Looking Out for You

By Charles Webb

By early adulthood most everyone figures out that very few people beyond your family are really looking out for you. In this day and age of economic uncertainty, I can't help but to notice the preponderance of people and institutions that are claiming to be there for us. A lot of them seem to be sales people. A lot of them seem to be selling financial products. I'm convinced that most people who claim to "have my back" are simply there because it's closer to my wallet.

Among all of these folks, the one group that stands proudly at the top of claiming to look out for all of us is the federal government. The fortress of cradle to grave support that is being constructed around us was made poignantly clear to me as I poked around the Health and Human Services website promoting the benefits of the soon to be fully implemented healthcare legislation.

Now I'll freely admit that I'm skeptical about how this whole legislative package is going to get implemented. I was curious when the President was selling insurance on TV and directing people to their new website. Drilling down through a bunch of pages full of pictures of people who looked like they didn't need insurance, I came across a link where I could find out who would qualify for premium assistance. What I found out was that the government will help pay the health insurance premium for a family of four earning over $94,000 a year. Two things struck me about this. First is that government assistance isn't just for the poor anymore and second, this is going to be really expensive. They're taking the concept of looking out for us to a whole new level.

But I wonder if they really are looking out for us? Where is all this free stuff coming from? Is there a price to pay and if so, how much and who's going to pay it? Even with the government's ability to print money, there is a price to pay. That price is the massive debt that the Feds are racking up. That debt in turn is driving the Federal Reserve's monetary policy.

This is the point that needs to be made. Through QE1, QE2, QE3, operation twist, the mortgage back security purchase program and a host of other market interventions, the Fed has been artificially holding down all interest rates for at least five years now. Traditionally, the Fed has exerted direct control over the shortest term rates but all the other rates have been established by market forces. For anyone living off their savings or those like us who are trying to find ways to generate that income, this has become an incredibly challenging time.

Investors now have to look to unfamiliar and riskier places for even modest income. This is a big deal. Based on the current market rates, you would need twice the savings today to generate the same income that you would have had seven years ago. We're now being told that this lost income can be made up by the gains in the stock market but that's far from a sure thing. Stock investors have loved these easy money policies as they've accounted for much of the run up in stock prices over the last few years, but even with the nice gains over the past few years, stocks are only up a few percentage points from 2007.

So if the economy is performing better than it was four or five years ago, why is the Fed still actively manipulating interest rates lower? We're told it's because the economy still needs it and they won't change course until a bunch of data points change their minds. I'm beginning to wonder. Who is really benefiting from these lower rates? Clearly anyone who is carrying a lot of debt is benefiting. And wouldn't you know that the very same folks that are holding rates down happen to also be the largest debtors on the planet - the U.S. Federal Government.

So if you're wondering when savers and those relying on their portfolio income to pay for their retirement are going to get a break, it may be a while. Just one percentage point more that the government has to pay in interest on 17 trillion dollars adds 170 billion in additional expense per year. That's real money even by Washington standards. So who are they really looking out for? The price for all of this government help is looking more and more like our retirement income.

Settlement Eases Medicare Rules

By Lori Eason, CFP(R)

Following a national class action lawsuit settlement, the government has decided to revise its Medicare manual. The new language will ensure broader availability of Medicare coverage for skilled nursing, home health and outpatient care. Before I go into the details, I'd like to refresh your memory on the different parts to Medicare since it is quite complicated, but very important given it is pretty much the only cost-effective health insurance available these days for senior citizens.

 

The Social Security Act of 1965 created Medicare to provide insurance for people over 65. While there were originally only 2 parts to Medicare, there are now 4 parts: Parts A, B, C and D. Part A provides hospital and skilled nursing care coverage and is paid for by the government as long as the insured has 40 or more quarters of Medicare-covered employment. It is financed mostly by the Medicare tax of 2.9% split between employer and employee. A deductible of $1,184 does apply. Part B covers physicians and other out-of-hospital expenses. The insured person contributes to the cost through a monthly premium, currently $104.90 with a deductible of $147 per year. Medicare Advantage plans are private plans that can help supplement Medicare benefits for an additional premium and are referred to as Part C. In 2006, Part D, a prescription drug discount plan, became effective.

 

A key point to remember is that Medicare does not cover long term care. While Medicare does pay for some short-term nursing home stays, the requirements to qualify for benefits are very specific and it is not intended for long-term stays.  Among the requirements is an inpatient hospital stay of 3 consecutive days or more.  One notable illness that often does not meet this requirement is Alzheimer's because the patient is often physically in okay shape, but mentally unable to care for his or herself.   If all requirements are met, Medicare pays the full cost of the nursing home for the first 20 days.  For days 21 through 100, Medicare covers the cost after the patient pays a daily copayment, currently $148.  After 100 days, Medicare pays nothing. 

 

Now I'll move on to the upcoming changes. According to current Medicare language, beneficiaries are required to show a likelihood of medical or functional improvement before Medicare will pay for skilled nursing and therapy services. Under the settlement of Jimmo v. Sebelius in October of 2012, the U.S. Department of Health and Human Services has agreed to relax these requirements. The government is set to revise its Medicare manual to make benefits available when care would only "maintain the patient's current condition or prevent or slow further deterioration." Standard nursing home care still won't be covered beyond its current limits (no more than 100 days), but it will expand access to skilled nursing, home health and outpatient care.

 

The lead plaintiff in the case is a 76 year old woman who has been blind since childhood and had her right leg amputated below the knee due to blood circulation problems. She received care from nurses and home health aides, but Medicare denied coverage saying her condition was unlikely to improve. At first, the Obama administration urged the judge to dismiss the lawsuit stating that the court lacked jurisdiction and that the plaintiffs had failed to state a claim for which relief could be granted. This motion to dismiss was denied. A proposed settlement was approved in October of 2012. The settlement was approved on January 24^th, 2013 during a scheduled fairness hearing and the Centers for Medicare and Medicaid Services will have one year to make the manual changes and carry out an educational campaign.

 

A spokeswoman for the U.S. Department of Health said the proposed settlement "clarifies" existing policy and that they do not expect change in access to services or costs. I completely disagree that the change in language only clarifies the current rules. Requiring that a beneficiary show a likelihood of improvement and requiring that the care maintains the condition or slows deterioration are very different things.

 

Some 10,000 cases in which Medicare beneficiaries' claims for skilled nursing and therapy were denied will have their claims re-examined. A public trustee of the Medicare program said that the proposed settlement would unquestionably increase costs but couldn't say by how much. Some argue that the program's higher costs for providing the additional coverage will rise but could be offset by allowing some beneficiaries to access physical therapy and home health care and avoid more expensive care in hospitals and nursing homes. While I could see this to a certain degree, there's no way the savings will be greater than the cost of expanding coverage. Medicare spending is expected to top $590 billion this year without the proposed changes.

Chicken Little

By: Charles Webb

 

As of this writing, there is no doubt that the automatic federal spending cuts, known as the sequester, will take effect on Friday March 1^st. You'd be hard pressed to miss the news coverage surrounding this deadline and the impending doom that it will bring about. Once the "meat cleaver" cuts "painfully and indiscriminately" into the various programs, teachers, firemen, the police and other first responders are going to be fired in mass. Our aircraft carriers will no longer be able to project our power abroad and will immediately be recalled to port. There will be no air travel for the lack of air traffic controllers. The next life-saving drug will not be discovered. Prisons will be emptied. GDP will fall precipitously throwing our weak recovery into another recession worse than the last one we came out of (although tax increases have no impact). Brace yourself. The end is near.

Satire usually doesn't translate well into writing. So in case you missed it, there was plenty of it in the previous paragraph. But if you listen to the comments coming from those who like to spend our taxes and borrow on our behalf or recipeints of those dollars, no truer words have been spoken than the above.

This is, of course, the biggest bunch of nonsense to come out of Washington in a very long time. The "draconian" cuts simply don't mathematically come close to matching the rhetoric being thrown about. This is bad politics at its worst. Let's go over some of the numbers.

$2,468,000,000,000 - Revenues 2012 (estimate)
$3,795,000,000,000 - Spending 2012 (estimate)
$1,327,000,000,000 - Deficit 2012 (estimate)
$44,000,000,000 - Sequester driven spending cuts (2013)

Let's drop 8 zeros and look at this using recognizable numbers.

$24,680 - Annual income
$37,950 - Annual spending
$13,270 - Debt incurred (this year)
$440 - proposed spending cut

So cutting back $440 on total spending of $37,950 represents a 1.16% spending decrease. That's a joke. Even after the spending cuts take place, the government will spend roughly $15 billion more than it did last year. Granted, the government works in big numbers so 1.16% looks like a lot when you assign a dollar amount to it (read that as scare tactics). But it's insulting to have us believe the government can't find barely over one percentage point worth of waste, fraud or ineffectiveness to cut.

The truly scary part of all this is the stink that's being raised over such a small step towards fiscal sanity. It makes you wonder how Washington will ever get its house in order.

The sky isn't falling.

Moving Past the Election

By Charles Webb

There has been no better evidence around here of the importance of this  year's presidential election than the number of phone calls and emails received after the election from worried clients questioning the economic impact of the results. The post-election thousand point drop in the Dow Industrial Average was another good indicator of the market's uncertainty. The two big questions the election has raised, or maybe not put to rest, are about taxes and the deficit, both of which are encapsulated in the drama surrounding the looming fiscal cliff. We've written extensively this year about all of these issues but we think a recap of those points is in order anyway.

The fiscal cliff is the popular shorthand term used to describe the decisions Congress must make come December 31^st regarding the expiration of the Bush era tax cuts and the scheduled spending cuts set to take effect in January. In 2010, Congress kicked the issues down the road by extending those tax cuts through 2012 and postponing any spending cuts until then as well.

The serious questions about spending and taxes were raised in 2010 because of the massive annual deficits which began in 2008 and have since run well in excess of a trillion dollars per year. The weak condition of our economy two years ago gave cover to the politicians in Washington to postpone any hard choices until now.

Two years later, the economy is in better shape than it was but is far from healthy. The most contentious part of the debate revolves around tax increases. We already knew that taxes on investments were going up with the implementation of the new healthcare legislation. Under that, investment income for those making $200,000 and above is going to be subject to Medicare taxes (3.8%). In addition, the president would like to see the tax rate on dividends and capital gains be subject to the ordinary income tax rate for those same individuals. Furthermore, he'd like to see the top ordinary tax rate raised by several percentage points. The combination of these proposals represents a substantial tax hike on investments and capital formation. For the record, we think this is a terrible idea.

We disagree with these proposals for a number of reasons, some philosophical and some economic. However, the primary reason is that we see big tax hikes as having little impact on fixing the deficit but likely adding substantial risk to the economic recovery. As we've noted before, our annual deficits have averaged roughly $1,300 billion ($1.3 trillion) per year for the past 4 years. A lot of that has been blamed on tax receipt shortfalls from the economic meltdown that began in 2008. While that may have been true in 2009, it certainly isn't now.

Year	Tax Receipts	Outlays	(Deficit)
2007	2,568	2,729	(161)
2008	2,524	2,983	(459)
2009	2,105	3,518	(1,413)
2010	2,163	3,456	(1,294)
2011	2,304	3,603	(1,300)
2012 Est	2,468	3,796	(1,327)

 

 

 

The above table shows tax receipts and expenditures in billions of dollars over the past half dozen years. You can clearly see the fall off in tax revenues from 2007 to 2009. You can also see that this year's estimated revenues are within $100 billion of 2007. It's important to note that in 2007, we had the highest level of tax receipts ever. The expenses are clearly the problem and should be the primary focus of the debate. 2012 expenses are projected to be $1,000 billion ($1 trillion) higher than they were back in 2007. It's hard to see how raising taxes will contribute in a meaningful way to put our country's fiscal house in order. The highest projection we've seen of the proposed tax increases is $120 billion. This, by the way, is if all the proposed tax changes were enacted and those tax payers being hit by them made no changes in response. How likely is that? Not very. A more realistic estimate is about $70 billion. That would bring this year's deficit down from $1,327 billion ($1.3 trillion) to $1,257 billion ($1.3 trillion). That doesn't even affect the rounding.

At the risk of beating a dead horse, this is the third time this year that we've presented these statistics. But we feel it's important to keep pressing this point. This problem won't get fixed until it is honestly addressed. The buzz word constantly thrown around in the fiscal cliff debate is "balanced" - meaning a solution will require both tax increases and spending cuts. In our minds, if the solution were to be truly balanced, we'd have to have 10 dollars in spending cuts for every 1 dollar of tax increases. Rest assured that there haven't been any proposals that resemble those figures.

There's a lot of talk about having to make changes to Social Security and Medicare to balance the budget. This is certainly true long-term, but those programs are not responsible for over $1,000 billion ($1 trillion) of additional spending per year since 2007. The budget would be balanced this year if spending was simply reduced to where it was in 2005. That was also at the height of the Iraq war. You have to ask yourself what in the world has changed in seven years that has necessitated an additional $1,200 billion ($1.2 trillion) of spending? Well, for starters we've had cash for clunkers, cash for caulkers, cash for first time home buyers, cash for high-speed rail, cash for solar, cash for wind energy, cash to help buy electric cars, cash to develop electric cars, cash to build the batteries for electric cars, and on and on and on.

Here's a more specific breakdown by category of where our tax dollars go. Ironically, the smallest percentage increase has occurred in pensions, which is Social Security. The next smallest percentage increase was in healthcare, primarily Medicare. From there, it's a who's who of government agencies and programs. The "Other" group sticks out with $200b in spending. Some of the big items in there are: Freddy and Fannie Mae Bailouts 40b, FDIC Insurance - 27b, Farm Support - 26b, TARP - 19b, NASA - 17b, Land Mgt - 12b, Green Energy - 10b, Pollution Ctrl - 10b.

Outlays By Category in Billions of Dollars
	2007	2012	Chg	% Chg
Pensions	628.3	819.7	191.4	30.5%
Healthcare	641.8	846.1	204.3	31.8%
Education	100.8	153.1	52.3	51.9%
Defense	652.6	902.2	249.6	38.2%
Welfare	262.1	451.9	189.8	72.4%
Protection	42.4	62.0	19.6	46.2%
Transportation	72.9	102.6	29.7	40.7%
Gen Govt	19.8	33.6	13.8	69.7%
Other	71.0	199.6	128.6	181.1%
Interest	237.1	224.8	(12.3)	-5.2%
Total	2,728.8	3,795.6	1,066.8	39.1%

 

 

 

 

 

 

One of the more interesting items here, and we think the most noteworthy, is interest. This gives you a pretty good indicator as to how much of a budget buster interest rates will be in the future. As we've stated before, the outstanding debt has risen roughly $6,000b ($6 trillion) between 2007 and 2012. Yet the interest expense has declined. That shows how far interest rates on Treasury bonds have fallen. If rates were currently where they were in 2007, interest expense would be approximately $380b. That's over $150b higher than it is now and would consume more money than all of the proposed tax increases combined.  

In addition, the government has been financing its deficits with short-term debt in order to take advantage of these super low rates. This is not unlike what subprime borrowers did with their homes a few years ago. Just like those borrowers, the government is going to see its interest cost skyrocket when rates head higher and they have to refinance all of those bonds coming due. Every one percentage point increase in interest rates on $16,000b (16 trillion) of debt would add an additional $160b per year of spending. The current yield on a 10 year treasury is almost 3 percentage points below its normal rate. There's only one reason rates are this low - the economy is in poor health. If you think the economy is going to get better, rest assured rates will return to their normal levels.

Earlier this year, I heard the president field a question about how concerned he is about the nation's debt. He replied that it was a concern longer term but in the short run it's not a big deal because rates have been so low. In my mind, that's a little like having a gun fired at you and thinking that it wasn't a problem because in the short run, the bullet's not here yet. It's ironic that our government is behaving exactly the subprime borrowers that got us in this mess in the first place.

Standing on the Edge of the Fiscal Cliff

By:  Lori Eason, CFP(R) With the election less than two months away, emotions are running high among Americans as the two candidates battle for the Oval Office. The stakes are high as our country has been plagued with an ever increasing deficit, unemployment and a struggling economy for several years now. Our country sat back and watched as the Eurozone debt crisis unraveled with many of us fearing that we were next in line if we continued on our current path. In fact, for the past 18 months, the number one risk that worried money managers has been Europe's debt crisis. Until September, that is. In this month's Bank of America Merrill Lynch Fund Manager survey, the looming fiscal cliff in the U.S. took over the number one mega risk spot.    The fiscal cliff is the popular shorthand term used to describe the decisions Congress must make come December regarding the expiration of the Bush tax cuts and the scheduled spending cuts set to take effect in January. In 2010, Congress kicked the issues down the curb by extending the Bush tax cuts through December 2012 and postponing the spending cuts until then as well.    The Bush tax cuts are a series of temporary income tax relief measures enacted by President George W. Bush in 2001 and 2003. They lowered federal income tax rates for everyone, decreased the marriage penalty and increased the child tax credit. These cuts also lowered capital gains and dividend income rates. The estate tax gradually decreased until it reached zero in 2010. Phase-outs on personal exemptions and itemized deductions were eliminated which allowed millions of households to escape the alternative minimum tax. Another tax break set to expire that is not part of the Bush tax cuts is the 2% reduction of the Social Security payroll tax which President Obama enacted in 2011. Without an extension of these tax cuts, it is estimated that the typical middle class family would face an annual tax increase of over $2,000.    The spending cuts referred to are part of the Budget Control Act of 2011 which requires $1.2 trillion in budget cuts over 10 years. These automatic cuts will be split between security and non-security programs and include $500 billion in cuts to the Department of Defense. There will be no cuts to Medicaid and Social Security. The first $109 billion in cuts are set to take effect in January of 2013.    So Congress clearly has 2 choices: extend the tax cuts and delay the spending again or do nothing and see how things play out. With the impending election, the most likely course of action is to postpone the tax increases and spending cuts and thus kick the issues further down the curb. Let's take a deeper look at these options.    If Congress doesn't avert these tax increases and spending cuts, the Congressional Budget Office predicts that the U.S. economy will face a significant recession in 2013. The CBO estimates that the policies set to go into effect would result in a 1.3% contraction in the first half of 2013 (which meets the definition of a recession) and a 2.3% expansion in the second half. The estimated growth in real GDP for the year would be .5%. The CBO warns that as a consequence of the spending cuts, the unemployment rate is projected to rise from 8% to 9.1% by the end of 2013. Keep in mind that these figures are projections from one group and should not be taken as facts.    If you have read our past memos, you know that the United States' spending problem is one of our hot buttons and in our opinion, the number one reason our country is in such bad shape. At the end of September 2008, our total outstanding debt was $10,000 billion (I'm going to phrase this in billions because the word "trillion" seems to have lost its meaning lately). As of last month, the total outstanding debt number is now $16,000 billion. That is an increase of 60% in just 4 years! And what has all that spending done for us? Given such a dramatic increase in such a short period of time, surely our government can find some way to shave $109 billion off of next year's budget without bringing on a recession. To put it in perspective, the total outlay for this year is projected to be $3,796 billion.    Now let's shift our focus from the spending side to the tax revenue side. Allowing the tax cuts to expire would raise taxes by $316 billion on more than 100 million Americans. Maybe a better term is not fiscal cliff but taxmageddon. There's no way that this economy could digest a tax increase of that magnitude. The White House has called for a mixed deficit reduction plan which includes the extension of all the Bush tax cuts for all families who make less than $250,000/year as well as some spending cuts. Republicans disagree with the $250k income cap and argue that would be a tax hike on small business owners. Romney has proposed extending all Bush tax cuts and postponing all spending cuts until he get in office (if elected) at which point he would construct his own deficit reduction plan.    Here's our take on the tax situation. If Congress were to let the tax cuts expire for those who make over $250,000, the CBO estimates the additional tax revenue in 2013 would be around $42 billion. When facing the decision of whether to raise taxes, the cost-benefit analysis should certainly be considered. Ernst & Young predicts that tax increases on the affluent would cost around 710,000 jobs and cut wages. Raising taxes on the wealthy causes them to redistribute their capital and use it in ways that are not as beneficial to the economy in an effort to shelter those monies from taxes. The risk of higher unemployment and lower taxable incomes hardly seems worth the benefit of only reducing the current year's deficit by less than 4% ($42b/$1,130b). No amount of tax increase on the rich could ever get us out of our debt crisis. We have to get to the root of the problem which is overspending. Our government has proven time and time again that access to more revenue and credit only feeds its spending addiction.    Despite the fact that several members from both parties have said Democrats and Republicans will have to compromise to reach a deal after the election, no leaders from either party have shown any willingness to do so. And there is definitely a cost to indecision which will likely affect the economy before 2013 begins. Households and business will most likely begin to change their spending habits in anticipation of the changes, which could reduce GDP by .5% by the end of 2012 according to the CBO. One lesson to be learned over the last few years is that Americans do not respond to temporary fixes. All of these stimulus attempts over the last several years (from the random tax rebate checks we all received back in 2008 to First Time Home Buyer and Making Work Pay credits) have done nothing but delay the inevitable and add to our outstanding debt. We cannot spend our way out of this mess!    The bottom line is that with either choice, the U.S. will still be in a precarious economic situation for the foreseeable future. Our spending problem is going to take years to fix, but we have to start somewhere.  The election results in November will tell us a lot about this country and the direction it is headed.

*All projections came from either the Congressional Budget Office or Treasury Direct.