Surviving The Solvency Tsunami

Senior Times

Credit crunch? What credit crunch you may well ask, if, that is, you happen to be over-50 and especially if you don’t have a €350,000 mortgage, €1,200 a month crèche or child minding fees, €10,000 outstanding on your credit card and another €20,000 to pay off on the SUV parked outside.

We over-50s are not, for the most part, of a generation that grew up believing that the value of assets could only go in one direction - upwards. Or that banks were friendly places that you could go to when your income didn’t stretch far enough to take two or three holidays a year AND pay the mortgage; or that borrowing and spending was a more plausible way to create personal wealth than saving and investing.

Financial Tsunami

I say ’for the most part’ because I happen to know plenty of my own contemporaries who did live through the job hungry 70s and 80s, but still ended up borrowing money to buy dot-com shares in the late 90s, or in this century, holiday homes and buy-to-let investments. By 2004 you were just ’soooo lame’, as my 15 year old would say, if you hadn’t bought at least one Section 23 investment here and a French leaseback holiday apartment. I mean, the tax breaks were just as good as a low cost loan. Weren’t they?

Maybe all the global property that ordinary Joe bought at the height of the credit boom really will come good and provide that pension that was otherwise being spent on the SUVs, private school fees, golf club membership and Christmas shopping trips to New York. But the problem with a credit boom collapse - which started in August 2007 and is only about a quarter or a third of its way through, depending on the pessimism of the economic commentator you happen to be reading - is that it tends to collapse all the other bubbles that fed off it.

When banks run out of money, and they don’t trust each other anymore to make good on previous loans, production slows, then trade. Consumers, already up to their eyeballs in debt, also cut down or stop spending (on stuff they don’t need anyway).

This is a natural cycle of decay, but attempts to halt it, and to "stimulate" lending and spending by bailing out the most reckless lenders on Wall Street and the City, and by further lowering interest rates that will ultimately drive up consumer prices, is just putting off the ultimate day of reckoning.

As our own hugely indebted property builders may have to learn, even the US Federal Reserve may have finally realised that moral hazard becomes endemic if everyone gets a bail-out; and so they let Lehman Brothers go bust (along with many smaller regional banks.) Whether they can stop the rot further is unknown, and not something any of us have any influence over anyway.

The appalling state of the global financial sector may even be out of the hands of governments and central banks at this stage. What looked like a serious problem of inflation and stagnant growth - stagflation - eight months ago, now looks like it could be turning into something far more serious: deflation, a period when all asset prices fall along with jobs and incomes. The Japanese have been going through it for the past 19 years after their property market and banks collapsed in 1989. Luckily for them, they remained a great industrial manufacturer. But the previous truly great deflation, which started in 1929 and lasted for more than a decade, was called something else.

Since I don’t have a crystal ball, this is all mere speculation on my part. But it is based on events that have happened many times before when governments debase their currencies by inflating their money supply, when they spend more than their tax base can support and when they conspire with bankers and other insiders to maximise their vested interests and returns. My teenaged son, who is studying Roman history, drew the parallel with the United States (and us) all by himself.

Entitlement societies, like our own, could have a difficult transition period if endless cheap credit and growth is not restored (and it won’t be soon). It won’t be easy to provide the expectation of affordable home ownership, free education to third level, world-class healthcare, pensions and other mostly tax-free social welfare benefits, infrastructure, a police force and even a fully-equipped and trained modern mini-army that we now lend out to anyone hell-bent on intervening in the bloody affairs of other countries.

If you have faith in central banks and governments - whether the American, British, European or our own - to solve the most serious global solvency crisis since the 1930s, good for you. If like me, you think that this great, damaging, deleveraging will have to before a recovery is possible - at its most basic, the price of an average family home around the world will have to be affordable on an average family income again (historically, three times income) - then you might want to take your financial security upon yourself.

Happily, for most over-50s, this shouldn’t be impossible if your income is secure, whether employment or pension income. Over the longer term, however, the great deleveraging could take some years, say the pessimists and you might want to review and reconsider the lifestyle you have or the one you hope for in retirement. Here’s how to do it:

Make a date with your spouse and partner to talk money. This may be the first time for both of you. Don’t be nervous; if you both stay calm and be gentle with each other, it shouldn’t take more than a couple of hours.

Talk it through

Begin by reviewing your income and ALL expenditure. Use a notebook and mark down everything - mortgage, food, utilities, travel, entertainment, holidays, and hobbies, clothing, (school fees and other family costs if you still have dependents), etc. If you are already spending more than you earn, start cutting back, especially on discretionary spending.

Do a similar tax review or hire a tax advisor to help. Are you paying the right rate of tax? Are you collecting all benefits and tax relief? Are tax-based investments paying off or have they become a tax liability? Have you considered the tax implications of inheritance and succession planning? Are your wills up to date?

If you have debt, start paying it off, starting with the most expensive store and credit cards, hire purchase loans, bank overdrafts, personal loans and mortgages. Use a tax-free pension lump sum to clear your debt.

Get your pension fund(s) and contribution level reviewed by an experienced, fee based, pension advisor (expect to pay €150-€200 an hour). Find out exactly how much your company pension is worth right now, what assets it has invested in, how they are performing and what income you can expect at retirement. If you are within five years of retirement, you urgently need to ensure that assets have been shifted to safer destinations (like bonds and cash). If they haven’t by now, you may have to consider working longer. If you had to take your pension early - as a result of illness or simply because you wanted to retire early - would it be sufficient to provide you with a retirement income for life?

Review your savings and other non-pension investments. If you are cash poor, but asset rich (and that’s a moveable target at the moment) and at least in your 70s and perhaps not in the best of health, you may be able to take out an equity loan. Bank of Ireland are the only bank taking applications.

Make sure to shop around for the best demand and longer term deposit rates. Check out the ’best buy’ sections in the national newspapers and go to www.deposits.ie for an overview of rates). It would be naïve at this point to assume that an Irish bank could not fail, given how exposed some of them to commercial property. The Irish bank deposit guarantee scheme only guarantees up to 90% of deposits or €20,000, whichever is the greater. Do not leave all your money with a single deposit institution.

Find out how well your investment funds are performing. Stock market values have been slashed - by as much as 50% in the past year. Until this solvency crisis ends, the markets could stay volatile (and irrational) longer than you can stay solvent (to paraphrase John Maynard Keynes.) If you do any further investing, make sure you understand exactly what you are buying, how risky it is, how long you are willing to keep the share or fund, whether it pays dividends or not and especially how much it costs. High upfront charges and on-going policy and fund management fees will eat away at your fund, regardless of whether it makes any profit or not. Beware of so-called ’guaranteed’ tracker bonds which are being re-introduced: these products are not transparent enough and the costs are too high. If you don’t want to lose your capital, put it in a bank account that at least matches the combined cost of inflation/DIRT - at least 5.3% at the moment.

Property values will not stop falling or recover until the solvency crisis is over. If you are losing money on a property investment your family home may be at risk too. Speak to your bank or an independent financial advisor about an exit or bail-out strategy. If you can’t find a buyer, lower the price and take a smaller hit now, rather than a larger one later.

Only invest in property these days (or any other asset) if you are a genuine investor, not a speculator. That means it pays you a genuine return - in the form of sufficient rent to meet all your costs plus a profit or, in the case of shares, a steady dividend. If you do speculate, never use money you can’t afford to lose and never borrow to buy shares on margin unless you have other liquid resources to cover any losses. Remember that no asset ever goes up in a straight line.

Aim for a diversified portfolio of cash, bonds, shares and property, appropriate to your age and risk profile. Consider investing a small proportion of your money in tangible assets, like land, property, precious metals, good art - things you can own outright and pass onto family members if you so wish. Their price or value may (and will) fluctuate, but they’ll never disappear. (All tangible assets, especially precious metals, need to be stored or protected so factor in insurance, taxes and other costs.)

If price inflation continues, this will whittle away fixed incomes; deflation will reduce the value of assets, like property and land. You may not be able to assist your adult children financially to the degree you’d like to. Be sure to secure you own income and retirement before transferring or selling assets to them in this market. Be very careful about guaranteeing their loans or mortgages and if you do offer a loan, make sure it is repaid by direct debit. If you disapprove of their lifestyle or levels of debt (and many parents do) offer to pay for them to have their own professional, objective financial review. They might take bad news better from a stranger than from you.

Resurrect those lessons about thrift and prudence that your own parents probably lived by: make do, recycle, seek out bargains.

Take advantage of discounts and free offers for older people. Don’t be shy to ask for reduced price health tests and treatments, beauty treatments and entertainment (like daytime cinema and theatre tickets). Take your holidays off-season or off-peak. If you are retired, and have access to free transport, work out exactly how much running a car really costs - the tax, insurance, maintenance, NCT test, depreciation, etc. Consider using a reliable, local taxi service instead and renting a car for long distance shopping (say, to the North for the day), for a day at the seaside, or a longer driving holiday. It will be cheaper.

There’s nothing ’doom and gloomy’ about preparing for bad times. If you’re over 50, but especially if you are over 70 or 80 and lived through depressions, wars and recessions, you know just how foolish are those four words: "It’s different this time."

We wouldn’t be human if we didn’t keep repeating history’s mistakes. We’re no different this time.

Jill Kerby is a columnist with The Sunday Times. She also writes MoneyTimes, a syndicated weekly column for a number of provincial newspapers, edits Irish Pensions magazine and is the co-author of the best-selling TAB Guide to Money Pensions & Tax and the TAB Guide to Property. She appears regularly to discuss personal finance issues on radio and television.

Copyright ©2010, Senior Times.