March 2010

March 25, 2010 03:00 p.m.
Housing, Health, and U.S. Debt

We continue to learn more about that huge health care bill. The latest nugget is that there will be a new government-sponsored long-term care plan. I’m still unearthing the details. What I’ve seen so far is that the plan will be optional, but you have to opt out of it. You pay money into the plan. If you need long-term care in the future and have been into the plan for at least five years, you’ll receive $50 per day to help pay for the care. I’ll have more on this and other developments in coming issues of Retirement Watch.

As we warned in the April issue of Retirement Watch, big changes are likely in the mortgage markets. There’s the potential for another avalanche of mortgage defaults in the next 12-18 months. To avoid this, the government wants lenders to simply write off part of the debt for these borrowers and knock the mortgage balance down to the current market value of homes or less. It looks like that’s happening now. Bank of America announced it was doing this “voluntarily” for some mortgages, and related programs are on the way. See this summary of the latest developments.

Meanwhile, the residential real estate picture remains dismal. Sales of new and existing homes had a brief surge thanks to a slew of government support programs. Recently, the market began sliding back down and remains at close to its lowest all-time levels. Here’s another good summary of the weakness in that market.

Finally, yesterday’s treasury bond auction could mark a turning point. Since the U.S. government accelerated its deficit spending and debt in 2008, analysts, economists and investors expected the high debt level to trigger higher interest rates and perhaps a flight from the treasuries. Until yesterday, that seemed somewhere in the future. Yesterday, however, investors started to turn away from treasuries. The Treasury offered a new bond issuance, and it didn’t go well. After the auction, investors sold off all treasuries. This is why we haven’t had treasuries in our recommended portfolios for some time, and why PIMCO’s Bill Gross and others have been reducing their treasury holdings. It may be an overreaction as some say in the article, or it could be a sign of things to come. That’s the problem with riding momentum that is contrary to fundamentals. You don’t know when the market will change, and you don’t know how sharp the turn will be.

March 23, 2010 10:00 a.m.
Health Overhaul and You

One thing I can tell you for sure about the new health care is that there is a lot of uncertainty. The main law is over 2,000 pages, and the House of Representatives passed a second law that it expects the Senate to pass in a few days. Of course, as the details become clear there are likely to be amendments before all the provisions of these laws even take effect. In addition, there will be lawsuits. States are suing over several provisions. Companies and individuals also are likely to litigate some parts of the law.

Most importantly, many details will be filled in by regulations and rulings. Government agencies have the power to determine the content and coverage of insurance policies, set premiums, set the profit margins of insurers, and set the rules of the marketplace. All those details are years away.

The changes are phased in. Some take effect almost immediately while many wait until 2014. Here’s a summary of the major changes and what you need to know. Of course, we’ll have more details in Retirement Watch over time as they become clear.

? In 2014 federal government will set formulas for Medicare payments to insurers and medical care providers and define “essential benefits” insurers must provide. The agency also will set rules on how insurers verify claims and pay doctors.

? An Independent Payment Advisory Board will be created to recommend Medicare spending cuts. In 2014, the recommendations of the board, appointed by the President, take effect unless Congress takes other action. Analysts believe this panel is most likely to affect prescription drugs and medical devices.

? Medicare Advantage plan members may lose their plans or some of their benefits. A major way the new benefits under the law are paid for is by reducing reimbursements to Medicare Advantage insurers. The reimbursement rates will be frozen in 2011 and gradually reduced after that, so you and your insurer have time to adjust to the changes.

? Medicare soon will pay for annual wellness visits and will increase reimbursements to primary care physicians. The annual wellness visits (instead of the current one-time welcome to Medicare physical) are supposed to decrease long-term costs by finding problems early. The increased reimbursements to physicians might alleviate the problem Medicare members have finding doctors who will accept them as patients.

? The Part D prescription drug program will have a change in the doughnut hole or coverage gap. In 2010, those in the doughnut hole will receive a $250 rebate. In 2011 they will receive a 50% discount on brand-name drugs. In 2020, the doughnut hole will be closed and 75% of prescription drug costs will be covered under Part D.

? There are a range of programs that hope to achieve savings in Medicare to pay for these benefits. The Independent Payment Advisory Board we discussed. The program also hopes to avoid duplication of services and to coordinate care for people with chronic conditions through quality of care awards. Variations in cost and treatment around the country are supposed to be reduced by test programs. Also, more money is being put into the system to combat fraud.

? Some taxes will increase. The main one is the Medicare payroll tax. First, the rate will rise from the current 1.45% to 2.35% for individuals earning more than $200,000 and couples earning $250,000 and more. Starting in 2013, these groups will pay a new 3.8% tax on capital gains and other investment income.

? In 2014 states may create and run online exchanges, or markets, for medical insurance. Consumers can comparison shop there. States may merge their exchanges with neighboring states, allowing consumers access to more policies. States also will be able to ban insurers from their exchanges for excessive premium increases.

There is much more in the law. You can read about the headline provisions, such as subsidies for premiums up to certain income levels and guaranteed issue, in other places. We’ll uncover more details over time and as regulations are issued.

To view a good summary of the different laws and provisions, go to www.kff.org. The best criticisms of the bill were from former Senator Bill Frist in an interview on CNBC. It avoids all the political rhetoric and slogans and focuses on details, incentives, and substantive issues. If you want a good account of how individual House members were persuaded to vote in favor of the plan, read this account.

March 19, 2010 11:0 a.m.
China, High Yield Bonds, and More

There’s been a lot of financial news in the last week. The bankruptcy examiner issued an extensive report on the Lehman Brothers failure that received a lot of attention. The health care overhaul sponsored by the administration is scheduled for a vote in the House of Representatives on Sunday. Here are a few items of importance I came across that haven’t received as much attention.

Doctors and patients continue to drop out of Medicaid, the program for those with low incomes. For years I’ve mentioned that a major problem of retirees in the Medicare program is finding a doctor who will accept new Medicare patients. The government continues to reduce its reimbursements under Medicare and Medicaid. Each reduction causes more doctors to either decline new patients in the government programs or terminate all patients in the programs. This process is likely to accelerate under either current law or the proposed reform as government seeks to control costs. Here’s another factor few people mention: As more people are covered under the reform proposal, demand for medical care will increase. You’re likely to have more trouble finding a doctor. If you have a good doctor, stick with him or her. If you’re thinking of moving, be sure you’ll be able to find a good doctor in the new location. Some areas have acute shortages of primary physicians, especially those who do a good job with older Americans.

The value of the Chinese currency drew a lot of attention this week. Members of the House of Representatives sent a letter to the Treasury Secretary, asking that he find that China is manipulating its currency. Multinational U.S. companies have been railing about China’s fixing its currency to the dollar for years. They claim the dollar is artificially high against its Chinese counterpart, and this makes it harder for them to sell to China. There are problems with China’s currency policy, but that isn’t it. One problem is that the Federal Reserve determine’s China’s monetary policy when the currency fix is maintained. China is growing much faster than the U.S., so China risks importing inflation from the U.S. The real problem is China’s government accumulates a lot of dollars to maintain the currency balance. It invests these primarily in U.S. treasury and agency bonds. This practice kept U.S. long term interest rates low through the last boom and contributed to the bubbles in housing and other assets. China needs to allow its citizens more freedom to trade and exchange currencies to avoid this problem.

A good review of the points of the debate is in this article summarizing the arguments of economist Paul Krugman and money manager Steve Roach.

The Fed released its quarterly Flow of Funds report in the last week. The report, which we cover regularly, documents the net worth of U.S. households, among other things. The headlines accompanying the report indicated net worth increased, debt declined, and households were in better shape. The report isn’t as optimistic. The debt decline was due largely to foreclosures, defaults, and bankruptcies. The level of debt as a percentage of either household assets or net worth still is very high, though below the extreme highs of 2007. Much of the increase in net worth in the last year is due to the stock market rally. That is something that can reverse quickly. The bottom line is that there still is a lot of deleveraging to come.

Another sign we are not out of the woods yet is the large amount of high-yield debt coming due for corporate borrowers in the next few years. This year many have avoided default by being able to refinance the debt with their lenders in a process known as “extend and pretend.” Investors had a great appetite for high-yield debt in the last year, but there are signs they’ve taken on enough. The article points out that 2012 will be the key year. If firms aren’t able to refinance before then, or the economy does not help them out, there could be a lot of defaults on the way.

Thinking of starting a business in retirement or to bridge the years between now and retirement? It’s a popular idea, and the tough job market causes more people to consider it. This piece from the New York Times gives a good review of the positives and negatives of the decision. It’s something you need to think through carefully before making a move, especially before investing your retirement funds in it.

March 9, 2010 06:50 p.m.
One Year After Peering Into the Abyss

It’s been a year since stock indexes bounced off their bottoms from the financial crisis, and the indexes have had an historic rally. The indexes generally rose over 70% from their lows, though right now they are below their recent highs. Bespoke Investment has a good summary of the returns from various indexes and stocks since the bottom.

The past is interesting, but the important question is what should we expect next? Many people are optimistic because of the changes in the markets and economy over the last year. It’s easy to find investors and analysts explaining why they are optimistic that we are early in a long-term bull market. The basic argument is that we are in a normal cycle. When the Fed starts to ease, the economy and markets recover. I’ve taken a different position. I believe we remain in a long-term bear market (which began about 10 years ago) and the last year has been a powerful bear market rally. Here, in summary, is why I believe this:

The traditional bull market and economic recovery is sustained by a long period of borrowing by individuals and business to make investments and buy things. Americans are so leveraged now that we are in for a long period of deleveraging. People can’t and won’t borrow. I watch the credit markets for signs this isn’t so, but I don’t see them yet. In fact, there’s a good chance we’re in the early stages of another phase of mortgage defaults and home foreclosures.

Much of the economic recovery over the last year is due to government actions and inventory rebuilding because businesses cut back too much at the end of 2008 and early 2009. There are few signs the economic growth we have can be sustained without the government support.

Despite all the government efforts, the economic recovery is weak. It is not strong enough to reduce the unemployment rate by much. The massive layoffs appear to be ending, but businesses don’t appear to be on the verge of re-hiring many of those they laid off.

The main reason people differ on how to interpret recent economic data is where they direct their focus. Most of the optimists focus on the recent rate of change, especially when compared to data from a year ago. The rate of change of much data is good, though not all of it and even some of the positive data is not comparable to the average for an economic recovery.

I tend to focus on the actual levels of the data. Most levels of economic activity are quite low compared to the economy’s peak in 2007. The economic decline was extremely steep. At current rates, it will take a number of years for activity levels to return to their peaks. Stock prices still are well below their 2007 highs, but they are high relative to economic activity levels.

The props under the economy were temporary and are being withdrawn. This will be a real test of the economy and markets.

The main point of optimism is that governments seem to have learned not to allow another major failure such as Lehman Brothers. They’ll do whatever it takes to avoid that. But that also means government debt will increase. We won’t have another liquidity crisis, I think. I expect the first half of 2010 to be okay. But the second half of the year could get rough as government support is reduced. Longer-term I expect a period of slow economic growth with high levels of government debt and spending that crowd out the private sector and risk declines in currencies.

March 5, 2010 03:15 p.m.
Warren Buffett, Bernie Madoff, and Buy-and-Hold Explored

Berkshire Hathaway issued its annual report last weekend with another edition of the famous Warren Buffett shareholder letter. This year’s letter doesn’t seem to contain as much varied commentary and bon mots as many past letters, but it’s still a good read. His discussion of the reasons for purchasing Burlington Northern is a good commentary on the economy’s long-term prospects. The past letters are worth re-reading periodically. That’s why I keep a permanent link to them on our web site

At the other end of the financial world, Bernie Madoff doesn’t seem to go away. The Feds seem to be near discovering the gang who helped him. (I never believed he was able to pull it off alone.) More interesting is the book from the hedge fund manager who tried to tip off the SEC about the scam. He details the difficulty of convincing the SEC how obvious the scam was. It’s another story that makes you realize all the good causes your tax dollars are going to. Some good overviews of the book are available here, here, and here.

Vanguard is the leading proponent of buy-and-hold investing. We’ve pointed out many times that buy-and-hold is good only in a bull market. We don’t encourage market timing, day trading, or the other options Vanguard offers in comparison. Instead, focus on risk management. Here’s an interesting example of how one of Vanguard’s marketing tools backfired. Vanguard’s web site has an interactive graph that compares buy-and-hold with what Vanguard calls emotional investing. But the graph allows investors to plug in different trading rules. This web site posted the Vanguard graph. Read the comments. The commentators explain how you can change the inputs so that emotional investing beats buy-and-hold, often by a sizeable margin.

Is it time to dump your checking account and use only credit cards to pay your bills? I know a few people who’ve ventured down this road, primarily because they have enough funds at their brokers that they get fee-free money market accounts with checks and debit cards. Here’s an article exploring how you might go about creating a bank-free world. It’s still too much work for most people now, but a few more increases in bank fees would make it practical.

Before moving for retirement or to re-locate for lower taxes, it’s a good idea to check all the taxes imposed in the prospective areas. Bankrate.com has a nice map that is helpful. It shows all the state-level taxes imposed and tips you off to the types of local taxes. It doesn’t reveal all the local taxes, but it does let you know which ones to look for in each state.