Now is not the time to pay off debt faster

Now is not the time to pay off debt faster

I’m sure there’s a politician somewhere who can spin the information to arrive at a different conclusion, but most of us are dealing with the following financial realities:

• Property values are down.
• Interest rates are down.
• The stock markets are down (then up for a while, and down some more).
• The US dollar is down – and the cost of living (especially fuel) is up.
• Our US economy is down (due largely to the real estate and financial crises).

As a result, many Americans are worse off than they were a year ago. Given these negative financial circumstances, where many people have less money and are less inclined to takes risks with it, I am reading commentary from financial “experts” saying the prudent thing to do now is to re-direct saving and investment dollars to pay off debt.

I’m all for eliminating debt. Debt is a financial millstone around the necks of most Americans, and it is debilitating, financially and psychologically. But while I’m sure many of these financial experts are well-intentioned, I would argue now is not the best time to pay off debt. Rather, now is the time to save money. Let me explain:

The argument that most pay-down-your-debt advocates make goes like this: If you don’t think you can earn above-average returns in stocks, and interest rates are low in guaranteed vehicles (like Treasury instruments, Bonds, CDs and Money Market accounts), then why not use your investment dollars to pay off high-interest (and usually non-deductible) debt? After all, if your credit card company is charging you 15-18%, making extra payments on the balance is “like earning 15-18 %.”

Superficially, this argument makes sense. Mathematically, you can “prove it.” But while this strategy is logical, it neglects some of the financial realities. Let’s use a hypothetical “real-life” example to illustrate.

Suppose you decide to follow the advice of the pay-down-your-debt gurus. Instead of saving or investing in your 401(k) or some other accumulation vehicle, you commit an additional $200 each month to paying off credit card debt.

If you make an extra $200 payment on the credit card, will you still have a payment due next month? Yes. Will the monthly payment be significantly less than the month before? Probably not. There may be some decrease, depending on the size of the balance, but especially if your balance is high enough that it would take a year or more of extra $200 monthly payments, the monthly decrease isn’t going to be that great. So while you technically “earned” the interest you saved, you don’t have more money in your pocket, and you still have a financial obligation next month.

Let’s inject a little more “reality” into this scenario.

Assuming you have used your “extra” $200 for the past few months to pay down your credit card balance, how will you pay an unexpected but necessary expense, such as an $800 automobile repair? If you don’t have any liquid savings, most likely you’ll end up using the credit card. If you do, your outstanding balance is goes back up, and so does the interest charge.

Here’s another “reality” situation. In the next few months, what happens if you lose your job, or have to take a pay cut? If you don’t have as much income (or no income) and no liquid savings, the likelihood is there’s not going to be a payment to the credit card company. And more than likely, one late payment will trigger a higher interest rate (along with fees) on your card – and your credit score is going to take a hit as well.

One of the reasons most people have high-interest credit card debt in the first place is because they haven’t learned the discipline of saving. They haven’t developed the habit of living below their means and paying cash for big-ticket purchases, vacations, emergencies, etc. In fact, the only saving many people do is through their retirement plan, where money is withheld from their paycheck. Thus, their default budgetary model is “if it’s in the account, I can (and will) spend it.”

Of course, this approach is ill-equipped to deal with unexpected expenses or large purchases, so borrowing becomes the other default action in their financial lives. There’s always the intention of paying the credit card off next month, but a few years later, unpaid credit card balances are a permanent part of their budget. Five years later, the monthly payments are putting a strain on current expenses. Consolidation may temporarily relieve cash flow pressures, but because the underlying behavior hasn’t changed, it isn’t too long before the balances are going up again.

If you really want to fix your debt problems, start saving and stop borrowing. Building a pool of savings (call it your emergency fund, rainy day fund, save-to-spend account, whatever) will keep you from going back to the lending trough. Having savings will keep you from missing payments if your employment situation changes. Having $10,000 in a liquid, safe account will change your life.

By the way, even if you already have $10,000 or more set aside, and have a very secure employment situation, I would still recommend saving instead of extra payments on debt, even credit card debt. The better approach is to make the scheduled payments each month until your savings balance is large enough to pay the outstanding debt in full.

Part of this is a matter of control. If Visa is satisfied with $100/mo., why send them $300? Keep your money under your control, and when it suit you, pay the balance in full.

The other reason for saving instead of paying off debt is that the math isn’t as favorable as you might think – even if there’s a significant different between the rates of return on your savings and the interest charged by the credit card company. For an eye-opening illustration, check out this article on www.worksaveown.com.

Saving money is not the same as paying off debt. Saving money is a behavior that leads to financial control and freedom. Paying off debt, even at a faster pace, may help relieve some financial pressure, but it doesn’t move you forward. If you don’t establish the saving habit, you will always be at risk of going back into debt. Bad habits not only need to be avoided, they need to be replaced.

With all the uncertainty surrounding the present economic situation, the best financial decision is to save.

Economic Stimulus Checks: Bread and Circuses

As the ideals of the Roman republic were eroded and displaced by the politics and tyrannical rule of the Caesars, governing parties realized that an oppressed citizenry could be pacified with food and entertainment. Thus, the government became the provider of bread and circuses (panem et circenses), an ancient Roman metaphor for people choosing food and fun over freedom.

 

The issuing of Economic Stimulus Checks is a straightforward application of the bread and circuses philosophy. Yet curiously, I haven’t heard much dissent regarding this approach. It seems there should be quite a bit of outrage.

 

First, if our elected officials see fit to “give back” some money, why did they take it in the first place? If they believe returning money to the citizens will help the economy, then it’s reasonable to suggest that taking it was harmful to the economy. (It’s a pretty twisted scenario where someone creates a problem so they can fix it, but that’s one of the essential illusions of government: create a problem so you can put forward your party and your policies as the solution.)

 

Second, where is the money coming from? We hear constantly of the ballooning federal debt and the lack of funding for government programs. How can an organization constantly in need of money afford to hand out $600 to every qualified taxpayer?

 

In the best Keynesian tradition, our government has either decided to borrow more to encourage spending, or to authorized its central bank (the Federal Reserve) to print more money. Either way, taxpaying citizens get stuck with the bill; in one scenario, the federal deficit grows larger, in the other, the value of the currency gets smaller. Thus, your $600 “rebate” results in higher taxes or less spending power.

 

Furthermore, government officials have the temerity to tell us how to spend it! They didn’t want us to use to pay off debt, or put it savings. No, they told us the best thing we could do was to spend it! The truly patriotic would use their “windfall” to buy a plasma TV, take a weekend ski trip, make a down payment on an new car, or visit the Caribbean. (It was a nice, benevolent touch when President Bush finally acknowledged it would be okay to spend the checks on necessities as well; you know, things like rent and gasoline.)

 

It’s absurd. They take your money, expect your gratitude for giving a fraction of it back – and then they want to tell you how to spend it! The arrogance is breathtaking. But nary a soul is demanding accountability for these actions – because they’re getting a check back! Not that you should sent your check back. From a purely pragmatic point of view, any money in your hands is better than leaving it under government control.

 

But instead of just accepting the scraps, why isn’t someone asking for more? Americans have become a docile populace, conned into believing that dependency on government hand-outs and consumer debt are necessary for survival. The collective mindset has such low expectations that many can’t imagine anything better than watching “American Idol” on a new TV (courtesy of your congressman!) Bread and circuses, indeed.

 

 

Not Yours To Give

Not Yours To Give

You can’t believe everything you read on the internet. (But even the lies and half-truths can provoke some interesting thoughts.) If you want to get the whole story here, take the time to read everything – because I saved the best for last.

On February 18, 2008, I received an e-mail about taxes, which included the following excerpt:

The next time you hear a politician use the word “billion” in a casual manner, think about whether you want the “politicians” spending YOUR tax money. A billion is a difficult number to comprehend, but one advertising agency did a good job of putting that figure into some perspective in one of its releases.

• A billion seconds ago it was 1959.
• A billion minutes ago Jesus was walking the streets of Jerusalem.
• A billion days ago no-one was around.
• A billion dollars ago was only 8 hours and 20 minutes, at the rate our government is spending it.

 While this thought is still fresh in our brain, let’s take a look at New Orleans. It’s amazing what you can learn with some simple division…

Louisiana Senator Mary Landrieu (D), is presently asking the Congress for $250 BILLION to rebuild New Orleans. Interesting number, what does it mean?

1. Well, if you are one of 484,674 residents of New Orleans (every man, woman, child), you each get $516,528.
2. Or, if you have one of the 188,251 homes in New Orleans , your home gets $1,329,787.
3. Or, if you are a family of four, your family gets $2,066,012.

Washington, D.C .. HELLO!!! … Are all your calculators broken??

Interesting statistics, right? They really help put the concept of “billion” in perspective. And wouldn’t it be nice to be a New Orleans family of four in line for more than $2 million in federal money. Except…

Senator Landrieu isn’t “presently asking Congress” for $250 billion. She asked for it in 2005, right in the midst of the all the “we’ve-got-to-do-something” hysteria about Katrina. After further review, it was fairly obvious the $250 billion figure was overkill. So while the billion info is interesting, the “outrage” is over something that didn’t happen.

However…

Skip the math. There’s another issue here. It’s the assumption that government should be involved in providing “relief” through disbursement of public funds. I know it may sound like a noble undertaking, but is there any rational economic or social justification for having FEMA or any other government disaster relief agency?

This is not meant to be cold-hearted or mean-spirited. Helping those is need is certainly one of the primary virtues of a healthy society. But strong, logical arguments can be made against using government as an instrument of social mercy. In fact, the more likely by-product of government-sponsored social relief – even in emergency and disaster situations – is greed, corruption and waste.

Almost 20 years ago, a mentor gave me a booklet entitled “Not Yours To Give” which convincingly explains why charity should not come from government coffers. The story features an incident in the life of the legendary Davy Crockett during his service as a Congressman. To read the full story – and to fully understand why government should not be in the social relief business, clink on this link “Not Yours To Give”

A Bailout Seems Wrong…But The Precedent For it Goes Back A Long Ways

“The Bush administration is hardening its opposition to the chorus of Democrats, bankers, economists and consumer advocates calling for a big-money government rescue program for struggling homeowners.”

(to read the entire article, clink on this link:

http://www.smartmoney.com/bn/smw/index.cfm?story=20080228102127)

The business people I know are probably praising the Bush administration for holding the line. After all, why should people who took on foolish debt obligations be allowed to skip out on them? When irresponsible people don’t make good on their obligations it leaves the responsible people – both debt payers and debt holders – holding the bag. But based on some of my recent reading, I won’t be surprised if the end result of the sub-prime mortgage crisis is some form of wholesale debt cancellation.

On a principled level, the idea of canceling debts seems wrong (provided you believe some governing authority has the right to legalize fractional banking and paper money creation). But from a practical aspect, the lenders – and the government – may have no choice.

In a 1988 book (now out of print) titled “Usury, Destroyer of Nations,” author C.S. Mooney provides an interesting history of debt, from ancient to modern times. In general, Mooney notes that debt follows a regular cycle of expansion then bust. At the point where large segments of the population are destitute and can no longer pay their debts, governments are faced with the prospect of widespread social unrest. And lenders, having repossessed or collateralized every asset and wrung every possible payment from the borrowers, have little hope of squeezing more blood from the turnip. For everyone’s safety, a repudiation of debts solves everyone’s problems – and allows the process to start all over again. Politicians can rule, and lenders can lend because borrowers have some of their collateral restored.

Mooney mentions several ancient examples of debt repudiation, among them:

• The Biblical story of Nehemiah after the Jews had returned from Babylon (for the full story, see Nehemiah 5:1-13)

• The Greek ruler Solon who declared that “all persons enslaved or attached for debt were released, those sold into servitude abroad were reclaimed and freed.”

Some commentators think Solon’s efforts were not a full repudiation of debts, but rather a restructuring. In either event, the attitude of the ancient rulers was the same as today: To maintain order (and keep lenders in business), it may be necessary to occasionally “take a loss” to return things to their “natural state” (i.e., the masses are mollified, the lenders get rich, and the politicians stay in power).

When politicians and lenders fail to heed calls for debt relief it can be disastrous. An unsympathetic Marie Antoinette said “let them eat cake,” and the populace responded with “off with her head.” The ignorance of the czars eventually led to the Bolshevik revolution. The corruption of Batistista (including his acceptance of the Mafia, some of the toughest lenders on the planet) gave Castro the popular support to become a dictator/liberator.

Granted, not all of the reasons for these revolts were exclusively financial. But prosperous people don’t usually resort to civil protest. When financial oppression rises, so does the inclination to violence and revolution.

In addition, the ability of the contemporary governments to arbitrarily print more money makes a bail-out/debt forgiveness plan more likely because it can be disguised. If necessary, lenders can be “paid” worthless paper to project the illusion of solvency. The reality of course, is that no real value has been tendered as repayment; but then again, no real value was loaned by the banks either. In a twisted way, one sham transaction can appear to reconcile the other.

Politicians may not learn all the lessons of history, but they are smart enough to learn the ones they need to keep their positions. Bottom line: If a bail-out makes political sense, it will happen.