Exjackly

Being in a reasonable financial position, I want everybody around me to also do well.  I know where I am and where I want to go.  Unfortunately, some friends of mine are in the opposite boat.  They do not have their financial lives together and do not know where they are are or where they are going.

Deep down, I want them to make the right choices and come on a similar journey to the one I am making.  I also know that they are not going to, and usually the worst thing I could do for our friendship would be to give them money to turn things around.

... usually the worst thing I could do for our friends would be to give them money to turn things around.

Friends usually get into financial trouble over a period of time.  It does not come up unexpectedly.  The signs are usually there for anybody who is watching: deferred maintenance on vehicles, problems cropping up around the house do not get fixed quickly, or you notice their spending habits changing for the worse.  A quick and easy fix of more money is not going to fix what caused the problem initially.  If the underlying financial activity that got them into trouble in the first place is not changed all more money will do is delay the final meltdown.

Even if the extra cash is enough to get them out of trouble, the loan can cause worse problems.

In My Heels knows this. She puts it well saying:

“It’s age old advice for a reason.  The problem with lending money to loved ones is this:  If you lend serious cash to someone you care about, you still expect it back right?  Sometimes the people we care about expect the relationship you have with them to excuse or “forgive” loans that you have no intention of forgetting about… especially if you can’t afford to.  Tempers flare, words fly like knives, and those knives sever relationships.  Sometimes those wounds heal, and sometimes the damage is permanent.

So, what should you do?  For starters, say NO.  Be nice about it.  Explain that financially you cannot support the loan without putting yourself into a bad position.  You can offer to help them non-monetarily.  Perhaps offer to go over their budget with them or help them look at their financial big picture to offer suggestions.  Maybe offer to make a gift of a visit with a financial planner who will do the same but with more authority than you have.

If You Decide to Say Yes Anyways

Should this not be enough deterrent, and you want to say yes, ask yourself the following questions:

1. Can I afford to not get this money beack, ever?
2. Am I willing to forgive this loan to save the friendship?
3. Will they sign a promissory note for the full amount?
4. If it is for an asset, will they accept a lien for the loan amount?

If you cannot answer Yes unreservedly to all of these questions, you should not make the loan.  End of story.

If you can answer Yes to all of these questions, proceed with caution.  You must ensure that both parties see this as an ordinary business transaction.  Otherwise, if your friends get into financial trouble later, you will be the first obligation that they ignore.  They will trust in your kindness to overlook them not paying you back.  It usually will not be malicious.  But they will expect you to understand and to be fine with it.

That will be where the friendship begins to unravel.  Let it go on long enough, they will forget about the loan completely and you will feel misused and abused.  The friendship will be poisoned with a slowly burning drug.  You will begin to see slights and insults where there were none before.  They may begin avoiding you out of guilt.  Eventually, you will drift apart if the friendship does not simply implode.

That is why it is better to not loan the money yourself.  It can work out great.  It can strengthen your friendship or family ties.  More easily, it can straing and destroy those same ties, and much faster.

If You Need to Borrow

If the situation is reversed, do everything you can to avoid borrowing from friends or family.  If the situation requires that you do borrow, follow these rules:

1. Treat it as a business arrangement - because it is
2. Review your own financial situation to ensure you can repay the new obligation - be honest
3. Behind food, shelter, and clothing make this obligation your top priority
4. Pay it off as early as possible.
5. Sign a promissory note and allow a lien to be placed to secure your friend's position.

Offer these things without asking.  Money is worth less than friends and family.  Do everything you can to prevent money from getting in the way.

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Please bear with me on this post. I know it is a long one. I thought about splitting it apart, but it makes a lot more sense to me as a whole, since partial implementation of these ideas are much less effective than all of them. Have ideas to add or want to discuss (even flame) mine? Add a comment.

Social Security Problems

Social Security and Medicare are two of the looming issues that will dominate and determine the economic future of our country. As they exist right now, they are welfare programs that will suck up more and more of this country's economic output every year until they are curbed or our country goes bankrupt. The most difficult part is that there are industrial (pharmaceutical) and demographic (AARP) forces that are going to push for them to be expanded and not moderated.

Since those groups are both well organized and well funded, a political solution that is good for the long term health of the economy is going to be difficult, happen slowly and not be sufficient unless there is a crisis which forces expedient change. There are only two alternatives: a) find a multi-billionaire who believes in the cause and/or b) start spreading the word about responsible changes and see if there is enough support for a grassroots campaign.

Anybody who looks into the budget and projections for Social Security will agree it needs to be massively overhauled. This huge program gives to every retiree - whether they need it or not. As the retirees grow - in numbers and percentage of the population - the impact of this program is going to grow significantly.

The problem is that this generosity has to come from somewhere. In this case, it is from the paychecks of millions of Americans. With so many of other people's wallets to draw from, politicians have had no problem making promises of future benefits. To meet those promises, more and more money is going to need to be borrowed and taxed from generations down the line.

This is going to bankrupt individuals if taxes are raised to meet the promises. It is going to bankrupt the government if they are not. This means the system as it exists today is severely broken and needs to be fixed.

While the system is severely broken right now, it is not the concept that is flawed, but rather the implementation. Here are some suggestions for how to go about fixing it.

• Do Not Change Benefits for Current Retirees
  
• Include Social Security in the Federal Budget
• Tax ALL Earned Income Equally For Social Security
  
• Not Everybody Should Be Eligible
• Provide Equal Benefits For All
• Really Balance the Federal Budget Every Year
  

Do Not Change Benefits For Current Retirees

It is critical that the changes to be made to Social Security do not impact current retirees. It would be unfair and disastrous to weaken or remove a major portion of somebody's income for retirement. It would be especially cruel for the government to renege on that promise at a point when many people would find it difficult or impossible to replace that lost income.

Included in this are those who are very close to retirement too. At least the 55+ year olds who would hve very little time to make changes to their financial plans for retirement if changes to Social Security are enacted swiftly.

For those of us who are further out from retirement, the amount of change that is reasonable will grow the more time we each have to deal with the issue. A phased approach is appropriate where the full changes should impact those who are currently in the 40-45 year old range. 20 years is a good amount of time for individuals to adapt to the new program.

Include Social Security in the Federal Budget

The accounting trickery that is used to keep Social Security and Medicare 'off the books' of the annual budget needs to stop. Social Security is not independent. The program will not be shut down just because the 'Trust Fund' becomes empty. Plus, the collected funds are 'borrowed' for use in the current budget anyways.

It is time to stop pretending. Include it. Incorporate the Social Security tax into the income tax. Do the same with the Medicare tax. By consolidating, it becomes clearer how everything is really being paid for and how much we, as a nation, are overspending.

Only then, when the budget and projections are accurate will we really see how bad the issues are. Only then, will we be able to make the hard decisions for sustainability. Only then will meaningful changes be possible.

Tax ALL Earned Income Equally For Social Security

As it is currently implemented, the Social Security tax is among the most regressive taxes in this country? It gets paid on an individual's first earned dollars, but not on their last. The poor pay a higher percentage of their total compensation to Social Security than do anybody else.

The quickest and easiest way to restore some of the equality to this tax would be make it apply equally to all earned income. This would generate additional income to meet the Social Security obligations without increasing the burden on those least able to afford it.

Not Everybody Should Be Eligible

The final step in 'fixing' Social Security is to limit who can collect. This ties in with allowing people to opt out of the retirement portion, but it also covers limiting benefits for people who otherwise would seek them.

Rather than handing it out to everybody who has paid in, benefits should go to those who are not able to provide for themselves. Those who lack assets and who are not earning a living income otherwise. Individuals like Warren Buffet and Bill Gates and Steve Jobs should not receive Social Security. My suggestion? Pick a point that is at 125% to 150% of the poverty level. Set Social Security at that level and phase out benefits at a 1/3 or 1/4 rate (Receive $3 or $4 in income, Social Security drops by $1. ). That way we have defined the minimum somebody will receive.

The actual amount of benefits can be adjusted based on the number of years in the workforce and the age benefits are first taken at, just like now.

If the desire is to limit the beneficiaries even more, there is another step that could be taken. Allow individuals to voluntarily remove themselves from Social Security. Let them have a reduction is Social Security taxes in exchange for not being eligible for retirement benefits. Thus, if I claim exemption for one year, I pay less taxes, but for Social Security calculations, it is just like I was unemployed for the entire year.

Now, before you say it - yes, some people would be in trouble from that. They would claim exemption, not save the money, and be destitute at retirement. This is America however, and along with the Freedom that we enjoy comes the responsibility to accept the consequences of our own actions. If I am able bodied, choose to opt out of Social Security, and don't save - why should I be rewarded?

Provide Equal Benefits For All

For everybody who qualifies for Social Security, the benefits should be the same. Not based on how much has been paid into the system. The changes to the system that I am proposing is to turn it into a safety net and nothing more than a safety net. As such, the idea is to ensure that anybody receiving benefits is able to live at a certain level of lifestyle. That level is consistent, no matter who you are.

If we accept that somebody who has been a contributing member of society for 45 years deserves not to fall between the cracks, does it really matter what they did or how much they made? Does a former janitor deserve less of a safety net than a former stock broker? If they did not save or could not save, should one receive more benefits than the other? If so, which one and why?

Lives well lived are equal in my book. Lets reward them the same.

Really Balance The Federal Budget

Yes, this ties in to Social Security - especially if it is incorporated into the budget like it should be. This ties in because Social Security expenditures are driven higher and higher because of inflation. Inflation is tied in to the federal debt and deficit numbers. Thus, if we balance the budget, Social Security will grow at a slower rate as inflation will also be held down.

Think of it this way: The economy has a certain amount of goods and services for sale. All of these are for sale regardless of how many or how few dollars there are out there. If there are a lot of dollars, people will be willing to pay more for those goods and services. They are willing to pay less if there are fewer dollars out there.

Every time the government spends a dollar it does not have, it creates a dollar. The mechanism of creation can vary, but in effect the federal deficit is a measure of extra dollars created from nothing to buy goods and services.

If the budget is balanced, even if the debt stays the same, we will have a positive effect. The economy will keep growing with more goods and services available. More goods and services, against the same amount of 'extra' dollars means each dollar is worth more.

Now, the federal government is not the only place that can 'create' dollars. Consumer borrowing plays a large role too. The federal government is the largest single entity and has enough power that its debt does influence the inflation rate.

Conclusion

Social Security needs to be modified for long term sustainability. However, the system should not be scrapped in its entirety. With a significant overhaul, it can become a positive program that does what it should and not more. With those changes, it will no longer threaten to damage or destroy our economy or personal lives.

Lets make difficult choices, but with an eye to our long term future. Do not pander to organized political interests. Instead, lets do what is best for ourselves and our country in the long run. Lets reduce the cost of Social Security and make it a safety net instead of a benefit for all. Lets give back our futures to each other and not to a Nanny Nation who knows how to plan for our retirement better than we can do on our own.

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I was Stumbling today and came across an interesting post on Millionaire Money Habits. It is the post titled 'The Money Spectrum'. This article and its accompanying graphic are useful as they are. However, I think it may be even more useful if it is brought over to a more personal level.

Working from the bottom up, we can look at the mindset of somebody at the various Stages of Wealth and see how things change as somebody amasses wealth. You will notice that there are no dollar amounts associated with the graphic. That is because - with the exception of the highest levels of wealth - anybody at any income level can be at any level. It is possible to make a 7 figure income each year and still be out of control. Likewise, it is difficult but not impossible to make $10,000 or so a year and still have your money working for you.

Admittedly, the more you make from any source, the easier it is to get higher on the scale.

Ignorance/Out of Control

A person at this stage probably has a negative net worth. Any money that comes in goes right out. If they are asked how much wealth they have they cannot answer because they do not know. They probably sense that it is not good, but there is not enough concern to find out. If they have credit, this person will generally be using most or all of it.

In the worst case, everything is so far out of control that they know things are bad. Notices from creditors and landlords get trashed or left unopened. The door and phone will not be answered in a last ditch effort to avoid the problem. The financial situation simply exceeds this person's ability to deal with it. Even if they get out of this situation with help, it is very likely that they will return to this state.

To move to the next state, ignorance needs to be removed, the problem identified, and the financial bleeding stopped.

Treading Water

Somebody in this state is still in debt, likely with a negative net worth. However, this person knows where they are financially. Being in debt, there is still a fight against the tide of economic forces. However, this person is no longer drowning. They have found a way to stay in place. Things are not getting worse, but they are not getting any better.

This individual is living paycheck to paycheck. As soon as money comes in, it is spent in some combination of needs and debt service. It is likely that some weeks progress is made and in other weeks gains are given up.

Climbing Out

This is the first of the truly positive wealth stages. Not only is the person not getting further into debt, they are actually decreasing their debt load. It is even possible that during this process a positive net worth is attained. Life is not easy, but there is some breathing room. The primary financial goal is to reduce debt.

Credit card debt, car loans, and home equity loans are still a part of the life during this stage of wealth. Using a debt snowball or other process, these debts are being eliminated over time. Depending how deep the hole was to begin with, this process can take a few months to a few years. When the short term, high interest debt has been eliminated it is on to the next Stage of Wealth.

Building The Foundation

This is the place to take a deep breath and celebrate. Somebody that has reached this point is ahead of a large portion of the population. With no short term debt there is a lot more flexibility with income and cash flow. Most people here have a positive net worth. In here the thought processes however will begin to differ.

Some individuals will continue with the debt snowball and work on long term debt like low interest student loans and home loans. Others will want to prioritize retirement saving. Still others will begin saving large emergency funds (6-12 months or more) or begin planning for large scale life changes.

The key point of this stage is that it is a transitional stage. The actions taken here are done to setup what is going to happen next. Usually, the actions involve continuing to pay down debt to some extent and increasing savings and investment rates. Once the foundation is complete, we move on.

Working For Yourself

This is where somebody is personally debt free. It does not always mean that there is no debt. Instead, any debt that is held on to is associated with an asset that generates the cash necessary to pay for that debt. For example, a rental property may have been financed, but the annual rents cover the mortgage and maintenance on it. There are other possibilities that work the same way (business loans, etc.).

What differentiates this stage is that while you still have to work, it is just to meet the daily, ongoing needs. Any money that is earned is yours. All income beyond the necessities can be spent as desired. Epicureans can spend it on food. Extreme savers can continue hoarding. Hobbyists can save up and add tools and other items to their collections.

By this stage, most people are continuing to save and invest with their sights on the next stage.

Money Working For You

This is where everybody wants to be. Between all of the assets that have been accumulated, there is enough free cash flow to live off of. Yes -full retirement is now possible. This is the level that most of us strive for because it is when we are truly free to do what we want. The only work that is needed is just to ensure that savings, investments, and other assets are maintained to keep the income for life going.

For anybody that wants to continue beyond this stage, their focus is going to be on continuing to grow their assets.

Money Working For The Future

Here, is is no longer about the here and now. All of the needs for a lifetime have been addressed and there is more money available beyond that. The concern at this stage is about leaving a legacy of some sort. It may be for the next generation - or several. It may be for a charity or a new foundation with specific goals. Whatever the desire is (and the range is infinite) it is beyond the individual.

Some people amass so much wealth and continue to be focused on more wealth acquisition that they fall into the last category:

Its Not Money...

Bill Gates. Warren Buffett. Steve Jobs. Larry Ellison. Among others. These individuals worked to build fortunes that far exceeded anything they could spend. All of them are continuing to work and build their wealth. It is a part of who they are. They are driven to succeed and control. They have visions and ideas about how the world should work. They are putting their efforts towards making those visions reality.

These individuals are very competitive. We hear about it too - one person gets a 200 foot yacht, the next gets a 250 foot one. A $20 million dollar house becomes a $30 million home. And it continues upwards. All of this is because of a never-ending drive to be the best and to be recognized as being the best.

The money eventually just becomes a way to keep score. There is not always a way to directly compare one person's achievements against another person's. So wealth and income become a proxy for measuring how people stack up.

Those are the stages of wealth. How far do you want to go? What are your goals? Where are you at now?

My desired destination is at the 'Money Working For the Future'. Currently, I am in the 'Climbing Out' stage but am shooting to be into the 'Building the Foundation' stage by the end of this year.

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The sub-prime meltdown has led to a lot of financial problems.  These cover the gamut from individuals, investors, financial institutions, builders, contractors, even governments.  The expected fix has been proposed - that of letting the government bail people out who have gotten into trouble.

This gives me serious heartburn.  I am among a significant - probably majority - of the country who believes that people should pay a price for their mistakes.  Why should people who were irresponsible - and I include lenders and other guilty parties as well as the borrowers - essentially get rewarded for bad behavior?

At the same time, with no intervention, there is going to be a lot of pain to be shared around.  And it will not be felt only by the irresponsible.  Those of us who find ourselves needing to sell our homes in the next couple of years are going to take a hit.  Depending on what bail-out programs are put into place the pain may be felt for five to ten years.

So what kind of compromise is available?  What mitigates the problems while still demanding sacrifice on the part of those responsible?  What can be done that will leave enough of sting to teach a lesson while not having serious repercussions that have worse unintended consequences?

A Hard Lesson

I think what needs to be done here is to teach a hard lesson to as many parties involved as possible.  This means that it will have to be a multi-pronged approach.  One part will have to penalize irresponsible lenders.  Another will have to soften the blow to the borrowers, without eliminating it.  The final part will be to penalize the supporting cast of players who made it all possible.

This is my proposal:

Congress shall create a limited life federally chartered corporation who will purchase troubled loans from financial institutions - the Federal Housing Preservation Corporation (FHPC).  These loans will be purchased at the face NPV (net present value).  The institutions selling the loans will in turn offer financing at 0% interest for 80% of the NPV to FHPC.

FHPC will modify the terms of the loans it purchases to limit the annual increases in mortgage payments to the 3-5% range to help borrowers stay in their homes.  All profit from this arrangement will return to the federal government to be used for reduction of the National Debt.

FHPC will have a set lifetime of 30 years, can acquire new assets for only the first 5 years of its life, and will sell off any remaining assets at public auction at the end of its federally mandated lifetime.

The third prong of the approach is to ask that Congress create another limited time organization to investigate the brokers, lenders, appraisers, and real estate professionals who contributed to the creation of this mess.  This commission will have the power to subpeona people and documents and to refer cases to federal or state jurisdictions as appropriate for any criminal activities discovered.  To limit the power of this commission, it should only be empowered to investigate residential real-estate transactions for the past 5 years.

The Results

This should have the desired results.   Financial institutions in trouble because of the number of bad loans have a way out that will give them cash to meet immediate obligations.  They may even lose less money than expected from the bad loans.  However, they will not be able to make any additional profit off loans that are 'saved'.  They stay solvent but make less profit than expected when they created the risky loans.

Borrowers will have an easier time staying in their homes, although the worst cases will still be brought into foreclosure.  At the same time, they will still face increasing payments and potentially higher overall outlays than if they had bought what they could afford.

The government, though involved with setting up a bailout program and putting money up front, has the possibility to break even or even profit from having to become involved.  With any proceeds aimed at debt reduction and limited life for the corporation managing this program, this is everything that can be done to minimize the impact (in terms of taxes or increases in national debt) on the rest of us.

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We hear about the federal debt and deficit on a regular basis. Yet, what do those Billions and Trillions of dollars mean to us? What can we do about it? What does it do to us? Does it really matter?

I am here to tell you that it does matter. Those dollars have a big impact on us in many different ways.  In their own way, they are a invisible force pushing the economy in directions it would not ordinarily go.  This is largely for two reasons: the government is huge and its driving force is not economic or material efficiency.

For starters, the US government is so large, that our annual taxes are not enough to pay for it all.  This leads to continual borrowing.  The borrowing increases the future budgets because of the increased amount of interest the government has to pay.  This is bad because not only does it lead to larger budgets for the future, but it gives our government less flexibility to respond to a true disaster.

Additionally, the government borrowing makes it more expensive for us to borrow money.  This is because there are a huge number of individuals, companies, and countries that are willing to loan our government money because they know they will get paid back.  Every dollar the US government borrows is a dollar that is no longer available for us to leverage towards buying a home, building a business, or develop something new.

Government spending also leads to decreased economic growth and employment.  This ties back to the efficiency goal mentioned earlier.  Since the government is not motivated by profit (aka efficiency) it is free to spend money in wasteful ways that do not contribute to the economic engine which drives this country and the world.  While this is not a problem when the money is being spent on basic services that the government should be providing, it is a big problem when the spending is being spent on activities and services the private sector can meet better.

This last item is the one that you and I probably notice the most however.  The more money the US government spends, the more US dollars there are out in the world.  The more dollars there are however does not translate into more goods and services to be bought with those dollars.  So, more money chasing after the same goods and services.  What does that do?  It causes inflation.  So, due to increased government spending, you and I are finding that we need more and more money each year just to stay in place.

My conclusion?  We need to do our best to convince out representation in Washington, DC that we would rather have money not spent than to see it wasted by the government.  Even if that waste is pork barrel spending in our districts.  That is a negative sum game.  Everybody wins if there is no pork barrel spending as opposed to just a few hand-picked winners from Congress.  Even on necessary spending, anything we can do encourage Washington to keep it down or find ways to eliminate spending is effort well spent.

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In my local newspaper, there was an article by Dave Ramsey recently talking about leasing a car.  In the article, it had some generalities and ultimately came down against leases completely, suggesting instead that the reader buy a two year old car because the most depreciation happens the first two years of ownership.

Now, I cannot argue against 'downgrading' to a two year old car from a new car.  Financially, it makes a lot more sense and is a lot easier to work into a budget.  For those of us that can control the desire to continually be driving something new and shiny, purchasing is almost always the better option.

I respect Dave Ramsey and do not wish to argue against his stance for personal financial responsibility.  Making our choices, living with them, and making an extra effort to do the right thing is important as an individual and as a society.  Despite this trust, I cannot take an article at strict face value.  I want to know why somebody says something.

In the article, Dave says, "The only one who comes out to the good in an auto lease is the dealership" and "...or as we call if 'fleecing' a car..." Such a blanket statements deserve to be looked at.  Dave does reference articles by Consumer Reports, Consumer Federation of America, and Smart Money Magazine.  That makes me expect his recommendation will be born out by looking at an example.

Buying

For the example, I will be looking at a $30,000 car.  To simplify the comparison, I will assume that insurance, maintenance, DMV fees and parking fees are the same over the 4 year comparison period.

This makes our comparison essentially the cost of the lease versus the depreciation on the car.

Since Dave provided the figure that the average car loses 60% of its value in the first 4 years, we get the following for buying the car:

• Purchase price: $30,000
• Depreciation:   $18,000
• Residual Value: $12,000

Thus, the loss/cost of the new car - ignoring the opportunity cost of spending $30,000 up front - is $18,000.

Leasing

Checking the same assumption at Ford, using a 2008 Mustang in their lease calculator (Sales price $30,000, No down payment or trade-in, 60000 mile limit) we get an estimated cost of $933 due at lease signing and $458 a month payment.  This gives us:

• Due at signing: $933
• Monthly Payments: $21,984
• Total Cost: $22,917

Conclusion

Using this example, it initially looks like Dave Ramsey is being accurate.  Essentially, it costs $4,917 extra to lease the car over buying it - a 27% premium.  Over 4 years, that is a good return for the dealership.  Especially since the people they choose to lease to have better than average credit and are generally unlikely to default on the payments.

However, I do like to try to be thorough.  Since we made the assumption that you can buy the car for cash to simplify the comparison, what if we assume that you have the $30,000 in cash when leasing too. How much do you have to make on the money to come out even if you invest the money you do not spend up front in the lease?

In other words, to make $4,917 over 4 years in interest on the decreasing $30,000 balance, what interest rate (compounded monthly) will it take?

Crunching the numbers in my spreadsheet, I get that it would take a 6.662% after tax investment return for you to break even in the lease vs buy comparison.  If you are in the 35% tax bracket, that translates to a 10.25% pretax rate of return.

Reference

Bankrate Car Lease Calculator

Suze Orman - Buy vs Lease

Edmunds Compares the Cost I want to highlight this article.  This one adds some information on buying a used car as well, which really helps to drive home the point that buying or leasing a new car is not the best way to minimize your long term cost of ownership.

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This is the third post in the Federal Debt Discussion series.  Previous articles discussed the The Scale of the Federal Debt and The Scale of the Federal Deficit.

The Federal Government borrows money for a lot of different reasons.  Some of it goes to funding operations.  Some of it is to balance cash flow with expenses.  Some of it is even intentional to help stimulate the economy and provide a short term push to avoid or get out of recessions.

Regardless of the reason, the total amount of debt has risen over the years.  It has varied some as a ratio of the GDP of our country.  Good or bad, that has been our history.

Debt Markets

When the US government wants to borrow money, it has to go to the same global markets as corporations.  Yes, global.  With advancement in technology and decreases in regulation of money flows, the markets to borrow money are now truly global in size.

Due to the perceived nature of risk, US government bonds and bills are seen as among the safest in the world.  The US has not defaulted on its obligations and is not expected to default either.  All of this, despite have a fiat currency and not one backed by an asset such as gold.

When the US government goes to these markets, it announces how much debt it will be issuing and different entities - individuals, companies, funds, and even countries - bid for the debt.  The highest bid wins, and the higher that bid, the lower the effective interest rate will be.

Those groups that win those auctions get what they want - a secure place to put their money that will pay them back at what is (hopefully) above the rate of inflation.  The rest of the bidders have to find someplace else to put their money to work.

That someplace else is generally in corporate debt.  That is where the problem lies.

Reducing Corporate Borrowing

The available money in the global debt markets is essentially fixed at any given point in time.  It will change significantly over time as to appeal of the stock markets wax and wane and inflation fears ebb and flow.  Other factors have an impact too.

There are a couple of constants.   First, there is less money available to be loaned out than there are requests for it. There are always disappointed groups in the market.  It may be because they could borrow less than they wanted or because they were able to borrow but not on the terms that they wanted.

Second, and more important, is that government borrowing reduces corporate borrowing.  On a very close to a dollar for dollar basis, any money that the US Federal Government chooses to borrow is no longer available for corporations to borrow.

This means that companies looking to expand operations, modernize plants, and purchase land and equipment are unable to do so.  Either they must borrow less at higher interest rates or reduce their plans for expansion.  This is the

The Production Problem

Government spending does not generally translate into new jobs and increased productivity like private investment does.  Part of this will be the different nature of governments and businesses.  Businesses have to be good spenders to get high value for their expenditures in order to exist from year to year.  Governments do not.

When governments borrow money, they reduce corporate borrowing.  The reduced corporate expansion plans result in a slowdown in economic growth due to fewer jobs being produced and productivity not rising as fast as it otherwise could.  Likewise, reducing the amount of government debt helps to encourage corporate growth.
This occurs because government spending does not create jobs and increase productivity like corporate spending.  Our government does not spend our money as efficiently as we do.

Conclusion

As I continue to investigate the impact of the Federal spending habits on our economy, specifically the deficit and debt, it is becoming clearer that the negatives of deficit spending outweigh the positives.  Honestly, the expectation was that the increased money supply created by deficit spending would have a multiplicative effect resulting in a positive impact on the economy.

Instead, what I am finding is that the impact is not as great as expected.  Government spending has less impact than private.  Maintaining significant national debt levels results in greater deficit spending and more borrowing from the future than what can be offset by the reduced value of the dollars that will be paid back.  So, we are stealing from our future prosperity by spending the money now.  Eventually, without a change in mindset and policy the bill will come due and the cost will be significant.

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This is a post in the Federal Debt Discussion series.

Previously, we discussed The Scale of the Federal Debt. This debt did not magically appear. It has been built up over a number of years, and has gone up and down during that time period based on the annual deficits (and occasional surplus) in the federal budget.

There is a lot less information on the deficit than there is on the debt.  From my investigations, it appears that the best source online is the US Government's Treasury Department and their Monthly Treasury Statement (MTS).

This site reports that for fiscal year 2007, our government ran a deficit of $163,681,000,000.

This is a significant decrease.  For comparison, here are the six previous years of data:

• FY 2001 was a surplus of $126,863,000,000 and ended just after the September 11 attacks.
• FY 2002 was $160,252,000,000 in deficit
• FY 2003 was $375,242,000,000 in deficit
• FY 2004 was $411,116,000,000 in deficit
• FY 2005 was $317,265,000,000 in deficit
• FY 2006 was $248,277,000,000 in deficit

As you can see, with the recent economic expansion, the deficit has shrunk significantly from four years ago.  This is to be expected.  The government's collections are a lagging indicator of the economy.  Deficits increase during a recession and decrease during a boom.

It is not that simple however, since there are a lot of variables that impact the deficit beyond the economy.  Things like:

• Congressional approval of new spending
• Tax cuts (or increases)
• Disaster relief
• The available interest rates for issuing new government debt

There is more that impacts this figure than that.  In the end though, it is the annual deficits (and occasional surplus) which ultimately result in the total debt.  Paying attention to the fluctuating deficit will also ultimately be our national route to staying strong economically.

Oh, before I forget, how much of the budget deficit can be traced to interest payments on the national debt?  According to the government's own figures from the Treasury, we spent $429,977,998,108.20 in interest last fiscal year.

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This post is part of the Federal Debt Discussion series.

The American National Debt is a staggeringly large number. It is several times larger than the total amount of US Dollars in circulation. Even trying to visualize that much money in stacks or circling the globe many, many times is very difficult to do.

Fortunately, the sheer size of the debt is not the big issue. It is the size of it in relation to the rest of economy and the federal budget that determines if it is sustainable or not. On that scale, it does not seem quite as bad. Here are some current figures:

On October 17, 2007, at about 11:15 am MST (GMT -7), the debt is estimated to be $9,056,509,178,557.40 - yes that is over $9 Trillion dollars.

This number is both accurate and somewhat misleading as a significant part of the debt is owed by one part of the government to another part of the government. This intra-governmental debt is detailed in the Federal Debt portion of the Treasury Bulletin. The most recent issue shows that about $4 Trillion.

Public Debt

That leaves over $5 Trillion owed to the public. The US Census estimates that there are 303 Million people living in this country.

Translated into per person figured for every man, woman and child, this is:

• $29,700 in total debt
• $16,501 in publicly held debt
• $13,199 owed for future obligations

It is these future obligation that are held by different departments of the federal government, with most of it held by Social Security and Medicare. It is these intra-governmental obligations that are going to reach $0 when Social Security and Medicare go 'bankrupt'.

Debt vs GDP (Gross Domestic Product)

The debt as a percentage of GDP has varied historically over the years. Currently, it sits above 60% of GDP. This means that to pay off the debt in one year, it would take more than 60% of what this country as a whole produces to eliminate the debt. Historically, since 1930 this figure has ranged from just below 20% to around 120% [just after World War II].

Fortunately, the debt is spread out over different maturities coming due any time from the next week to several decades from now. Additionally, our government and economy are seen as strong enough that there are no problems exchanging old debt for new as the old matures. Thus, we are in no danger of an immediate credit crunch.

Looking Ahead

Even with the sheer size of the debt, it has not gone horribly wrong yet. Interest payments are slightly above 10% of the annual budget. Even in a personal budget, paying out 11% of income as interest is a hefty chunk, but is not necessarily an immediate problem. Having a large mortgage payment alone could be enough to reach this level.

The concerns, as will be enumerated later in this series, is that projected increases in mandatory government expenditures - especially Social Security and Medicare - will become a fiscal crisis as obligations grow and the workforce shrinks. The way to avoid that is to address the issues now. Unfortunately, the current Administration and Congress do not appear to be ready to do so.

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This is part 3 of a series talking about bad debt. The parent post is at What to do about Bad Debt. Part one can be found at What to do about Bad Debt and part 2 is at The Terms of Bad Debt.

This post talks about how Too Much of a good thing can be enough to turn an otherwise good debt into a bad one.

There are really two ways that Too Much can be bad financially. The first is when an alternative would help you become wealthier faster. The second is when too much is truly more than can be afforded.

Too Much - Better Alternatives

Using credit can improve your investment returns by increasing your leverage. Forbes.com has a good articles title Burdening Your Retirement With a Mortgage that talks about the risks of leverage. For a Canadian point of view, you can try leveraging - the basics at RRSP.org (Warning: several acronyms in the post are not defined and may be confusing). Not to ignore anybody across the pond, try this link to The Uncarved Blog, Having a Mortgage post.

Few people would argue that a mortgage, in general, is a bad debt. Encouraging people to get a home by using a mortgage is even considered conventional wisdom and there are many programs designed around helping first time home buyers through the process. Unfortunately, this home ownership push could use more scrutiny.

Take a look at this table:

Rent vs Buy

What it shows is a very simple comparison of the rent vs buy debate. Column by column we have:

• Rent - This is the cash outlay a renter would expect to have over the given time period.
• Buy - This is the cash outlay a homeowner would expect to have over the same time period.
• Total Difference - This is the total difference in cash outlay between the two, with simple interest of 5% per year.
• Equity - This is the amount of equity the homeowner would have at the end of the time period, assuming 5% annual gains in the value of the home.
• Rent Value - This is the difference between the Total Difference column and the Equity column. Essentially, this is how much ahead the renter is on paper. It does not include sales cost for the homeowner.

Now, feel free to jump all over me for the assumptions I made if you want to. This is intended to be a simple example using low, but comparable numbers.  One thing I would like to emphasize is that variations in rents, interest rate, home appreciation rates, tax rates, and market performance can change the result of this evaluation.  For another writeup on the rent vs buy debate, head on over to InvestorGeeks and read Misconception: Renting is for Suckers.

This example highlights that conventional wisdom is not always correct.  In this case, for somebody who moves frequently or wants a significantly larger amount of free cash flow, renting IS the way to go.   It is important, even when applying rules of thumb and conventional advice, to check the specifics and make certain that your choice is the right one.

Remember, what is best for somebody else has absolutely no bearing on what is best for you.  You are unique, your financial situation is specific to you and general advice is no better than asking people on the street what you should do.

Too Much is More Than Enough

It is possible to have a plan that is overall good for your health, but a bad plan because you will never get to the payoff at the end.

Examples of this are all too common.  Even without the current increased level of foreclosures in the housing market, there are many homeowners who bought more house than they should have.  The large payments require them to cut back or eliminate other areas of their budget, severely limiting their quality of life.

Likewise, choosing to take on multiple debts, each of which is reasonable on their own, can quickly mount to overwhelming proportions.   Take student loans, add a mortgage to it, throw in some credit card debt from having to move yourself to start your new (higher paying) job and it can be a lot for a budget to absorb.  While each of these are reasonable (one would hope you had an emergency fund to pay for the move, but not many have one coming out of college) together they are huge.

This brings up the last point I want to make about Too Much: every financial commitment that is made has to be considered in the full context.  If every financial obligation is included in choosing to add a new commitment (like buying a home) it is much easier to make a wise decision that will maximize your financial well being.

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