A House of Cards: Part 1

The current credit crisis has impacted multiple sectors of our financial economy. Home foreclosures are on the rise. Credit-worthy consumers struggle to secure mortgages. Investment banks are brought to their knees. Foreign and domestic stock markets experience gut-wrenching volatility. The Federal Reserve is forced to take historical steps to maintain liquidity. And the list goes on....

In an effort to help the ordinary investor make sense of it all, here's the first part of a simplified explanation of the credit crisis that has overtaken our economy. Hopefully you'll come away with a better understanding of the situation, along with some lessons you can apply to your own personal finances.

As with all true disasters, a series of mistakes are made that culminate into a full-fledged crisis. History provides us with many examples, including the sinking of the Titanic, the stock market crash of the 1920s, and more recently, 9/11 and Hurricane Katrina. In each case, a series of circumstances, along with multiple human errors, combined to bring about a true disaster.

Such is the case here. We can't just blame the banks, or the mortgage companies or the housing market or the Federal Government. This was a real group effort and there's plenty of blame to go around in this chain of events.

Let's start the story at the beginning of the chain, with the American home-buyer. We all know how to buy a home. If your income and credit score are high enough, and your outstanding debts are low enough, you can get home loan from a bank or mortgage company. And many people do. But as home prices continue to rise and the supply of credit-worthy consumers dwindles, a way has to be found to keep the mortgage profits flowing.

So loan requirements are relaxed. Adjustable rate mortgages, with low initial teaser rates, are introduced. Down payments are lowered or eliminated altogether. Documents proving credit worthiness, like income tax returns, are no longer required. Loans for more than the price of the house are given. Suddenly almost anyone can get a loan for more house than they can really afford. But that's no problem, certainly not in the middle of one of the hottest housing markets in recent memory. House prices are going up like a rocket and everyone wants to go along for the ride.

Once a bank or mortgage company gets a loan, they turn around and sell it to investment banks, freeing up capital so they can loan even more money. The investment banks, believing that these mortgages have been given to credit-worthy consumers, in turn sell groups of mortgages to shell companies they create. This way these mortgage loan assets are off their books, freeing up capital they can reinvest to earn even more profits.

The shell-companies don't have the capital requirements that banks do, so they can leverage these loans even more by issuing short-term commercial loans to institutional buyers and hedge funds. They are earning more off the mortgages than they are paying on the commercial loans, so they make a profit. The rates offered on the commercial loans aren't high because the mortgage bonds collateralizing them are AAA rated.

The institutional buyers like the AAA ratings of the underlying bonds, and buy large amounts of the short-term loans they're based on as a secure source of income. Everyone believes that these groups of mortgages are well diversified and are from credit-worthy consumers, hence the AAA rating. As long as house prices keep climbing, everyone is happy and keeps making money.

So far, our chain of events is all about leverage. The home-buyer leverages a small (or no) down payment and monthly house payments to fund a substantial mortgage. The bank or mortgage company leverages the profits from these loans to loan even more money. The investment banks that purchase these mortgages from the original lenders are able to move them off their balance sheets and into shell companies they create, leveraging them even further. The shell companies leverage them yet again, allowing them to make even more loans and helping institutional investors increase profits.

In our next article, we'll see the tragic consequences when all this leverage is turned on its head and the house of cards based on a booming housing markets collapses.

Nationally-syndicated financial columnist and Certified Financial Planner(R) Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA. He'll answer your financial question ^FREE at www.guardingyourwealth.com.

Sticker Shock

It can be difficult for someone in the financial services industry to know how the investor feels, especially when first choosing which advisor to work with. I recently had an experience that put me in your shoes for a change.

A couple of mornings ago, my teeth began hurting for a short time after I brushed them. It had been awhile (too long) since they were cleaned so I decided to go to the dentist for a cleaning and check-up...

I only have one set of teeth and I know that they need to take care of me for the rest of my life. Unless I want to exist on soft food, it's vital that I take care of them. Likewise, someone retiring only has one nest egg and their lifestyle and ability to remain retired will depend on what happens to it. Make a mistake and you can lose a good portion of it.

How do you choose an advisor? How do you choose a dentist? I could look in the phone book and I can ask people that I know whether they are pleased with their dentist. Still, how do I know if their experience with a dentist is going to be the same as mine? It's not like you can interview a dentist, get a price list and an extensive list of references!

Worse, the reason I was looking for a new dentist was because I wasn't pleased with the dentists I'd used in the past. Surely this time I would find one that I would like! So I called a dentist that seemed to do a good job for another family member and I set an appointment.

A red flag went up during the first call. I asked for an appointment after the stock market was closed for the day and amazingly, they just happened to have had a cancellation and I could get in that very day! Having a sales background, I know that's a common tactic to use because you don't want to give the impression that you aren't busy.

Another red flag was raised as soon as I walked into the office. There was leather furniture, a cafe and a plasma screen television. The coffee table featured literature on various cosmetic improvements. The plasma TV, it turned out, was just playing a loop designed to sell those improvements. I never realized that having whiter teeth would have such a positive impact on my entire life!

The phone sales tactic I picked up on was confirmed when I heard the receptionist say the same thing to others that were calling in. In the financial services industry, these are seen as harmless statements. "It's no big deal, they'll never know," the advisor might explain to the assistant. Maybe I'm old fashioned, but I don't want to be treated that way and neither do my clients.

Soon, I was ushered into the chair where I thought I was going to have my teeth cleaned. After a few pleasantries, the dental assistant said that she needed to take some x-rays and that they recommended the 360 degree one. "It is $199 for both sets, is that OK?"

While examining my gums she mentioned that oral cancer was very hard to detect and affected many people. They had a test that would screen for it and it only cost $49 would I be interested? No.

My appointment was for a cleaning. But all I received was the x-rays and the initial consultation‚. It's possible‚ I have a cavity under one of my existing fillings and the dentist recommended it be fixed, not with a traditional filling but with a new crown that would be much better.

I left feeling like I paid $200 for some x-rays and a sales pitch. The full cleaning, it turns out, will cost over $500! That partial crown would only be $850! For comparison I called another dentist. This one seemed to be more old school. His cost for a cleaning? $110.

Have you ever felt like I did after going to an investment advisor? Undoubtedly, some of you have and I am ashamed to say that it is becoming more common. There are advisors out there, though, that are more focused on your needs than their own. Trust your red flag indicator, don't move quickly, and do extensive research on any recommended products.

Nationally-syndicated financial columnist and Certified Financial Planner(R) Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA.

Read more or ask Jeff a question at www.guardingyourwealth.com.

An Ounce of Prevention

We've all heard the old adage that an ounce of prevention is worth a pound of cure. This applies to many areas of life, but perhaps none better than in the area of long term care. Nobody likes to think about the possibility of needing this kind of care and, as a result, many people put off preparing for it until it is too late. Here's a real life story that will hopefully motivate any procrastinators out there into action.

A dear friend of ours, whom we'll call April, has been helping her 88 year old mother recover from some fractures in her spine caused by osteoporosis. After living independently and refusing any kind of assistance for years, she has now decided she does not want to go back home from the rehab hospital, but would rather go straight to a nursing home facility.

As often happens with the elderly, declines in health and mental attitude can come on quickly and such is the case here. April's mother has been a widow for several years and did not even want her own children dropping by to help her with housekeeping. But when her severe back pain turned out to be three fractured vertebrae requiring surgery, she had a sudden change of heart. Now, she would rather have others care for her and not have to deal with keeping up a home.

Fortunately, 18 years ago when April's mother was 70 years old, she purchased a long-term care insurance policy. While it only covered nursing home care and not assisted living, it promised that premiums would not increase over the life of the policy. Her premiums were $1,800 a year, which seemed like quite a sum to her and her husband back in 1990. But given the longevity on her side of the family, they felt it was a wise decision.

They didn't buy a similar policy for April's father, because he was a World War II veteran. In those days veterans knew that they could live out their days in a V. A. nursing home should the need arise. As the years went by, the couple remained in relatively good health. When a letter from the V. A. arrived years later, he didn't understand exactly what it said and didn't realize that the once-promised nursing home benefits for veterans had drastically changed.

His family didn't realize this either, until the father developed severe Alzheimer's a few years ago. That's when they discovered that the V. A. would only cover nursing home care for the first 90 days. After that, you were on your own. Unfortunately for him, his ability to swallow went away quickly and he died soon after. Had his illness progressed more slowly, his condition would have financially devastated his wife's financial security.

But because of the policy bought 18 years ago, April's mom will be well cared for. While $1,800 a year seemed so expensive back in 1990, today it's an absolute bargain. With nursing home care in our area costing about $175 a day, the $32,400 she's paid in premiums will be recovered in less than 6 months. Think about that. She's paid premiums for 18 YEARS and will get it all back with only 6 months care.

It's true that if she recovers well enough to handle most activities of daily living and goes into an assisted living facility instead, she will have to pay for it. But given her age and current condition, even if that is the case, most likely the need for nursing home would simply be a matter of time. But her policy gives her options she would not have otherwise and will allow her to choose a quality facility without having to consume her nest egg.

There are several lessons we can all learn from this story. While we can't predict our future, the increasing of life spans and medical advances means most of us can expect a longer life than our parents, increasing the likelihood of needing some kind of long term care. Medical costs continue to outpace inflation. If you wait too long to apply for long term care, you may have developed conditions that will medically disqualify you for it.

So don't put off this very important aspect of your financial plan. An ounce of prevention is certainly worth a pound of cure.

Nationally-syndicated financial columnist and Certified Financial Planner(R) Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA.

Read more or ask Jeff a question at www.guardingyourwealth.com.

A House Divided

One of the biggest issues seniors face as they get older is how to preserve an inheritance for their children. Their biggest fear is spending all of that money on assisted living and/or nursing home care. As each family situation is different, so is each solution. Perhaps you can learn something from the experience of one of my clients.

Here's their situation in their own words, with their names changed, of course:

"Tom's mom has decided that she wants to move to a retirement home while she can make her own decisions about where and when to go. She's on the waiting list at one that's so nice I may go too!"

"Anyway, we are looking at options of what to do with her house. She's always wanted the house to go to Tom and his brother Les even if she has to use up every other asset she has."

"Les is disabled and on Social Security Disability Income. Mom sends Les about $150.00 a month to help out. Her first thought was to sell the house and divide the proceeds now. Tom thought it might be better for her to lease it and then she could still send Les money each month."

"Also, if she were to sell, we think she should keep the money in case she ends up needing it to live on. I know there are tax limits on gifts of money, (and not sure what all that would do to Les's assistance eligibility). Maybe she could sell, give each $10,000 and keep the rest for her future living expenses. Anyway, I think she could well be heading toward some mental issues (lots of forgetfulness, etc.) so we need to make the right decision."

"What say you, Mr. Financial Guy?"

These are difficult situations. First, you need to make sure that you have the appropriate legal documents in place to handle any incapacity that may/may not occur. There should be Powers of Attorney for Assets and Healthcare and/or a Living Trust. There should be a Living Will. If she doesn't have a Living Trust you will want to make sure that her Will is up to date.

There are issues relating to Les receiving an inheritance in that it might disqualify him from SSDI. It's important that any inheritance he receives go to a Special Needs Trust. Otherwise, the government might take the money as pay back for what they've spent. Be sure and consult a qualified attorney for this kind of trust.

Depending on her income, she may need the money to cover her assisted living and/or future nursing home care. Some want to leave an inheritance and try to get the government to pay for their care. That is done through Medicaid. To qualify, one has to be indigent--having less than $2k in assets.

So if she sells the home and uses the money for her care, she will need to spend it down to $2k before qualifying for Medicaid. There is a 5-year look back period when someone applies for Medicaid. If they have gifted money within that period, they will be denied benefits for the amount of time that money would have otherwise covered.

There are really two unknowns here. First, whether mom will need all her money for her care and, second, whether that will occur within 5 years. If she sells the house, she can gift all the money to her sons now without having to worry about Federal Gift Taxes (other than filing a form). She should check to see if there will be any state gift taxes.

As long as her other money lasts for 5 years the gift wouldn't impact future Medicaid eligibility. Another option is for her to consider long term care insurance. She has to medically qualify and her memory issues may keep that from happening.

In short, Mom should make sure she has enough money to cover her expenses for the next five years. She might need some of the house proceeds to cover this. Then she could go ahead and gift the remaining house proceeds to her sons. If she qualifies, long term care insurance could help cover future health care expenses. And you're right to not put off these kinds of difficult decisions. Deal with it now, before it's too late.

Nationally-syndicated financial columnist and Certified Financial Planner(R) Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA.

Read more or ask him a question at www.guardingyourwealth.com.