Monday, January 9, 2017

Trust Issues - Relying on Contracts

Relying on contracts to enforce your rights is problematic in many way.

If you have been bravely reading this blog on a regular basis, more power to you.  However you may come to realize that I seem to have a number of "trust issues" which probably stem from growing up in a dysfunctional household.

The idea that you can trust other people to do what they say they will do is a somewhat alien concept to me.  I find it difficult to set myself up in a situation where I have to rely on the actions of someone else - even someone I trust - in order to get things done.  More often than not, I find myself disappointed when I take someone's "word" for something or rely on a "handshake."   It just isn't a good way to do business.

It's a good thing to be trusting, I'm sure.  However trusting people are often taken advantage of in this world, particularly in recent years when it seems like "anything goes" in the business and economic world.  You're pretty much on your own these days, so you have to use your judgement very carefully on who to trust. Moreover, people should earn your trust and it should not be given freely or loosely.

Almost every economic transaction we engage in today amounts to a contract. Whether you are buying something at a store, or putting money in your 401(k), what you were doing is contracting with someone else. You give them something, and they give you something in return. You give a store money, they are supposed to give you goods that are worth the money you gave them and not be faulty or defective. You put money into your retirement account, it should be invested in something sound that yields returns.

Yet lately, our society has changed such that it is possible for people to avoid their responsibilities - their contractual obligations - and as a result make an awful lot of money by basically ripping people off. That is why I don't suggest you rely on contractual obligations in your financial life more than you need to.  It is also a good reason why you should never rely too much on one person, institution, or investment.   Diversification not only is a way of hedging bets, it is a way of hedging fraud.  Ask anyone who put all their retirement savings into Enron stock, if you don't believe me.

The problem with any contract is that you have to be willing to go to court to enforce that contract in order to ensure that the other party performs as they promised. As soon as the other party realizes that you will not go to court or cannot afford to go to court, they will skip out on their obligations under the contract.  It is as simple as that.

Thus, for any trivial transaction, that is to say under $20,000 or so, people realize that you're not willing to spend an equal amount of money in legal fees to enforce such a contract.  That's one reason why these eBay and Craigslist scams are perpetuated by people from overseas.  They offer to sell you a car that is worth $10,000 for only $5,000 and get you to wire them the money.  Even if you could somehow serve them and prosecute them in Nigeria, the cost of doing so is not worthwhile.

That is why, traditionally, such small transactions are generally done with "cash in hand."  You hand somebody the cash, they hand you the goods and the transaction is completed. Any small transaction - and by small I mean under $20,000 which may seem like a lot of money to many people but really is not that  much - should be conducted in person with goods being exchanged for money at the same time.  Alternatively, at least deal with an entity with a known address who can be served and sued.

Unfortunately there are a lot of contracts that are worth far more than this, that people seem to be willing to skip out on these days, leaving many people high and dry.  Pension plans are one example of a contract lately is being routinely avoided, and in perfectly legal ways.  One way to avoid performance on almost any contract is to declare bankruptcy.  Bankruptcy means you are unable to perform on your obligations, and that you're largely excused from most of them.

So, it is a nice thing to have a fat pension from a big corporation, provided the big corporation is on sound financial footing and will be, throughout the life of your pension. Unfortunately many poorly run corporations are now unstable today and end up in bankruptcy court. At this point the promise or contract made in the pension plan now becomes void.  Like any other contractor, you are merely creditor to the bankrupt assets of Corporation and have to stand in line behind others to receive your share from the pittance that is realized in bankruptcy.

Sadly, this is even happening to folks in government employment which was once thought to be immune from bankruptcy or insolvency.

The only real solution, is to look out for yourself.  That means not to rely or trust people to perform contracts as expected, but rather to expect that in a certain number of cases, people will fail to perform as promised.  If you set up your finances to rely on one single thing, and the one single thing goes South, you are in for a world of woe.

For example, you count on Social Security as a bulwark of your retirement. Good plan, but then Donald Trump is elected, and the Congress starts talking about cutting benefits and a "needs test" for the plan.  If you made Social Security the centerpiece of your retirement or counted on it for a substantial portion of your retirement, you might be screwed.

Ironically, though, if you save up more money so you don't have to rely on Social Security - you know, the responsible thing to do, which ordinarily Republicans would applaud, you might end up losing those benefits to the "needs test."  Once again our society rewards the spend-thrift, the borrower, the lazy man, while at the same time punishing the thrifty, the saver, and the hard worker.  Nice going, Republicans!  What is it they stand for again? It would seem they have lost their way with regard to "values".

If you approach retirement relying on Pension Plan without having put any money aside for savings, or worse yet failing to pay down your debts, you could be in for a rude surprise when it turns out the pension plan is bankrupt and you receive only $0.40 on the dollar of your pension money.  And many people do just that - borrowing money well into retirement, counting on a pension to make the monthly payments on these debts.   It can backfire in a big way.

And this can happen to anyone, even someone whose pension retirement is funded through a 401(k) or IRA. Investing in the wrong vehicles could result in bankruptcy in retirement.  The only solution is play it safe. Diversify your investments, pay down debt, and be debt-free in retirement.  That way, if promises are not kept at least you are not entirely screwed.

Now bear in mind, I am not saying that everyone should revert to a cash-only or barter economy.  That is not practical.   But it illustrates how much of our economy is based on trust and what happens when that trust is violated.   When people are allowed to duck out of their contractual obligations, particularly when it is legal to do so, commerce grinds to a halt.   People stop doing business when business becomes impossible to do.   And sadly, many on the Right fail to realize this when they argue for "less regulation" in the marketplace.   When economic transactions become toxic, people stop engaging in all economic transactions - as much as they can.

The car dealer is a case in point.  Who doesn't want to buy a shiny new sports car or SUV and drive around.  Sounds like fun, right?   Now think about the nuts and bolts of the transaction, as they are traditionally handled.  Spending four or five hours at a car dealer dicking around with price and terms and getting screwed over one way or another, leaving the place never knowing whether you paid a fair price or not.  That's one reason people hang on to their old cars - what is parked in the garage is a known quantity.  Often the best used car value is parked in your garage already.

When people trust their commerce partners in a transaction, they are more likely to engage in that transaction.  When trust is lost, so are sales. I am pummeled daily by offers for cable or satellite television - offers that I will never respond to.  Not only is the product (commercial television) toxic, but the companies that are selling it (e.g., Comcast) have some of the worst customer service records on the planet.  No one loves their cable TV company.  The only reason they get away with this model of commerce is that they have convinced so many people that they "need to have" 500 channels of poor normative cues.

The older generation here on Retirement Island is tied to cable at the wrists and ankles.  How would they live without their daily outrage from Fox News?  When I tell them we have no cable and watch commercial-free shows on Netflix, they mumble, "Yes, my nephew does that....."  As a result, Cable disconnects are on the rise, as their user base ages out and dies.  They made a toxic product with toxic service and cannot understand why our generation isn't lining up to be whacked on the head.

Which brings another point:  When you do business with untrustworthy people, you only encourage untrustworthy business.  The shady salesman or dealer or lies and cheats will always get ahead if people keep patronizing his business. Worst yet, his "honest" competitor will be forced to stoop to such actions in order to stay in business.  Commerce has always been a race to the bottom - that is, until people say "enough is enough" and stop trading.

Trust is what drives the marketplace - not fraud or deceit.

Sometimes, maybe having "trust issues" is not a bad thing.  Blindly placing trust in people and institutions to perform as promised can put you into a lot of peril.