Friday, January 9, 2015

The Nature of DEBT

How did our debt-culture evolve, and can it persist in an era of self-funded retirement?

Debt is a funny thing.  At one time or another in our lives, we all have it.  Indeed, in almost every culture throughout the world, people are in debt to one another almost all the time.

Even if you are debt-free, you owe debts and others owe you debts.  Your employer owes you pay, but pays you only every two weeks.   On the day before payday, he can owe you quite a bit - and owe the government taxes on your behalf.

You owe your utility company every time you flick on a light switch.   But you only pay once a month.   Such debts are fairly trivial and common, as a pay-as-you-go model of payment for work or utilities, or taxes or whatever, would be largely unworkable.

But in the past, many people held debts of others, based on commerce.  In the 1700's, in this country, when you bought something, you often had the merchant "put it on your tab" to create an outstanding debt that might not be paid off until the end of the month - or for months.   Our Founding Fathers worried a lot about debt - and many of them died penniless or nearly so.   Debt was a constant threat.

And debt back then, was one threat that was taken seriously.  Debtor's prisons are no more, but they illustrate the dire consequences of debt.   You go into debt, you can be thrown into a debtor's prison, until you pay the debt - which you cannot do, because you are in prison.   Many died there, as a result.

It is like the punishments back then for counterfeiting - which was often death.   Messing with the economic system was considered serious business, and if you tried to debase the currency or fail to honor your obligations, the consequences were dire.

But long-term debts - debts of 30 years or more - were not that common back then.  As I mentioned in an earlier posting, I found, at a garage sale, the Syracuse "New Homes Guide" of 1933, which touted the stylish new homes of the day (most far less than 3000 sq. ft., most all with a single bath) and the new "longer term" 15-year mortgages.  It was quite an eye-opener to read.  Back then, we had less because we could finance less - and for a shorter period of time.

It was only in the postwar era that long-term 30 years mortgages really exploded - along with consumer financing for cars and more importantly, the television set.  I have read that the advent of television brought on the era of consumer financing, as most people could not afford to pay cash for a TV (which cost as much as a used car back then) but could make the payments "on time".

Today, most people cannot imagine a world without debt - perpetual mortgage payments, perpetual car payments, perpetual student loan payments, etc.   When one loan is paid off, another one is taken on - or old debts are folded over into new ones, as part of a series of refinances of the primary mortgage.

To many people, financial success is measured by your credit score - the ability to borrow more.   And a "balance sheet" is figured on a monthly basis - how much comes in, from wages, and how much goes out - in loan payments.   So long as your wages exceed your expenses, you are doing OK, right?

And maybe that was true for the defined-benefit pension generation.   I wrote recently about two educators who have healthy pensions - and hefty debts.   They have only $50,000 in savings.   So long as their pension plan is solvent, they are set for life.   But I realized, since writing that post, that their entire future is dependent on one thing and one thing only - their pension.   They will have no "plan B" to fall back on, if the municipality backing their pension goes bankrupt.  And they will have no estate to leave to their children.  It is an all your eggs in one basket kind of gamble.

But like I said, they have a defined-benefit pension that is fully vested.   So they are set, or let's hope they are.

The problem with our debt culture is this:  It is a recent construct that evolved in an era of steady employment - where perpetual paychecks or pension checks could make loan payments until the day you died.  Along the way, a few things changed, and somebody forgot to tell the general population that the old ways don't work anymore.

To begin with, jobs are no longer guaranteed.   Our friends who work for the school district were pretty secure in their jobs.   But for people in the private sector, things have changed.   You are quite likely to be laid off at age 55 - or see your company fold up, slim down, or close a division.   It happens a lot these days and many folks are not ready for retirement and still mired in debt - with little in the way of savings.

And is funny, because back when I entered the job market, government employment was not seen as that good a deal.  Teachers were really underpaid back then, and government employees were not paid at the same rate as in the private sector - where competition for workers drove up prices.   But that changed, and today, there are more workers than jobs, in many sectors, and wages are stagnant.   But in the interim, government workers' salaries have climbed - including those of the lowly underpaid teachers.  And now, being a retired schoolteacher is a far better gig than being a retired Engineer!   How times have changed.  Maybe it won't be so hard maybe to find a good Science or Math teacher, these days.

But of course, that will change too.  The strikes, recall election, and new anti-union legislation in Wisconsin was not an anomaly.  Property taxes are skyrocketing and homeowners cannot pay them.  This does not bode well for the future of pensions.

Getting back to our topic, however, there is a second way the rules have changed, and it is not much talked about.   Our generation - the 401(k) generation - is set to retire, and retire on a fixed income based on a fixed amount of savings.   Many if not most are looking at retirement and realizing they do not have as much saved as they would like to have.   Others simply have no clue - thinking that $50,000 or $100,000 is "a lot of money" to have saved up, and not just 2-4 years of income.  The reality of our generation is that you pretty much have to be a Millionaire to retire comfortably - and future generations will have to be Millionaires by retirement, if they want to live at all.

And part and parcel of this is having little or no debt in retirement.  If you retire with debt, then you have to withdraw more money from your 401(k) or IRA to pay these debts.  This knocks you into a higher tax bracket, and defeats the point of the 401(k) or IRA.  Not only that, it dwindles down your savings at an alarming rate.

But again, no one told the great masses about this change.   The television still hypes monthly payment and loans and debt.   And the media tells us that we should obsess about our credit score and our ability to borrow - and that refinancing debts over and over again is a "smart move".  There is a disconnect between what our society teaches and what it expects.

Being debt-free is so alien to our culture that you are viewed as a heretic or a kook if you suggest it.  My Fidelity "adviser" who is in his 30's with a mortgage, car payments, and the whole nine yards, doesn't understand why I would want to pay off my mortgage instead of having monthly payments.   But I am close to retirement and he isn't.   Will he be in debt when he retires?  I suspect he will - he buys into the debt culture idea and chases after the almighty deduction as if it were wealth.

It may take a while before people figure out that the 401(k) culture - a culture of owning money and acquiring wealth conflicts completely with our debt culture which is a culture of weekly paychecks and monthly payments.

And sadly, most folks will likely never figure this out.

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