirement income of 40% to 50% of working wages.)  In order to get 10.9 times final wages using the actual past 20 year’s savings rates, they would have to save almost 21% of their disposable income for the next 20 years.  Starting now!

 

“Can you imagine the difficulty of getting the national savings rate to 21%?  The only time it has been that high since the Great Depression was during World War II when virtually all people, wives included, were working and there was nothing to buy.  Industry was focused on weapons production, not goods for civilians.  Further, almost everything was rationed.  It was politically correct for everyone, including school children, to invest in savings bonds.  It took that kind of environment to achieve such high savings rates, all in spite of the highest income tax rates we’ve ever had.”  Quotes above are from www.analyzenow.com from the Economics page of Helpful articles.

 

In fact saving 25% of disposable income took more than war conditions.  It took a nation that had just come out of the Great Depression where people were conditioned to a harder life.  Most people had very little.  There were no television promotions of a more desirable lifestyle or media advertisements for innumerable pieces of intriguing electronics.  Further the nation had a cause: the possibility of being overrun by aggressors just as was happening in Europe.  People were patriotic and united.

 

One would think that people would be saving more as employers abandoned pensions in favor of savings plans.  For the most part, the government jobs are the ones that still have both pensions and savings plans.  Not only that, but most of the government pensions have cost-of-living adjustments, COLAs.  These are very rich pensions indeed—usually supported by strong government unions.  Together they form an extraordinarily powerful voting block that will surely not support a reduction in their jobs (many with tenure), compensation or benefits.

 

With almost one out of every five people working for the government, four out of five must pay for their support—adding to the problem.  This ratio will rapidly deteriorate as the working population decreases when the baby boomers retire and the size of government continues to increase, both in ratio and in absolute numbers.  Remember, too, that the government sector has wage and benefit levels about half again higher than private sector employment.

 

The way out of this economic mess:

 

We won’t be able to solve the nation’s problems, but we in the private sector can do something as individuals to help ourselves.

 

“Forgo the Joneses’ lifestyle,

 

Make conservative plans,

 

Preserve some funds as reserves for unknowns,

 

Shift to fixed income investments [as we age],

 

Ladder immediate annuities late in life,

 

Repeat planning process every year.”

 

Points are from “Getting Started in a Financial Secure Retirement,” Wiley & Sons, 2007.

 

Actions like these will make what is inevitably an unbearable situation for the average person in the private sector to something that’s tolerable for those who save, invest conservatively, and plan for a difficult economy.  This is much of the theme in the Web site, www.analyzenow.com.

 

The final point is the often cited 1787 quote supposedly from Alexander Tyler, a Scottish history professor at the University of  Edinburgh.  There is no evidence of this being an actual quote, but the thought is something to consider.

 

“A democracy will continue to exist up until the time that voters discover they can vote themselves generous gifts from the public treasury.  From that moment on, the majority always vote for the candidates who promise the most benefits from the public treasury, with the result that every democracy will finally collapse due to loose fiscal policy.”

 

I hope that this is not the final outcome of our future years, but the alternative outcome often cited seems quite unlikely.  That alternative outcome is a booming economy with relentless consumerism that provides enough money to support our government’s largess, thriving business and retirees without savings.  This dream will fade as the majority of baby boomers count on Social Security as their primary retirement resource and a financially failing Medicare for their health needs.  All this while the private sector work force reduces and tries to bear ever increasing government costs.


Note:  Many of the things above are covered in more detail in “Getting Started In A Financially Secure Retirement,” Wiley & Sons, 2007, as well as in the Helpful Articles section of www.analyzenow.com.

Another misleading wealth chart

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This is a contribution from Bud Hebeler who runs Analyzenow.com

So here we go again. The Wall Street Journal publishes the Fed Reserve’s Wealth chart* which makes it look like our household wealth has been increasing even though savings rates are zilch.


Consider the following:

First and foremost, this includes Bill Gates, Warren Buffett, George Zoros, etc. I personally don’t expect to get any of their wealth.

The chart is not inflation adjusted. That brings the 2007 value down almost to the 1999 value.

Retirement savings do not account for income taxes due.

Then we look at the footnotes from the Federal Reserve. Real estate is adjusted upwards to replacement costs.

And finally, it doesn’t account for the growth of the population.

So, what would an honest chart on wealth look like?

Instead of the total wealth of the country’s households in then year dollars it would be the Median Value of Wealth PER Household in Today’s After-tax Dollar values. (Median Value would eliminate the problem of Gates, Buffett, Zoros, etc.) Then to really make it exciting, it would subtract the per-household-value of national debt and present value of unfunded obligations for Social Security, Medicare and public pensions. Of course, the result would be all negative values on an ever worsening plummet downward. And maybe we wouldn’t be viewed as the richest people on this earth. Maybe the dumbest, but not the wealthiest.

Bud

Stop complaining. We’ve just been spoiled.

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This is a contribution from Bud Hebeler who runs Analyzenow.com

We’re actually paying less than we did for gasoline in the past if you look at inflation-adjusted amounts.

See http://www.randomuseless.info/gasprice/gasprice.html. (I don’t know who created the chart. I just googled gas price history and got this as the first item.)

Of course most of Europe has always had much higher gas prices. I can remember paying more per gallon in Europe years ago than we are paying here now.

Those that are complaining about the producer’s high profits should consider that the government makes many times more via gas taxes than the producers do in profits–and the producers do all of the work while the government just sits back and collects the money.

Environmentalists have been increasing the barriers to self sufficiency for as long as I can remember. I remember the ridiculous increases in government regulations when Boeing was helping to build nuclear power plants. We couldn’t even use a piece of rebar that had a small scratch on it. (Can you imagine what it costs to handle 2″ diameter rebar so that it doesn’t get scratched?) Then there were all of the fears about the Alaskan pipeline killing off the caribou. It turned out that the herds actually increased because they liked the warmth of the pipes. Between our coal and oil resources we could easily be self sufficient and preserve our self-inflicted wild spending if there weren’t so many environmental restrictions. Not that restrictions are all bad, but they certainly are much more aimed at being PC instead of using good perspective.

The real problem is that we’ve all become spoiled with a standard of living that we can’t afford. Increased productivity lets us buy more as does not saving any money further fueled by huge increases in our debts. Our children and grandchildren will have it worse. I’d like to see a Congress that didn’t spend all of its time interrogating athletes who may have used drugs or industry leaders who we all agree probably make too much money. They should be working on the real long-range problems like the national debt, Social Security, funding Medicare, realistic trust funding for the growing number of retired government employees with COLA pensions, reducing our national government overhead, applying more practical limitations on developing energy self-sufficiently, rebuilding our deteriorating roads and bridges, etc. Instead of paying attention to the future lives of our children and grandchildren, all they can do is pander to the groups tha t provide the votes to stay in office. From that standpoint, there is no difference between Republicans and Democrats. We are all greedy and the law makers are more interested in preserving their jobs than the future of this country.

I like to tell the story of my boss, T A Wilson, head of The Boeing Company. When the company was in really deep financial trouble with too much debt and a bad economy, T called us into his office and said, “We’ve got to cut costs ourselves or otherwise the shareholders will send in someone with pince-nez glasses and ice water in his veins to do it for us.” We need some congressmen with the guts and foresight like T A Wilson who can save a country instead of a company.

Bud

Ask Bud about buying an Inflation-Adjusted Immediate Annuity

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This is a contribution from Bud Hebeler who runs Analyzenow.com

Dear Mr. Hebeler:

Thank you for your books and spreadsheet in assisting with retirement fund disbursement planning.  Your conservative thoughts are a rudder in the sea of misinformation. 

Here’s my hypothetical question for you:  Inflation and annual expense ratios are onerous costs for wealth accumulation. I can and have populated my asset allocation with low cost admiral shares of Vanguard’s mutual funds so those are minimized.( I like the ability to adjust your investment fees in the “what if” section of the spreadsheet. I’m going to use that feature to show people the real cost of a fund charging 1.5% vs. 0.2% annual fees.) 

Inflation is a whole horse of another color. As you point there is no reason inflation will be constant or that it will remain moderate.  If I go to the Vanguard Retirement Center planner, I can use their Annuity for Life calculator to give me a quote for an immediate annuity.  This says that for each $1,000 I place in the immediate annuity they will provide $4 per month, adjusted for inflation, for the rest of my life, starting at age 50.  That’s $48 annually per $1,000 or 4.8%. And that amount is indexed to inflation. 60% taxable. 

Being a frugal fellow I’ve also saved additional money, half in an IRA and half in post tax investments, that I’d like to not place in an annuity, but maintain in my current portfolio of about 60% stocks and 40 % bonds. This seems to be an intelligent move. It’s a hedge against inflation for my basic living needs and I maintain control of a larger amount of my assets.

Thanks, 

Gary S.

 

Thank you for asking.  I believe that Vanguard’s inflation-adjusted immediate annuity is a good investment for part of a retiree’s savings.  I think it’s better than getting into the commodities or collectibles markets to offset inflation.  I think that things are so wild now that there is some possibility that we could either go into something like the Great Depression or have hyper inflation–or even a combination of the two.

There are two things to be cautious about:  (1) That you have enough other investments to handle surprises that might require a large amount of immediate cash without borrowing, and (2) the solvency of AIG, Vanguard’s underlying insurer.  AIG is one of the world’s largest insurers, has a good rating, and I believe that Vanguard could step in if AIG got into trouble, but who knows?  (AIG has had a problem recently, but I understand it’s not serious as a % of its total assets.) 

You might also consider using I bonds to accomplish the same thing without the worry about solvency.  Until this January, you could buy $30,000 worth each year per Social Security number, but now the US, fearing another burden from inflation, cut the maximum to $5,000 a year.  However, you can buy $5,000 from a bank and $5,000 from Treasury Direct.  That’s a total of $20,000 for a couple each year.

If you were over 55, I would suggest that you consider using a direct transfer of money from your IRA to buy the immediate annuity.  Then use your taxable account to hold your equity investments.  That will give you a more favorable tax break.

Of course, my own sense of what way the economy will go and what are good investments is just my own opinion–and I could be very wrong.  That’s why I never put all of my eggs in one basket no matter how strongly I feel about such things. 

Bud

49% of people have saved less than $25k in the US

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This is a contribution from Bud Hebeler who runs Analyzenow.com

USA Today had an article (4/11/08) that had a table showing that 49% of the people have saved less than $25k in the US. (And that doesn’t account for any of the debt on the other side of the ledger.) Even more disturbing, the table shows that 40% of those between 45 and 54 have saved less than $25k and 36% of those over 55 have also saved less than $25k. In the latter group, only $51% had saved more than $100,000. Find out more on this in http://www.ebri.org/files/RCS08_FS2_Saving.pdf

To give you an idea of the impact, a person who has saved $25,000 for retirement could spend only $1,000 of that per year (increased by inflation each year) for retirement and would not have money for emergencies. A person who had $100,000 at the start of retirement could spend only $4,000 a year for retirement. Yet, both my analysis and that of Fidelity Investments shows that a couple will need over $215,000 savings just to pay for Medicare Part B and a Medigap health policy.

I often cite the decline of national savings over the past two decades as an indicator of real trouble to come. This is just further evidence. There are going to be lots of babyboomers on welfare. This isn’t just a tax impact. It’s a huge effect on consumption and therefore industry and therefore on the economy, jobs and the stock market.

Incidentally, the article graciously mentions my Web site, www.analyzenow.com, but the site you should look at for additional perspective on savings statistics is http://www.ebri.org/files/RCS08_FS2_Saving.pdf.

Bud

If Passed, the FHA Modernization Act of 2007 Harkens Good Things for Reverse Mortgage Borrowers

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How Much Money You Can Get for a Reverse Mortgage Will Increase and Qualifying for a Reverse Mortgage Will Get Easier with the FHA Modernization Bill

The FHA Modernization Act is designed to improve the Federal Housing Authority’s ability to help Americans obtain safe and affordable home loans and many see the Act as an answer to some of the woes of the subprime debacle. The Act is a bipartisan measure and has the support of the Bush Administration as well as both consumer and industry groups.

S. 2338, the Federal Housing Authority (FHA) Modernization Act, is good news for borrowers interested in a Reverse Mortgage. The Bill has been passed by the Senate by an overwhelming majority (93 to 1) and many hoped that it would be tacked onto the Economic Stimulus Package and be signed into law this week. However, it was not and is now waiting to be voted on by the House of Representatives. The House version of this Bill differs in many ways, but on HECM Reverse Mortgage issues, the House and Senate versions are identical.

The FHA Modernization Act Will Improve the Terms of Reverse Mortgages

The FHA Modernization Act will change the HECM program (HECM is the most popular type of Reverse Mortgage) in the following ways:

  • Offer a Single National Loan Limit: Currently the actual amount you can qualify for with a HECM Reverse Mortgage varies depending on your county. The FHA Modernization Bill sets a single national limit of $417,000.. For most borrowers this means more money is available to them.

  • Eliminate of the Authorization Cap: Currently only a set number of Reverse Mortgage loans may be granted. The FHA Modernization Act eliminates this limit, enabling the FHA to authorize as many loans as the market demands.

  • HECM Could Be Used for Home Purchase: Currently Reverse Mortgage borrowers must reside in their home for at least one year before they can get a Reverse Mortgage on it. The FHA Modernization Act enables borrowers to actually purchase a home with a Reverse Mortgage — assuming an adequate down payment. This change makes a Reverse Mortgage an appealing loan for retirees who are downsizing and others.

  • HECMs Could Be Used on Coops: Currently only single family homes are eligible.

As a whole, these changes should mean more money and better terms for seniors doing a Reverse Mortgage.

Learn More About FHA Modernization and Contact Congress Now

If you wish to see the FHA Modernization Act become law, consider contacting your Congressperson. You can locate them here: http://www.house.gov/

To learn more about The FHA Modernnization Act, visit here:

http://www.opencongress.org/bill/110-s2338/show

Who Should Fund The Boomer’s Retirement?

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So, my Mom met with her accountant last week. She is getting a life insurance policy to cover her business partner’s expenses if something were to happen. Her accountant suggested putting a Long Term Care Insurance rider on the life insurance policy.

Great idea, right?

Yes, the Long Term Care rider might be a great idea. The costs of Long Term Care are an expense that most retirees have not planned for and not having long term care insurance can completely devastate your finances. Please review information on the need for long term care insurance here

http://www.newretirement.com/Planning101/Serious_Medical_Crisis.aspx .

But, here comes the shocking part of the recommendation: The accountant suggested that that my mother ask my brother and I (her children) to fund the monthly premium on the rider since we would end up paying for Long Term Care expenses if she hadn’t taken care of them herself.

Indeed, Long Term Care insurance payments are likely less expensive than the ultimate cost of Long Term Care, but why should we, her children, pay for either. We would of course fund her needs — or make arrangements for her to move in with us — if necessary, but why is the general population and a financial expert recommending that it is indeed our responsibility to fund these things?

Social Security, Medicare, Long Term Care Insurance and More — Who Should Pay for It All? Boomers? Children of Boomers? Grandchildren of Boomers?

We children of boomers are already going to have to fund Social Security and Medicare. The baby boomers are retiring with these programs being unfunded. We will be paying our taxes to fund our parents (and grandparents) retirement.

What’s worse, the under- or un-funding of these programs is not even factored into the known and mounting deficit that we are inheriting.

We children of Boomers have an incredible financial burden to bear.

Retiring Boomers Should Consider Who Should Fund These Costs

Please boomers and those advising boomers, please think about the sanity of putting these costs on your children and grandchildren. Is this what you want your legacy to be?

Retirement should be earned. Barring severe health issues, there is no logical reason to retire before you have saved enough money to cover your costs.

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