As we deconstruct the subprime fiasco and attempt to fix the problems, everyone has an opinion about where the fault lies for the whole mess. Some claim it was unscrupulous lenders, others say it was reckless borrowing. For the record, I think it was a little bit of both. Whenever we reach the peak points in any cycle, greed tends to distort everyone’s ability to make a rational decision and bad stuff happens.
Were there aggressive mortgage brokers who pushed people into loans that paid more handsome commissions? Sure there were—these are the same types who happily sold IPOs to the public in the late nineties when neither the sellers not the buyers were conversant in the risks that existed. But there were plenty of borrowers who today are crying foul, but back two years ago, were bragging to their neighbors about their low mortgage rates. It seems highly inconceivable that all of the borrowers were poor, unsuspecting souls. As in most booms and subsequent busts, there were probably some small number of out and out fraudulent loans and thankfully we have laws to deal with those. But the rest of those individuals and institutions who were caught up in the greed of the moment are probably paying the price they deserve to pay.
Regardless of where you fall on the blame issue, it is clear that the government is planning to get involved now. On Monday, Treasury Secretary Henry Paulson announced that he is aggressively pursuing an agreement with lenders and investor groups to freeze rates on subprime adjustable rate mortgages at their original levels. The plan is designed to prevent a surge in home foreclosures over the next year or so. I have a split opinion about the government involvement: as an investor, I like any action that helps to restore confidence in the economy and when Uncle Sam keeps your mortgage payments lower, you may have a few extra bucks to pump into the economy.
But then the CFP® in me takes over and becomes angry about the proposal. It’s people like me who kept providing counsel to clients, radio listeners and TV viewers, to “stick to the plain vanilla thirty-year fixed rate mortgage!” Now when there is supposed to be some sort of relief as a result of “doing the right thing”, the government pokes the responsible folks in the eye! The bail out seems unfair to those would-be homeowners, who waited patiently as they accumulated their 20% down payment to qualify for a conventional mortgage. To add insult to injury, the good guys now have to face the fact that as taxpayers, they will be forced to help bail out their irresponsible neighbors. Ouch—that smarts!
Wednesday, December 5, 2007
Nuanced Notions Part 1
When the dot-com bubble burst, I was quick to judge my industry and my peers. I spoke up for the “little guy” and held in contempt those professionals that I thought took advantage of unsuspecting investors. How else to explain how 70-year old Mrs. Jones ended up with a $1 million IRA account? With a few years and a bit more wisdom, I have come to believe that it usually takes two to tango.
I have come to regret some of the harshness of my past criticism because it too quickly placed blame without a more nuanced understanding of how greed can grip buyers, sellers, promoters and even regulators. Please know that this is not to say that at any given time, there are some bad guys who do bad things. But generally speaking in my experience, those are outliers. That is why I approach the subprime issue with a bit more of a balanced approach. It’s time to come to terms with how the situation emerged, where the fault lies and the solution to get out of this mess.
No matter what kind of crisis emerges in the financial markets, it usually boils down to two simple concepts: greed and fear. When boom times occur and greed grips the landscape, people are careless. When I say people, I mean institutions, individuals and regulators. Everyone forgets all of the important lessons that we have learned in the past. That’s what happened in the late nineties---at some point, investor amnesia took hold and all of the sudden concepts like risk, over-concentration in individual sectors/industries and realistic performance expectations went out the window amid cheers of “it’s different this time!” Then something bad happens and fear infects the environment.
Now we have the same revisionist history when it comes to the subprime lending crisis. When interest rates dropped to rock-bottom levels, it encouraged financial service professionals to create new ways to put the cheap money to work and allowed “subprime” (those with low credit scores) and “Alt-A” borrowers (those who attained mortgages without having to support their income and asset levels with the normal documentation) to borrow money and purchase homes when maybe they should have been more conservative in their behavior.
When housing prices were rising and interest rates remained low, everything was fine. But as the market changed, so too did the ability of some of the borrowers to repay their loans, causing delinquencies and defaults. Now, many of the subprime and Alt-A borrowers are forgetting that they had something to do with this mess.
Earlier this week, no less than the venerable Wall Street Journal, seemed to imply that many borrowers were “duped” by unscrupulous lenders. Tomorrow, I will discuss whether these claims have merit and if they do, what are the ramifications for the housing and mortgage market.
I have come to regret some of the harshness of my past criticism because it too quickly placed blame without a more nuanced understanding of how greed can grip buyers, sellers, promoters and even regulators. Please know that this is not to say that at any given time, there are some bad guys who do bad things. But generally speaking in my experience, those are outliers. That is why I approach the subprime issue with a bit more of a balanced approach. It’s time to come to terms with how the situation emerged, where the fault lies and the solution to get out of this mess.
No matter what kind of crisis emerges in the financial markets, it usually boils down to two simple concepts: greed and fear. When boom times occur and greed grips the landscape, people are careless. When I say people, I mean institutions, individuals and regulators. Everyone forgets all of the important lessons that we have learned in the past. That’s what happened in the late nineties---at some point, investor amnesia took hold and all of the sudden concepts like risk, over-concentration in individual sectors/industries and realistic performance expectations went out the window amid cheers of “it’s different this time!” Then something bad happens and fear infects the environment.
Now we have the same revisionist history when it comes to the subprime lending crisis. When interest rates dropped to rock-bottom levels, it encouraged financial service professionals to create new ways to put the cheap money to work and allowed “subprime” (those with low credit scores) and “Alt-A” borrowers (those who attained mortgages without having to support their income and asset levels with the normal documentation) to borrow money and purchase homes when maybe they should have been more conservative in their behavior.
When housing prices were rising and interest rates remained low, everything was fine. But as the market changed, so too did the ability of some of the borrowers to repay their loans, causing delinquencies and defaults. Now, many of the subprime and Alt-A borrowers are forgetting that they had something to do with this mess.
Earlier this week, no less than the venerable Wall Street Journal, seemed to imply that many borrowers were “duped” by unscrupulous lenders. Tomorrow, I will discuss whether these claims have merit and if they do, what are the ramifications for the housing and mortgage market.
Tuesday, December 4, 2007
Holiday Cheer: Part 1
The year is winding down quickly and as I peruse the calendar, I realize that there is not much time to take advantage of some year-end financial action items. To help you maximize the time left in the year, over the next few weeks, I will provide tips for end-of-year planning, which hopefully will allow you to save or make more money before Santa arrives.
Today we’ll start with one of the best places to find money: in your taxable portfolio. While 2007 should have been a pretty good year for most investors, you may also find some assets that still have losses from the bad old years. Now is a great time to assess your portfolio and position it for the year ahead. Obviously taxes are not the only reason to buy or sell an investment, but if you can reap tax advantages while diversifying your portfolio or adjusting your asset allocation, you should definitely do so.
Consider selling the following assets:
Securities that have performed well this year, but whose prospects for continued growth are limited
Securities that have risen, causing your overall asset allocation to be different than your risk tolerance would suggest
Mutual Funds that have large capital gains distributions
While it makes sense to sell some losers, not all losers are created equal. Try not to alter your overall asset allocation strategy by selling too many investments. The best way to do this is to replace the loser with a similar asset, without facing the “wash-sale rule,” which is the IRS rule that ensures that you are not taking losses in one security as you invest in a “substantially identical” investment within 30 days of your sale. One way to avoid this is to replace a traditional open-ended mutual fund with a cheaper exchange-traded fund, thereby taking your loss and reducing the fee you pay for your investment.
Additionally, if you are thinking of dumping out of a loser mutual fund, do so quickly. Most mutual funds distribute annual capital gains during the month of December so if you are planning a year-end sale, get going! Remember that even those mutual funds that have gone down this year could still distribute long-term capital gains. Additionally, some funds are distributing large gains, while other similar funds may not. Consider swapping funds to reduce taxable distributions.
Beware of potential tax law changes: Until 1997, the long-term (investments held for over one year) capital gains rate was 28% and was then reduced to 20% until 2003. Since the tax cuts of 2003 were enacted, the top rate of long-term capital gains has been 15%, but it's set to rise to 20% in 2011. While it would be nice if capital gains rates stayed at these rock-bottom levels, it is probably more realistic to assume that rates will increase in the future. Many tax experts expect that if a Democrat assumes control of the White House, he or she will move quickly to raise the top rate even higher than 20%, perhaps back to 28%.
While I am never one to let the tax tail wag the investment dog, I have been advising clients to consider selling off concentrated low-basis positions in 2007 and 2008 to capture the current rate, as long as selling the asset will better diversify the portfolio. The potential window of opportunity could save significant dollars and perhaps might push you to do something that you have been meaning to do for some time (“I really should sell off some of Nana’s IBM, but I hate to pay the taxes!”) You should consult your advisor or accountant to discuss the implications of executing this strategy. Clearly investors should sell assets only after careful consideration of individual circumstances.
This is just a start—next week, we will discuss additional year-end strategies to boost your holiday cheer!
Today we’ll start with one of the best places to find money: in your taxable portfolio. While 2007 should have been a pretty good year for most investors, you may also find some assets that still have losses from the bad old years. Now is a great time to assess your portfolio and position it for the year ahead. Obviously taxes are not the only reason to buy or sell an investment, but if you can reap tax advantages while diversifying your portfolio or adjusting your asset allocation, you should definitely do so.
Consider selling the following assets:
Securities that have performed well this year, but whose prospects for continued growth are limited
Securities that have risen, causing your overall asset allocation to be different than your risk tolerance would suggest
Mutual Funds that have large capital gains distributions
While it makes sense to sell some losers, not all losers are created equal. Try not to alter your overall asset allocation strategy by selling too many investments. The best way to do this is to replace the loser with a similar asset, without facing the “wash-sale rule,” which is the IRS rule that ensures that you are not taking losses in one security as you invest in a “substantially identical” investment within 30 days of your sale. One way to avoid this is to replace a traditional open-ended mutual fund with a cheaper exchange-traded fund, thereby taking your loss and reducing the fee you pay for your investment.
Additionally, if you are thinking of dumping out of a loser mutual fund, do so quickly. Most mutual funds distribute annual capital gains during the month of December so if you are planning a year-end sale, get going! Remember that even those mutual funds that have gone down this year could still distribute long-term capital gains. Additionally, some funds are distributing large gains, while other similar funds may not. Consider swapping funds to reduce taxable distributions.
Beware of potential tax law changes: Until 1997, the long-term (investments held for over one year) capital gains rate was 28% and was then reduced to 20% until 2003. Since the tax cuts of 2003 were enacted, the top rate of long-term capital gains has been 15%, but it's set to rise to 20% in 2011. While it would be nice if capital gains rates stayed at these rock-bottom levels, it is probably more realistic to assume that rates will increase in the future. Many tax experts expect that if a Democrat assumes control of the White House, he or she will move quickly to raise the top rate even higher than 20%, perhaps back to 28%.
While I am never one to let the tax tail wag the investment dog, I have been advising clients to consider selling off concentrated low-basis positions in 2007 and 2008 to capture the current rate, as long as selling the asset will better diversify the portfolio. The potential window of opportunity could save significant dollars and perhaps might push you to do something that you have been meaning to do for some time (“I really should sell off some of Nana’s IBM, but I hate to pay the taxes!”) You should consult your advisor or accountant to discuss the implications of executing this strategy. Clearly investors should sell assets only after careful consideration of individual circumstances.
This is just a start—next week, we will discuss additional year-end strategies to boost your holiday cheer!
Monday, December 3, 2007
Maybe I can Protect you from Yourself…
Last week I wrote about “Jack”, a client who had directed us to liquidate all of the securities in his account. Despite our exhortations, Jack was unflappable and all of the positions were sold on MONDAY---yes, last Monday, which was the day before the big back-to-back stock market rally on Tuesday and Wednesday.
Jack came in on Friday morning to provide me with the rationale for his action. As I walked into the office, I looked at him and said, “I am so mad at you! How could you do that to my beautiful portfolio?” Jack grinned sheepishly and admitted that he knew that I would give him an earful about his bail-out. After an eight-year relationship with Jack and his wife, I wondered why he did not even ask to talk to me about the decision. The answer was obvious: had Jack spoken to me, I simply would have not let him do it and he very desperately wanted to sell.
“When I realized that I had lost $20,000 in one week, it just made me go off the deep end,” he admitted. When I probed further, Jack said that he had felt worried over the summer, but when the markets recovered, he thought that we had dodged a bullet. As the downside pressure mounted, he became more and more anxious. “Why didn’t you call me to talk about it?” I wondered. He just didn’t want to feel like a wimp, but then time wore on and the emotions grabbed hold.
I told Jack that even if he was right for a few days and the market continued to slide, his rationale was ill-founded. Then I went back to the drawing board and reminded Jack that he had a balanced portfolio; that he did not need to access the money in the account for at least a few years; that the account was up 7.5% this year; and most importantly, that he pays me to actively manage this money for him, so he had to let me do just that. He heard all of my explanations and said, “What should I do now?” Ah, the magic words that I needed to hear!
Last week I noted that Jack would be faced with a terrible decision: “either admit that he made a mistake and get back into the market or significantly reduce his spending while sitting in a money market account.” Thankfully, Jack chose the former and by the end of the day, his portfolio was repositioned. The snap decision cost Jack a few bucks, but in the end, at least he had the wisdom to see the error in his ways. Every so often, maybe I can help protect people from themselves!
Jack came in on Friday morning to provide me with the rationale for his action. As I walked into the office, I looked at him and said, “I am so mad at you! How could you do that to my beautiful portfolio?” Jack grinned sheepishly and admitted that he knew that I would give him an earful about his bail-out. After an eight-year relationship with Jack and his wife, I wondered why he did not even ask to talk to me about the decision. The answer was obvious: had Jack spoken to me, I simply would have not let him do it and he very desperately wanted to sell.
“When I realized that I had lost $20,000 in one week, it just made me go off the deep end,” he admitted. When I probed further, Jack said that he had felt worried over the summer, but when the markets recovered, he thought that we had dodged a bullet. As the downside pressure mounted, he became more and more anxious. “Why didn’t you call me to talk about it?” I wondered. He just didn’t want to feel like a wimp, but then time wore on and the emotions grabbed hold.
I told Jack that even if he was right for a few days and the market continued to slide, his rationale was ill-founded. Then I went back to the drawing board and reminded Jack that he had a balanced portfolio; that he did not need to access the money in the account for at least a few years; that the account was up 7.5% this year; and most importantly, that he pays me to actively manage this money for him, so he had to let me do just that. He heard all of my explanations and said, “What should I do now?” Ah, the magic words that I needed to hear!
Last week I noted that Jack would be faced with a terrible decision: “either admit that he made a mistake and get back into the market or significantly reduce his spending while sitting in a money market account.” Thankfully, Jack chose the former and by the end of the day, his portfolio was repositioned. The snap decision cost Jack a few bucks, but in the end, at least he had the wisdom to see the error in his ways. Every so often, maybe I can help protect people from themselves!
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