Hot Off the Web– April 13, 2010

Personal Finance and Investments

Terrence Belford’s Financial Post article entitled “Financial freedom” describes reverse mortgage taken out by a couple in their early 70s as a “wonderful windfall”. With a 3.75% rate they received a $143,000 representing 40% of the home appraised at $375,000. However, there are a couple problems: 40% of $375,000 is $150,000 so the other costs must have absorbed about $7,000, the 3.75% rate is variable (see  CHIP rate   variable rates are 3.75%, while 6 month, 1, 3 and 5 year rates are 3.95%, 4.25% 5.5% and 6.25% which are about 2% higher than currently available mortgage rates) with the associated risk of increasing rates over the life of the mortgage, and since the couple probably doesn’t need all of the $143,000 immediately but rather over their remaining life then they end up investing the un-needed proceeds at rates much lower after-tax rates than the cost of the mortgage. All in all this sounds like anything but a “wonderful windfall”. (I also found an interesting DBRS article “Rating reverse mortgages in Canada” which explains, to those so inclined, some of the inner working of reverse mortgages from the perspective of a rating agency.)

In WSJ’s “Is your advisor getting fee-hungry?” Karen Blumenthal reports that “With profits falling in the wake of the 2008 market tumble, advisers are working to add more clients, charging hourly fees for some services, taking on one-time “projects” and, in some cases, selling commission-based products. That isn’t all necessarily bad—you may well feel the need for more planning or tax services. But you should be wary if your adviser is pushing new services or offering new products that might pay heftier commissions, like mutual funds with loads or various kinds of insurance, which may pay hefty commissions.” Watch out if the new product offered is variable annuities (e.g. GMWBs) which come with high fees. However if this trend accelerates the shift from commissions to fee only approach then it is probably not as bad as it might seem.

Tara Struyk’s Investopedia article “Don’t be duped by a good pitch” in the Globe and Mail tells readers that they must “know (that) when they are dealing with a commission salesperson who may or may not have their best interest in mind. There are many highly professional commission salespeople out there, but consumers need to approach these relationships with care and be aware of the possible conflicts of interest that commission sales can create.” She then proceeds to give examples such as: bank “advisers” selling financial products, real estate agents, car dealers, insurance agents, and stock brokers. She gives examples of conflicts of interest and how to deal with some of them.

Pensions

Ottawa Citizen’s Bert Hill writes in “Small companies hope to leave recession behind”that “Not much is going right for Nortel Networks pensioners and former employees of the insolvent company.” His list includes: additional pension plan losses since the early 2009 estimate of 69% due to foreign exchange losses, interest rate changes and a reduction of equity exposure to 31% just as the equity market was ready to take off (i.e. missing the upside after taking heavy losses due to the earlier 60% equity exposure entering the market downturn), “Last week, pensioners and long-term disability recipients lost a bid for a bigger share of Nortel assets when the insolvent company winds up operation” and the pensioners “are also prevented from suing former Nortel directors and executives for failure to properly fund the plan unless they can prove fraud.” Hill adds that “Meanwhile, the big U.S. creditors continue to extract assets from the U.S. estate.” (Canadian pensioners are getting suckered with the help of Ontario’s court while the Federal and Ontario governments are standing by and watching on the sideline in a state of total paralysis.)

The Toronto Star’s Tony Van Alphen reports in “Pension trustees hit with record fine” that nine trustees of one of Canada’s  largest multi-employer pension plan were fined $22,500 each “for spending too much of the fund’s money on questionable Caribbean hotels and resorts.” (So there are some judges in Canada who are beginning to pay attention to the responsibilities of trustees toward pensioners, but $22,500 is slap on the wrist compared to the losses resulting from failure to perform fiduciary and professional duties by trustees, investment managers, actuaries, regulators, custodians and others living off pension plans.)

Real Estate

In WSJ’s “Pending home sales rise”, Connor Dougherty reports good news and bad news. The good news is that “the National Association of Realtors said Monday that its index of pending home sales increased to 97.6 from 90.2 in February. The index, which can be volatile due to a small sample size, shows homes that are in contract but not yet purchased.”, and the bad that “Construction spending fell for a fourth consecutive month in February, dragged lower by the sagging commercial real estate market and ongoing weakness in the housing market”.

Also in the WSJ, Karmin and Hagerty discuss in “Foreclosures hit rich and famous” how some of the (previously) wealthy and famous are being hit, as “Houses with loans of $5 million or more will likely see a sharp rise in foreclosures this year”. Film stars, film producers and Wall Street executives are mentioned. The article also suggests that “the bigger borrowers may be more prone to stop making payments when they have lost all their home equity…. Over the next few years defaults spread rapidly to better-heeled borrowers, especially those who got loans without documenting their income… Wealthy people have the means to stretch out the distress process, sometimes for years”. “It’s very, very difficult for these people to believe they’ve had such a severe reversal of fortune”. The article also indicates that “The upper end is definitely a lagging indicator,”

Things to Ponder

The Economist’s “Crisis in slow motion” suggests that despite recent improvements, Japan’s recovery is unlikely to be sustainable, “because the cyclical upturn is unlikely to do any more than paper over Japan’s deep-seated problems. These include deflation, huge public debt, ugly demographics and a glaring lack of decisiveness among policymakers about how to deal with them. Unless things change radically, these problems seem destined to sap nominal growth for years to come, with possibly disastrous consequences.” (Lead from CFA Institute Financial NewsBrief)

The WSJ’s “Two Treasury forecasts: a Grand Canyon-size gap” reports that “the two best economic forecasting teams of the past two years couldn’t disagree more about where Treasuries will go next. Morgan Stanley believes the 10-year yield will rise to 5.5% this year, the highest estimate among top Treasury dealers. Goldman Sachs Group Inc. says yields are headed back down to 3.25%.” And on the same topic, John Dizard in the Financial Post’s “Goodbye Mr. Bond: Sell your Treasuries” is clear in his view of the direction of interest rates. However in Globe and Mail’s “Deflationary undertow threatens U.S. recovery” David Rosenberg argues that “despite the positive headlines on payrolls, don’t think for a second that the Fed is not aware of, or insensitive to, the deflationary pressures that continue to build in the labour market. Against this backdrop, any premature tightening by the central bank or a sustained backup in bond yields is simply out of the question.” Similarly, the debate is still continuing even inside the Fed as reported in the “Inflation fears cut both ways at the Fed” by WSJ’s Jon Hilsenrath, where some argue that “abating inflation rate as convincing evidence the economy still is burdened by excess capacity and needs to be sustained”, while others argue that “current inflation measures are distorted by an epic decline in housing costs and could mask a buildup of inflationary pressures.” (So, the debate continues, but the risk of being completely invested based on one side of the debate is increasing.)

And finally, in the Financial Times’ “The Madoff story reveals more faults” Jonathan Davis argues that “The Madoff story is ultimately a story about breach of trust. Investors were naïve to trust Mr Madoff, naïve to trust the intermediaries who channelled money to him in such prodigious amounts, and naïve to believe that regulators could or would stop such an accomplished liar and conman. In Mr Markopolos’ view, although the majority of individuals in the financial services industry are honest, incentives to cut corners and breach both client trust and regulations are hard-wired into the system they work in.” (Mr. Markopolos is the “whistleblower who tried unavailingly to get the SEC to investigate Bernie Madoff over more than 15 years.”)