The Prosperity Blog

Understanding the Impact of Credit in the Economy

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Most of us have a basic understanding of how credit works based on our personal experiences. We borrow someone else’s money (the bank’s, the mortgage company’s, a friend’s) to buy something today, and then repay the lender with interest. That’s the basic formula whether credit is used to buy a house, a car, or dinner at a restaurant.

Likewise, our decision to take on a debt obligation is usually as simple as “who will lend me the money?” and “can I afford the payments?” Our assessment of our use of credit is often measured by our payment history and credit score. (i.e., “I have a credit score of 810, so I guess that shows I know how to borrow effectively.”).

But lenders and economic policymakers have bigger agendas and different objectives. Here’s how credit impacts the broader economy.


Credit is Like Lighter Fluid on Charcoal; It Gets Things Started Faster

Instead of having to save for long time in order to obtain a big-ticket item (like a house or an automobile), credit allows the borrower to have the item immediately, while using future earnings to make repayments over a period of time.


Credit Expands Purchasing Power; IE: It Allows People to Buy More Things

And the more people buy, the more the economy expands.

In the short term, everyone likes the effects of credit. Buyers get what they want today, sales rise for businesses, and lenders add to their income streams by collecting more payments.

Of course, there are consequences to speeding up commerce and expanding purchasing power.


Borrowers May Forfeit Future Financial Opportunities

Using credit today predetermines how a portion of tomorrow’s earnings will be spent, because borrowers are committed to making payments at a later date. Who knows what future opportunities will be forgone because of an outstanding loan obligation?


Abundant Credit Usually Results In Price Increases

Wherever credit is used to purchase goods or services, the costs for those goods and services will usually increase as well, because when more people are potential buyers, the increased demand will result in higher prices.


The Credit Format Works Only as Long as Borrowers Make Payments

Having a few borrowers default is inevitable, but too many defaults make lending unworkable for both borrowers and lenders. If borrowers can’t afford the interest rates and lenders can’t afford to lend money, it won’t be repaid. When the flow of credit slows or stops, the economic activity dependent on credit often contracts as well. This is why credit-driven economies have regular cycles of expansion and contraction.


Because of it’s Lighter-Fluid-Like Impact, Politicians Often Enact Legislation to Facilitate Credit in Favored Segments of the Economy

For example:

  • Government-approved student loans feature deferred payments and lower interest rates (because they are subsidized/supported by tax dollars) to encourage borrowing for higher education.
  • FHA, Fannie Mae, Freddie Mac and other special programs for low-income and first-time home buyers provide additional incentives for both borrowers and lenders to enter into mortgages.
  • The “cash-for-clunkers” rebates provoked a brief burst of automobile purchases, the majority of which were financed.

The perceived societal benefits of college education and home ownership may provide a rationale for making it easier for people to borrow. But a frequent unintended side effect of special borrowing programs is greater price distortion in those areas. In an August 24, 2009 Atlantic article, Niraj Chokshi writes that Labor Department statistics show “for 27 of the past 30 years, the price of education has grown at a faster rate than that of medical care. Education also grew faster than inflation for 29 of the past 30 years.” Likewise, many financial commentators have stated that government programs which encouraged sub-prime lending bear some responsibility for the bubble in the housing market.


Credit May Encourage Reckless or Undesirable Behavior

Distorted prices and bad credit decisions by both lenders and borrowers can’t be blamed on government policy alone. Many people simply can’t handle debt responsibly – they borrow too much, spend recklessly, miss payments, lose the house and go broke. Some lenders prey on the weakness of borrowers. They charge exorbitant interest rates and fees, or keep offering credit cards to those who are already over their head. The flaws in human nature make any credit agreement a potentially dicey proposition. Here’s financial analyst Ian Hodge’s explanation from an April 26, 2009 blog commentary:

…you can see that the real problem is instant gratification.  People don’t like to wait for something in the future.  They want it now.

Because their appetite is insatiable, the demand for instant gratification drives sellers in the marketplace to constantly increase their prices, and they don’t care that ordinary folk have to go into debt to buy their goods.  In fact, they have a vested interest in debt, because now they can get higher prices for their goods.  This is especially true in the real estate market.  This is why I have never heard any property developer complain about the high debt levels in the economy.

No home seller complained about Fannie Mae and Freddie Mac.  They were happy to leave the problem to “other” people.  They took their inflated prices and pocketed the huge increases in property values that were driven by debt.

Instant gratification.  Sellers were not prepared to wait for higher prices that might come through supply and demand.  Instead, they preferred the instant higher prices obtainable through debt.

Thus it is the greed of sellers – coupled with the… buyers who want to borrow – that is the cause of our economic problem.

Borrowing and lending has the potential to be a corrupting agent – financially and ethically. While most discussions today regarding credit focus only on financial particulars, there are important social and moral implications to the use of credit as well. Historically, many societies banned or stigmatized lending because of the potential for abuses. This particularly applied to lending to individuals (as opposed to business organizations or governments). Because credit is like lighter fluid, it can burn things up as well as get them started.

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Divided By Debt

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Where You Stand Today May Determine
Where You End Up Tomorrow

The ripple effect of the financial crisis that originated in the sub-prime mortgage sector in 2007 is still reverberating through the global economy. The shakeout is far from over, but recent responses of both individuals and institutions in the aftermath of the first waves of financial distress are likely indicators of some long-lasting changes in the financial culture of the United States.

Among the issues that most likely will see major change: the use of credit, and the business of lending and borrowing.


Assessing The Credit Landscape


Don’t want to be a richer man


Just gonna have to be a different man

– David Bowie

Today, on a global basis, we are feeling the aftershocks of too much credit gone bad. After a boom period of easy credit when almost anyone could buy anything, the bust is upon us. People are looking for strategies and actions that will stop the bleeding and lead to a recovery. Some responses to the current financial adversity are logical and self-explanatory, others are unexpected or unusual.


1. No Surprise: Financial Institutions Have Tightened Their Lending Standards

It doesn’t make sense to lend to people who can’t make payments. With both credit card and mortgage default rates at all-time highs, lenders have become more conservative in their lending practices.

Citing information by the Federal Reserve, Sara Murray and Jon Hilsenrath wrote in the August 18, 2009 Wall Street Journal that “most banks reported that they expected their lending standards across all loan categories would remain tighter than their average levels over the past decade until at least the second half of 2010.”

Remember how you used to get four or five offers a week for a new credit card – with no fees and no interest for 6 months? For most, such offers are things of the past. Now credit card companies are reducing limits, canceling cards and looking to clean out problem borrowers. Andrew Martin, writing in the May 18, 2009 New York Times says: “Banks are expected to look at reviving annual fees, curtailing cash-back and other rewards programs and charging interest immediately on a purchase instead of allowing a grace period of weeks, according to bank officials and trade groups.”

The message: If you want to borrow, prove to us you can pay it back. We’re no longer taking your word for it.


2. A Bit of a Surprise: Americans Have Decreased Their Borrowing and Increased Their Saving

For years, financial commentators have lamented Americans’ pathetic savings rate, which as little as two years ago was actually negative. Well, it didn’t take long for that behavior to swing around.

Under the headline, “Amid Recession, U.S. Savings Rate Hits Highest Mark Since 1993,” a June 26, 2009 article posted on stated:

As the longest recession since World War II drags on, Americans are responding by shying away from spending, opting instead to save money at the fastest pace in 15 years, a new report shows.

The Commerce Department reported Friday that consumer spending rose 0.3 percent last month, in line with expectations. Meanwhile, the savings rate that had hovered near zero in early 2008 surged to 6.9 percent, the highest level since December 1993.

It’s somewhat remarkable that saving would spike so dramatically in the midst of a severe recession that includes high levels of unemployment and diminished incomes. The reduction in spending can be attributed to not having money, but an increase in savings indicates some people do have money but are choosing not to spend it.


3. Quite a Surprise: Some Financial Commentators and Politicians Have Been Critical of Both Cautious Financial Insti-Tutions and Thrifty Individuals

Prudent lending practices and increased saving rates may seem like rational economic responses, but according to those who believe in the financial power of credit, these common-sense actions will not lead to a robust recovery.

When governments poured new money into lending institutions to stabilize the financial system, it was with the belief the institutions would then be able to continue making loans and allow the economy to keep spending. But lenders are understandably reluctant to use new money to make the type of loans that got them into trouble in the first place. They have the money, but are much more careful about lending it. This lack of new lending prompted Campbell Harvey, a finance professor at Duke University’s business school, to observe “Basically we have dropped a huge amount of money … and we have nothing to show for what we actually wanted to happen.” (Wall Street Journal, 01/26/2009).

President Obama’s comments in his State of the Union Address in February 2009 summarized the perspective of those who see renewed lending as necessary for recovery:

The concern is that if we do not re-start lending in this country, our recovery will be choked off before it even begins.

You see, the flow of credit is the lifeblood of our economy. The ability to get a loan is how you finance the purchase of everything from a home to a car to a college education; how stores stock their shelves, farms buy equipment, and businesses make payroll.

But credit has stopped flowing the way it should. Too many bad loans from the housing crisis have made their way onto the books of too many banks. With so much debt and so little confidence, these banks are now fearful of lending out any more money to households, to businesses, or to each other. When there is no lending, families can’t afford to buy homes or cars. So businesses are forced to make layoffs. Our economy suffers even more, and credit dries up even further.

And it’s not only lending institutions that need to loosen up. Every American must do his/her part by continuing to be a healthy consumer. Here’s a February 12, 2009 headline from Chris Isidore, a senior writer at Why Saving is Killing the Economy.

The opening paragraph:

It wasn’t that long ago that many economists worried that Americans were saving too little.

Today, the growing concern is that Americans are starting to save too much.

It’s not that the savings rate today is high by historic measures, or by comparisons to some other countries. But it has moved sharply higher in recent months — at a time when what the economy needs most is for consumers to be spending more freely.

Later in the article, Isidore quotes Mark Zandi, chief economist for Moody’s who says increased saving is “a lot of spending that’s not happening.” Consumer spending is “the difference between an economy that is growing and one that is struggling mightily.”

Isidore concludes:

Saving more and cutting debt might sound like a good plan to deal with the recession. But if everyone does that, it’ll only make matters worse.

In brief, lenders are getting tighter, individuals are saving more and borrowing less, and experts want both groups to loosen their purse strings.

What’s going on?

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“Down Goes Math! Down Goes Math! Down Goes Math!” (Again): Will Asset Allocation Keep Working?

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Joe Frazier was a feared boxer, a heavy-weight champion who, between 1971 and 1975 fought three momentous bouts with Muhammad Ali, winning once. In 1973, he fought a relatively inexperienced George Foreman in Kingston, Jamaica. Foreman had been a 1968 Olympic champion, but the veteran Frazier was a prohibitive favorite. The fight was no contest. Foreman knocked Frazier to the canvas six times, and ended the fight with a 2nd-round knockout. The legendary sports commentator Howard Cosell was at ringside calling the fight. As Foreman pummeled Frazier, a stunned Cosell, uttered this famous refrain (that is so legendary you can even buy as a ringtone for your cellphone):

“Down goes Frazier!
Down goes Frazier!

In the world of financial mathematics, a “veteran” financial formula has taken a similar beating as a result of the recent stock-market decline. Asset Allocation is a historical, mathematically-driven approach to investing that attempts to select investments from different asset classes to form a diversified portfolio, with the idea that the mix of investments will limit losses and smooth out returns.

At the mathematical heart of the Asset Allocation strategy is the matching of disparate asset classes – ones that move up when others move down, and vice versa. This disparity is quantified by using a correlation ratio; if two investment classes perform exactly alike, their correlation is 1, while asset classes that perform quite differently might have a correlation of 0.2. For most asset mixes in the United States, the benchmark asset class is the S&P 500 stock index, against which all others are compared.

Asset Allocation has a long history. It first appeared in the 1950s, and Harry Markowitz, a pioneer of Modern Portfolio theory, was awarded the Nobel Prize for his work. As Wall Street Journal reporter Tom Lauricella writes in a July 10, 2009 Wall Street Journal article (“Failure of a Fail-Safe Strategy Sends Investors Scrambling”), “asset allocation became ingrained in nearly every corner of Wall Street.” For over four decades, asset allocation was used in all sorts of financial products and delivered consistent, almost predictable returns.

But the last two years have not been kind to Asset Allocation. Lauricella notes that when the S&P 500 dropped 47% from March 2008 to 2009, many asset allocation funds performed even worse; their diversification didn’t work as a buffer against losses.

What happened?

The analysts interviewed by Lauricella noted two significant changes. First, globalization of the economy means greater correlation and less opportunity for diversification. The economy in China is connected to the economy in Europe, is connected to the economy in America – when they all act the same, you can’t diversify by investing in different regions.

Second, the popularity of diversification may actually make it a less useful strategy. As analyst Vineer Bhansali said, “when (lots of) people start buying an asset, the act of them diversifying actually makes the asset less of a diversifier.”

Money managers are divided about whether Asset Allocation is finished as a viable model. The value of diversification still seems logical and useful, so some adherents believe the process simply needs tweaking. But others see it as a relic of a past economic era – the “new” economy will require a different method of diversification.

But either way, there is a financial lesson that bears repeating: While events in life can be cataloged and categorized, life cannot be reduced to a mathematical calculation. This is especially true about the use of formulas to predict the future. There are too many variables that can change, and too many ways for the changes to be unforeseen. And just because something is improbable does not mean it is impossible. A primary objective of a good financial program is to adequately address all possibilities, not just those considered most likely.

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Using a Lottery as an Incentive to Save

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According to Wikipedia, behavioral finance is a “separate branch of economic and financial analysis which applies scientific research on human and social, cognitive and emotional factors to better understand economic decisions by consumers, borrowers, investors, and how they affect market prices, returns, and the allocation of resources.” Among the things behavioral finance studies are the factors that influence people to make bad or short-sighted economic decisions. For example, why do many people opt for the unlikely chance of a big payout from gambling, and avoid the sure-fire success of regular saving?

As Jason Zweig notes in his July 18-19, 2009 “Intelligent Investor” column in the Wall Street Journal, “in 2007, the latest year numbers are available, Americans spent $92.3 billion on legalized gambling, according to Christiansen Capital Advisors; that same year, says the U.S. Bureau of Economic Analysis, Americans saved only $57.4 billion.”

Why do Americans put more dollars toward gambling than saving? Someone in the field of behavioral finance would theorize that people tend to over-estimate the odds of rare occurrences, like winning the lottery, or breaking the bank at Vegas, in part because the magnitude of reward is so enticing – “I know the odds are 10 million-to-one, but can you imagine what we could do with a million dollars!” Saving, on the other hand, provides minimal thrills, and no chance of outrageous gain. For many, potential thrills trump low-level guarantees. This is especially true with smaller amounts of money. Given the choice between saving $25 or buying 5 lottery tickets, the tendency to gamble is strong, because $25 saved doesn’t add up to much, but a single winning ticket could mean millions.

But what if there was a way to tie the thrill of gambling to the boring activity of saving? This was the idea behind the “Save to Win” program developed by Peter Tufano, a professor at the Harvard Business School.

In a campaign launched in February 2009, eight credit unions in Michigan offered one-year Certificates of Deposit, with a minimum deposit of only $25. These low-minimum, short-term CDs actually pay interest below those of conventional CDs, but come with a unique kicker: With each new CD, the depositor is entered in a monthly and annual drawing. The monthly winner receives $400, the annual winner $100,000. In essence, depositors get to play the lottery when they save money.

Zweig’s article noted the campaign has been quite successful: In 25 weeks, the credit unions attracted over $3 million in new deposits. But some of the best comments come from participants in the program, reporting their experience on the Internet. Here’s one, from “Dean L.” posted in a forum on :

I had less than $5 in my bank account a couple of months ago. This had been a typical savings amount for me for as long as I can remember.

I have read about saving money and have known for a long time that it’s something that intellectually I know I should be doing, but there had never been the incentive for me to do so. The paltry interest rates that banks pay made me feel like it was a waste of time to put aside money, so I took my chances each month and played the lottery instead. It was always $2 here, $5 there, but it added up to close to $100 over the entire month.

That all changed two months ago when I walked into my local credit union and learned about a new savings promotion they were offering called “Save to Win” where if I placed $25 or more into a 1 year CD, I had a chance to win up to $400 on a monthly basis plus a chance at $100,000 at the end of the year. Although the payout isn’t as high as the lottery, it gives me a chance to win something which makes the low interest rates more palatable.

Since that time I have put aside the money that I would have put toward the lottery and instead have placed it into CDs. I’ve opened 5 CDs over the last 2 months which has my savings at more than $125 – an amount that I haven’t had saved in years. I plan to continue to place the money I would have spent on the lottery into CDs for the rest of the year and should have close to $1,000 in savings by then. And if I’m lucky, I may win some cash prizes along the way or $100,000 at the end of the year.

One of the popular books relating to behavioral finance is Nudge (Penguin, 2008) by Richard Thaler and Cass Sunstein. The subtitle of the book is “Improving Decisions About Health, Wealth and Happiness,” and extensive sections of the book are devoted to methods used by individuals and institutions to provide strong incentives for a desired financial outcome, whether it is cutting expenses, saving for retirement, or even spending money on luxuries.

In the paradigm of the book, the “Save to Win” program is an example of what the authors call “Libertarian Paternalism,” which means people are free to choose, but choices are structured to encourage the “better” choice. No one is forced to put money in a one-year CD, but as Dean L. writes, the “chance to win something…makes the low interest rates palatable.”

The next time you have a discussion about your long-term financial objectives (with your spouse or one of your advisors) you might want to consider “nudges” you could include in your financial strategies. You might not be entered into a $100,000 drawing, but any strategy that can help you “save to win” is probably a good one.

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W-2, 1099, or Schedule C? It Doesn’t Matter, Because Everyone is Really “Self-Employed”

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“Those who spend too much will eventually be owned by those who are thrifty.”
– Sir John Templeton

The Sun Sets On Industrial Age Employment

Some commentary on current events, from a long-term perspective:

On July 17, 2009, US Bureau of Labor Statistics reported the national unemployment rate as 9.7%, the highest since 1983. In several states, unemployment is well over 10%, and is even as high as 20% in some metropolitan regions. This is a major employment upheaval, one that significantly impacts the financial lives of a large segment of the populace.

If the future is consistent with past history, many of those currently unemployed will eventually find their way back into the workplace when the economy rebounds. But those who return to work will find their employment landscape fundamentally and permanently changed, because it is quite likely this “Great Recession” officially marks the end of lifetime employment.

Lifetime employment was one of the crowning distinctions of the modern Industrial Age. Beginning in the post-war 1940s, it was characterized by steady employment, guaranteed pensions, and employer-provided benefits. As a result, millions of blue-collar American households ascended to middle-class affluence; they bought homes in the suburbs, sent their kids to college and after 40 years of service, retired to a life of relative security and ease. At the same time, the white-collar professional and management class grew as well. Every now and then some observer might moan about the dehumanizing aspects of factory work or cubicle life in the corporate maze, but throughout history, there’s never been a socio-economic model that delivered so many financial benefits to so many people on such a stable basis.

However, in a world where the only constant is change, Industrial Age lifetime employment could not last forever. The power technologies that fueled the Industrial Revolution (steam, electricity and the internal combustion engine) laid the foundation for the micro-technologies of the personal computer and the Internet, ushering in the Information Age. And while government policymakers may strain mightily to preserve the “old world” of lifetime corporate employment, every indication is that changes are not only on the horizon, but already here. Even American automobile manufactures finally recognized it. Unless you are working in government (including education) or the military, lifetime financial security, courtesy of your employer, is a thing of the past.

Self Employed in the Information Age

Going forward (if you haven’t experienced it already), these changes will have huge implications for your individual finances. In the emerging Information economy, workers will find it to their advantage to think and act as if they were self-employed. For some, this means adopting some different paradigms and acquiring some different financial habits.

Fluctuating Income, Multiple Sources

First and foremost, the nature of your work and income may change. You are less likely to remain in one industry, with one employer, doing one job, receiving one paycheck. Instead, work is more likely to resemble a series of long-term but temporary assignments with several employers (sometimes at the same time), with periods of unemployment and self-employment. This is particularly true for younger workers. As Maureen Sharib, an employment “sourcer” from TechTrak, put in a July 14, 2007 commentary:

“Today, there are 149 million people in our nation’s workforce. Every year, approximately 50 million people leave their jobs. And approximately 50 million find new jobs. That means one-third of our workforce turns over each year because of new opportunities. And the average American has had nine jobs by the time he or she is 34 years old because of new opportunities.”

Not only are tomorrow’s workers more likely to experience regular employment changes, they will also encounter different forms of payment. While government prefers making as many workers as possible W-2 employees because income taxes are withheld by the employer, the just-in-time, low-overhead pressures of the Information economy make it financially desirable for companies to limit their full-time employees and consider out-sourcing or contracting. For many, this could mean the end of regular paychecks.

Combine frequent job changes with non-W-2 compensation and the inevitable result is irregular cash flow, one of the major characteristics of self-employment. Successful self-employment requires strategies to manage these fluctuations and still pay the bills.

Portable, Personal Benefits Packages

As you move, you must either maintain or perpetually re-establish your benefits package. When the “company man” was the default career path, the trip included employer-provided benefits. That scenario is no longer on the table for most workers.

Even in holdover Industrial Age jobs, the cost of providing benefits has skyrocketed (particularly for health care), so most employers require employees to share in the costs. Alternately, employers reconfigure their work force so that fewer employees are eligible for any benefits. The structure of Information Age employment puts the responsibility for benefits more directly on the worker.

If offered, group disability and life insurance protection may be an inexpensive way to obtain income protection, but these options are usually limited to active employees – if you terminate employment, you can’t take the coverage with you (you may be able to convert  life coverage to an individual policy, but the costs are no longer at group rates). This leaves you either hoping your new (and often temporary) employer will offer similar benefits, or hoping you are healthy enough to qualify for similar benefits on an individual basis. The older you get, the more problematic this arrangement becomes.

In the long run, securing a personally-owned package of portable (and permanent) benefits may be a better option, particularly for disability and life insurance, where premiums and coverages for individual policies can be guaranteed to remain the same for specified time periods. In addition, healthy individuals who obtain permanent coverage at a young age may realize some long-term savings because younger, healthy individuals usually subsidize the costs of insuring older, less healthy people in group policies.

Your Own Financial Management Systems

Not only must your benefits package be portable, but so must your financial management systems. All employers are subject to regulation regarding taxes and withholding for the employees on their payrolls. This includes the requirements to pay the employer’s portion of FICA and Medicare taxes, plus withholding on income paid to employees. However, when workers are paid by the job or under 1099 conditions, the responsibility for these taxes falls on the worker, not the employer. This increases the possibility that you may have to make quarterly estimated tax payments, at both the state and federal levels. (Even if you receive a W-2, you may be considered a “non-statutory employee,” in which case the employer will not manage your withholding requirements.)

This means your tax return will probably require more than a 1040-EZ form. It also means you’ll want to keep records for deductible expenses, as well as earnings.

Additionally, employers typically handle automatic deductions for qualified retirement plans, like 401(k)s, and often facilitate direct-deposit transactions, making it easy to execute long-term saving objectives. But if you’re not eligible to participate in a company’s plan, where will you put retirement savings – and how will you deposit the money? These issues must be addressed by your financial management system.

You are the Pension Fund Manager

Beyond finding the financial vehicle and making the deposits, you are responsible for creating your own pension income from these savings. Unlike the Industrial Era job, there are no formulas based on average salary and years of service to determine your retirement benefit. Instead, it’s up to you to answer questions like: How much funding will be required? When will you be able to receive payments? How big will they be? In addition to figuring out how to best accumulate the funds, you must also become your own actuary and determine how they will be distributed.

If You Can’t Handle Self-Employment, Will the Government Bail You Out?

Consider the brief listing above of additional assignments: Insurance, Accounting, Retirement Planning. For the typical employee at the end of the Industrial Age, all these assignments were handled “in-house:” It was group benefits, a W-2, and a pension. Now, the trend is that these are being replaced by the individual. Not surprisingly, it appears many individuals are not up to the challenge of functioning as self-employed independent contractors. Statistical evidence seems to indicate that too many people are under-insured against the difficulties of life, and under-funded for retirement.

This collective poor performance has compelled government officials to seek legislative fixes, using taxation and regulation to guarantee minimum levels of financial well-being. The legislative push for national health care is the most prominent example of current government initiatives, but in the past year, other items have been considered as well, including an idea to establish mandatory all-inclusive Government Retirement Accounts (GRAs) as replacements for company-sponsored 401(k)s.

Some might think that broadly-available government programs for insurance and retirement might serve as suitable replacements for Industrial Age company benefits, sparing individuals the challenges of self-employment. But anytime government enacts policies that seem to restrict or resist market forces (such as out-sourcing, globalization and the Internet), there are usually unintended consequences.

For example, economists have regularly documented that minimum-wage laws typically lead to either a decline in employment or inflation. While those who are currently working at low-wage jobs do make more money, employers often consider hiring fewer workers or raise their prices to accommodate their increased labor costs.

What might be the unintended consequences in some of these government proposals? Suppose the law requires companies over a certain size to provide health insurance or be hit with a fine. Depending on the cost, one practical response might be to shrink the company (or perhaps divide it), to fall below the threshold. After careful analysis, another option might be to pay the fine, but not provide insurance. Even if the company conforms to the proposal, the insurance coverage may not be a plan that matches the individual’s medical needs.

Because no one knows how the national health care issue will play out, the above comments are pure speculation. Perhaps politicians can actually craft a utopian solution that delivers far beyond our wildest dreams. But the pragmatic response, considering history, is to assume that government initiatives will not restore Industrial Age benefits to the Information Age economy. Better to think and act as a self-employed individual than hope for nationalized group benefits.

(Even with mandated nationalized programs, you still end up functioning as an individual. Think of Social Security. When it comes time to apply for benefits, you aren’t part of a union, or some other select pool of beneficiaries. You don’t have a Human Resources advocate to guide you through your options – you’ll go through the bureaucratic maze on your own, or hire expert assistance – just like a self-employed person would.)

You Might Be Self-Employed, But You Don’t Have to Do Everything Yourself

30 years ago, a successful self-employed individual understood the necessity of a team of financial advisors. Finding someone to keep books, secure insurance, oversee investments, prepare returns, was part of the cost of doing business. This hasn’t changed. If you’re self-employed, you will almost certainly benefit from expert assistance.

One of the fortunate side effects of the Information Age is the expanded access to expert services and technologies. When computers occupied entire floors in corporate offices, only big businesses could deliver the benefits of advanced technologies. Now, a personal computer and an Internet connection can bring all sorts of expertise right to your doorstep. And the technology far surpasses anything that was produced by a 1970s main-frame program.

It is understandable that some people choose to hold onto the past as long as possible; they will do everything possible to preserve the status quo. But contrary to efforts by politicians to “preserve” or “create” more Industrial Age jobs, the free-market trend is toward a new era, and a different paradigm. Specialized self-employment comes with a new set of challenges, but also better ways to overcome them.

Here’s a simple checklist. As a self-employed individual, how well have you…

  • Made allowances for fluctuations in
    cash flow?
  • Established good management systems?
  • Secured your insurance benefits?
  • Prepared a spending plan for retirement?


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Financial Literacy Question: Adjusted for Inflation

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At an intellectual level, everyone understands that inflation affects prices – the same product or service costs more because our money is worth less. But at the same time, technology and other economic factors can also have an affect on prices, which is why computers and other electronic technology devices seem to get cheaper all the time, even with monetary inflation. So it can be hard to tell if the things we buy are really more expensive than they used to be.

This is why economists have developed the idea of adjusting for inflation. By taking the price for a similar commodity from the past and adjusting that number for inflation, it provides a method for comparing prices from different eras.

Question: According to the GasBuddy website ( the average price for a gallon of gasoline in the United States on June 25, 2009 was $2.63. Adjusting for inflation, how does this price compare to the average price in 1979?

A.)  Higher

B.)   Lower

C.)   About the same


And The Answer Is… 

The correct answer is “B”.

Using data from the Consumer Price Index, which the Bureau of Labor Statistics uses to calculate inflation, $2.63 today is the equivalent of .79 in 1979. From historical information provided by the Energy Information Administration, the average price of a gallon of gasoline in the United States in 1979 was .86 per gallon. This means a gallon of gas is 8% cheaper today than it was 30 years ago.

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BANKRUPTCY: Proceed With Caution

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Rebecca Wilder, the pen name for an “economist working in the financial services industry in Boston, MA,” had this headline in a December 28, 2009 article.

The Hottest Trend in 2009: Declaring Bankruptcy

Jane Bryant Quinn kicked off the New Year with these comments in the January 12, 2009 issue of Newsweek:

Go bankrupt in 2009. If you’re reaching the end of your rope, don’t try to hold on. Save what you can

Either these commentators know their stuff, or a lot of people are following their advice. A June 3, 2009 USA Today article reported that consumer and commercial bankruptcy filings are on a pace to “reach a stunning 1.5 million this year, according to a report from Automated Access to Court Electronic Records…In May, the number of bankruptcy filings reached 6,020 a day, up from 5,854 in April.”

This is sobering information, especially in light of legislative reforms enacted in 2005 that made it more difficult to use bankruptcy as a legal procedure to erase debts. And while most of the increase in filings is due to the financial distress inflicted by a struggling economy, a change in attitude may also be a factor.

Some may now see bankruptcy as a pre-emptive measure rather than an act of last resort. Quoting Bryant: “The right time to go bankrupt is when you’re financially stuck but still have assets to protect.” As more people file for bankruptcy, the social stigma diminishes, individuals are taking a closer look at the legal and financial merits of a bankruptcy filing.

An Overview of Bankruptcy 

Bankruptcy has a long history, going back to ancient times, because there have always been people who find themselves unable to pay their debts. While not an ideal solution, the process of bankruptcy provides a structure for resolving this dilemma, for both debtors and creditors.

The word bankruptcy comes from the Latin bancus, the tradesman’s counter, and ruptus, broken. (In Rome at the time of the Caesars, a merchant or tradesman unable to pay his debts would have his bench in the market place either broken or removed by a court-appointed official, who would then auction off the bankrupt person’s property to the highest bidder.)

The first English bankruptcy law was passed in England in the late 1500s during the rein of Henry VIII, and provided the foundation for basis for bankruptcy laws in the United States. Under both Roman and English law, bankruptcy was not something an individual chose; rather it was forced upon them by their creditors. Besides the seizing of assets, creditors could continue to demand repayment of all outstanding debts. If the debtor failed to repay, some laws allowed for imprisonment and even physical punishment.

Today, there are two basic forms of court-authorized bankruptcy: liquidation or reorganization. In the US, liquidation is known as Chapter 7 Bankruptcy, which refers to the chapter of the bankruptcy law that allows your assets to be sold off. Reorganization bankruptcies can fall under Chapters 11, 12 and 13, with 13 applying to most individuals. Chrysler and General Motors both filed under Chapter 11. When you file for bankruptcy, the court prohibits your creditors from taking action to collect debts without the approval of the court.

Chapter 7: Liquidation 

In a liquidation bankruptcy, you put your personal property in the hands of the bankruptcy court, which sells it and uses the proceeds to pay your debts (or as much of your debt as possible). Once the process is completed, old creditors have no further claim of payment, but the bankruptcy stays on your credit history for 10 years, which may result in restriction or denial if you attempt to borrow money during that time.

Under the new law passed in 2005, you may not have the choice of filing a Chapter 7 liquidation bankruptcy. If your income exceeds the median income for the same size family in your state, you must submit to a bankruptcy means assessment. This test essentially establishes a budget for you, based on a minimum standard of living. If after imposing this budget, the court believes that you have $100 or more per month in disposable income that you could apply towards your debt repayment, you may be pushed into a repayment plan under Chapter 13, instead of qualifying for Chapter 7.

Chapter 11, 12 or 13 – Reorganization 

In any reorganization bankruptcy, the filer submits a repayment proposal to the bankruptcy court. Payment plans usually cover three to five years, and not all debts receive equal treatment. The law requires that some debts must be repaid in full, while others may require a percentage, and some may not be repaid at all.

There are some debts that cannot be discharged or “forgiven.” These include debts you forget to list in your bankruptcy papers, child support and alimony, most student loans, fines and penalties as a result of breaking the law, tax debts, and judgments for personal injury or death caused by driving while intoxicated.

During the repayment period, the court will place restrictions on how you can spend money. In many cases, wages will be garnished by a trustee of the court, who will make the payments to your creditors.

Provided you make your payments as promised, it is possible that creditors will grant you credit at the end of the repayment period. But the bankruptcy will stay on your credit history for six years.

Asset Protection in Bankruptcy 

Bankruptcy laws allow filers to exempt certain types of assets from liquidation for settlement with their creditors. Typical exemptions include homesteads or personal residences, qualified retirement accounts, college saving accounts and some types of trusts. These exemptions are designed to keep filers from losing everything, but often create some potential ethical and legal challenges – with significant adverse financial consequences if abused.

Federal government allows each state to determine which assets are exempt, and there can be quite a variation in which assets qualify. Some states have generous exemptions, some do not. When individuals are contemplating bankruptcy, they may realize that certain assets might be excluded from bankruptcy if the asset could be transferred to someone else. Or they might conclude that it would be advantageous to establish residence in a different state, because the bankruptcy exemptions are more favorable. This awareness leads to what some bankruptcy attorneys call “exemption planning.”

While some measures can be taken to enhance the status of exempt assets, individuals must understand that “transfer of assets prior to filing is generally a ‘no-no,’ “ according to Leon Bayer, a Los Angeles Bankruptcy lawyer with 29 years of experience, in a legal guide posted on  Bayer continues: “Do not hide, conceal, transfer, or falsely encumber non-exempt assets. Doing so carries the risk of being prosecuted for committing bankruptcy crimes, it is likely to result in the denial of a bankruptcy discharge, and the trustee can still recover such property, or its value, from whoever it was given to.”

The Importance of Correctly Positioning Assets 

Indirectly, the issue of bankruptcy emphasizes the importance of forward-thinking risk management. While you know you can’t expect to transfer assets in anticipation of filing bankruptcy, the ramifications of a possible future bankruptcy may cause you to consider how your assets are owned right now. In the event of a financial setback, one that might result in either bankruptcy or a lawsuit, which assets would you want protected? Planning (and action) undertaken now might be your best defense against sacrificing years of hard work to satisfy creditors or litigants.

Nobody wants to file bankruptcy. Nobody wants to be in an automobile accident, either. But while most responsible individuals recognize the value of auto insurance, a much smaller percentage actually follow through on securing “insurance” on their assets, either through the vehicles they use, or the financial structures around them.

Because of bankruptcy’s complex legal issues and the variations between different states, it is important that any asset transfers be supervised by competent legal counsel. The licensed insurance or investment professional you work with should be made aware of your intentions, as they can provide assistance with the details of properly titling assets, from the perspective of their industry expertise.

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