Bogue's Blog

For those who invest in municipal bonds, or for that matter are receiving a pension or expect to receive a pension from a municipality, you should pay attention what Warren Buffett has to say.

On Wednesday, Warren Buffett said at a hearing of the U.S Financial Crisis Inquiry Commission in New York said that there will be a “terrible problem” for municipal bonds and said, “Then the question becomes will the federal government help.”

There is no question that local governments are under pressure as the financial crisis lowered revenues that they receive in the form of income, real estate and sales taxes. Further compounding matters, many pension plans are underfunded due to the market losses suffered a few years ago coupled with the rosy return projections and lower funding that came beforehand. Yes, from a prohibitive perspective this can create a vicious cycle and quickly become a contagion similar to the fall of 2008.

What should you do? Now for those who are currently receiving a pension, the odds are quite low that your benefits will be reduced. But I wouldn’t make the assumption that they are perfectly safe either. For the current worker that expects to receive a pension in the future, I wouldn’t hang your retirement hat solely on your pension. I believe the same would be said of people solely relying on Social Security.

For people who invest in municipal bonds, I’d be very careful. Regardless of the potential risk addressed above, I’m not a big believer in buying individual muni bonds as for most people the dollar amount needed to buy an individual bond makes it very hard to diversify the risk. Unless you directly buy from the issuer, brokers make an awful lot of money on the spreads as muni’s are very thinly traded, which eats away at your yield. This lack of liquidity also makes it more difficult to sell an individual muni at a favorable price. If you do purchase municipals, it is best advised to use mutual funds to accomplish this; in particular funds that only buy bonds with high credit ratings. If you must buy individual muni bonds, focus on the one’s that are backed by the taxing authority of the entity rather than revenue bonds, which repayment is backed on a specific project. Because of this project risk, these types of bonds are more likely to default than ones that have the ability to tax to pay back the debt. If you are at risk of paying the Alternative Minimum Tax (AMT), you want to stick to funds or bonds that generate little private activity interest as this is an exception item for the AMT.

Finally, there are some scenarios where you should never buy municipals. It’s simply a waste of time to buy municipals in an IRA as the tax benefits are lost. And you really don’t get much benefit if you are in a low tax bracket.

In the end, just keep in mind that the risk of municipal default is quite real. And I wouldn’t bet against what Warren Buffett has to say.

Love it or hate it, what our government calls healthcare reform is now law. These are the financial planning implications you should consider in light of the changes:

Higher taxes: If you are single and making over $200K or married and making over $250K, watch out. Starting in 2013 people with these income levels are going to see their Medicare payroll tax increase from 1.45% to 2.35%. In addition, any investment income such as interest, dividends, capital gains and rental income will be subject to a 3.8% Medicare Tax. This tax is egregious as if you fall just one dollar above the stated income limits, ALL of this unearned income is subject to this Medicare tax, not the dollar amount over the limit.

Also be aware, the tax environment was already scheduled to get worse before the healthcare reform legislation was enacted. Next year the current tax bills “sunset” where qualified dividends will be taxed as ordinary income (from its current 15%) and long term capital gain rates will go to 20% (from its current 15%). So it may not seem like the new Medicare taxes are that costly, but the combination of this and the expired tax breaks may become very costly to some people. Think about it, some people will pay a 43.4% tax for dividends where they are paying 15% now.

If you are on the fringe of these income levels, you better plan now. For example, if you have investment property that you are considering selling that has a large capital gain, you may want to accelerate the sale into this year or at least by 2012 rather than waiting. You may want to begin repositioning any taxable investment accounts into more tax efficient holdings such as index funds, municipal bond funds or save more towards tax efficient IRA’s or employer sponsored retirement plans. If your situation dictates, you may want to consider converting a Traditional IRA to a Roth IRA if you have a taxable account that generates a lot of income now and is sufficient enough to cover the tax cost of the conversion. Not only could this lower the amount of unearned income that could be exposed to the new Medicare tax in the near term, converting it to a tax free Roth can reduce the chance you may be subject to the tax later in life. Finally, people who own C corps with high accumulated earnings may want to take a large dividend this year before the higher rates are imposed.

Now if you have a high deductible health insurance plan or are considering one, things will change here as well as the deductible will be limited to $2,000 for an individual and $4,000 per family. The lower deductible is most likely going to result in an increase in premiums. Current high deductible plans are grandfathered as long as they meet certain minimums so you may want to consider enrolling in a high deductible plan while you still can. It also would be advised to contribute as much as you can now to a health savings account.

Finally, if you decide not to carry health insurance, starting in 2016 you will pay a fine of $695 or 2.5% of income, whichever is greater. In 2018, if you pay premiums in excess of $8,500 for an individual and $23,000 for a family, then there is a 40% tax on the excess amounts.

The above just addresses planning aspects from an individual perspective. If you are a small business owner, there are a lot more planning implications that should be considered. But start planning now because all of the financial implications are right at our doorstep.

Yesterday, a Senate sub-committee chastised Goldman Sachs executives for creating and selling mortgage backed securities to investors while betting against them in their own account. If only the Senate would eat their own cooking.

The new regulatory reform legislation originally had language that would address this issue. It would have required everyone who gives investment advice to the public to act as a fiduciary. Or in other words, the advice would have to put aside the interests of the individual and the firm that the person works for and give recommendations that are in the best interest of the client. If Goldman Sachs was a fiduciary, I would think they would be in a lot of trouble now. But Goldman Sachs does not have any fiduciary responsibility. Registered investment advisors have this obligation but Goldman and other brokerage firms do not.

This leads to the irony of the story. The language in the new reform bill requiring a fiduciary obligation was removed by Senator Tim Johnson of South Dakota earlier this year. Instead Senator Johnson wants the Senate to “study” the issue instead. I don’t have too much confidence in conducting a “study.” A few years ago the Rand Corporation was commission to do a study on the issue and came to the conclusion that consumers were confused and that’s about all that came out of that.

In the end, Goldman Sachs will probably prevail against the SEC suit. They aren’t a fiduciary; ethically questionable actions were made, but they are allowed to do this. So we may see them pay some fine without admitting any wrongdoing and both parties will go about doing what they do. In the end, these mortgage backed securities were not the reason for the financial crisis, but they played a hand in exacerbating the severity of the problem. And a fiduciary obligation probably would have played a strong hand of stemming this severity.

The sad part of this is that the Senate subcommittee totally danced around the fiduciary issue yesterday, but I truly feel they don’t get it. Earlier this year former Presidents George W Bush and Bill Clinton spoke together at a conference geared towards the financial planning community. When asked about fiduciary standards, they both looked at each other and didn’t know what to say. Senator Susan Collins yesterday seemed to be one person yesterday who knew the difference between who does and doesn’t hold a fiduciary obligation. In the end, when the subcommittee was chastising Goldman, too bad that Senator Johnson wasn’t asked to explain why he thinks a fiduciary standard isn’t that important. And it isn’t too late to ask your Congressperson why its not important either.

A great article was written in the Wall Street Journal at this link:
http://online.wsj.com/article/SB10001424052748703940704575089413832399630.html

You’ve probably been hearing quite a bit about Greece in the news lately. Well you better be paying close attention because it could soon be our problem.

When Greece entered the European Union, they were required to keep their spending and debt in check as a condition of membership. But in the end, they weren’t as forthcoming regarding their finances than they should have been. Now the bill has come due and with $28 billion coming due in April and May, they are at risk of default. The European Union has been debating whether to bail them out. But this isn’t the only European country at risk as Portugal, Italy, Ireland and Spain have similar problems.

The Greek problem isn’t totally new. According to a recent article by John Mauldin, Greece has been default in one way or another for 105 of the past 200 years. Tax evasion in the country is common as only 70% of the citizens file taxes and only six people claimed to be a millionaire. Government spending is 50% of its GDP with one of the highest percentage of public employment in all of Europe. It’s a train wreck that was eventually going to happen. Of all the options Greece has, none of them are good. They can choose severe austerity measures that will lead them to depression, but will get them out of economic turmoil sooner or they can take the easier ways out which means an extremely long recession. Pick your poison, none of it is good if you live and work in Greece.

Why is it our problem? There is the worry that Greece and the other nations above will all default on their sovereign debt and send us back another credit crisis like 2008. This should be recognized, but I’m thinking long term. For many years pundits have warned about the problems with Greece and their bloated spending and entitlement system. We are on the doorstep to the same problem as we have begun the reverse wealth transfer of to the baby boom generation from the younger generations and unborn. According to the “The Complete Idiot’s Guide to Economics,” 23% of the U.S. budget is spent on Social Security, 12% on Medicare, 7% on Medicaid. And this is only going to increase. Aren’t the pundits sending the same warning signs?

The United States has some difficult choices to make. We can decide to make some hard choices now that will be less severe in nature which will cause some sacrifice. Or we can wait to become Greece sometime down the road. Higher taxes and more entitlements for everyone with a pulse isn’t the solution. But we should be thinking about these things as they were originally intended; as a social safety net for those who don’t have the means. In turn, if Washington held onto the money that eventually went to pork projects over the years, maybe we wouldn’t have to worry about this problem.