Has Your Food Budget Soared?

For anyone who has recently shopped for groceries, you may have noticed meaningful price increases.  If you haven’t, perhaps the prices themselves have not jumped, but the packaging has shrunk:

http://www.nytimes.com/2011/03/29/business/29shrink.html

With a tight job market keeping wages relatively flat, food manufacturers are reluctant to raise prices on cost-conscious consumers.  However, their input costs have risen enough where those firms need to generate extra revenue to stay profitable.

Consequently, the quantity of food in a standard package can decline while the price remains the same.  At first glance, a 14-ounce package may not seem all that different from a 16-ounce one.  Buying a 14-ounce can of fruit for the same price you used to pay for a 16-ounce can seem more palatable than having the price increase by 10% one day.

In actuality, a 10% price increase is better for the consumer than the 16 à 14 ounce reduction.

You need to consider unit prices, where measurement is in the denominator.  If the can of fruit remains at $2.00, it used to cost 12.5 cents per ounce [$2.00 / 16 oz].  Now the fruit costs 14.3 cents per ounce [$2.00 / 14 oz].  This 1.8 cent per ounce price increase equates to a 14.3% jump in fruit prices.

Most Americans will be lucky to receive a 2-3% increase in wages and benefits this year, so meaningful food inflation will reduce their discretionary income which supports other economic sectors.  Reductions in food quantity are especially insidious, as many consumers don’t internalize just how much more they are paying for items.

This phenomenon exemplifies the inflation you and I face every day, much of which can be attributed to the Federal Reserve’s “easy money” policies discussed in this previous post.

Source:  http://www.extension.org/mediawiki/files/2/2f/15oz_cheerios.jpg

Campaign Finance Reform

This issue has been a hot-button topic for years and will continue to be.  To alleviate a screaming conflict of interest, I offer a modest proposal for campaign finance reform.  Public sector unions should not be able to direct mandatory union dues to political candidates, and there is ample logic behind this statement.

·         You and I are taxpayers.

·         Government workers are paid by taxpayers.

·         Many government workers are required to join a union and pay union dues.

Therefore, union dues are paid by taxpayers.

·         Unions contribute money to political candidates.

Therefore, unions influence politicians to give them favorable terms when negotiating compensation and collective bargaining rights.

·         The overwhelming majority of union political contributions are allocated to one political party.

Therefore, money is taken from you and me to support political candidates we may agree, or disagree, with.

Setting one’s personal politics aside, this situation is blatantly unfair.

There are two simple ways to make this more equitable, and either one would suffice:

1.       Prohibit public unions from contributing to political candidates

Workers are required by law to pay taxes, and via compulsory union representation and dues, taxpayer money gets directed to finance certain politicians.  These politicians are empowered by unions, so the politicians effectively negotiate on the union’s behalf against their employer (government / taxpayers).

In essence, taxpayers literally pay money so that a group can more effectively negotiate against taxpayers!

2.       Union dues that are allocated to campaign contributions become voluntary

Currently, millions of government workers personally support opponents of union-backed political candidates, yet their union dues are directed against their interests.

Union members should voluntarily contribute to union-backed candidates or have the ability to opt out.

Campaign finance reform is riddled with complexity, but here is an eminently fair, reasonable, and logical approach to protect taxpayers and to better align the preferences of government workers with the unions representing them.

Has the CARD Act Helped You?

For years, members of Congress have named bills with flowery language to increase support for them.  After all, who wants to run a re-election campaign with an opponent blasting you for voting against the Clean Water Act, the PATRIOT Act, or the American Recovery and Reinvestment Act?  By implication, voting against this legislation could brand you as being against clean water, unpatriotic, and against economic recovery.

Another such example was H.R. 627, the Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD Act).  During the midst of the credit crisis and bank bailouts, few politicians wanted to take sides with unpopular credit card companies.  And how could one be against accountability, responsibility, and disclosure?  The bill passed with flying colors:  279-147 in the House, 90-5 in the Senate, and was signed by the President.

By any objective measure, this vote was politically popular, but does that make the CARD Act good law?

Unlike mortgages which have secured collateral in the form of a home, credit card loans are unsecured.  Credit card loans are therefore riskier, so a lender needs to compensate for that risk by charging a higher interest rate.

Additionally, we must accept that some borrowers are much riskier to lend to than others.  Pretend that you are a lender for a moment – what are some important factors that will help you decide whether to lend someone money and on what terms?

·      Credit history à people with poor credit and younger folks with little to no credit history are riskier to lend to

·      Income à people with lower incomes are generally riskier

·      Other debts à if substantial income is needed to service existing debts, this increases a borrower’s risk profile

Source:  http://www.sparkhid.com/CreditCardLOGOSforwebsite!.jpg

Keeping this in mind, you need to be mindful of changing circumstances in order to accurately price for risk.  If a consumer is more than 30 days late on a payment due for student loans or a different credit card account, that consumer certainly becomes more likely to miss interest payments on the credit you have extended to him or her.  To accurately price for the increased risk, it is only natural to raise rates.

However, the CARD Act greatly curtailed a lender’s ability to do just that.  At first glance, this may sound good from a consumer’s standpoint, but it is imperative to dig deeper and examine the bill’s true consequences.  Without chronicling dozens of provisions in the legislation, here is a big-picture summary:

·      Many consumer advocates were heartened by the CARD Act, believing it would stifle what it deemed to be “abusive” and “predatory” practices by the credit card industry

While this approach sounds good in theory, I contend that virtually all consumers were actually hurt by this legislation.

·      Lenders were curtailed in their ability to entice customers with attractive offers, and later modify interest rates if a borrower’s financial situation and creditworthiness worsened.  In effect, people with poor credit histories and financial circumstances would pay enough in fees to help make the industry profitable while it offered more favorable terms for lower risk borrowers and also loyal customers.

Some legislators may have been well-intentioned to help protect struggling constituents who experienced interest rate increases on their credit cards at the first sign of trouble.  It is extremely commonplace, however, for legislation rooted in good intentions to produce a series of adverse and unintended consequences.

Here have been the primary effects of the legislation over the past two years:

1.     Credit card lenders reduced the availability of credit to solid and marginal customers alike.  Recent college graduates are often denied credit, and the ones lucky enough to receive credit have very limited borrowing capacity.  This development is particularly troubling for responsible borrowers with steady income and employment, as building a successful credit history becomes critical later when people obtain mortgages to purchase a house or apartment.

While borrowers with spotty credit histories would purportedly benefit from the CARD Act, it now makes little to no economic sense for lenders to offer credit if they are denied mechanisms to price appropriately.  As a result, many subprime borrowers who have experienced financial hardship and seek to make ends meet no longer have access to credit cards.  Many are instead resorting to payday loans that carry far more exorbitant interest rates than what credit card companies would charge, which only exacerbates the situation.

2.     Interest rates have risen across the board.  With the CARD Act provisions taking effect months after the legislation was signed into law, lenders sought to re-price for risk ahead of time.  Instead of re-pricing on select accounts depending on more individual circumstances, they raised rates on nearly everyone to help offset their future inability to do the former in a timely fashion.  Moreover, many of the fixed rate credit offers were converted to floating rate ones, which will prove significant when interest rates eventually rise.

If you take a hypothetical family with an exemplary credit history but is tight on cash, let’s suppose they had $8,000 in credit card debt at a fixed interest rate of 7%.  Following the legislation’s passage, an account like this would have likely been adjusted to a floating rate, with an interest rate equal to prime + 12% for instance.  Despite there being no change in the family’s own credit profile, it now costs hundreds of after-tax dollars more per year to service their existing credit card debt, which could represent a significant portion of discretionary income that would otherwise be used to boost the economy.

3.     Rewards programs have been curtailed for more stable customers.  At first glance, people who carry a small balance or no balance are not ideal credit card customers because they don’t pay what the firms would consider to be an optimal interest rate.  However, fees are assessed on these transactions, and the low-risk borrowers provide stable cash flows for lenders.  Many of these customers could easily pay in cash for any purchases but instead choose credit cards for convenience and programs that reward customer loyalty.  These rewards programs may include cash-back, hotels, airfare, and merchandise.

To offset a revenue decline from the CARD Act, many lenders scaled back on such programs to help stabilize their bottom line.

In summary, this legislation produced a cascade of bad consequences which affected borrowers across the economic spectrum.  Many of the most vulnerable people became unable to obtain lines of credit, forcing them to seek alternative financing sources that were more expensive than anything they experienced while having access to credit cards.  Customers with good credit histories but tight budgets had their rates preemptively raised ahead of the legislation’s effective date, and they are incurring more financing charges than was previously the case.  The most responsible and creditworthy consumers who valued rewards programs experienced their own economic loss as well from these developments.

Important lessons from the CARD Act should be learned and applied elsewhere.  Politically popular legislation hardly guarantees that it is good legislation that will benefit the country.  It is healthy to apply some skepticism to proposals that sound too good to be true, and there must be recognition of behavioral changes by individuals and companies that could undermine a law’s stated intent.

Source:  http://www.destination360.com/north-america/us/washington-dc/images/s/washington-dc-us-capitol-s.jpg

Golf Course Design Ideas

Despite the immense popularity of Tiger Woods during his prime, the number of American golfers has remained static over the past 15 years.  The sharp economic downturn has certainly harmed the sport, as cash-strapped Americans cut back on nonessential spending.  Golf costs more to play than most sports, making it prohibitively expensive for many aspiring junior players who need to play often to improve their skills.

I don't pretend to have all the answers to solve these dilemmas, but do have some ideas.  Here is one place to start:

Build courses with 12 holes

Golf is a game rooted in history and tradition, and few courses are willing to deviate from the 18-hole standard.  For a humorous take on golf's invention, check out this priceless (warning: expletive-laced) Robin Williams clip:

http://www.youtube.com/watch?v=8qPrR49qsDc

The sport has changed, however.  Holes used to be considerably shorter before equipment advances forced designers to construct longer holes.  Courses used to be 5,500 – 6,000 yards, but numerous venues now exceed 7,000 yards.  It simply takes longer to navigate 18 holes than it used to.
 

Source: http://www.golfclubatlas.com/

My idea of having a 12-hole course offers some distinct advantages:

·      New courses only require 2/3 of the acreage as before, reducing startup costs

·      If 18 holes take 4 ½ hours to complete, 12 holes would take 3 hours.  Those 90 minutes of savings makes the game more accessible.  People with tight schedules, or folks who simply prefer not to play golf for 4 ½ hours, would now enjoy the game more frequently.

·      With shorter rounds, more people can play on a busy day, adding to a course’s revenue

·      Numerous golfers I have come across like to play more than 9 holes, but definitely fewer than 18 if given the option.  Problem solved.

Anecdotally, I often hear complaints that the game takes too long to play.  Despite playing competitively for many years, I frankly agree with this assertion.  For most people in most situations, the marginal benefit of playing holes 13-18 is quite low.  It is easy to get tired and lose focus, resulting in poor play that detracts from the experience.
 

Logistically, the 6^th, 9^th, and 12^th holes should all finish near the clubhouse to provide maximum flexibility for the golfers.

Due to lower maintenance costs, courses could charge less and attract more golfers than before.  Overall, I believe this setup would be an improvement from the status quo for millions of golfers out there.  Also, some future posts will be devoted to other ways the sport can be improved.

TPC Sawgrass in Ponte Vedra Beach, Florida

After a thrilling Masters, the Players Championship is the biggest golf tournament until the U.S. Open.  The famous island green on the par 3, 17^th hole is pictured:

Source:  http://www.golfcourseartwork.com/images/TPC.SAWSTADIUM.17%2796.TG.jpg

Even if you’re not a golf fan, tune in on Sunday, May 15 at around 4:30 PM.  If the tournament is close, the water in play on 16, 17, and 18 makes the finish very compelling.

Roth IRA Guidelines

If you have not received my guide to retirement accounts (5-page Word document) and would like to view it, send me an e-mail at krkreflections@gmail.com .

Relating the National Debt to You and Me

Without a serious reality check on government spending, the United States will endure economic hardship that will make the Great Recession seem like a joyride.

Think of the enormity of one billion (1,000,000,000) of a given item.

For the 2011 budget, we will manage to spend $3,800 billion, compared to $2,200 billion of revenue.

Running a $1,600 billion annual deficit, coupled with a $14,300 billion overall debt, is downright shameful.  Our deficit and debt are incomprehensibly large.

For perspective, imagine developing a budget for you and your family.  Through past excesses, you currently have $143,000 in credit card debt.  Your take-home pay this year is $22,000, but you will spend $38,000.

Furthermore, imagine that you should be saving money now to pay for your kids’ college education in the future.  This major expense can be compared to entitlement programs for retirees, which have not been paid for.  If anything, you should be running a major surplus now to retire existing debt and save money for college.  Unfortunately, this household is hemorrhaging money without caring about consequences.

Clearly, this cannot go on forever.  Your lender is getting anxious and will raise the interest rate as you become less creditworthy.

This action will increase your expenses further and could lead to a suffocating debt spiral.

Any sensible person would consider this situation and try to stave off ruin by paring back expenses from $38,000 to around $30,000 at most.

Of course a different approach is to disparage cuts that would reduce your $143,000 debt by a whopping $600, which is equivalent to the liberal position during the recent budget negotiations.

You would be appalled by the fiscal recklessness of this household and would urge a complete overhaul of expenses to prevent financial doom.  Yet our country’s state of affairs is equally terrible.  Curtailing spending to the levels of just three years ago, which in fact ties to $30,000, would be a completely reasonable and necessary first step.

Like any household, we must determine our absolutely essential expenses and spend little more in order to shore up our finances.  We cannot shirk this responsibility, or we will succumb to a devastating crisis beyond anything we desire to comprehend.

Source:  http://reddogreport.com/

Basics of Housing Finance

Americans purchase homes and finance them with either 100% cash or a combination of cash and a loan.  These financing options are not unique to homes.  Most people take out a loan when purchasing an automobile, and some people purchase stocks on margin.

In all cases, lenders charge an interest rate and seek assurance they will get paid back.

Suppose someone is looking to buy a home that costs $200,000.  Paying for it using 100% cash may be a tall order, so the buyer would seek to borrow money from a bank.  Historically, it is common for creditworthy borrowers to receive mortgages equal to 80% of the purchase price.

In effect, the buyer purchases the home with $40,000 of his/her money, and borrows $160,000 from a bank to close the transaction with the seller.  The seller receives $200,000 before paying a sales commission and retiring any outstanding mortgage debt.

The buyer agrees to pay back the $160,000 mortgage to the bank, according to a payment schedule outlined in a contract both parties legally enter into.  To protect the lender, after a sustained period where the borrower fails to make required loan payments, the lender can foreclose on the property and gain control of it.

Without the home serving as secured collateral, instead of a borrower obtaining a mortgage at 5 or 6 percent, the rate would be closer to the 12-15 percent range, even for folks with good credit.

These concepts will tie directly with a forthcoming post about “underwater mortgages,” where a homeowner’s outstanding mortgage debt exceeds the value of the home.

Proposal for NFL and NBA Salaries

Unfortunately for sports fans, there is a real possibility of a lockout in professional football and basketball, because of disputes over salaries and revenue sharing between owners and players.  This affords an opportunity to consider how compensation is distributed to players.  I contend that most NFL and NBA athletes, plus their families, would benefit financially from receiving more deferred compensation.

According to a 2009 Sports Illustrated article:

·      By the time they have been retired for two years, 78% of former NFL players have gone bankrupt or are under financial stress because of joblessness or divorce

·      Within five years of retirement, an estimated 60% of former NBA players are broke

Source:  http://sportsillustrated.cnn.com/vault/article/magazine/MAG1153364/index.htm

These statistics amply demonstrate the abysmal track record that so many athletes have in dealing with their finances.  Conspicuous consumption, bad investment schemes, and poor life choices are typically to blame.  High profile cases include Antoine Walker and Scottie Pippen, both of whom earned over $100 million during their careers yet have declared bankruptcy.  More typical are NFL players who make high six figures for 3-4 years before their careers are cut short by injury or supplanted by new talent.

For the vast majority of NFL and NBA players, the most money they’ll earn throughout their working years will occur in their 20s and early 30s.  This phenomenon is unique compared to most professions and career paths, which in my view justifies players foregoing some compensation now in exchange for receiving more after leaving the league.

If a player makes over $400,000 let’s say, 25% of their compensation should be mandatorily withheld and paid over a 5-10 year interval (or longer in the case of very highly compensated athletes) once they retire.  That will force their current budget downward to more prudent and sustainable levels, and smooth out their income stream during the toughest years to adjust to financially.

So if a player earns $2 million a year for 10 years, they’ll receive $1.5 million a year during their career and an accumulated $5 million (plus investment gains / interest) that can be distributed to them during their retirement.  By that point they’ll have gained more maturity, discipline, stability, and an income stream which should dramatically reduce the odds of financial ruin.

Unless banks granted players massive loans against their future income stream, I honestly think this framework would solve much of the problem.  I encourage you to submit your thoughts.

Source:  http://www.basketball-clipart.net/basketball_clip_art.jpg

Source:  http://icons.iconarchive.com/icons/icons-land/sport/256/Football-Ball-icon.png

Relationship Between Inflation, Interest Rates, and U.S. Treasury Bonds

Inflation has resurfaced over the past few months as an economic outcome we should all be acutely aware of.  Besides fiscal policy, a huge determinant of inflation is monetary policy established by the Federal Reserve.

In an effort to spur the economy, the Fed is essentially manufacturing money to the tune of $600 billion to buy U.S. Treasury bonds.  If the demand for Treasury bonds rises, pari passu (all things being equal), the price will rise as well.  An increase in bond prices also translates to a decline in interest rates.  Here is a simplified illustration:

Current Bond Price	Interest Rate	End Payment
$80.00	25%	$100
$90.91	10%	$100
$95.24	5%	$100

In this example, the current bond price is what you’re willing to invest today to receive $100 in one year.  The interest rate identifies the rate of return that will entice you to buy the bond (lending money with the promise of being paid back at a later date).  A company or government borrowing money through bonds will pay a lower interest rate if it is viewed a safe investment.

The Fed’s policy of buying Treasury bonds has the effect of keeping interest rates exceptionally low since, pari passu, more demand à higher bond prices à lower interest rates.

In effect, the Fed is trying to keep interest rates lower than what the Treasury market would ordinarily dictate.  Part of the reason is because interest rates on other debts (particularly residential mortgages) are tied to Treasury yields.  This explains why mortgage rates have been at historically low levels over the past 6-12 months.

Debtors are benefiting from these low rates, but there are major costs to this approach.  Savers are earning next to nothing on bank deposits, which depresses their interest income.  Insurance companies and pension funds are also generating less investment income, which is added concern for state pension funds that may be insolvent within a decade.

Furthermore, the Fed’s policy actions are devaluing the U.S. dollar (namely because it is manufacturing $600 billion not previously part of the money supply).  If one U.S. dollar today is believed to be worth less than it was three months ago, pari passu, suppliers of goods and services would raise their prices to compensate.  People’s incomes are relatively static over the course of a year, but anyone who has shopped for groceries or filled a car with gasoline knows that these expenses rose substantially just in the past few months.

These price increases are especially problematic because spending on necessities is increasing while incomes remain constant, effectively making people poorer.  With a constant income, consumers paying more for food and energy takes away from their discretionary income, thus reducing their ability to make discretionary purchases and pay down debt.

An even more troubling scenario is if investors in U.S. government debt become concerned about 1) the country’s ability to pay its debts and 2) the value of future dollars used to make principal and interest payments.  By monetizing the debt, the Fed’s actions are helping stoke these fears, and it is absolutely imperative that foreign and domestic investors do not lose confidence in the U.S. government.  Sustained concern about our debts will drive up interest rates considerably, making it more expensive to service our debts.  Higher borrowing costs will depress the economy, making it even more difficult to repay investors, which in turn produces a death spiral as evidenced by Greece, Ireland, Portugal, and Spain.

Like with so many other fiscal issues, it is tempting to enjoy artificially low interest rates now and deal with the consequences later, but a little sacrifice now could help prevent an economic cataclysm.

Golf in Hawaii

The PGA Tour begins its year at the Kapalua Resort in Maui.  Here is a view of Molokai Island from the golf course:

Source:  http://www.kapalua.com/accommodations/villas/image-gallery.php?album=2

From January thru March, the PGA Tour will host events in Hawaii, California, Arizona, and Florida.  Particularly for those of us who experience winter in northern climates, it is always pleasant to take in the pristine scenery that the world’s best golfers enjoy this time of year.

The Next Time You Shop

Fresh off the holiday season, we were constantly being enticed by retailers to spend money.  This presents an opportunity to talk about tax-effecting.  While this topic isn’t nearly as fun as buying gifts, they are inextricably linked.

When you are saving money to buy presents, have a great dinner, take a vacation, etc., it is natural to view a savings goal in terms of the amount of time you need to work to earn that money.  If someone hypothetically makes $20/hour, it reasons that (after fixed expenses) 5 hours of working can translate to affording $100 worth of purchases.

However, you need to tax-effect your earnings for a true portrayal of how much something costs.  Someone making $20/hour may face these marginal tax rates:  25% federal, 5% state & local, 6.2% Social Security, 1.45% Medicare.  This totals to 37.65%.

Instead of a $100 gift being financed by 5 hours of work, it actually takes 8 hours.  To tax-effect $100 of after-tax income:

Pre-tax = After-tax / (1 – combined marginal tax rate)

Pre-tax = $100 / (1 – 0.3765)

Pre-tax = $100 / 0.6235

Pre-tax = $160

So in actuality, someone making $20/hour would need to work 8 hours to earn $160 pre-tax.  Once taxes are applied, that gets effectively reduced to $100 which enables him or her to make the purchase.

Depending on your income, you can calculate your combined marginal tax rate and use that figure to identify the true cost of whatever you’re purchasing.

As a general rule, the higher your tax rate, the more relatively expensive purchases become.

Applying this concept to the discourse on taxes, it stands to reason that progressive proposals to extract even more tax revenue from higher-income families could produce adverse consequences.  Millions of households would not only experience an income reduction but it would become more expensive for them to consume goods and services.  With 2/3 of the U.S. economy driven by consumption, a pronounced decline in purchases by affected taxpayers would be unsettling for the entire country.  This concept is often overlooked in the taxation debate, but it clearly merits attention and should be given proper consideration when evaluating the costs and benefits of different tax proposals.