Hot Off the Web- February 23, 2010

Personal Finance and investments

Jamie Golombek in the Financial Post’s “Investment puzzle: Inside or outside”tries to answer investors’ recurring question: “which investments should be held inside versus outside your registered plan (RRSP)?”, now further complicated with the availability of TFSAs. The short answer is: fixed income in tax sheltered (RRSP or TFSA), Canadian dividend paying stocks in taxable account, dividend paying foreign equities could be in tax-sheltered RRSP where they are exempt of withholding tax (however you also end up paying your highest marginal tax rate on withdrawals rather than capital gains tax rates). Still, as Golombek says, “there are no right answers”.

In the NYT’s “A card fee still hides in the luggage” Ron Lieber discusses the “noxious” 2.5-3.0% “foreign transaction or currency conversion fee” levied by credit card companies (also in Canada) and some ways to avoid paying them: “Capital One which charges nothing” (or look for other cards with similar policies), or carry cash or use ATMs (but find out before you leave on your trip, what fees are attracted by their use.)

Paul Sullivan in NYT’s “Broker?  Adviser? And what’s the difference?” discusses “who is better able to look out for your money, a broker or an independent adviser?” While you no doubt have read about this here and elsewhere, it is worth repeating since “business practices and regulatory guidelines that are rarely understood by the client and often blurred in practice. Brokers are governed by the “suitability rule,” which requires them to have “reasonable grounds for believing that the recommendation is suitable,” according to the Financial Industry Regulatory Authority. Registered financial advisers are supposed to adhere to a higher standard — “fiduciary responsibility,” an ethical and legal requirement that the investor’s best interest comes first, not the adviser’s own financial gain.” The article is interesting because it explains that the distinctions are not always black and white, and concludes that “the one looking out for your interest may have to be you.” (You might also want to re-read Bernstein’s “Muggers and worse” chapter in “The Investor’s Manifesto: Preparing for Prosperity, Armageddon, and Everything in Between”)

Brett Arends in the WSJ’s “Bond bubble? What you can do about it”looks at the risks associated with bond investing in the current low interest rate environment and suggest some risk reduction techniques such as “minimize exposure to long-term bonds, “move some bond money into TIPS” (Real return Bonds for Canadians), and “consider some dividend stocks as well”.

In WSJ’s “High yields aren’t always a good thing” Jason Zweig looks at high yielding Closed End Funds (CEFs) and risks associated with them: buying at a big premium above NAV of underlying assets. “Buy such a fund, and you may double-dose on risk. A yield that looks stable can crumble; then the premium may collapse as panicked investors dump the fund. That leaves you with less income than you expected—and a big market loss to boot…. many of these funds engage in “return of capital,” an odd but legal tactic that pays your own money back to you.”


In the Financial Times’ “Cost of pension risk rises” Sophia Grene writes that in the U.K. the cost of buying bulk annuities in order to offload a company’s pension risk/plan “is 144 per cent of the pension’s accounting value, according to a new index from Mercer. Although the bulk annuity market, where a plan sponsor pays an insurance company to take on its pension liabilities, has been growing, it is still not a transparent, commodified market.” (Not clear to me how exactly this is calculated but “accounting value” might imply liabilities discounted using investment grade (AA rated) corporate bond rates rather than the lower government bond rates; 144% would mean that if the pension plan is 100% funded on accounting basis, the plan assets would buy only 69% of the expected pension value; interest rate spread for AA rated bond changes, 0.5-1.0% range is not uncommon and this might imply corresponding solvency rate of about 85-90% (due to the lower applicable discount rate). Based on these assumptions the annuity that Nortel’s claimed 70% solvency funded plan might only buy 54% of the expected pension, excluding CCAA recoveries and PBGF insurance.)

In the Globe and Mail’s “Ex-reformers face embarrassment of pension riches”Steven Chase rubs the noses of former Reform party MPs (like Prime Minister Harper) into the dirt with, they “rode into Ottawa as freshman MPs decrying the “fat-cat” pensions on offer, and now, many years later, the handful of former Reformers still serving in Parliament have racked up generous retirement packages of their own.” Numbers quoted for parliamentarians’ pensions are $100,000-150,000/ year indexed! (Now who said that there is a pension crisis? Not for MPs.)

Canadian pensioners are being offered a “deal” worth about $2,000 per pensioners in exchange for forgoing a fight for priority status for pension underfunding and the right to sue those who had a hand in failing to protect pensions despite their fiduciary and professional duties to do so; the forgone incremental claims would be for losses ranging individually for $10K-$100K and more. How else could pensioners end up with 30-40% underfunded plan when the sponsor goes into bankruptcy protection, without those in charge having failed to do their duty toward pensioners?  In “U.S. creditors lodge objections to Nortel deal with ex-employees” Ottawa Citizen’s Bert Hill writes that “creditors oppose a provision which opens the door to former Canadian employees getting a bigger share of Nortel assets if the federal government changes insolvency laws.” (The creditors seem to be concerned that the pensioners may fight for priority in the Courts and they are concerned that the government may change the BIA to be consistent with most other developed/civilized countries where such priority is already enshrined in law.) The U.K. pension regulator watching Canadian pensioners’ are being crushed in the Court, decided that they also want piece of the action. In Ottawa Citizen’s  “British fire shot at Nortel battle”Bert Hill writes that the Brits seeing that Canadian court approved acceptance of a “$2.06-billion charge against Canadian assets to settle a U.S. tax claim”, the U.K. regulator wants in on the Canadian estate to the tune of $3.2B! Now, all the sales proceeds are being held in a U.S. vault with Canadian pensioners and other creditor access or share yet TBD. Where is the Canadian government with the necessary BIA and other amendments to insure that Canadian pensioners’ rights are protected?

And I am puzzled why the Financial Post would spill more ink on Mr. Mintz defending his views (“Jack Mintz: The pension crisis myth”) that “all is OK with Canada’s pension system” without providing alongside space for opposing views which were clearly articulated in earlier reports. Clearly, Mr. Mintz knew that Canada’s pension system was in good shape before he was selected by Mr. Harper’s government to lead a study on Canada’s pension system and his study confirmed what he knew before he did it (see Impressions of the Whitehorse Pension Conference: ) One of Mr. Mintz’s differentiated contributions is counting the value of Canada’s seniors’ residences as a component (perhaps the largest for many) of their retirement assets. A couple of small problems need to be considered such as: Canada’s house prices might be near bubble territory, what will the prices be if/when most of the boomers try to sell their houses and who will buy the millions of houses from these boomers looking to spend the value of their residences? Oh well, just details. In the U.S. Paul Volcker thinks that Social Security is the “bedrock of any retirement policy in this country” in Bloomberg’s “Volcker says Social Security the ‘bedrock’ for securing savings”and not the reforms proposed for 401(k) plans (and Americans have higher contribution room than Canadians in tax deferred accounts and have much lower cost vehicles to implement their retirement savings plans. In the meantime Canadians will have to trust Mr. Mintz and Prime Minister Harper that all is OK in Canada’s retirement income system.)

Real Estate

The December 2009 U.S> housing index is reported in “A look at Case-Shiller, by metro area”. The 10 and 20 city indexes are down 2.5% and 3.1% YoY, respectively. The biggest losers for the year were Las Vegas (-20%) and Tampa/Detroit/Miami/Phoenix (around -10% each). The largest increases for the year were San Francisco, San Diego and Dallas. (I couldn’t link to the S&P website, but the referenced article has tables for the metro areas.) “David M. Blitzer, chairman of S&P’s index committee, said that the housing market is “definitely in better shape” and that the pace of deterioration has stabilized. But the rate of improvement seen during the summer hasn’t survived.”

Is there is housing bubble in Canada? Read and judge for yourself. In the ‘yes’ camp “Jarislowsky says he’s convinced Canada has housing bubble”, the ‘maybe’ camp is described in “Bubble trouble? No, it’s our thirst for debt” and Mr. Flaherty after being steadfastly in the ‘no’ camp decided some action was required after all, as described in  “Flaherty sets stricter mortgage rules” and “’Reckless’ speculators get a cold shower”; “Ottawa’s decision to increase the minimum down payment required to obtain Canada Mortgage and Housing Corp. insurance on investment homes to 20 per cent, from just 5 per cent, will have a sizable impact, said Craig Alexander, deputy chief economist of Toronto-Dominion Bank, because these properties account for up to 15 per cent of all new mortgages.” However for those worried that this will slow down the rising Canadian house prices can put their mind at ease by reading, Garry Marr in the Financial Post says “Don’t worry, home loan rules can still be bent”.

In the U.S. where the bubble has burst the “Housing crisis proving too big to solve”; in this Herald Tribune article, Alan Zibel explores how President Obama’s ambitious loan modification program to fix the housing crisis has failed to deliver, so far. Of $75B of incentive funds only $15M has been delivered; “One million people have entered the modification program, and almost 12 percent, or 116,000, have completed the process. A third of homeowners who made the three monthly trial payments on time have now fallen behind. More than 61,000 homeowners have dropped out, and hundreds of thousands more are expected to do so in the coming months” and “An increasing number of people are opting to walk away from mortgages because they owe more on their mortgages than their homes are currently worth.”

As to Florida, in the Sun Sentinel’s “Florida foreclosures soar” it is reported that foreclosures were up 44% in 2009 compared to the previous year. “Nationwide the percentage of borrowers who missed a mortgage payment” decreased from 3.8% to 3.6%, whereas in Florida it increased from 12.18” to 12.66%. “Nationwide, 4.58 percent of mortgages were in foreclosure at the end of last year, compared to 13.44 percent in Florida.”

Things to Ponder

You might want to read Barbara Moses’s Globe and Mail article “Be smart about money- but not owned by it” in which she discusses the importance of our relationship with money. “Poor choices can have lasting repercussions on how you experience your current life and your longer-term work and personal choices.” “Unfortunately, many can’t make this distinction (between needs and wants). The result is a gnawing sense of deprivation, or spending money that one doesn’t have. The better choice is to feel good about what we have, rather than mourn what we don’t.”

In WSJ’s “Investors recruit terminally ill to outwit insurers on annuities” Maremont and Scism describe (a scam to some and a scheme to others, of taking advantage of a loophole in variable annuity contracts) the latest business opportunity whereby an ‘entrepreneur’ “discovered a way to use an investment product sold by insurance companies to make no-risk bets on the stock market. He recruited dozens of terminally ill people to in effect serve as paid fronts for purchases of the product, variable annuities. The lawyer and other investors put tens of millions of dollars into the policies, hoping to reap a profit when the recruits died.” “The twist that makes variable annuities attractive to professional investors is a money-back guarantee built into the plans, called a death benefit. In effect, insurers promise that a buyer’s beneficiaries will get back at least the amount that was originally invested, less withdrawals…Some insurers added enhancements to this basic death benefit, including a built-in interest rate that gradually increases the minimum money-back amount. Insurers figured they could recoup the cost of the guarantees over time, through the hefty fees usually associated with the products.” What the insurance companies didn’t expect is the organized recruitment of the terminally ill….(this) transformed a long-term product with hefty fees into a short-term, no-lose way to play the stock market.”

In the Financial Times’ “Why we should not fear the spectre of deflation”Edward Gottesman writes that “From 1865 to 1895, the US had persistent deflation. During that period, industry flourished. While the monetary value of assets declined, businesses produced real output from innovation, capital investment and human resources, without illusory gains from currency depreciation….Inflation’s perverse incentives encourage debt. Youth have become chronic borrowers, believing that government will repay part of their loans by slow, but inexorable, debasement of the currency….Deflation promotes saving. Creditors win; debtors lose. Once savings rates are restored, prudent consumption and income-producing investment will follow….Deflation can help kick the debt habit. Going “cold turkey” is painful, but saving and investing before spending can improve the western world’s financial health.”

And finally, Forbes Elworthy writes in the Financial Times’ “Modern day pyramids and a new challenge” that Keynes believed that the reason that “the Egyptians were able to maintain a stable civilization for 2,000 years” was their focus on two activities: “the construction of the pyramids and the search for precious metals. Unlike most goods, the pursuit of these activities does not “stale with abundance”. You cannot get too much state religion (the pyramids) or gold.” “Rich, highly productive societies as a whole have a very different problem: of excess production rather than of scarcity. These societies attain such high levels of production that they become unstably rich. When a shock occurs, we all panic. We conclude we are living beyond our means.” He believed that “with goods like state religions (pyramids), the less useful they are, the more likely they will keep being demanded and produced.” Today’s pyramids are: fashion, holiday travel and housing. Other pointless activity mentioned is finance and banking, “an industry that absorbs capitalism’s surplus” He concludes with “We need to devote the amazingly creative and productive capacity of capitalism to correctly solving the biggest problem it has ever faced – environmental destruction. This is a high elasticity destination for our productive surplus.” (Now there is something to ponder!)


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