Topics: Dodd-Frank looking better, universal public LTCI? Gross: death of equities, Malkiel: equities alive and well, US/Florida house prices up, Toronto/Vancouver sales slow, ‘lump-sum’ vs. annuities, voluntary vs. mandated pensions, pensions and muni bankruptcies, Danish rates go negative, Finra’s unsavoury arbitration, money market reform, Sarbox failed, end-of-life plans.

Personal Finance and Investments

In the Globe and Mail’s“Dodd-Frank: The surprise appeal of the reform everyone hated” David Parkinson argues that outlook on the two year old Dodd-Frank bill that everyone loved to hate is now shifting: “Americans of all political stripes are seeing a certain appeal…(that now) they like it so much that they’d like to see more”. An AARP related survey indicated that: 73% support Dodd-Frank, “two-thirds of voters – including 78 per cent of Republicans – favour allowing individual states to enact and enforce even tougher consumer protection laws than the ones contained in Dodd-Frank.” Not surprisingly, the banking community is less enthusiastic about the bill. (In Canada there is no talk of reform, the financial industry must love it.)

CARP’s“IRPP Study: Financing long-term care in Canada” reports that an IRPP “report concludes that a universal public (long-term care) insurance scheme is the best option, compared with private savings and private insurance schemes…arguing that the chosen scheme should be efficient, equitable, respectful of beneficiaries, and inter-generationally fair. The report defines long-term care coverage as services assisting with daily living activities and chronic care, including home and institutional care, as opposed to acute and rehabilitation care.” (I haven’t done a great deal of thinking about such a public system, but the current private LTC insurance schemes generally are ineffective and expensive, see my Long- term Care Insurance (LTCI- I) and Long-Term Care Insurance (LTCI) II- Musings on the Affordability, Need and Value: A (More) Quantitative View blogs)

In the WSJ’s “Bill Gross: We’re witnessing the death of equities”Steven Russolillo reports that Bill gross argues that the investors need to reconsider the old “buy-and-hold” investing approach. “The 6.6% real return belied a commonsensical flaw much like that of a chain letter or yes — a Ponzi scheme. If wealth or real GDP was only being created at an annual rate of 3.5% over the same period of time, then somehow stockholders must be skimming 3% off the top each and every year. If an economy’s GDP could only provide 3.5% more goods and services per year, then how could one segment (stockholders) so consistently profit at the expense of the others (lenders, laborers and government)?” Gross is also pessimistic about bond returns. His conclusions are that: lower returns translate to having to work longer to accumulate retirement assets and valuation of existing holdings will be reduced; furthermore investors should get ready for governments to attempt an “inflationary solution in almost all developed economies over the next few years and even decades”. (It’s difficult to argue with Gross’s perspective, though he has been wrong recently with his call to dump Treasuries a few months ago. Still unless we go into a stall, world (rather than US GDP) growth is in the neighbourhood of real 4%/yr and cost of borrowing is pretty low by historical standards, so there are some unmentioned upsides TBD…as the old saying goes “forecasting is difficult, especially about the future”.)

But in IndexUniverse’s“Don’t get buried by bonds” Olly Ludwig interviews Burton Malkiel who argues that: (1) the China story is intact with real growth in the 7-8% range, inflation down to 2% and China has more remaining stimulus capacity than developed countries, (2) while not a gold bug he make a strong case for it on the back of a wealthier population in China and India which will demand gold, (3) there are grounds for pessimism on the Eurozone but the US will lead developed countries out of the downturn, (4) that equities are cheap (especially in emerging markets) and (5) Treasuries are very expensive and counting on Treasuries as a long-term retirement asset is plain crazy. He also argues that indexing is here to stay because it works, even in bond markets; and while he admits that there is much that we don’t know about financial markets but he says that “the one thing I’m absolutely 100 percent sure of about financial markets is the lower the fee that I pay to the purveyor of the investment product, the more there is going to be for me.”

Real Estate

In WSJ’s“Case-Shiller shows strong price gains in May” Nick Timiraos reports on the May 2012 Case-Shiller indices that “Without the seasonal adjustment, prices were up by 2.2% from April, which is the largest monthly jump in the 12-year series for the 20-city composite index, which tracks prices in 20 major U.S. cities. Compared with one year ago, home prices were down by 0.7%. But that represents a major improvement from the 4.1% year-over-year decline from the end of 2011. According to the commentary accompanying the just released S&P/Case-Shiller Home Price Indies “On a monthly basis, all 20 cities and both Composites posted positive returns and 17 of those cities saw those rates of change increase compared to what was observed for April. Seventeen of the 20 cities and both Composites also saw improved annual rates of return. We have observed two consecutive months of increasing home prices and overall improvements in monthly and annual returns; however, we need to remember that spring and early summer are seasonally strong buying months so this trend must continue throughout the summer and into the fall… Miami and Tampa are two other Sunbelt cities that were hard-hit in the downturn, but are now showing positive annual rates of change.”

In Palm Beach Post’s “South Florida home prices on six-month run” Kimberly Miller reports that “The nation’s leading home price index showed continued momentum in South Florida real estate in May, marking a six-month run of increases buoyed by low interest rates and shrinking inventory. A 3.4 percent surge in prices from May of last year was measured by the Standard & Poor’s/Case-Shiller index for Palm Beach, Broward and Miami-Dade counties. A 1.4 percent increase for the region from April left prices at their highest point on the index since November 2010.”

Ora Morison reports in the Globe and Mail’s “Summer chill cools Toronto, Vancouver” “Sales of new Toronto condominiums fell by half in the second quarter from the year before, new data released Thursday show, while in Vancouver, the number of residential sales last month was the lowest for any July in 10 years… In Toronto, a record high 18,123 condo units were left unsold at the end of the second quarter, and condo sale prices grew at their slowest pace since early 2010… A record 343 new condo buildings are currently under construction in Toronto.”

Pensions

(Though clearly circumstances are different in the US and the decision is heavily dependent on personal circumstances and preferences, here is another dry-run opportunity for Nortel pensioners on how to make the upcoming ‘lump-sum’ vs. ‘annuity’ decision.)Paul Sullivan in the NYT’s“When your pension offers a choice” discusses the lump sum vs. annuity decision (triggered by the GM pension changes), should your employer give you the choice. Sullivan’s personal driver to such a hypothetical decision to ‘lump-sum’ would be control. Behavioural finance professor Thaler’s view is that: (1) the decision is not about making a break-even decision, even though for those healthier/much-less-healthy than average, the annuity option might make/not-make sense, but about (2)  how comfortable are they to manage the windfall in retirement, rather than receive a regular “paycheck” or (3) to think of the annuity as an insurance policy to protect your children from having to move in with them when you run out of money. Shlomo Benartzi, another behavioural finance professor, argues that “most people were incapable of managing a lump sum of money well and that at least half of them got worse at it by the time they turned 80 and their mental faculties declined”, so the annuity might be preferred by most GM pensioners. Prudential, who has signed up to offer annuities to GM pensioners also has an exposure: will the sickest of the group opt for ‘lump-sum’ and the healthiest for annuity? Prudential has never taken on such a group annuity with an option to opt out. Other considerations for pensions are: desire for bequest, and lack of indexation with inflation (especially if you are a young pensioner). A couple of other ideas mentioned was take lump sum but buy a deferred annuity  (longevity insurance) which starts an annuity stream at 85 (not available in Canada) and/or delaying Social Security (CPP)  till age 70. Others might consider partial annuitization.

In the NYT’s “Our ridiculous approach to retirement” Teresa Ghilarducci writes that “The specter of downward mobility in retirement is a looming reality for both middle- and higher-income workers. Almost half of middle-class workers, 49 percent, will be poor or near poor in retirement, living on a food budget of about $5 a day… To maintain living standards into old age we need roughly 20 times our annual income in financial wealth… beyond what you will receive from Social Security” She calls the expectation to make up any shortfall in retirement by working- a fantasy world! She argues that “failure is baked into the voluntary, self-directed, commercially run retirement plans system”. She writes that the only viable approach is a compulsory, “guaranteed rate of return retirement account on top of Social Security which would pay out as an annuity. For those who don’t like mandates she writes “Just as a voluntary Social Security system would have been a disaster, a voluntary retirement account plan is a disaster.” (Not everyone will agree with her proposal, which is nothing like Canada’s PRPP, but it certainly sounds better that the PRPP. But of course anything based on a little retirement income solution expertise coupled with some common sense, would be guaranteed not to look like the PRPP.)

And the Bloomberg Vekshin, Nash and Yap article entitled  “Police chief’s $204,000 pension shows how cities crashed” speaks for itself as it explains how outrageous pensions contribute to the bankruptcy of US cities: police chief retiring at age 52 with $204,000/yr pension after 8 months on the job, another police chief retires after 2 years on  the job with $166,890/year, followed by the next police chief who also stayed 2 years on the job and retired with $202,398/year pension. “We have some safety retirees that are actually earning more in retirement than they earned when they were working because they were able to manipulate the system enough in that last year that they could crank that last year’s income and then get 3 percent times their 25 to 30 years”.  ” Municipal “governments struggle to support six-figure lifetime benefits for some retirees even as they cut police and fire services for city residents.”  Bottom line- no wonder that several US cities started bankruptcy proceedings, and there are more on the verge.

Things to Ponder

And for those who think that interest rates are too low, In Bloomberg’s “Denmark has lessons for Draghi as official rates go negative” Frances Schwatzkopff reports that Denmark “…lowered the rate it offers on certificates of deposit by a quarter of a percentage point to minus 0.2 percent on July 5… it’s about deflecting a capital influx that threatens to strengthen the krone beyond the limits of its euro peg… (Danish central bank governor) Bernstein says that there’s no limit on how low the deposit rate can be cut. He’s ruled out capital controls to defend the krone’s peg to the euro, preferring instead to drag conventional tools deeper into what he last month described as “uncharted territory.””

In InvestmentNews’ “Cohan: Time to shut down Finra’s arbitration panels” William Cohan describes some of the unsavoury practices of financial self-regulatory organizations (SROs) like Finra and how “sunlight is said to be the best of disinfectants”. (Effectiveness of SROs will always be challenged by conflicts of interests; independent regulators (paid by a ‘tax’/levy on the regulated industry) has a far better chance of doing justice for the clients of the industry.)

In the Financial Times’ “The Achilles heel of America’s financial system” Gillian Tett discusses a recent Federal Reserve paper suggesting necessary changes to the $3.2T US money market sector, not being covered by deposit insurance, could have a “cliff” problem (aka ‘run on the bank’). The SEC makes a number of sensible recommendations like “funds to hold cash reserves, to absorb losses, and to operate with floating net asset values, to educate investors that these investments cannot be treated like a bank account”, while the Fed paper suggested “investors should be “gated” in a crisis, or forced to leave a small proportion in the fund to absorb losses; a mere 2-4 per cent could prevent runs”; Tett believes the proposals are “sensible” and would “probably reduce systemic risk”.

In the Financial Times’ “Ten years after Sarbox, time for an audit of the auditors” Francine McKenna writes that the ten year old Sarbanes-Oxley failed to restore investor confidence in the audit process. Just like rating agencies, auditors are “just an oligopoly sponsored by government mandates”. The value of both is questionable given that their operation is heavily challenged by conflict of interest: (1) audit objectivity is constrained by those audited paying auditors directly for the audits, (2) auditors selling “additional services to audit clients” and the clincher is that under Sarbox (3) audit committees have  the “power to hire and fire auditors”. It is time to redesign Sarbox.

And finally, in the Financial Post’s “Most Canadians have no end-of-life plan” Sharon Kirkey reports on the not much discussed “end-of-life plans”: one’s explicit wishes/directives, the non-existence of directives (only 20% have written plans), selection of a substitute decision maker (only 46% have named one), the impact of the explicit or default plan on the family, acceptance of inevitability of death, when to discuss (pre or post crisis) one’s wishes, reversing directives and deciding to live with the limitations, medical intervention to prolonging life or “just prolonging the dying experience”? (You, as I, must have seen too many instances of the latter, not to realize the importance of and the difficulties presented by this subject. Perhaps some quality counseling for self and family might ease the personal decision-making process.)