Liberating the Indebted States of America 13 comments
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The following was sent to Kelly Letter subscribers last Sunday:
The Indebted States of America
Do not lose sight of the fact that poor debt management is the root cause of all this trouble. I spend almost all of my time writing about investing, and the bestselling of my books are about investing, but the most important book I've ever written is The Neatest Little Guide to Personal Finance.
Nobody wants to read about paying off their credit cards and managing their mortgage. No, they want stock market action. So do I but, as you know, investing should happen only after one's financial house is in order. For most Americans, the only "investment" they should make is in a zero balance on their credit cards and in curbing spending to live within their means.
Do you know that Americans as a group will be in hock to the tune of $2.6 trillion by the end of this year? That's more than $13,000 per person over 25 years of age. Not me and not you, maybe, but on average.
For more than a generation, Americans have lived beyond their means. Everybody feels entitled to a big car or truck (or two or three), a big house, designer clothes, five-star meals, fabulous vacations, and the latest in home entertainment equipment.
Yet, it's probably no coincidence that some of America's richest people live frugally. Sam Walton of Wal-Mart (WMT) drove an old truck as a billionaire. Warren Buffett described his son's $50k annual income as being a lot of money.
Speaking personally, I've never owned a new car and I've never made a car payment in my life. No matter how much money I make, the depreciation in the first two years of a car's life is just too good to pass up. Perfectly fine, still new-smelling, pre-owned cars are fine for me. The one exception I'm considering is being among the first to own a brand new electric car when it's available, but the reasons for that go beyond economics.
Our country is being killed by debt. Subprime mortgages would never have become a problem if the people borrowing had been able to pay their bills. Yes, it was stupid for the bankers to lend to such unqualified borrowers, but back up a step and consider why we have so many unqualified borrowers in the first place. The lack of financial understanding needed to apply for a zero-down, adjustable rate rip-off loan with a payment too high to make each month is pathetic.
Our country is also being killed by dependence on oil. The current political talk about energy independence misses one truly inconvenient truth: neither party has done squat on this issue for 30 years. Around half of America's $800 billion annual current account deficit is directly attributable to oil importation. That money backs nut cases in the Middle East, Russia, and South America instead of doing something good for the U.S.
Meanwhile, China enjoys a $265 billion annual trade surplus against the U.S.
America's service economy produces what? Asset-backed securities, lawsuits, consulting firms, and insurance packages. (And, I have to admit, investment newsletters.) Half of our $13-billion gross domestic product comes from that kind of fluff. What's it based on? What's it built from? What can we point to as having any real value? Very little, which is why the same thing that took down Enron is now scratching its claws on the whole economy. When values are assigned to concepts without intrinsic value, it takes just an eraser to change their values.
The Fed has now shelled out nearly $400 billion, about half of its reserves, to bail out companies. That's led to the government selling debt to replenish the liquid assets of the Fed, the first time that's ever happened.
Debt, debt, debt. It's everywhere you look. The words of Shakespeare's Lord Polonius in Hamlet have rarely looked wiser: "Neither a borrower nor a lender be; For loan oft loses both itself and friend, And borrowing dulls the edge of husbandry." The idea's been around since 1603, but never known less popularity than it knows now.
Changing the country is hard, changing relatives is challenging, but changing our own families is within reach and worth it.
If you're in debt, get out. Never get in again. Borrow money only for assets that appreciate, and even then think it over carefully and be sure you can handle the payments. Real estate is a fine investment, but not when bought with subprime mortgages whose payments can't be made.
If you're out of debt, help somebody else get out. I don't mean financially. That often backfires. I mean by talking to them, helping them see the problem, and helping them solve it. I recently had a chance to do this with somebody in Colorado, and it felt great. They went from defensive ("everybody's this far in debt") to interested ("it would be nice to free up those payments") to eager ("I can do this!") in a matter of days. I think she really will.
If you've ever needed confirmation that you can't count on the gang at the top to take care of things, you've had it this year. Make differences where you can, and make them count.
Reducing debt is a fine contribution to America, at any level.
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This article has 13 comments:
So lending in Japan has stalled out badly and those who need to borrow such as young families, can't. This leads to a drop in the birthrate.
The solution here is very easy: realistic interest rates that attract savings and discourage EXCESS lending. Instead, the Fed is trying to have stupid lending by dropping rates well below inflation. We certainly have inflation far higher than 2% right now.
Yet no one suggests this sane solution except maybe Volcker.
For whatever reason, your fellow reporter, James Quinn with his "On Board the 'U.S.S. Titanic" must hate America and what it stands for. Not all millionaires made their money making trades for people, or selling them bad loans The majority made their money owning a small business and providing good paying jobs to quality people.
I paid all of my sales people from $75,000 to $250,000 a year and was happy to do so. As you mentioned of others, I only buy used cars and pay cash for them and worked 16 hours a day building my business.
The, I want the American dream, and I want it now, and don't want to put a penny in the bank to get it attitude, has ruined our nation.
There is good debt and bad debt, we have a massive supply of bad debt, and our country is now addicted to it. We never even tried to educate our population in high school as to how to make a basic budget, get a good loan, manage credit cards, how to invest, or god forbid, don't spend more than you make.
It is our own fault that the majority in America are financially illiterate and can't understand why they are paying $1000.00 a month for their home loan while their neighbor is paying $2500.00. He just thinks that his neighbor is stupid, right up until the time that they come for his house. Then he screams, I didn't know......
We need something symbolic from Washington to save all of these small businesses from laying off all of these well deserving people.
Jeff
Meanwhile in the 2Q of this year, net issuance of home mortgages totaled $80 billion. That is down 93% from the rates of 2005 at the real estate market peak. The entire mortgage market has essentially stopped dead, and this numnut is worried about household indebtedness rising.
Incidentally, household net worth is the same as at the end of 2006, while personal income (disposable, meaning net of taxes) is higher by $1.2 trillion. All figures absolute, nominal dollars, no price level games involved.
I realize journalism and doom mongering as synonyms, but at least a pretence of objectivity is usually expected...
Excerpt from remarks given by Richard W. Fisher, President and CEO of the Federal Reserve Bank of Dallas given before the Commonwealth Club of California
San Francisco, California
May 28, 2008
Please sit tight while I walk you through the math of Medicare. As you may know, the program comes in three parts: Medicare Part A, which covers hospital stays; Medicare B, which covers doctor visits; and Medicare D, the drug benefit that went into effect just 29 months ago. The infinite-horizon present discounted value of the unfunded liability for Medicare A is $34.4 trillion. The unfunded liability of Medicare B is an additional $34 trillion. The shortfall for Medicare D adds another $17.2 trillion. The total? If you wanted to cover the unfunded liability of all three programs today, you would be stuck with an $85.6 trillion bill. That is more than six times as large as the bill for Social Security. It is more than six times the annual output of the entire U.S. economy.
Why is the Medicare figure so large? There is a mix of reasons, really. In part, it is due to the same birthrate and life-expectancy issues that affect Social Security. In part, it is due to ever-costlier advances in medical technology and the willingness of Medicare to pay for them. And in part, it is due to expanded benefits—the new drug benefit program’s unfunded liability is by itself one-third greater than all of Social Security’s.
Add together the unfunded liabilities from Medicare and Social Security, and it comes to $99.2 trillion over the infinite horizon. Traditional Medicare composes about 69 percent, the new drug benefit roughly 17 percent and Social Security the remaining 14 percent.
I want to remind you that I am only talking about the unfunded portions of Social Security and Medicare. It is what the current payment scheme of Social Security payroll taxes, Medicare payroll taxes, membership fees for Medicare B, copays, deductibles and all other revenue currently channeled to our entitlement system will not cover under current rules. These existing revenue streams must remain in place in perpetuity to handle the “funded” entitlement liabilities. Reduce or eliminate this income and the unfunded liability grows. Increase benefits and the liability grows as well.
Let’s say you and I and Bruce Ericson and every U.S. citizen who is alive today decided to fully address this unfunded liability through lump-sum payments from our own pocketbooks, so that all of us and all future generations could be secure in the knowledge that we and they would receive promised benefits in perpetuity. How much would we have to pay if we split the tab? Again, the math is painful. With a total population of 304 million, from infants to the elderly, the per-person payment to the federal treasury would come to $330,000. This comes to $1.3 million per family of four—over 25 times the average household’s income.
This paragraph explains why JasonC's subsequent comments are nonsense. (First let's replace a "b" with a "t"). The "net worth" that Jason points to is ephemeral, unreal, paper worth that is the result of the massive debt inflation that brought us to the sad condition we now find ourselves in. Unwinding this bubble of unreality will wipe out most of this so-called "worth". If it was real, it would remain. It was never real, so it goes poof. Jason and the geniuses of financial engineering and black-box trading algorithms engineered themselves a massive Ponzi pyramid scheme, and put themselves at the top of it. Instead of arresting them, we're going to open what's left of our wallets to them so they can take the rest.
What a country.
"When values are assigned to concepts without intrinsic value, it takes just an eraser to change their values."
This is even more true of individuals. There is simply no reason whatever to borrow money at rates above that of debasement for any purpose other than investment (and then only rarely; as I note above, if your business plan requires significant leverage or borrowing at very low interest rates in order to generate decent ROE, it's probably unsound in the first place). Investment is not the same as "buying assets that [may] appreciate." A work of art and a bar of gold may "appreciate" in dollar terms, but they cannot produce the income needed to pay the interest on the debt you take on to buy them. Therefore these assets should not be acquired with borrowed money. Your residence is a special case: it does not produce income, but it does eliminate the need to provide income to someone else. If the total cost (in interest as well as the opportunity cost or forgoing the risk-free rate of return on the entire purchase price) of purchasing your residence with borrowed money is lower than the cost of renting it, a lightly-leveraged purchase may make sense. But I would not recommend taking on debt for this purpose even in those rare cases in which it may make financial sense to do so. Taking on debt is a risk, and personal debt is a risk no one is paying you to take.
With those lazy politicians running this country, what do you expect ? You voters put them there, so, keep quiet !!