By Robert L. Moshman, Esq.
These are fearful times in which we plan. Set phasers to "stun" as we assemble a landing party and beam down to planet Earth to assess an assortment of alien adversaries affecting financial planning.
Stranger Than Sci Fi
"Captain, the tri-corders are picking up strange readings!"
This is certainly an uncharted and hostile part of the universe and it has provided threats no one ever heard of before: Sub-prime mortgages, structural macroeconomic debt overhang, collateralized debt obligations, mark-to-market valuation manipulation, toxic assets, and even zombie banks. This is pretty far out there.1
Our economy isn't on Star Trek or the Twilight Zone, this is reality. The financial world has turned on a dime and financial planning has been turned on its ear. Stock market bubbles, real estate bubbles, and various other bubbles have burst and bubbled over. Planning has always coped with uncertainty and change, but there is a pervasive new element shaping planning models and it isn't a new tax law or new technology or even a new world order. It is something more basic: Fear.
Let's take inventory of these extraordinary threats that are affecting the context of planning, allay what fears we can, and consider a few practical perspectives and ideas.
Identifying Dangers
Sudden Dramatic Losses: The net worth of American families dropped 18% during 2008. That's $11.2 trillion in declining values with $8.5 trillion of the damage in the stock market and another $2.7 trillion in real estate. A theoretical person with a stock portfolio tracking the Dow Jones Industrial Average has lost more than half the value of his or her holdings through early 2009. The Dow Jones Industrial Average surpassed 14,000 in October 2007 but closed at 6,594 in early March. And if you invested with Bernard Madoff, you lost it all.22
Lack of Stimulation: It's as though the earth has stopped spinning. The economy has gone limp, vapid, melancholy, and flat lined. It needs caffeine, adrenaline, a Jamba Juice boost, and defibrillators. Instead it got an unhealthy dose of ...
Credit Creation: When things are sluggish in the economy, one way to jump start things is by extending credit so that people buy homes and businesses produce products and the whole economy gets up a head of steam and runs on its own. But too much credit creation has a downside in that it can lead to...
Sub-Prime Stew: Don't eat the stew! There was a credit crunch in 2007 and borrowers not meeting prime lending standards, i.e., with shakier finances and who were less likely to pay back mortgages, found lenders who enabled them to buy homes with little or no money down. Those lenders then packaged up such mortgages and sold them. When the economy soured, borrowers lost jobs and couldn't make mortgage payments and the homes fell in value and were worth less than the outstanding mortgages. Entities extending the loans or purchasing the mortgages in packages were left foreclosing on assets that couldn't cover the face value of the loans.
Toxic Assets: How many times has this happened to you? You go to a flea market and buy a giant pink elephant weighing 3,000 pounds, haul it home, and then realize that nobody is buying 3,000-pound pink elephants. Same thing has happened to some financial institutions that bought up lots of these unusual assets. Doesn't matter that they got terrific deals on their purchases at the time if there is no longer any trading market to sell them...anywhere. Those financial entities holding Collateralized Debt Obligations (CDO) (a type of asset-backed security first designed in the late 1980s) have no place to sell them at all...they are stuck with them. If you can't sell it and can't use it, then its value is zero.
Debt Overhang: Also known as "flat broke." When debts exceed assets, businesses can't reorganize under Chapter 7 bankruptcy and end up out of business with a receivership under Chapter 11. The only thing worse than debt overhang is...
Structural Macroeconomic Debt Overhang: Okay, this one definitely sounds worse, debt overhang on steroids. This is where latent underemployment and debt build up until banks fail and private debt has to be replaced by public debt in the form of...
Bailouts: Instead of allowing entities to fail, the Federal government takes over entities that are deemed essential to the national interest. How does the government throw lifelines out to banks, auto makers, insurers, and other businesses when it has no funds? By borrowing funds from other nations such as China and engaging in...
Deficit Spending: The newly proposed federal budget has $1.7 trillion of deficit spending.3
Mark-To-Market Flu: In 1997 the tax law started allowing securities and commodity traders to make an accounting election. Wall Street regulars quickly found ways to exploit this and the same fraud then spread to banks and corporations like the flu and also has hurt valuations. The Emergency Economic Stabilization Act of 2008 that was enacted in October 2008 provided the SEC with the authority to suspend mark to market accounting. In December the SEC declined to do so. However, the Financial Accounting Standards Board has recently relaxed mark-to-market standards in circumstances such as inactive markets.
Zombie Banks: No, banks were not re-animated by gamma rays and they don't walk around eating brains. Banks which got stuck holding too many of those toxic assets or assets affected by skewed valuations are like hollow shells.
A Combo Sandwich: Now lets use all the new jargon in a sentence: The zombie bank was holding toxic CDOs that were valued with mark-to-market accounting rules and as a result the bank appeared to own next to nothing.
We Are The World: When the United States catches a cold, the rest of the world sneezes. We provide foreign aid and purchase foreign products and funds from around the world are invested in our treasury bonds, real estate and stock markets. So we are not alone; a recession here is felt all over the world. And things will be improving. Recessions are cyclical, there are positive signs amidst all the negativity, and financial planning means taking advantage of current conditions like lower values and tax breaks to shape a more prosperous future.
TECHNICAL REFERENCES
"We have nothing to fear, except fear itself.
-Franklin Delano Roosevelt
These are fearful times in which we plan. Set phasers to "stun" as we assemble a landing party and beam down to planet Earth to assess an assortment of alien adversaries affecting financial planning.
Stranger Than Sci Fi
"Captain, the tri-corders are picking up strange readings!"
This is certainly an uncharted and hostile part of the universe and it has provided threats no one ever heard of before: Sub-prime mortgages, structural macroeconomic debt overhang, collateralized debt obligations, mark-to-market valuation manipulation, toxic assets, and even zombie banks. This is pretty far out there.1
Our economy isn't on Star Trek or the Twilight Zone, this is reality. The financial world has turned on a dime and financial planning has been turned on its ear. Stock market bubbles, real estate bubbles, and various other bubbles have burst and bubbled over. Planning has always coped with uncertainty and change, but there is a pervasive new element shaping planning models and it isn't a new tax law or new technology or even a new world order. It is something more basic: Fear.
Let's take inventory of these extraordinary threats that are affecting the context of planning, allay what fears we can, and consider a few practical perspectives and ideas.
Identifying Dangers
Sudden Dramatic Losses: The net worth of American families dropped 18% during 2008. That's $11.2 trillion in declining values with $8.5 trillion of the damage in the stock market and another $2.7 trillion in real estate. A theoretical person with a stock portfolio tracking the Dow Jones Industrial Average has lost more than half the value of his or her holdings through early 2009. The Dow Jones Industrial Average surpassed 14,000 in October 2007 but closed at 6,594 in early March. And if you invested with Bernard Madoff, you lost it all.22
Lack of Stimulation: It's as though the earth has stopped spinning. The economy has gone limp, vapid, melancholy, and flat lined. It needs caffeine, adrenaline, a Jamba Juice boost, and defibrillators. Instead it got an unhealthy dose of ...
Credit Creation: When things are sluggish in the economy, one way to jump start things is by extending credit so that people buy homes and businesses produce products and the whole economy gets up a head of steam and runs on its own. But too much credit creation has a downside in that it can lead to...
Sub-Prime Stew: Don't eat the stew! There was a credit crunch in 2007 and borrowers not meeting prime lending standards, i.e., with shakier finances and who were less likely to pay back mortgages, found lenders who enabled them to buy homes with little or no money down. Those lenders then packaged up such mortgages and sold them. When the economy soured, borrowers lost jobs and couldn't make mortgage payments and the homes fell in value and were worth less than the outstanding mortgages. Entities extending the loans or purchasing the mortgages in packages were left foreclosing on assets that couldn't cover the face value of the loans.
Toxic Assets: How many times has this happened to you? You go to a flea market and buy a giant pink elephant weighing 3,000 pounds, haul it home, and then realize that nobody is buying 3,000-pound pink elephants. Same thing has happened to some financial institutions that bought up lots of these unusual assets. Doesn't matter that they got terrific deals on their purchases at the time if there is no longer any trading market to sell them...anywhere. Those financial entities holding Collateralized Debt Obligations (CDO) (a type of asset-backed security first designed in the late 1980s) have no place to sell them at all...they are stuck with them. If you can't sell it and can't use it, then its value is zero.
Debt Overhang: Also known as "flat broke." When debts exceed assets, businesses can't reorganize under Chapter 7 bankruptcy and end up out of business with a receivership under Chapter 11. The only thing worse than debt overhang is...
Structural Macroeconomic Debt Overhang: Okay, this one definitely sounds worse, debt overhang on steroids. This is where latent underemployment and debt build up until banks fail and private debt has to be replaced by public debt in the form of...
Bailouts: Instead of allowing entities to fail, the Federal government takes over entities that are deemed essential to the national interest. How does the government throw lifelines out to banks, auto makers, insurers, and other businesses when it has no funds? By borrowing funds from other nations such as China and engaging in...
Deficit Spending: The newly proposed federal budget has $1.7 trillion of deficit spending.3
Mark-To-Market Flu: In 1997 the tax law started allowing securities and commodity traders to make an accounting election. Wall Street regulars quickly found ways to exploit this and the same fraud then spread to banks and corporations like the flu and also has hurt valuations. The Emergency Economic Stabilization Act of 2008 that was enacted in October 2008 provided the SEC with the authority to suspend mark to market accounting. In December the SEC declined to do so. However, the Financial Accounting Standards Board has recently relaxed mark-to-market standards in circumstances such as inactive markets.
Zombie Banks: No, banks were not re-animated by gamma rays and they don't walk around eating brains. Banks which got stuck holding too many of those toxic assets or assets affected by skewed valuations are like hollow shells.
A Combo Sandwich: Now lets use all the new jargon in a sentence: The zombie bank was holding toxic CDOs that were valued with mark-to-market accounting rules and as a result the bank appeared to own next to nothing.
We Are The World: When the United States catches a cold, the rest of the world sneezes. We provide foreign aid and purchase foreign products and funds from around the world are invested in our treasury bonds, real estate and stock markets. So we are not alone; a recession here is felt all over the world. And things will be improving. Recessions are cyclical, there are positive signs amidst all the negativity, and financial planning means taking advantage of current conditions like lower values and tax breaks to shape a more prosperous future.
TECHNICAL REFERENCES
1 These new financial demons are as intimidating as the energy beings
encountered by Captain Janeway in the dark matter nebula of the Delta
Quadrant--and possibly as mind blowing as the phenomena experienced by
Captain Archer in the Delphic Expanse. But one suspects that the Borg
encountered by Captain Picard might appreciate the zombie banks.
2 Unless less you made money from Madoff, in which case, his other
investors would like a word with you right away. Bring a lawyer.
3 The National Debt is currently at $11 trillion.
I read throughout the article and I dont think to anything else in this article.I agree with you. Nice comment as well as nice article.
Terrence
estate planning