Hot Off the Web– August 30, 2010

Personal Finance and Investments

In the WSJ’s “Paying off the house in 15 years” Amy Hoak reports that “Between January and June, 26% of homeowners who refinanced chose a 15-year fixed-rate mortgage…During all of 2009, 18.5% of borrowers who refinanced opted for a 15-year term.” Refinancing, for those Americans who qualify, gives them an opportunity to not just reduce the rate on their existing 30 year mortgages but, if they feel secure about their income stream, allows them to get even lower 15 year rates and lock themselves into a forced saving program. Those with already relatively low 30 year rates, but feel less secure about their future income stream and yet feel disciplined enough, might choose to stay with their 30 year term mortgage but commit increase their monthly payment by a specified amount.

The  Financial Times’ “Price/earnings multiples” reminds readers that it (P/E defined as the company market cap divided by annual net income) has “questionable predictive power” and it can be used only by keeping in mind: (1) it is a comparative measure relative to “peers, the market and stock’s own growth and valuation history”, (2) validity (same time period and same accounting standard), (3) watch for adjustments (e.g. expensing vs. capitalizing of key costs like R&D or giving away stock or ignoring cash hoard), and (4) “Shiller’s cyclically adjusted P/E incorporates ten years of historic data” whereas a prospective number is just a guesstimate. (If you are interested in the various meaning of P/E you might wish to read my earlier blog on the topic   P/E Ratio)

Jeff Opdyke in WSJ’s “How to game Social Security” writes that “An often-overlooked provision allows Social Security recipients to withdraw their original application for benefits and to re-file. For many retirees already collecting benefits, the strategy—known informally as a “Social Security reset”—could sharply increase their monthly income… though: Not all retirees will benefit, and those who potentially would will need access to a large stash of cash to start the process.” He also warns that this is not advantageous for those who: might end up on Medicaid, have short life expectance (e.g. terminal illness) and who “want to leave a lot of money to heirs”.

Also, see Larry Elford’s two-minute video spoof on “How to become an investment advisor”. It is entertaining and educational.

Real Estate

One of our readers (SI) pointed out to me that those who would like to have a smooth handover of their Florida property to the next generation might want to consider an “Enhanced Life Estate Deed or Ladybird Deed” .This document deeds the parents’ property to their children but “reserve for client a life estate coupled with the ability to sell the property at any time. This is called an “Enhanced Life Estate.” In layman’s terms, this means that (1) my client still owns the property; (2) my client can sell the property at any time without notifying her beneficiaries; and (3) if my client never sells the property, the house will pass directly to her beneficiaries after she passes away without going through probate.” (I have never heard of this approach, but you may wish to investigate its applicability to your situation, including discussing it with your lawyer.)

The Economist’s “Sudden stop” provides what it calls “your unpleasant housing market chart of the day, showing about an 80% drop in New Home Sales and Recessions since the 2005 peak.

On the U.S. housing front, the Globe and Mail’s Joanna Slater reports that “U.S. home sales plunge 27%” with existing single family homes changing hands at “a pace not seen in 15 years”. The report also includes some interesting charts on sales, foreclosures (California and Florida are leaders). Housing inventory at current rate of sales is in excess of one year compared to 9 months in June and 7 months typically. This is despite “average rate for a 30-year fixed-rate mortgage fell to 4.42 per cent, the lowest in the history of the 39-year weekly survey by U.S. housing giant Freddie Mac”. Also, in Bloomberg’s “Housing slide in U.S. may drag economy into recession” Gittelsohn and Willis write that high unemployment, high foreclosure rates, excess supply, slower than expected GDP growth, “epidemic of thrift” are all affecting U.S. housing, but 9.6% unemployment (the highest since 1983) must be reversed before we are likely to see improvements.

In Florida, Michael Braga in the Herald Tribune’s “Price swoon reignites regional housing debate” reports that in the Southwest Florida “this summer’s price declines, including a double-digit July drop reported Tuesday, have market watchers wondering whether the worst is really over.”  Braga looks at opinions of real estate insiders of opposing views of the future.


In CBC’s “Ontario unveils pension overhaul” and Janet McFarland’s Globe and Mail article “Ontario to overhaul pension fund” (and many other articles) it is reported that Ontario Minister of Finance Duncan tables proposed reforms. These ‘reforms’ can be best described as tinkering, rather than grabbing the bull by the horn in an effort to tackle the fundamental changes that pensions, now in systemic failure, need. These proposals will do little if anything to improve security for current or future retirees, or to encourage companies to establish new pension plans. What should have been addressed, and was not, is (1) how to improve protection for private sector pensioners’ deferred wages in case of sponsor bankruptcy, and a new pension system architecture which (2) encourages increased savings consistent with desired retirement income levels, (3) provides low cost investment vehicles for accumulation and growth of savings and (4) provides low cost decumulation and longevity insurance strategies in retirement. See my separate in-depth analysis of what should have been announced and was not in “Ontario pension reform? What really needs to be done?”

California Governor Arnold Schwarzenegger in WSJ’s “Public pensions and out fiscal future” writes that “Much needs to be done. The Assembly needs to reverse the massive and retroactive increase in pension formulas it enacted 11 years ago. It also needs to prohibit “spiking”—giving someone a big raise in his last year of work so his pension is boosted. Government employees must be required to increase their contributions to pensions. Public pension funds must make truthful financial disclosures to the public as to the size of their liabilities, and they must use reasonable projected rates of returns on their investments. The legislature could pass those reforms in five minutes, the same amount of time it took them to pass that massive pension boost 11 years ago that adds additional costs every single day they refuse to act….Reforming government employee compensation and benefits won’t close this year’s deficit. It will, however, protect the next generation of Californians from overwhelming burdens.”

Pension on unpaid work pension? Bev Smith, a member of the Common Front for Retirement Security (CFRS)leadership team, is driving for recognition of the “value of unpaid work”. Specifically, the drive recognize the societal value of unpaid work and to identify mechanisms to a secure pension benefit (e.g. CPP) for individuals who choose to stay at home to raise small children, or to attend to sick or elderly parents. The arguments are quite persuasive, but it may be a tall mountain to climb in Canada where public policy is inclined toward forcing everyone to work (e.g. by discriminating in taxation against single earner families). However things may be changing, and 20 years from now policy might be driven by relative strengths of two counteracting forces driven by growing proportion of the population aged over 65: on one hand the dependency ratio (fewer workers to non-workers) would drive policy in same direction as today (whatever your age, go get paid work), on the other hand public cost of nursing home care and capacity of available facilities to deal with the rising number of elderly requiring care, might result in a policy to encourage more people to stay at home and take care of their parents. (It sounds sensible to me; one way we as a society might be able to pay for this is to allow single earner families’ discriminatory income tax levels to be allocated to CPP contribution on behalf of spouse performing unpaid work.)

An interesting development was reported by Bert hill in the Ottawa Citizen’s “Retired Nortel Networks inventor claims patent deals invalid” about an ex-Nortel inventor, David Steer, who like many others assigned patents to Nortel in return for “valuable considerations”. “The language—common in intellectual property law—represented his paycheque, benefits and future pension.” Since bankruptcy protection took effect the pensioner lost part of his retirement income with more losses to come with reduction in pension and elimination of his health and life insurance benefits. What “Steer claims in letters to U.S. and Ontario judges handling the Nortel case, is that the signatures he and other inventors provided on the patent consent agreements “were obtained under false pretences and are void as a consequence of fraudulent activity.” (Sure worth a shot, everything else seems to have failed.)

Things to Ponder

In Barron’s “Stacked deck” Alan Abelson reports that “Malmgren observes that HFT (high frequency trading) provides an illusion of almost limitless liquidity, liquidity that can vanish abruptly if a few HFT platforms take a break. Implicit, he says, is “mammoth systemic risk.” And since high-frequency traders have become the dominant market makers and shakers, their capacity to turn on a dime and sell off everything, means that a market correction could go much faster and far deeper than the Street imagines.” (Not very comforting thought; per it really would make sense to put some friction in the system (perhaps by increasing the cost of the trade) to slow things down a little, as suggested in Gillian Tett’s  article referred to in the August 23 Hot Off the Web.)

In WSJ’s “Economist Shiller sees potential for ‘double-dip’”, Simon Constable reports on an interview with Robert Shiller, who figures: the probability of double dip is >50% and imminent, the housing decline could continue for five more years, the U.S. economy is “teetering on the brink of deflation” and that the biggest problem is the level of unemployment. He also suggests that governments must address unemployment by extending the Bush tax cuts, and he says that bonds are not in a bubble.

In Barron’s “The Indie challenge”,given the apparent imminent universal U.S. requirement for fiduciary standards in the financial industry, Suzanne McGee asks how independent planners will differentiate themselves; she also suggests that perhaps “you should be careful what you wish for”. But, independents argue that they will continue to thrive because they: are smaller can be more nimble, have “open architecture’, have removed most of Maddoff related fears (with trading, custody, audits by independent arms length entities) and clients appreciate their true independence.

Jonathan Chevreau in the Financial Post’s “Demographics & asset markets: Who will take care of the baby boomers?” refers to a pessimistic newsletter article written by Magnus about the impact of boomers: on equity prices as they will eventually de-risk their portfolios by reducing equity allocations, on housing prices because who will buy their houses, by reducing GDP growth rate due to boomers’ lower spend rate and to top it all of dependency ratios will drop from current 2.5-4 in developed countries to 1-2 by 2050. Boomers who have inadequately provided for their retirements will have to be supported by their children and grandchildren. The ‘good news’ in the article is the timing of the current financial crisis which might focus the “attention on the need for people to save more for retirement”.

The WSJ’s Meena  Thiruvengadam reports in “Doomsayer invests as if the end is nigh” about Peter Schiff’s prediction that we are going into a depression. Schiff specializes in gold (stored outside the U.S.) and in foreign investments handled over foreign exchanges. The picture he paints is as dark as it comes: people leaving the U.S. en mass and enactment of laws preventing individuals from leaving with their assets. To those who challenge him he retorts that “There are things that I have forecast that haven’t happened yet. Does that mean I’m wrong or does that mean I’m early?” Mr. Schiff said. “I like to think it’s the latter.” (Cocky?)

The Financial Times’ “View of the day: Toby Nangle, Barings”argues that to retain AA or AAA ratings as sovereign entity, the sustainable level of debt is 60-80%. “The only plausible way of (G7 governments) meeting it will be to turn central bank and Treasury functions on their heads, and engage in simultaneous belt-tightening, inflating and defaulting. The bulk of defaults will fall on non-tradable obligations such as pensions.” “The most notable outcome will be that emerging economies will take the opportunity to lift their relative living standards. Western multinationals with the ability to fund at low real rates in depreciating currencies, while enjoying the growth in emerging markets, should also prosper.”

According to Gregory Zuckerman in the WSJ’s “Firm makes bold bet on falling prices” Canadian insurer “Fairfax paid $174 million in upfront fees to protect $22 billion of its investment portfolio against the possibility of deflation over the next decade. In exchange, Fairfax will receive a payment amounting to the drop in CPI below 2%—the level of inflation when Fairfax bought its contracts—multiplied by the $22 billion. If deflation averages 2% annually over the next 10 years, Fairfax’s contracts would rise in value the equivalent of 4% of $22 billion, or $880 million, each year over the next decade, according to traders familiar with Fairfax’s trades.”

And finally, in the Financial Times’ “The real losers in the battle for alpha” John Chapman suggests “Freedom from regulations has resulted in trading advantages for hedge fund managers – ability to select clients, low administrative costs, illiquidity, freedom over strategies and concentrations, unrestricted use of derivatives, unlimited leverage, the ability to go short, and close relations with prime brokers.” Over the 1999-2009 period hedge funds have achieved 8.5% (after fees) annualized returns, compared to FTSE All Share 3.5% and S&P 500 0.9%. Then for the $1.7T hedge fund industry even a 5% outperformance translates to close to $100B! Of course not everybody believes that 8.5% return number because of survivorship bias and whether with increasing levels of assets they’ll be able to continue to outperform (if in fact they do so now). Nevertheless, “Given that authorities have allowed a minority significant trading advantages, those with resulting losses could claim to be victims of licensed robbery. Authorities could respond that the less well-off needed the protection, but there are no obvious examples of selective regulation leading to a minority gaining perhaps $100bn a year from others.”


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