Financial Literacy

One government retirement plan was just closed out as a colossal failure last year, and the statists are pressing for yet another government-run savings account. At a Detroit Economic Club speech last month, the billionaire Executive Vice Chairman of Blackstone, Tony James, wants a national savings account that is mandatory for all employees. James and a labor economist, Dr. Teresa Ghilarducci, co-authored a new book to promote this retirement account along with corresponding tax credits.

Let’s review a few off-hand problems with their plan:

• Social Security is already a mandatory government retirement account that has become mis-managed. The moment budgets got tight, politicians effectively replaced the cash with some “custom” U.S. Treasury debt instead. If social security were viewed as an investment, for many groups of people the return is negative (depending on your marital status and how long you live). Social Security is scheduled to be broke in 16 years and Medicare is scheduled to be broke in 8 years. This account will be no different.
• The last national retirement account, Obama’s MyRA, was launched by the federal government in 2014 and cost $70 million to start-up. This horrible account was shut down in under 3 years for lack of participation. When people reject bad statist ideas, the statists respond by trying to make them mandatory.
• As history has proven, all of the state-run college funds underperform and over-charge.
• For the last 16 years, James has worked for Blackstone, the giant money management company. What better way for James to make more money than mandate another big pot of money to manage and siphon fees. Mr. James hasn’t been so forthcoming with this conflict of interest. Meanwhile, Dr. Ghilarducci, a labor economist and Hillary Clinton adviser, and wants ALL current retirement accounts to be controlled and managed by (wait for it) the U.S. Department of Labor. Where presumably, Ghilarducci would have had a job if Hillary Clinton had won the 2016 presidential election.
• The 3% savings rate that James advocates cannot mathematically add up to any kind of notable amount of money. It certainly cannot become a major part of someone’s retirement income, although their book argues that it will. Particularly if the money is placed into his recommended annuity; the highest fee-laden insurance/investment product that exists.
• Every few years, U.S. Congress tries to raid retirement accounts because they are easy targets: IRAs, Roth IRAs, 401(k)s, etc. and this new account will be no different. Once the account is started, there will soon be members of congress clamoring for “means testing” to get your money back. Meaning, if you earn over a certain threshold amount, then you are disqualified from receiving your fair-share of your money back. Then that threshold will be ratcheted down.

If the last +2,000 years of government handouts are any guide, then Washington politicians and Wall Street will be the only ones who benefit from this government savings account. Maybe a few crumbs might make it to retirees. A mandatory saving account is still stolen money. Your hard earned-money is taken from you, placed into a prison of high-fee, low-return investments, and maybe you’ll get a little back after you retire. That is the optimistic scenario – it is more likely that the government will change the rules so you effectively get very little back.

So what should be done about a low national savings rate?

I have observed only three inciting forces that raise personal savings rates:

1. Ongoing financial education and exposure to personal financial concepts.
2. Experiencing financial struggle from a lack of savings, either you or someone close to you.
3. A broad economic calamity: economy collapse, currency collapse, hyper-inflation, etc. lasting enough years so that a high savings rate becomes ingrained in the culture.

The government could help more people, at a speck of the cost, by providing early financial education instead of another doomed socialist program.

As background: the State of Illinois has the worst credit rating of any state, has chronic budget deficits, and the City of Chicago is in even worse financial shape. Instead of addressing structural problems to reverse its situation, the state doubled the income tax rate in 2012. Three years later, Chicago had the largest property tax increase in history, by $1,750 per household.

The State of Illinois just passed a new budget that included a series of additional tax increases: sales tax, income tax, and business tax. Not only were taxes increased, they are retro-active back to January 1, 2017, a year and a half ago. Going forward, the average Illinois household will pay an additional $1,125 per year.

A few details of their new plan:

• Income tax will be 4.95%
• Corporate income tax will be 7%
• Sales tax of 6.25% is expanded to many other services
• Increases in cable and satellite TV taxes
• Reductions in business tax deductions

By raising all kinds of taxes, the state can ignore its runaway spending and increasing pension liabilities.

As long as residents allow more tax increases, then state unions and politicians will have no interest in changing from pensions to affordable 401(k)-type retirement plans.

Let’s review a few of the effects, so far, from the Illinois state government mis-management:

1. Since 2013, there has been a steady and increasing stream of companies moving from Illinois to neighboring Indiana, and some to Missouri or Wisconsin. Not only small businesses but large manufacturers such as Mitsubishi Motors, Heinz, and General Mills. Although global giant, Caterpillar, is headquartered in Illinois, the company CEO, Doug Oberhelman put it bluntly, “We are building dozens of new factories in other states and Illinois is NOT in the running for such projects.”
2. There has been a net migration of residents leaving Illinois for years. I know a family that moved from Chicago to Missouri last year because they didn’t see the “tax increase train” turning around anytime soon. And they were afraid of some new government fiasco would unexpectedly damage their home’s value. Think about this: they left the state because of their fear of even more catastrophic moves by the Illinois government.
3. To avoid high Illinois prices, many residents already travel to Indiana to buy regular goods. Now, an increasing number of people from Illinois drive to Indiana to purchase any big-ticket items like appliances or vehicles.
4. Chicago’s Mayor has jacked up the cost of every minor fine, tax, permit, sticker, and fee the city can get its hands on.
5. Even worse, local court systems are financially supporting themselves with aggressive “civil asset forfeitures.” This means randomly impounding your car for huge fines or just stealing your car and auctioning it off and keeping the cash. Social media, particularly around Chicago, has all kinds of stories of “pulled over for an alleged broken tail light” and only getting their car out of impound after thousands of dollars. The city and county each play by their own rules so the city can dismiss a case against you and yet the county couldn’t care less – they’ll still keep your car.

Illinois has a few other self-inflicted business problems: the 4^th highest business tax, ranked 42^nd in regulatory burden, 4^th highest workers compensation insurance, and it is not a Right-to-Work state (no forced union membership). So the State of Illinois continues to be uncompetitive compared to its neighboring states, kicking the can down the road for reductions in pensions and spending, and continuing its worst-in-the-nation credit rating.

What did the famous Nobel-winning economist, Milton Friedman of the University of Chicago say about this type of situation 50 years ago? “Higher taxes never reduce a deficit. Governments spend whatever they take in, and then whatever they can get away with.”

From households to banks to countries, nothing is more predictable than a financial calamity resulting from mismatching assets and liabilities. In order to be sustainable, a debt needs to match the asset that supports it: the maturity date, currency, credit rating, etc. Every few years some country or central bank gets blown out because they selected an easy short-term solution, only to go bust because of an obvious mismatch. Mismatching is a roll of the dice: sometimes you win. But when you lose at the country level – residents pays heavily for decades to come.

For example, U.S. President Bill Clinton moved long-term U.S. debt into short-term debt to save a percent in interest and make his annual budget number look good. Never mind that he financially imperiled the country to get favorable press for a couple days. This time it worked out, but it was still a 50-50 gamble.

Argentina hasn’t been so lucky with their gambles and today the Argentine peso is in free fall from its latest losing gamble (as seen in the chart). When you peg your currency to the U.S. dollar, and issue a lot of debt in U.S. dollars – how are you going to afford it when the U.S. dollar strengthens against your home currency? You can’t. That is what Argentina’s socialist government failed to learn, yet again. Argentina cannot afford a rising debt payment – debts that were just issued this January are likely to become unaffordable. What was the term of this new debt? Oh, just 100 years. Anybody want to buy some certain-to-default debts that won’t be paid back for 100 years?

Large debts are prompting the Italian government to consider a parallel currency to the Euro. No one will lend to spendthrift Italy (just like spendthrift Greece a few years ago), so Italy is trying to create a new currency (just like Greece a few years ago) to get some liquidity. But just like Greece, the European Central Bank and International Monetary Fund (IMF) will not allow this to occur. So the poor and middle class Italians can likely look forward to becoming ground into the dirt like the European Union did to Greece just a few years ago.

Financial literacy is very important for a family but even more critical for a country. For example, the average Venezuelan adult lost 25 pounds last year from a lack of food. Not from any natural disaster, but from 15-years of increasing socialism where inflation is now around 150% per month. The Venezuelan government is still taking no action to reverse the downward spiral of their economy or currency. This is why holding your money in gold or bitcoin is commonly banned in countries with a continually weakening currency. Government-issued capital controls slows down the currency collapse by erecting a prison that keeps money from escaping toward stronger currencies and assets. It is unfortunate that financial literacy appears to be rare for both families and countries.

A few hundred years ago, it was common practice in Europe to limit the freedom of debtors who were behind on their payments until they paid it back. Some debtors were housed in actual prisons plus forced to pay for their incarcerations and pay back their debt by working. Many countries have a specific debtors’ prison history, even the U.S., but most countries abandoned the practice 100-200 years ago.

However, lenders need some kind of mechanism to compel re-payment and governments give themselves the most leeway in collecting on past-due bills.

Expected actions by the state include:

• Garnishing wages
• Seizing money in bank accounts
• Liens on cars, homes, or property

But there are more aggressive collection options that are available to government, depending on the state. For example, past due child support or federal student loans can result in in the state revoking your:

1. Driver’s license
2. Professional license (teaching, nursing, doctors, etc.)
3. Camping or state parks license
4. Fishing and hunting license
5. Garnishing social security payments

Budget constraints have prompted some municipalities to charge high fees, fines, and surcharges for misdemeanors; more than doubling their cost. If a defendant is unable to pay the fine, they are jailed even though they were found innocent of the criminal offense. Defendants are also being billed for more of the costs of their own trials. According to an ACLU lawsuit, 25% of misdemeanor defendants in Benton County, Washington, serve jail time for unpaid fines. These fines can be hundreds to several thousands of dollars, accruing interest at a rate of 12% per year.

Even a debt to a business can cascade into an arrest. A woman driving in Illinois with her children was pulled over for a broken tail light and was arrested for an outstanding warrant. She had failed to appear in court for a $2,200 judgment against her from a finance company. Another person In New York did not receive a state tax hearing notice because it was mailed to an incorrect address. Luckily, she had enough money in her bank account, that the state seized, to cover the disputed amount (which was later reversed), or she could have ended up being arrested as well.

All of these debt-collection laws are additional reasons for financial literacy, financial stability, and proactively managing all aspects of your financial life.

Accounting standards for more realistic assessments of state government pension funding have revealed that more states are in financial trouble. For example, all of the Minnesota State Pensions (including municipalities) were 80% funded last year; which is terrible, but could be turned around. However, using the new accounting standards for this year, they are just 35% funded and on the path to insolvency in just 35 years. Three years ago, David Bergstrom, the executive director of the Minnesota State Retirement System dismissed any concerns as “alarmist.” (Similar to Banking Committee Chairman, Senator Barney Frank, declaring Fannie Mae and Freddie Mac as financially sound just 4 years before they became insolvent and plunged the world into the 2008 financial crisis).

As bad as the funding is for Minnesota’s pensions, there are several states with a lower funding rate:

• 9% New Jersey
• 4% Kentucky
• 6% Illinois
• 1% Connecticut
• 0% Colorado

The main factors contributing to pension shortfalls are:

1. States had been wildly overestimating their investment returns in the artificially-low interest rate environment that we’ve had for the last decade.
2. States with budget pressure have been underfunding the pensions for years.
3. Life expectancies have been increasing.
4. Continually adding new union members with pensions instead of affordable 403(b) retirement plans

The bad news is that, at some point, one of two things must occur: either state retirees won’t get paid their promised pensions, or taxes will have to skyrocket in a over a dozen states. Well, unless there are recessions that further impair the state budgets and pension investments that accelerate the time horizon to pension insolvency. Ok, how many states have a fully funded state pension system? Just one: Wisconsin.

Like all financial matters, you’re really on your own to create your own retirement fund.

There is a great website showing all kinds of economic statistics at usdebtclock.org. The website also shows the current level of public debts including U.S. federal debt that just passed the $20 trillion threshold.

What does that mean, if anything?

From the website, that means that that the U.S. debt per citizen is an unaffordable $62,422; or an ultra-unaffordable $168,671 per taxpayer (check back in a month to see how fast these numbers are increasing!).

A question someone might ask is: Is there any plan to dramatically reduce government spending?

Unfortunately, Trump’s presidency has revealed that the swamp in Washington DC really is in charge and they have zero interest in change, let alone a reduction in government spending or staffing.

Well, if there is no reduction in spending, what are we facing?

There are several reference points and a common one is the Debt-GDP ratio. This is a measurement of the size of the economy to the debt that the government needs to support. Today, the debt-to-GDP ratio is 105%. So the debt owed by the government is 5% larger than the U.S. economy. This is not sustainable. There are several studies on debt-to-GDP going back hundreds of years on dozens of countries. Depending on the study, anytime the debt-to-GDP goes over 70-90%, then there is a 100% certainty that the government WILL default on its debt obligations. So the U.S. is well past the point of no-return for defaulting on its debt. There is a wide time frame for this default, so it could be 10 years or 40 years, depending on the rate of spending growth and interest rates. As the debt default nears, it will be painful for people – as witnessed recently in Greece, Venezuela, Argentina, Puerto Rico, Brazil, and other countries that could not pay their debt. (Since 1975, 17 currencies have gone to zero and were replaced. Since the founding of the latest U.S. Federal Reserve in 1913, the U.S. dollar has lost 98.8% of its value already.)

Is there any financial opportunity?

Whichever temporary band-aid the government uses to delay debt default, it will become obvious as it must involve creating inflation by some kind of money printing. Printing more money weakens the U.S. dollar and strengthens other currencies, including the two financial metals, gold and silver.

In the 2014 State of the Union Address by President Obama, he announced a new government-run retirement account called a MyRA. The moment the details were released, I wrote a blog post that this account was just horrible. It offered: high risk, high fees, and tiny returns. I recommended workers avoid this poorly thought out account.

It is now three years later and the MyRA program was just shut down. The government spent $70 million (that it doesn’t have) to launch this dog, and only lured 20,000 people to signup with an average account size under $1,700. People that put their money in a stock market index earned 400% more return than the MyRA participants.

The best retirement account for deferred or tax-free growth is a Roth IRA account. (Some employers offer a Roth-401(k) or Roth-403(b) account, which is the same thing.) Unlike IRA’s or other retirement accounts, a Roth allows for both contributions and earnings to be withdrawn tax-free in retirement. This is a tremendous financial benefit that will add roughly 25% to the money you’ll be able to spend in retirement. This 25% number is probably low since state and federal taxes, of all kinds, have only been increasing.

If you have no retirement savings or accounts, many Roth IRA custodians allow for small opening balances and tiny deposits. If you’re unsure where or how to begin, I recommend opening a Roth IRA account at Vanguard.com and enlisting their assistance in getting invested into a broad stock index fund.

Chronic financial mismanagement creates physical calamities, whether it is a household, a business, or a government entity. But unlike a household or business, when the government mismanages money, the greatest numbers of people are adversely impacted. Today, the following state pensions are closest to running out of money: California, Connecticut, Illinois, Massachusetts, and New Jersey. Not only was their credit rating recently downgraded, analysts are projecting that current workers are highly unlikely to collect the full amount of their promised pension.

The pension assets for Illinois public retirees are currently under funded by $130 billion. This is so much money that the state cannot raise taxes high enough to cover the $130 billion. Let’s examine the mechanism of how an underfunded pension spirals down. Each year that the pension plan is underfunded means that the fund cannot earn an assumed 7% on that missing money that is required to fund retirees. By the end of 2017, the Illinois pension fund will be missing an additional $9 billion (the 7% return on the missing $130 billion) in earnings because the fund has a gap between what they need to have and what they owe retirees. This also means that by the end of 2018, there will be additional missing $630 million (the 7% return on the missing $9 billion). In this manner, each successive year that a pension fund is underfunded, the gap becomes exacerbated the following year. This growing gap between how much a pension fund’s actual value and how much it should have to remain solvent and pay its obligations is a financial death spiral that becomes exponentially larger each year. Sooner or later, the payments become too large for the size of the fund and a financial cliff is reached: there is not enough cash in the fund to make current pension payments to retirees. The Illinois pension problem is not the state’s only financial issue; they haven’t passed a state budget in 3 years so they have $14.6 billion in unpaid bills that has already prompted all kinds of layoffs. The State of Illinois now has the lowest municipal credit rating in the country. Even the two big lotteries, Powerball and Megamillions, are going to exclude the state by July 1^st if they don’t pass a budget.

But wait – the death spiral gets worse! When you’re in financial trouble, you have to pay a higher rate on your debt – whether it is a personal loan, business loan, or for a government entity. When you can least afford it, a higher interest rate consumes even more money, accelerating the downward spiral. Last week, the Chicago Board of Education has variable-rate bonds that shot up to 9%. This means the bonds they were paying on had cost 4.6% in interest a few weeks ago but now they have to pay 9% interest. The rate would have gone higher but they were already contractually capped at 9%, so it is likely that they cannot borrow any more money at a reasonable rate. So Illinois and other government entities that rely on issuing bonds for funding may be precluded from doing so, accelerating the timeline to bankruptcy.

Connecticut has the highest income per-capita in the country, and yet, their pension fund is only 51% funded. What about solving it by raising taxes? Connecticut already ranks 2^nd highest in tax burden among the states.

In other government fiscal news, the U.S. Federal Government will be bumping up against its own debt ceiling within a few months and is projected to add another $10 trillion to the federal debt over the next 10 years.

You can’t make this up. The state of California is going to raid its rainy-day fund just to pay half of one year’s pension-payment shortfall. And this payment isn’t nearly enough to get the pensions on a path to solvency. Where will next year’s shortfall payment come from? How will the principal, let alone the interest, ever be paid back to the Rainy Day Fund?

Let’s start at the beginning. In 2014, Californians passed a voter-ballot proposition in 2014, called the Rainy Day Stabilization Fund; 69% voted yes. This ongoing new tax was sold with these claims:

1. Safeguard public schools and infrastructure
2. Protect the public from future property tax increases
3. Pay down long-term school debt avoid devastating budget cuts
4. Requires politicians to live within their means
5. Smooth out the boom-bust cycles of the economy on schools and police/fire departments

Who spent the $18 million to get this proposition approved? Government and unions. It turns out that each of the advertised claims were false.

The latest Governmental Accounting Standards Board ruling requires pension plan audits to include retiree healthcare benefits and more realistic investment return assumptions. These changes increased California’s pension liabilities by $172.5 billion. California’s pensions were already underfunded by $228 billion, said another way, the pension fund only has 65% of what is needed to sustainably pay retirees. This jump in debt forces higher annual contribution payment to the state’s pension funds, nearly doubling from $5.8 billion to $11.8 billion a year.

Not so fast Skippy. Where did California get the extra $6 billion to double its pension payment up to $11.8 billion? It will borrow the money from the Rainy Day Fund. The state’s plan to “repay” half of the money it took from The Rainy Day Fund is to relabel the normal ongoing contributions to the Rainy Day Fund as a “repayment”. Um, that isn’t a repayment at all.

This shell game is the OPPOSITE of how the Rainy Day Fund was promised to operate. To be clear: the state politicians can now overspend on anything they want and short change the pension payment. Then steal money from the Rainy Day Fund to pay for the pension payment because it is “an emergency;” and never pay it back. All the while, racking up more interest charges from loans that reduce money available for services from the state. I call this a shell game but it’s really financial fraud to hide financial mismanagement; and partly why the state of California is always in the bottom 3 states for financial standing.

The U.S. island territory of Puerto Rico just entered history books as the largest municipal bankruptcy in U.S. history. Puerto Rico’s default on $73 billion in bonds is almost 4 times larger than the next largest municipal bankruptcy, Detroit in 2013. How did this happen? Puerto Rico implemented every unaffordable socialist program that they could find:

• Public health care and heavily subsidized public university
• 40% of all workers are employed by the government
• Ever-growing union and government employee benefits
• Pension plans underfunded by 96%
• High minimum wage makes island labor uncompetitive in the region
• Welfare payments make up 20% of the island’s personal income
• High-speed train boondoggles to nowhere

Adding to their economic troubles, the legislature made Spanish the official language in 1991 for all school and government use. Since English literacy has now fallen to only 14%, U.S. businesses cannot expand there, not even for low-skilled call centers. This leaves Puerto Rico with a horrifically-high unemployment rate of 45%, even if you include an estimate for their “informal economy.”

Now, Puerto Rico and its allies now call all the bond investors “Vultures” for suing the government for what they are owed. Sure, some money managers recently bought their imperiled bonds for 30 cents on the dollar, hoping for a big score if the U.S. federal government bails them out. It is hard to sympathize with the island’s leaders who have refused to restructure or get on a financially sustainable path for the last decade. Instead, Puerto Rico’s leaders have sprinted even faster toward the financial precipice that it now finds itself.