Tuesday, January 18, 2005

Younger Americans Going into Debt?

An article at Bankrate.com paints a dire financial picture for America's Generation Xers (ages 25-34).
Americans between the ages of 25 and 34 now boast the second-highest rate of bankruptcy, just behind the 35-44 group. The average credit card debt for this group increased by 55 percent between 1992 and 2001, with the average young adult household now spending approximately 24 percent of its income on debt payments.
The source of the information cited above was from an analysis performed by Demos, self-described purpose as
to help build a society where America can achieve its highest ideals. We believe that requires a democracy that is robust and inclusive, with high levels of electoral participation and civic engagement, and an economy where prosperity and opportunity are broadly shared and disparity is reduced.
The italicized portion of the quote is my doing. I highlighted to draw specific attention to that phrase.

Previous posts here have discussed the general increase in bankruptcies in recent years, but the general observation was that while increases in bankruptcies are a fact, the underlying factors as to why debt increases are difficult to assess.

Bankruptcy Judge Judge John C. Ninfo II is in a position to know about the underlying issues of bankruptcy filings.
He hears the stories behind the numbers: college students who run up the credit card bills each semester, then take out extra on their student loans to pay them off. They graduate with as much as $8,000 in debt from this shell game alone -- plus the last semester's financial flings. "Nobody warned me," is an everyday wail in his world.
To fight this growing problem, he has started
an outreach program called Credit Abuse Resistance Education. CARE's website describes the following view:
Unfortunately, too many of our young people are financially illiterate. Too many of them do not get the information in school or at home that they need to overcome the temptations of overspending and abusing credit. They need and deserve the opportunity to hear a counter-message to the constant “just do it” and “spend, spend, spend” messages they see on television, at the movies, on their computers, and often, in their own family’s spending habits.
It is the hope of the program that students will not go down the road of consumer credit abuse once they understand:
(1) the true cost of consumer credit;
(2) how difficult it is to repay consumer debt incurred to buy and do things that you really can’t afford and don’t need;
(3) the many consequences of financial problems, which are becoming more numerous and serious;
(4) the need to have savings and how to effectively budget with a view towards needs versus wants;
(5) that just maintaining debt is not being able to afford it, affording debt is being able to pay it back; and
(6) it is better to live consumer debt free.
I think it is safe to say that CARE's approach to this problem is one of education. However, does financial literacy help those from the lower income strata?

The director of Demos' economic opportunity program and the lead author of Generation Broke, Tamara Draut, describes the situation facing younger Americans.
Student loan debts have doubled to almost $20,000, she says. "When the car breaks down, there's no savings, so it goes on the credit card. Holiday trips home go on the credit card. All sorts of things end up there because young people have already committed more of their money than we did a generation ago," she points out.

As for those still on campus, many from lower income families don't want to burden Mom and Dad, who have already mortgaged the house for tuition and housing, for daily living items. Charging a bagel with cream cheese is their misguided way of helping out, she says. Draut believes the solution begins with prioritizing the country's financial aid policy and expanding grant-based systems. She's also in favor of state legislation, like New York's, that regulates credit card marketing on state university campuses.

Even if younger Americans had the requisite education, Draut argues that children from lower income levels have to use credit cards to make ends meet. The solution? Expanding grants and financial aid.

As if this weren't enough, Draut continues to describe a bleak situation facing those entering the workforce.
But just-say-no programs won't work for a generation that Draut sees as driven to economic hardship by a starting salary too low to cover rent, utilities and health care. "A lot of young people I talk to know very well the difference between wants and needs, and are still in credit card trouble," she says. Even the crazy, out-of-control spending sprees reflect the economic insecurity of this country in her book.
The Bankrate.com article also includes the perspective of Robert D. Manning, Ph.D., a professor in the college of business at Rochester Institute of Technology. He is the author of Credit Card Nation (a book I've purchased but yet to read) and familiar with the topic at hand: younger Americans and debt. He offers a sober outlook for the future.
Manning says the real answer lies in a society that starts smelling the coffee. "It's essential Americans recognize the promise of unlimited resources is over. The government will not be there for this generation, so they need to start targeting their financial goals in five- and 10-year increments."

True reform, he believes, will happen only through an awareness-building, skill-building and behavioral-change approach. So far, he rates Americans as "barely at the awareness level." Yet he pooh-poohs most literacy programs' effectiveness because they lack a sense of urgency.
Judge Ninfo agrees with this assessment.
"Ninety-nine percent of my bankruptcies can balance their checkbook, they just don't. So we don't teach that because it's not the problem. It's the addictiveness of credit cards we're addressing," he says.
Where does that leave the recently graduated college student? There's no disputing the fact that bankruptcies and credit card debt is on the rise for younger Americans. What's in dispute is the solution.

Judge Ninfo is silent on the financial outlook for Americans, his CARE organization stresses that having a basic financial education about consumer credit, budgeting, and understanding needs vs. wants will go a long way in giving Americans the foundation for success.

Ms. Draut's view of the situation is grim: starting salaries are too low to even pay for the necessities. Just Say No programs are empty words, that do nothing to address the problems. The answer? More grants and financial aid. And prohibiting credit card companies from being able to market their product on college campuses.

While I've never been in a position of financial distress, so I can't speak to the pressures that such people face. However, I do not think that the answer to the problem lies with expanded financial aid and grants. I cannot determine if this pertains to educational financial aid and grants or general financial aid. Assuming this relates to education, it may have the effect of reducing the student loan debt burden for college graduates, it may not be beneficial to everyone.

If the larger expense of college is reduced through grants, the remaining dollars available to spend elsewhere would increase. While this in and of itself isn't necessarily a bad thing (setting aside the government monies to pay for education issue for a moment), the question becomes what does the student do with those additional monies?

Does it go to pay for room, board, and other essentials of life that would have gone unfulfilled or onto a credit card? Or, does the money go for clothes, beer, and other (arguably) non-essential things?

Making a blanket statement to a hypothetical scenario doesn't achieve anything. However, the underlying issue of financial (il)literacy still lurks in the shadows. Does giving extra monies to a college student actually teach them how to better manage their money? Even more fundamental: is it too late to change the financial habits of these college kids?

Friday, January 14, 2005

Assumptions About Retirement

When we initially sign up for that 401(k) plan, the idea is to save money for our retirements. As our 'retirement' is sometime in the future, it is hard to predict how much or when we will be able to retire. Yet we all assume that we'll live that long and the money we set aside today will have grown to an amount that can support us in the future.

Are those reasonable assumptions? Let's take at some of the basic assumptions that we are making in saving money for retirement.

These are just a few of the basic, underlying assumptions I think we all make in investing for the long-term. They are reasonable assumptions to make, yet they are largely out of our control. Can we as individuals ensure the United States will be around in 40 years? Will the rules and taxes surrounding retirement funds be the same? Will we live that long (as individuals)?

This post isn't meant to be pessimistic or alarmist. It's about looking at this distant far off concept (retirement) and trying to understand some of the basic assumptions we all make. when

Wednesday, January 12, 2005

Your Uncle and Your Retirement Funds

Imagine for a moment you were promised a retirement package by your uncle. You gave your uncle a portion of your paycheck every two weeks and you entrusted your uncle to hold onto the money until the day you needed it. When that day came, your uncle gave you the locked box and you opened it only to find pieces of paper on them with the letters 'I O U'.

Angry and confused, you went to your uncle and said, "Okay, give me my money. I'm ready to retire."

His response? "Um, well, I'll be back in a few days. I have to go get it for you." So he goes to your children's house and demands a bigger cut of their paychecks, talks them into taking in less benefits in the future, and also sells them some bonds.

Your uncle comes back to you and gives you your money.

Sound like a scandal? Well, the above situation is a loose analogy to the current status of the Social Security Trust Fund today. The trust fund is full of paper labeled 'I O U'. $1.6 trillion of them to be exact.

Where's the money? Well, it's been spent. According to a Money/CNN article:

But that surplus isn't a pile of cash waiting to be used. In fact, the money -- $1.5 trillion plus interest to date -- has already been spent.

In accordance with the law, the extra money Social Security takes in is loaned to the U.S. Treasury, in exchange for which it receives special-issue Treasury bonds. The actual cash goes into the government's general revenue pool.
The 'full faith and credit clause' of the US government backs these bonds. Ultimately, when the bill (social security retirement payments) comes due, the money will have to be raised to pay the recipients via debt or increased taxes, lower benefit payments, or a combination of the above.

However, let's think about this for a minute. Suppose there was no law requiring the transfer of excess funds to the US Treasury. Instead, the funds remained in an account at the US Treasury for the benefit of the Social Security beneficiaries (retirees). That's $1.6 trillion dollars.

That's a lot of money to be sitting idle. Why not invest it? Well, who would own the fund? What would the investment philosophy be? Who would determine the philosophy? Would the investment philosophy be 'socially conscious'? Essentially, do we want the US government involved in the business of investing public monies in the public markets?

I would be leery of such investment clout residing with an agency of the government. CALPERS board members have recently been criticized for becoming aligned with special interests. CALPERS is America's largest pension fund with ~$170 billion dollars held in trust.

While the above scenario is just a mental exercise, it highlights a problem in keeping piles of retirement money in the hands of the government: it can sit idle (not economically efficient), be invested on behalf of the trustees (thus making a government agency an owner of public stocks), or be spent by the politicians yearly (perhaps the least worst option, in the short run).

A key assumption in the above exercise is that the government retains ownership of the retirement monies. What if individual persons were allowed to keep at least a portion of their monies to invest/save for their retirement? Sure, the ponzi scheme would come crashing down faster, but that day is going to come regardless if we attempt a fix now or wait.

  • Friday, January 07, 2005

    Opting Out of Credit Card Solicitations

    Credit card companies are prolific marketers. Television ads. Sponsorships. And direct mailing.

    Credit card mailings are in the billions. These mailings are offers to individuals to sign up for a company's credit card, transfer balances from old cards, often times, combining the two.

    Do credit card companies blindly mail out solicitations to everyone in the United States? Probably not. Each company, each card, each campaign often has a strategic rationale behind it: targeting college students, unmarried professionals, the business traveler, etc. Even within these categories, the card companies may only want to extend credit to those with 'good credit'.

    Prior to any mailing campaign, credit card companies will develop specific markets they wish to target. A key characteristic is the credit worthiness of the borrower. (Coincidentally, the three main credit bureaus are also in the business of providing this information.)

    Per Experian's 2003 10-k:

    Our customers utilize the information we provide to make decisions for a wide range of credit and business purposes, such as whether to, and on what terms to, approve mortgage or auto loans, credit card applications, identity verification, and similar business uses. Risk management and fraud detection and prevention services enable banks and financial institutions to monitor default rates by proactively managing their existing credit card accounts.

    Experian's 10-k indicates that it has over 400 million persons from across the world. Chances are, if you meet the pre-determined criteria, you will receive a credit card solicitation via mail.

    Are there problems with mass-mailed credit card solicitations? There are at least two. First, the more solicitations received by the consumer are one more opportunity to apply for and receive credit. This is the nexus of one key problem: who is to blame for the credit decision-the lender or the applicant?

    Second, these pre-approved mailings are opportunities for identity theives to steal an application from your mailbox and open up an account in your name. This is very crucial for recent college grads, who move from place to place. Pre-screen offers mailed to old addresses...frightening?

    There is a solution: removing your name from the marketing databases of the credit card bureaus. This gives the individual the chance to reduce the temptation for applying for new credit and reduce the opportunities of identity thieves stealing your mail.

    Below are a few links to help you to opt out:

    The FTC's opt out letter.

    Experian's Opt Out web page.

    A Scandal Bigger than Enron?

    Enron in many ways was the poster child for corporate failures in the early part of this decade. Shareholders lost billions; thousands lost their jobs and their stock options, and some even lost their retirement (unwisely putting much of their funds into Enron's stock).

    To add to the intrigue, the Houston-based Chairman and CEO of Enron was a staunch supporter (fundraiser) for President Bush's election run.

    Have there been any accounting scandals recently, at least to large, well-known companies, involving persons with loose political ties?

    Well, yes there has. Who? Fannie Mae (and Freddie Mac). The initial guestimates of the accounting 'irregularities'? $9 billion. Because of these accounting problems, Fannie recently changed it's auditing firm to Deloitte & Touche. Included in Deloitte's engagement is to reexamine prior year (audited) financial statements.

    Why is this significant? Because Fannie Mae poses significant systemic risk to the US economy. A Federal Reserve economist describes the relationship between Fannie Mae (and other Government Sponsored Enterprises) and the US Government as ambiguous.

    The housing-related government-sponsored enterprises Fannie Mae and Freddie Mac (the "GSEs") have an ambiguous relationship with the federal government. Most purchasers of the GSEs' debt securities believe that this debt is implicitly backed by the U.S. government despite the lack of a legal basis for such a belief.
    The general perception is that if Fannie (or Freddie) gets into trouble, they will be bailed out by the US Treasury. This perception is dangerous. Investors and creditors in Fannie Mae believe there is no default risk (risk of loss). When investors construct their portfolios using this assumption, prudent investment strategies (primarily diversification) are ignored. This leads to greater risk for those investing in Fannie.

    Areas where Fannie may pose systemic risk are in it's derivative portfolio (coincidentally the source of much of the $9 billion error) and in the debt issued by Fannie held by investors, banks, and credit unions.

    Derivatives are nothing new. Accounting for them is. Significant estimates and judgement are required to faithfully present them in the financial statements. Significant changes in value can impact the net worth of the company, favorably or unfavorably. In addition to the valuation and presentation of derivatives, there is also a risk that the counterparty to the transaction will be unable to pay/settle the contract. Holes can open up on the balance sheet when the counterparty cannot pay a receivable due from the failed counterpary.

    Fannie also issues significant amounts of debt/bonds. Investors like these instruments because they are perceived as nearly riskless yet offer a higher yield than government securities (the safest investments of them all).

    If Fannie does default, a hole opens up in the balance sheets of all the holders of Fannie's debt. That hole could wipe out significant portions of retained earnings/net worth, causing the institution to become insolvent.

    As for politically connected, Fannie hires numerous former government officials. Notable (former) Fannie employees were:

    I cherry picked these (there are others/more) but for those that want to hang Enron around Bush, has anyone bothered to hang Fannie's problem on Clinton, as spurious and reaching as it may be to do?

    So, we have a company that poses significant systemic risk to the US economy, has (so far) a $9 billion accounting problem, has switched audit firms, the CEO and CFO have resigned, and former Clinton/government officials were in key leadership positions at the company.

    This scandal, on the surface, is just as serious as Enron, and arguably worse, given the systemic risk Fannie poses to the US economy.

    Does anyone care?

    Saturday, January 01, 2005

    Do You Really Know What's In Your Wallet?

    Mike Hatch, Minnesota's Attorney General, has filed a lawsuit against Capital One alleging deceptive advertising. The advertising is misleading because a low rate is advertised, yet that rate could significantly increase.
    Minnesota Attorney General Mike Hatch filed a lawsuit today against Capital One Bank and Capital One F.S.B. for using false, deceptive and misleading television advertisements, direct-mail solicitations, and customer service telephone scripts to market credit cards with allegedly “low” and “fixed” interest rates that, unlike its competitors' rates, will never increase. In fact, the lawsuit alleges that Capital One increases the interest rate on such cards up to 400% for consumers who trigger a “penalty” rate by defaulting in any number of ways.
    (Editor's Note: State Attorneys General are (usually) statewide elected officials.)

    All lenders, including Capital One, are required to adhere to Regulation Z (Truth in Lending). Often times, this disclosure comes in the form of a folded piece of paper with extremely tiny print. By law, lenders are required to disclosure the terms and conditions of the loan, including situations where the interest rate would increase.

    The complaint reads like a 'bait and switch' scam: bait them in with a great offer and switch the deal on them. The mechanisms by which Capital One can raise rates are referred to as 'penalty pricing' or 'trip-wire pricing' in the complaint. Examples of what triggers the penalty pricing are late payments or being over limit on a Capital One card.

    The complaint also cites the ability of Capital One to unilaterally change the terms of the agreement at any time, including interest rates with limited notice to the cardholder.

    The evidence cited in the complaint does not appear to be completely egregious. In one instance, the rate was increased on the cardholder and she simply closed her account. In another, the cardholder made a payment two days late and his rate was increased. However, the press release asks those who think they have been victimized to call the Attorney General's office.

    Two questions come to mind for me:
    1. Do prospective cardholders read the disclosure statements and understand them prior to using the card?
    2. Should the cardholder be penalized for not adhering to the terms and conditions of the card, specifically for late payments or going over the credit limit?
    Let's ask ourselves another question: will Capital One be a profitable company with a portfolio of credit card loans yielding just 5%? I don't think so.

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