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February 19, 2009

Can Home Price Recovery Lead Us Out of the Recession?

"A decline in home prices led us into this recession and a recovery in home prices will lead us out."

This is the mantra that is being uttered on Wall Street as if it were a fact, father than merely a hope.  My suspicion is that a recovery in home prices will only help to slow the bleeding, not lead to a recovery.

Why?  Because real wages have been declining for decades and the the prosperity of the past 20 years has been funded entirely by debt.  The whole thing's been a mirage and we've been eating the sand. 

People also talk about the paradox of thrift and the downward spiral that comes when people save rather than spend.  But the balance between spending and saving must come from a decision about what to do with money you earn, not what you do with money you borrow.  To pressure people to buy things they can't afford (and increase our overall debt load) just to stimulate the economy in the short run is foolhardy advice based on panic rather than logic.     

Anyone who doubts that the problems with the economy go deeper than housing and fear need to watch this lecture by Elizabeth Warren of Harvard University on the potential collapse of the middle class http://www.youtube.com/watch?v=akVL7QY0S8A

While I don't believe we are facing Armageddon, I do believe we are going to have to revolutionize the way we think, act, and conduct our business and personal affairs (the way I propose in my book) if we are ever going to get to the point where we grow our country slowly, steadily, and prudently rather than in fits and starts, booms and busts, bubbles and bursts.

We need to find a way to get our adrenalin rush from building something strong and lasting rather than from living on the edge all the time.  We need a new scorecard - one that places value on something other than money and the things money can buy.  We need to redefine the term "living the American Dream" to mean prosperity not bounded soley by materialism.  If we can do that, then it will be amazing how quickly panic will subside and action will take its place.  


February 18, 2009

The Wealth Shiftathon is ON

Yesterday, American Express Co (AXP.N) said that credit card delinquencies rose in January as job losses accelerated in the United States and the global economy deteriorated.  In a regulatory filing, the company said the annual net charge-off rate -- a measure of credit default -- rose to 8.29 percent in January from 7.23 percent in December, while the rate for loans at least 30 days delinquent increased to 5.28 percent from 4.87 percent.

The problem with wildfires is that while you are busy putting out a fire in one place you fail to notice a fire growing out of control in another place.  While we are over here, busy dealing with the sub-prime crisis and the banking crisis, we are failing to deal effectively with our upcoming credit card crisis.  Not only that, but we are also failing to realize that every problem we are currently dealing with is the direct result of an even bigger crisis in this country - our national crisis of character.

In this country we are still operating on the notion that ethics trumps survival the way it did during the Great Depression.  We expect people who are down on their luck to quietly move into cardboard boxes under bridges rather than using every resource available to them, ethical or not, to prevent that very scenario from happening.  But there has been a fundamental decline in ethics that virtually ensures that anyone who loses their job or feels that they have nothing to lose will, indeed, not only default on their mortgage but also run up every credit card they have on their way to Shantytown.  

But, really, why should we be so surprised?  We have no ethical role models to inspire us to do the ethical thing and tear up those credit cards before we are tempted to rack up debt we won't be able to repay, and plenty of role models that are inspiring us to get all we can while the getting's still good.  (For example, I am actually hearing investment advisors like Jean Chatzky on The Today Show's Money 911 advising callers to max out their cash advance limits and put the money in money market accounts against the possibility of reductions in credit limits and job loss)

A smart banking system would get together and take away the credit cards of anyone who is delinquent on a single loan.  However, that is not what credit card companies are doing.  They are lowering credit limits instead of canceling cards altogether.  Why?  Because they have a vested interest in postponing the news of how bad the credit card situation really is because they don't want to panic the nation and cause their stocks to tank even further. 

The Amex figures are just the tip of the iceberg.  They reflect defaults and delinquencies, but not the manic increase in credit card balances that has occurred over the past year or the percentage of credit card accounts that are either near or at their limit.  In point of fact, much of our current spending is still being funded by credit.  As a result, we aren't going to be able to see the full extent of the financial crisis until the Shiftathon ends and the Wealth Shift hits the fan.         

February 16, 2009

Why Giving Everyone Money Won't Solve the Problem

Many people feel that the best way to solve the current economic problem would be for the government to dole out money to everyone - in the form of tax cuts, mortgage principal reductions, outright checks, etc.  They see this as stimulative when, in fact, it would have the opposite result.  


Because doing so is like taking a cash draw on the only credit card we have left with a little room on it.  Even if we pay down other debt with the payments it only buys us a little time, it doesn't make our total debts any smaller.  We may think we'll spend the money more wisely than the government and learn from having been near the brink of disaster, but history shows we have not been very trustworthy on that score.   

The other thing that people fail to realize is that credit is not an asset.  A credit limit is not the same thing as cash in the bank.  Borrowing is only worthwhile if it results in an increase in net worth over time.  But most people don't borrow as a result of putting pen to paper.  Most people borrow in spur-of-the-moment ways for pleasure or to avoid pain in the short run.  (Unfortunately, the pain of owing money only becomes tangible when the Wealth Shift hits the fan and credit is maxed out.)

So what is worth going into debt for?  Something that is going to help you either make or save money in the long run.  And because of the power of compounding, if your credit is limited, you need to make your debt choices even more wisely than someone whose credit is less limited. 

Ironically, people whose credit is limited tend to make the very worst choices of all.  They tend to squander their credit on clothes, cars, and eating out (all wasting purchases that neither make nor save money in the long run).  And most people who have had easy access to credit have not made the very best choices, either.  As people and as a nation we have borrowed a lot and gained much less than we could have.  

Let me give you an example.  In his book, The Snowball, Warren Buffett talks about how he agonized over the purchase of his first (and only) house that cost $31,500 in the late 1950s.  Buffett called the house 'Buffett's Folly' because the house's ROI fell far short of his normal rate of return.  He saw the house as a bad use of capital when compared with what he could have done with that money had he invested it elsewhere.  It is interesting to me how starkly this philosophy contrasts with the average person's investment strategy of buying the biggest house they can possibly afford.

So what should the government do? 

If the government is going to incur debt to try to stimulate the economy it must spend the money on investing in the future in industries that need a little kick start of capital to become viable and grown up enough to become interesting to the private equity sector.  Things like computerized health records, energy independence, education, and scientific advancements in technology.  These are spending catagories with the highest rate of return, unquatifiable rates of return - gifts that have the potential to keep on giving indefinitely. 

It all goes back to the age-old adage - Give a guy a fish you feed him for a day.  Teach a guy to fish and you'll feed him for a lifetime.             

February 11, 2009

Change is Painful

During the Great Depression unemployment skyrocketed to nearly 30% - in part because of a shift in the allocation of human resources away from an agrarian society and toward a consumption-driven society.  People who had been employed in the farming industry were made obsolete by machines that could do the work of hundreds of men in half the time.  While this radical shift was painful at the time, in the long run we were successful in redefining our nation and the roles of the people in it. 

One piece of the economic crisis puzzle that may not be receiving enough attention is the possibility of a permanent reduction in consumerism which will require us to  redefine our roles once again.  Because this change will be painful, it is tempting to want to subsidize existing businesses in an attempt to avoid the pain, but in the end we must allow the change to occur.

It is tempting to spend stimulus dollars to try to re-establish the status quo rather than accept the fact that the changes we are seeing in consumption patterns are going to be permanent.  And the harder we fight against accepting this truth the more painful it is going to be.

Why is the reduction in consumerism going to be permanent?

1)  Our consumerism has been driven by massive amounts of debt - credit card debt, consumer debt, multiple mortgages debt that we are now faced with repaying.

2)  Lending practices of the past ten years have allowed us to rack up more debt than we would otherwise have had (or that is remotely prudent).

3)  Even if credit "unfreezes", lenders will not go back to lending indiscriminately - there will be higher lending standards and tighter qualifications.

4)  Our assets have declined in value which is resulting in buyer's remorse.  Because money is no longer growing on trees, we are beginning to wake up to the fact that money not only does not buy happiness - it often buys misery instead.  We are beginning to see the value of having a few unspent dollars in our pockets and savings rates are going up.

If a reduction in consumerism is permanent, what should we be spending stimulus money on?  It seems obvious, doesn't it?  We need to be spending money to help people change careers and learn how to manage their resources better.  We need to look into the future, define where we want to be, and then spend money to get there.  Perhaps the homes of the future won't have as many knicknacks, clothes, or SUVs, but they may have solar energy panels, smart appliances and electric cars.  Resisting change builds a bridge to nowhere.  Accepting change builds a bridge to the future.





February 04, 2009

American Airlines CEO Gerard Arpey

Recently I saw a documentary entitled 'Inside American Airlines: A Week in the Life', in which the interviewer, Peter Greenberg, lauded American Airlines CEO, Gerard Arpey, for limiting his compensation to a mere $600,000 annually.  When Mr. Greenberg expressed his appreciation for the fact that Mr. Arpey's compensation is so very reasonable when compared to that of other CEOs, Mr. Arpey didn't bother to correct him.  Instead, he merely joked that Mr. Greenberg was welcome to leave a contribution on his way out the door.  In doing so, Mr. Arpey committed a sin of omission and allowed Mr. Greenberg and his viewers to erroneously believe that he is, in fact, walking the walk when it comes to shared sacrifice at American Airlines.  After all, the focus of the entire documentary was all about that concept, and went into great detail discussing all the pay cuts and reductions that had been agreed to by the unions, pilots and stewards.  The documentary, which was filmed in 2006, was a glowing report card on American's employees' success in working together for the greater good of the whole and the long-term health of the company and its shareholders.

"A-hah!" I thought...a perfect example of an ethical CEO!  But before giving Arpey a "Guy in the Glass Award", I decided to do my own due diligence by accessing the company's proxy statement to verify Arpey's 2006 compensation.  Here's what Gerard Arpey really made in 2006:

Base Salary:  $581,534

Stock Awards:  $8,558,878 

Option Awards:  $851,398

Non-equity Incentive Compensation:  $225

Change in Pension Value and Nonqualified Deferred Compensation Earnings:  $$169.255

Other Compensation*:  $39,769

 *This amount includes a $33,000 allowance in lieu of perquisites commonly awarded to executive officers of other public companies such as automobile leases, club memberships, financial/estate planning fees and split dollar life insurance.  The amount also includes an allocation of incremental cost for personal air travel provided to Mr. Arpey and his family.

The entire proxy can be accessed at this link:


Total Compensation?  $10,201,059.

I can only hope that when American Airlines employees renegotiate their compensation they will do the due diligence to discover what the executives at American Airlines really make and not just listen to sound bites in interviews that fail to disclose the whole story.

Shame on you, Mr. Arpey.  Not for making the money you actually make, but for allowing people to believe you share the pain your employees have experienced working for American Airlines.