Too much debt takes away people’s autonomy. They lose their freedom to work where they want and with whom they want, they lose freedom to change jobs or careers because they need the next paycheck. I worked with client’s personal financial situations for 7+ years and the biggest problem I saw was that people were unwittingly auctioning off their autonomy to Mastercard or to their mortgage provider. When I had this conversation with clients, many changed habits because they now had the facts and could see what their purchase of new kitchen appliances or that Mercedes would do to their freedom. Clients still purchased homes because of the history and hope for house appreciation we have seen in California. But, they usually told me they would hold off buying that next car or they could live awhile longer with their furniture all for the sake of keeping more of their freedom.

I think the answer continues to be knowledge about money, compound interest, saving and investing. The conversation needs to change to one of new virtues being no credit card debt and a bank account instead of the old virtue of having the nicest clothes, best wines, exciting and expensive vacations, Mercedes, a boat, plasma TV and huge house.

The New York Times
June 10, 2008
Op-Ed Columnist
The Great Seduction
By DAVID BROOKS

The people who created this country built a moral structure around money. The Puritan legacy inhibited luxury and self-indulgence. Benjamin Franklin spread a practical gospel that emphasized hard work, temperance and frugality. Millions of parents, preachers, newspaper editors and teachers expounded the message. The result was quite remarkable.

The United States has been an affluent nation since its founding. But the country was, by and large, not corrupted by wealth. For centuries, it remained industrious, ambitious and frugal.

Over the past 30 years, much of that has been shredded. The social norms and institutions that encouraged frugality and spending what you earn have been undermined. The institutions that encourage debt and living for the moment have been strengthened. The country’s moral guardians are forever looking for decadence out of Hollywood and reality TV. But the most rampant decadence today is financial decadence, the trampling of decent norms about how to use and harness money.

Sixty-two scholars have signed on to a report by the Institute for American Values and other think tanks called, “For a New Thrift: Confronting the Debt Culture,” examining the results of all this. This may be damning with faint praise, but it’s one of the most important think-tank reports you’ll read this year.

The deterioration of financial mores has meant two things. First, it’s meant an explosion of debt that inhibits social mobility and ruins lives. Between 1989 and 2001, credit-card debt nearly tripled, soaring from $238 billion to $692 billion. By last year, it was up to $937 billion, the report said.

Second, the transformation has led to a stark financial polarization. On the one hand, there is what the report calls the investor class. It has tax-deferred savings plans, as well as an army of financial advisers. On the other hand, there is the lottery class, people with little access to 401(k)’s or financial planning but plenty of access to payday lenders, credit cards and lottery agents.

The loosening of financial inhibition has meant more options for the well-educated but more temptation and chaos for the most vulnerable. Social norms, the invisible threads that guide behavior, have deteriorated. Over the past years, Americans have been more socially conscious about protecting the environment and inhaling tobacco. They have become less socially conscious about money and debt.

The agents of destruction are many. State governments have played a role. They aggressively hawk their lottery products, which some people call a tax on stupidity. Twenty percent of Americans are frequent players, spending about $60 billion a year. The spending is starkly regressive. A household with income under $13,000 spends, on average, $645 a year on lottery tickets, about 9 percent of all income. Aside from the financial toll, the moral toll is comprehensive. Here is the government, the guardian of order, telling people that they don’t have to work to build for the future. They can strike it rich for nothing.

Payday lenders have also played a role. They seductively offer fast cash — at absurd interest rates — to 15 million people every month.

Credit card companies have played a role. Instead of targeting the financially astute, who pay off their debts, they’ve found that they can make money off the young and vulnerable. Fifty-six percent of students in their final year of college carry four or more credit cards.

Congress and the White House have played a role. The nation’s leaders have always had an incentive to shove costs for current promises onto the backs of future generations. It’s only now become respectable to do so.

Wall Street has played a role. Bill Gates built a socially useful product to make his fortune. But what message do the compensation packages that hedge fund managers get send across the country?

The list could go on. But the report, which is nicely summarized by Barbara Dafoe Whitehead in The American Interest (available free online), also has some recommendations. First, raise public consciousness about debt the way the anti-smoking activists did with their campaign. Second, create institutions that encourage thrift.

Foundations and churches could issue short-term loans to cut into the payday lenders’ business. Public and private programs could give the poor and middle class access to financial planners. Usury laws could be enforced and strengthened. Colleges could reduce credit card advertising on campus. KidSave accounts would encourage savings from a young age. The tax code should tax consumption, not income, and in the meantime, it should do more to encourage savings up and down the income ladder.

There are dozens of things that could be done. But the most important is to shift values. Franklin made it prestigious to embrace certain bourgeois virtues. Now it’s socially acceptable to undermine those virtues. It’s considered normal to play the debt game and imagine that decisions made today will have no consequences for the future.

Divorce, or variations on that theme, is starting to look almost as certain as death and taxes… the national average seems to be holding with about 1 out of 2 marriages ending in divorce. Among my friends, family and clients, it seems the number of couples around me calling it quits has escalated over the past few years. I suppose it could simply be my age, the circles I travel in and living in California. With splitting couples, very often their home will be their single largest asset. They may even fight tooth-and-nail to keep the home and send their “ex” packing. Here’s the thing: this could be a huge financial mistake. Often the consequences are not realized until long after signing the settlement agreement. Generally there are three issues around real estate that come up that are often overlooked in a divorce.

The first issue has to do with the property as an asset class and liquidity. Let’s say a couple (Popeye and Olive Oyl) owns a home worth $1,000,000 free & clear, i.e. no mortgage. And in addition, they have $1,000,000 of cash and invested assets. They agree to split everything 50/50. But Olive Oyl wants the home. So she will give Popeye her half of the cash in trade for his half of the house. Though Olive now has a place to live, she has 100% of her assets invested in real estate with no liquidity (unless she sells or finances some of the equity out of the property). This is equivalent to having all of your money tied up in one single, privately held investment… not real consistent with Modern Portfolio Theory.

The next issue has to do with affordability and qualifying. Let’s say Popeye and Olive have a $500,000 mortgage. The payment on the house with property taxes and insurance is $4000 per month. Olive only has to give Popeye $250,000 of her cash to buy him out. So she has $250,000 left in cash plus the house with the mortgage. The first question is can she afford the payment? That’s a much bigger question than I can address here, so let’s say she thinks she can handle the payment. But Popeye doesn’t let her get off the hook so easy. Since both signed the mortgage obligation when they were married, Popeye will remain liable from the lender’s point of view even though he may not be on the title as an owner of the property. If Olive can’t qualify on her own either for a new mortgage or in assuming the current one, Popeye may be very reluctant to go along with this.

Last, and probably one of the most overlooked issues with taking the home, has to do with . . . taxes. Popeye and Olive bought their home for $500,000 a while back. Since the value has doubled, they would have a $500,000 gain if they sold the home today. Because it was their principal residence for two out of the last five years, they would be able to exclude all $500,000 of the gain from being taxed as a married couple (see IRS Publication 936 at www.opesadvisors.com/resource/links.html). But if Olive buys out Popeye and at some point in the future she sells the home, she will only be able to exclude $250,000 of the gain as a single person. This means she will take on about a $62,000 tax burden that she will realize when she sells the home (assuming the tax laws don’t change… so could be more!). Additionally, if Olive sells the property and pays a real estate commission, she will incur 100% of that expense, as opposed to splitting it with Popeye. This could easily be another $25,000 she would have otherwise not paid (50% of a $50,000 commission). Olive has now blown about $90,000, or 12% of the assets she received out of the divorce settlement, without even knowing it.

For those of you that are able, consider working to have your marriage not be the one-out-of-two that divorce. For the other half, seek out financial, tax and legal advice prior to settling the terms of your agreement. Your attorney may be very skilled in representing you legally, but unlikely to know all of the finance and real estate consequences to your decisions.

Copyright © Jeffrey T. Smith • (415) 464-9500 • jtsmith@opesadvisors.com Jeffrey T. Smith is a financial advisor and the Marin Manager for Opes Advisors, a Wealth Management Firm specializing in Mortgage Banking and Investment Management.