Bad Times Breed Crimes

That’s the introduction to one of the chapters in our book, Retire on Social Security – A Guide to Living Well on a Budget of $1,000 a Month. In these “bad� times, crimes against the elderly are steadily increasing.  The one thing no one can afford is to be swindled out of all or a portion of one’s lifetime savings.

A lot of crime against the elderly goes unreported because victims fear involvement in the court process, embarrassment, and fear of being placed in a nursing home.  The elderly are a rich target and the chances of being convicted of a crime against them is less.  That makes crimes against the elderly appealing to the criminal element.

According to a study last year by MetLife Mature Market Institute, the elderly lose more than $2.6 billion a year to thieves (many of whom are in their own families).  Again, that is probably a low estimate, MetLife says, given that many schemes are never reported.

A common scam in the suburbs is home repairs. The scammers will case a neighborhood looking for elderly residents.  They’ll knock on the door saying they were in the neighborhood, perhaps claiming they were working for a neighbor, and offer to fix a roofing problem they spotted, trim your trees, pave driveways, fix widows, plumbing, whatever. Don’t fall for it.  Don’t let them in your home; one may engage you in conversation while the other burglarizes your home.

Remember, chances are that anyone who comes knocking on your door unsolicited, offering home services if not a scam is likely to be expensive for what you get (if anything).  Simple advice, don’t employ any stranger who comes a knocking on your door.

Budget Crisis: 46 U.S. States Face “Greek-style” Deficits

Bloomberg, Tuesday June 29, 2010

Californians don’t see much evidence that the worst economic contraction since the Great Depression is coming to an end. Unemployment was 12.4 percent in May, 2.7 percentage points higher than the national rate. Lawmakers gridlocked over how to close a $19 billion budget gap are weighing the termination of the main welfare program for 1.3 million poor families or borrowing more than $9 billion in the bond market. California, tied with Illinois for the lowest credit rating of any state, is diverting a rising portion of tax revenue to service debt, Bloomberg Markets magazine reports in its August issue.

Far from rebounding, the Golden State, with a $1.8 trillion economy that’s larger than Russia’s, is sinking deeper into its financial funk. And it’s not alone.

Even as the U.S. appears to be on the mend — gross domestic product has climbed three straight quarters — finances in Arizona, Illinois, New Jersey, New York and other states show few signs of improvement. Forty-six states face budget shortfalls that add up to $112 billion for the fiscal year ending next June, according to the Center on Budget and Policy Priorities, a Washington research institution. State spending is 12 percent of U.S. GDP.

“States are going to have to cut back spending and raise taxes the same way Greece and Spain are,� says Dean Baker, co- director of the Center for Economic and Policy Research in Washington. “That runs counter to stimulating the economy and will put a big damper on the recovery in the latter half of this year.�

Stimulus Dries Up

State budget woes are a worsening drag on growth as the federal government tries to wean the economy from two years of extraordinary support. By Jan. 1, funds from the $787 billion federal stimulus bill will dry up. That money from Washington has helped cushion state budgets as tax revenue has plunged.

State leaders won’t be able to ride out this cycle the way they have in the past. The budget holes are too large. For the first time since 1962, sales and income tax revenue fell for five straight quarters, through December 2009, according to the Nelson A. Rockefeller Institute of Government at the State University of New York at Albany.

Lawmakers need to overhaul tax policy, underfunded public pensions and entitlement spending programs such as Medicaid if they want to establish long-term plans that will foster growth, says former New Jersey Governor Christine Todd Whitman.

If they fail to act, state fiscal positions will steadily erode and hurt the U.S. economy through 2060, according to a March 2010 report prepared for Congress by the U.S. Government Accountability Office.

‘Major Surgery’

“States don’t have a choice anymore,� Whitman says. “These problems are going to require major surgery.�

Reform may get short shrift as Republicans and Democrats intensify their age-old fight over taxes and spending in this election year. On May 20, New Jersey Governor Chris Christie vetoed a Democratic bill that would have raised income taxes for residents earning at least $1 million a year to help close an $11 billion deficit. Christie, a Republican, wants to cut spending for school districts and cap property tax increases.

“At some point, the people’s ability to pay runs out,� Christie said in a speech in New York on May 25.

The widening deficits have led to some unorthodox moves. In California, the state grabbed $1.7 billion in redevelopment money from local governments in May. Riverside County, a Los Angeles suburb where the housing bust has left unemployment at more than 15 percent, lost $28 million that had been set aside to build fire stations, senior centers and other public works.

Jobs or Education

The projects would have created 3,000 jobs, says Tom Freeman, spokesman for the county’s Economic Development Agency. The government needed the county cash for schools, says Aaron McLear, spokesman for Governor Arnold Schwarzenegger.

The episode demonstrates how the fiscal mess pits job creation against education in a zero-sum game, says Robert Hertzberg, the Democratic speaker of the State Assembly from 2000 to 2002. California is locked in a rigid system in which legislators need a two-thirds majority to raise taxes and yet must comply with voter-approved initiatives that mandate prison construction and other spending.

There’s little chance of any sweeping changes this year ahead of a gubernatorial race between Republican Meg Whitman, former chief executive officer of EBay Inc., and Attorney General Jerry Brown, a Democrat who was governor from 1975 to 1983.

‘So Dysfunctional’

The winner will have to muster the political courage to take on core constituencies, whether anti-tax conservatives who support Whitman or labor unions that back Brown, says Steve Westly, California’s Democratic treasurer from 2003 to 2007.

The risk is that California ends up like Greece, with no one trusting that it can get its financial house in order, says Westly, now a venture capitalist in Menlo Park. “It has to be a combination of cuts and revenue increases,� he says.

Still, California isn’t Greece. It’s home to Silicon Valley, Hollywood and a $27 billion agriculture industry. “It’s unbelievable,� says Bob Nichols, CEO of Windward Capital Management Co. in Los Angeles. “How do you screw up a place with the growth capability of California? It’s so dysfunctional.�

To contact the reporter on this story: Edward Robinson in San Francisco at edrobinson@bloomberg.net.

What Are the Probabilities That Your State Could Default?

Here is an analysis of default risk for sixteen states based on their credit default swap (CDS) costs.  The number next to each state represents the cost per year to insure $10,000 worth of state bonds for 5 years; the higher the price, the higher the risk of default risk.  Remember only 16 states are covered, 34 are not included.  Those shown may not be those with the greatest risk

Read the Analysis: http://www.bespokeinvest.com/thinkbig/2010/8/30/state-default-risk.html

Public Pensions in the Hole Three Trillion Dollars – Plus

Courtney Collins and Andrew J. Rettenmaier of the Center for Policy Analysis just issued a report that indicates that state and local pension funds are drastically under-funded.  They estimate that state and local pensions are under-funded by some $3 trillion.  Quoting from the executive summary:

“Many state and local government pension plans’ liabilities are calculated using discount rates that are not commensurate with the risk they may pose to taxpayers.  Accounting standards allow pension funds to calculate their liabilities using a discount rate comparable to the expected rate of return on the funds’ assets.  This typically high discount rate tends to reduce the size of a pension plan’s accrued liabilities.  However, pensioners have a durable legal claim to receive their benefits and consequently, it is more appropriate to use a lower discount rate in calculating the plans’ accrued liabilities.

“Due to the use of high discount rates, the liabilities of state and local government pension plans are underestimated.  For example, recent reports by the Pew Center on the States and others indicate that assets will cover about 85 percent of the pension benefits owed to participants.  But other studies that adopted lower discount rates have found liabilities may actually be 75 percent to 86 percent higher than reported.  As a result, taxpayers’ role as insurer may be much greater than anticipated.” (End of quote)

Keep in mind that in most states the law will not allow for adjustment to the terms of pensions.  It is the taxpayers who are ultimately on the hook for bloated pension benefits.  To pay for these benefits will require higher taxes and/or reduced services.   Additionally, high unemployment rates in the private sector compound the problem; fewer private workers translate into less state tax income.  Worse, most pensions assume they are going to get an 8% return on their investments.  With long term bond yields in the 5% range the under-funding grows every year, compounded by poor returns from the stock market. (I suggest checking out how your state stands in its pension liabilities. You might want to consider retiring to a state that won’t be facing draconian financial measures to meet its bills.   For the statistics, go to the site listed at end of this piece.)

Why do most public retirement plans use an assumption of an 8% return?  Because…if they used more realistic numbers, they would have to make  l-a-r-g-e-r contributions to the pensions (Refer to yesterday’s article Ex-SEC Chief Levitt: Municipal Bond Market Massacre Is Coming).

The low rates of return on investments, high unemployment, and over-promised and under-funded retirement benefits assure one thing: This is all going to end very badly.  Plan accordingly!

Check how your state is and read the whole report: http://www.ncpa.org/sub/dpd/index.php?Article_ID=19634

Ex-SEC Chief Levitt: Municipal Bond Market Massacre Is Coming

Wednesday, 25 Aug 2010 08:29 AM – Moneynews.com

Former Securities and Exchange Commission chairman Arthur Levitt says there’s a massacre about to happen in the municipal bond market.  The municipal bond market is “rife with the hallmarks of abuse: poor disclosure, little regulatory oversight, made-to-order accounting rules and insider deals driven by banker and consultant fees,” Levitt writes at Bloomberg.

Read the full article: http://www.moneynews.com/StreetTalk/Levitt-Muni-Massacre-bonds/2010/08/25/id/368345

Thank you Roger L, $20.00 donation.

Bond Market Risks

Wall Street Journal August 18, 2010 page A-17

Investors who are now crowding into bonds and bond funds are courting disaster. The last time interest rates on Treasury bonds were as low as they are today was in 1955. The subsequent 10-year annual return to bonds was 1.9%, or just slightly above inflation, and the 30-year annual return was 4.6% per year, less than the rate of inflation.

Furthermore, the possibility of substantial capital losses on bonds looms large. If over the next year, 10-year interest rates, which are now 2.8%, rise to 3.15%, bondholders will suffer a capital loss equal to the current yield. If rates rise to 4% as they did last spring, the capital loss will be more than three times the current yield. Is there any doubt that interest rates will rise over the next two decades as the baby boomers retire and the enormous government entitlement programs kick into gear?

Read the full article: http://online.wsj.com/article/SB10001424052748704407804575425384002846058.html#mod=djemWMPIndia_t

Widow Sues Brokerage Firm – Claims She Was Sold Volatile, Risky Securities

You Won’t Believe What They Were!

An elderly widow sued her brokerage firm claiming that she was sold highly volatile risky securities that were inappropriate for her age and objectives.  Her portfolio had lost over sixty percent of its value due to the purchase of these inappropriate investments.

This is not a joke.  The woman did indeed lose over 60% of the money in her portfolio.  She hadn’t been on margin or used any leverage or derivatives; she was on 100% cash basis.  This was an actual lawsuit (and there were many others like it at the time).  I recall reading it on the front page of the Wall Street Journal in the early 1980s.

What had the greedy evil stockbroker pushed on this hapless widow?  The answer: United States Treasury Bonds!

How could she lose so much money in what many “think� is a totally “safe� investment?  Here’s how.  What most bond investors do not realize is that there are two risks to investing in bonds.  The first risk is that the bond will default – not pay you interest and the maturity value.  But the second MUCH BIGGER RISK is what is called “interest rate risk�.  That means that after you buy a bond, interest rates increase.  And if that happens; you can lose – big time!

Let’s take an example that might have been the case of the widow.  Let’s say she invested $100,000 in 30 year Treasury bonds when the going rate of interest was, say, 5%.  She would receive $5,000 in interest every year and $100,000 in principal when the bonds mature in 30 years.  For simplicity let’s say one year later interest rates rose to 10% on new 30 year treasury bonds.  A new investor who invests $100,000 in the new 30 year treasury bonds will receive $10,000 a year in interest (twice as much as the widow).  So…what do you think the widow’s bonds, paying just $5,000, would be worth then?  If you answered $50,000 you understand the concept.

The market value of all fixed income investments is directly linked to the current rate of interest.  So, if new bonds pay 10%, the value of a 5% bond must fall in price until it will yield the same rate as new bonds.  Thus, if the 5% bonds were priced at $50,000 the yield would be 10%, $5,000 divided by $50,000 is 10%.  That’s called the “current yield� it’s simply the interest divided by the price.  But there’s another factor involved.  The new 10% bond will mature for $100,000, but the 5% bond, if purchased at $50,000 will mature for $100,000.  It will double but the 10% bond will remain the same.  Incorporating that factor into the price is called the bond’s “yield to maturity�, which would increase the value of the bond to about $530.00 (for quick calculations of yield to maturity go to: http://www.moneychimp.com/articles/finworks/fmbondytm.htm).

A rough formula you can use to determine how much a long term bond will change in value if interest rates change is to take the current rate of interest, let’s say 4%, which is close enough for today’s 30 year Treasury bond rate.  To estimate the loss if interest rates were to go up 1% to 5%, divide 4% by 1%, which equals 25%.  Then subtract about 10% of that value (2.5%) and the loss would be about 22.5%.  So, a $100,000 portfolio invested in 4% 30 year Treasury bonds would be worth about $77,500 if rates went up to 5%.

Looking at it another way, the loss from just a one percent increase in interest rates equates to a loss of capital ($22,500) equaling 5.6 years of interest ($4,000 X 5.6 = $22,400).

Be aware that the lower the current rate of interest at the time you invest the greater the risk.  A 1% change when rates are 5% is a 20% change.  A 1% change when rates are 4% is a 25% change.  A 1% change when rates are 3% is a 33% change.  Now try the results when the change is 2% or 3%.

The shorter the maturity, the less the loss (or gain) in market value would be due to interest rate risk, the longer the maturity, the greater the loss (or gain).  A thirty year bond will change more than a twenty year bond.  And a fixed income investment with no maturity will change more than a 30 year bond.  Fixed income instruments which would fit the description of no maturity would be investments such as: preferred stocks and long term bond funds and ETFs.

I recall the situation of a retired banker years ago.  He wanted to be absolutely safe in his retirement so he had invested his entire portfolio in long term Treasury and ATT bonds in the late 1970’s.  When the fed began raising interest rates to fight inflation in the early 1980’s it absolutely destroyed his retirement.  Inflation ate him alive on his fixed income.  Worse, he couldn’t sell his bonds because the loss (caused exclusively by interest rate risk) had wiped out over 60% of his retirement portfolio.  While he was stuck getting $5,000 a year (per $100,000) on his old bonds (now worth $40,000), new investors were getting nearly $15,000.

Think about it.

This is not investment advice, just some observations from the investment school of hard knocks.

Atlas Shrugs Off the United States

Nearly sixty years ago Ayn Rand came to America from the Soviet Union with striking insights into totalitarianism and the destructiveness of socialism. In 1991, a survey by the Library of Congress and the Book of the Month Club found that readers rated her novel, “Atlas Shrugged” as the second-most influential book in their lives, behind only the Bible.  Those familiar with Rand’s work have noticed that with each new bailout plan and economic-stimulus scheme out of Washington, our current politicians are committing the very acts of economic lunacy that “Atlas Shrugged” parodied in 1957.

For those unfamiliar with the novel, the story is simply this: Politicians invariably respond to crises (crises that in most cases they themselves created – Fannie Mae, Freddie Mac, public employee pensions and benefits, etc, etc.) by spawning new government programs, laws and regulations. These, in turn, generate more havoc and poverty, which inspires the politicians to create more programs and the downward spiral repeats itself until – the productive sectors of the economy collapse under the collective weight of taxes and other burdens imposed in the name of fairness, equality and do-goodism.

(Currently one-half of American taxpayers pay no income tax; consequently, the other half pays for them.  And an ominous new trend is emerging: the number of wealthy Americans emigrating from the United States {those at the very top} doubled this year.  Here’s a clue for Washington – the rich didn’t get rich by being stupid; overtax them and  they, along with their wealth and expertise, will find a new home —  as New Jersey finally found out so too will the United States – eventually.)

Every new act of government futility and stupidity carries with it a benevolent-sounding title.  In the novel these included the “Anti-Greed Act” (to redistribute income), the “Equalization of Opportunity Act” to prevent people from starting more than one business (to give other people a chance) and the “Anti Dog-Eat-Dog Act,” (to restrict cut-throat competition between firms and thus slow the wave of business bankruptcies).

(Today they are called, “Cash for Clunkersâ€�, cash for those who bought gas guzzlers paid for by those who bought energy-efficient cars {and got no cash} – or the loan modification program and the debt forgiveness program for people who bought homes beyond their means also to be paid for by, who else, those who lived within their means.  And then there’s the $700 billion “Emergency Economic Stabilization Act”, the “Auto Industry Financing and Restructuring Act,â€� and the “American Recovery and Reinvestment Plan.”)

Our nation’s current economic strategy is right out of “Atlas Shrugged”: The more incompetent you are in business, the more handouts the politicians will bestow on you. (Remember, rewarding the incompetent must be paid for by someone, guess who?  Those who were competent.) That’s the justification for the $2 trillion of subsidies doled out already to keep afloat distressed insurance companies, banks, Wall Street investment houses, and auto companies.  Standing next in line for their share of the booty are real-estate developers, the steel industry, chemical companies, airlines, ethanol producers, construction firms and even catfish farmers. With each successive bailout to “calm the markets,” another trillion of national wealth is subsequently – lost.  Yet, as “Atlas” grimly foretold, we now treat the incompetent who wreck their companies as victims, while those resourceful business owners who manage to make a profit are portrayed as recipients of illegitimate “windfalls.”  One pertinent warning resounds throughout the book: When profits and wealth and creativity are denigrated in society, they start to disappear — leaving everyone poorer.

David Kelley, the president of the Atlas Society, which is dedicated to promoting Rand’s ideas, explains that “the older the book gets, the more timely its messageâ€�.

Read the full article: http://online.wsj.com/article/SB123146363567166677.html?KEYWORDS=%27Atlas+Shrugged%27:+From+Fiction+to+Fact+in+52+Year

Social Security in the Red Years Before Government Projections

Back in my July of 2009 blog I wrote: “President Obama maintains that the Social Security Program is financial sound.  That’s a partial truth.  It depends upon the underlying assumptions you make and what time frame you are encompassing.  For example, if one of the underlying assumptions is that we have 5% unemployment and instead we have 10% unemployment, the subsequent reduction in revenue will significantly reduce the time to insolvency.  If workers are laid off from jobs paying $75,000 a year and can only find new employment at $25,000 a year that will similarly reduce the revenue and shorten the time.  As of now, I have seen no projections incorporating anything less than “rosy scenario� assumptions.�

Then, in my August 4 Blog, I issued the following warning, “WARNING: the longer this recession/depression lingers (or deepens), the longer people are unemployed (or underemployed), then the faster Social Security funds will be depleted.   And if Social Security is jeopardized, virtually every state, county, municipal, and corporate retirement program will be too.   A potential economic crisis looms ahead.   Govern your personal financial affairs accordingly!

“As a consequence of the depression/recession, many older workers became unemployed and even though many would like to continue working, they had no where to turn for income but their Social Security benefits.  The number of applications for retirement benefits was 23 percent higher this year than last.  Since the beginning of budget year in October (through July), almost 2.2 million people applied for Social Security benefits, compared with just under 1.8 million for the same period last year.  While the Social Security Administration expected applications to increase, given the number of baby boomers reaching retirement, they didn’t expect the increase to be so large.

At this time, according to Rosy Scenario, Social Security will begin earning a surplus again in 2012.  Then, in 2016, it will be in deficit – permanently.  Personally, I doubt that Social Security will ever generate a surplus again from this time forward.� (end quote)

Last week Social Security announced that for the first time in over twenty years it was paying out more money than it took in and will redeem $41 billion from the Social Security “Trust Fund� this year.  It now expects to run a deficit for the next five years and a surplus in 2016 (Oh sure, in a land where unicorns romp under pink skies). In May of 2009 it was estimated that a deficit would not occur until 2016.  As recently as August 2009 the revised estimate was no earlier than 2013.  That this has occurred in 2010 should come as no surprise to anyone but government statisticians.

This year the Treasury will have to borrow money to redeem $41 billion of the trust fund’s Treasury securities to make up the deficit.  This means that the government now has to borrow from investors in order to make its payments to retirees.  When Social Security’s cash deficits begin running more than $100 billion a year (next year in my opinion), it’s going to take a whole lot of extra borrowing on top of existing trillion dollar-plus deficits to keep the checks coming.  Sooner rather than later, something is going to have to give…higher taxes… lower benefits… Plan accordingly.