Recently I was involved in a discussion about the economy in which someone pointed out that it’s just so hard to keep up now because the cost of living has gone up so much in the last twenty years or so.

That made my ears twitch because I don’t think that statement is entirely correct, unless you’re looking mostly at home prices. In that sense, the cost of living has definitely gone up - but it isn’t really the cost of “living,” it’s the cost of “looking like you’re more affluent than you are because you think your neighbors are rich but they aren’t either.”

Because these types of things really get into my head and won’t leave me alone until I spend way too much time researching them …

I hopped over to the Census Bureau to look a few things up to verify my beliefs, with the first stop being the report on New Home Characteristics for 2007. On page 363 of the document there is a historical table of new home sizes dating back to 1973. Picking 1980 somewhat at random (and in the hopes that I’d be able to find other data on other products from about the same time to help me out in this little project), it appears that the average new home size across all of the US was 1,660 square feet. By 2007, the average new home size was 2,521 square feet - an increase of 861 square feet.

861 square feet is a LOT, but not all of that is livable space that needs to be furnished. I also looked up the “parking facilities” to see how much space was being taken up by garages. In 1980, there was no data available on how many homes had three car garages, but by 2007, 19% of new homes had three car garages.

So right there, we have homes that are substantially larger and therefore, we have more room for “stuff.” Since most of us are not minimalists by nature, we feel compelled to fill up those spaces with furniture, gadgets and toys. Gone are the days when you borrowed a tool from your neighbor - just go buy one of your own, you have the room!

Moving right along, let’s look at incomes. In a Census report regarding 1980 incomes (in a hilariously 1980s font, I might add), the median household income was $21,020. In 2007, it was $50,233. Keepl in mind that in these figures, we’re not talking about the average, we’re talking about the median - the number in the middle when you calculate everyone out there making an income. If there is an extreme disparity between low and high ranges, the average would be lower.

Next, food. This one’s a bit more of a challenge because a lot of foods we see in grocery stores now did not exist in 1980, but I did find this from the Economic Research Service of the USDA:

Specifically, from 1980-2006, inflation-adjusted prices of chocolate chip cookies, cola, ice cream, and potato chips fell by an average of 0.5-1.7 percent each year. During the same period, inflation adjusted prices of Red Delicious apples, bananas, Iceberg lettuce, and dry beans fell by an average of 0.8-1.6 percent each year. Inflation-adjusted prices of cabbage, carrots, celery, cucumbers, and  peppers fell by an average of 0.5-1.5 percent each year, over a slightly shorter period of time. These latter time series are somewhat shorter because BLS did not report prices for these foods for all years.

Rising price trends were observed for broccoli and field-grown tomatoes. These trends are not counter-examples, but reveal that the selection process was not exclusive enough to screen out all foods that have undergone quality change. Unlike in 1980, today’s consumer expenditures for broccoli are for partially or fully prepared products— washed and bagged florets and other cut products. Similarly, a technological improvement in the late 1980s changed the types of tomatoes grown and their sensory qualities.

In general, it doesn’t look like food prices have gone up much, but one activity involving food that I believe has increased dramatically is dining out. I qualified this statement with “I believe” because I couldn’t find any data to support my statement (if you can find some, I would love to include it) but I think most people in my age group would agree that in 1980, most meals, especially breakfast and dinner, were taken at home. Going out to eat, even to a fast food joint, was a big treat. I was 11 in 1980 and am really struggling to even recall the name of a restaurant in the small Illinois town we lived in. I remember plenty of chicken and rice casseroles at home, though.

Clothing prices have also not increased since the 1980’s, although just as with food, we all have more than we did back then. Just think about how big your closets were when you were a kid, or even now if you live in an older home. The first home I purchased in Denver was built in 1949 and each bedroom had a closet with about 5 feet of hanging rack space. That was it. And the rooms themselves were not large enough to hold a large dresser, so I had to scale down my wardrobe accordingly.

Some other “cost of living” adjustments that we’ve seen between 1980 and now are expenses that simply did not exist or were not widely utilized back then:

• Cable television (HBO wasn’t widely available until the 80’s, and MTV launched in August of the 1981 - quick, you know the first song played on MTV, right? Do they even play songs anymore, by the way?)
• Cell phones and fees, including data plans
• Video game consoles in the home.
• STARBUCKS - yeah, you know who you are!
• iPods (yes, there were Walkmans, but the model has changed dramatically)
• Blockbuster, Netflix and home theater systems
• Multiple personal computers and accompanying internet connections (we have three computers)
• Multiple televisions (we have two - but we never watch one of them)
• Kitchen gadgets (microwave ovens were widely available in the mid 70’s but not a standard household item)
• TOYS - the sheer volume of kids’ toys.
• Gym memberships and equipment, along with diet supplements.

There are probably hundreds of other differences between the world of 1980 and now, but I’m not going for a dissertation here. The point is that when you think of your “cost of living,” it’s important to keep in mind that many of the items you spend money on now are not necessities of life or even of comfort. Much of your “cost of living” is within your control, with a little creativity, a little more community sharing, and an understanding that keeping up with the Joneses is ultimately an immature need for approval that doesn’t serve you or those around you well.

Harsh? Maybe … but so is the prospect of living on social security and food stamps in your retirement because you couldn’t bear the thought of looking less affluent than your neighbors.

When the next election cycle comes around, I would like to suggest that everyone just disregard all statements made by their legislator that implies any surprise or disapproval of the mortgage industry’s shenanigans, because seriously - it’s all a farce.

I’ve read quite a bit of political and economic news and over the last few months, I’ve found that any kind of article involving indignant legislators is all of a sudden very easy to skim. Being able to substitute “blah blah blah yada yada yada” for entire paragraphs can seriously condense an article, you see.

Take, for example, this article in the Voice of America news about mortgage lenders defending themselves in front of Congress:

“Their own risk managers raised warning after warning about the dangers of investing heavily in the sub prime and alternative mortgage market,” said Henry Waxman. “But these warnings were ignored”

Blah blah blah.

“Your whole excuse for going to risky and unreasonable loans that are defaulting at an incredibly high rate is that everyone is doing it,” said Daryl Issa. “If we don’t do it, we’ll be left out.”

Yada yada yada.

And this whole bit with Kucinich:

KUCINICH: “Do you take responsibility for the risks that your company took when you ignored the advice of your credit risk officer and when you cut the budget, do you take that responsibility?”

MUDD: “I followed the process to listen to all of my staff, not just the chief risk officer.”

KUCINICH: “But what did you do though. What did you do. Did you cut the budget of your credit risk officer?”

MUDD: “Just liked all budgets, as long as I have been involved in business we negotiated the right number for the people that he could hire.”

KUCINICH: “Is the answer yes or no, did you cut your credit risk officer’s budget?”

Whatever, Yoda.

I’m not going to defend mortgage lenders but frankly, if I was in charge of Freddie or Fannie, I’d be pretty mad at the way these folks were talking to me. It’s not that Fannie and Freddie were unaware of the dangers of the sub-prime market or the inevitable collapse that would occur, it’s that they were stuck between a political rock and a hard place.

Taking Fannie Mae into account particularly, remember that although they are a public company, they were created by Congress. Their whole existence is about buying and securitizing mortgages from other lenders so that money is constantly available to lend to folks wanting to buy a home. THAT IS WHAT THEY DO. Freddie Mac was created, also by the government, to compete with Fannie Mae in 1970  … which is really odd when you think about it … but their job is the same.

The “blame Clinton for this entire mess” crowd likes to point to how he encouraged Fannie and Freddie to reach out to lower and middle income families, and that’s a fair accusation. But in Fannie and Freddie’s defense, when the President of the United States tells a government created organization to do something, I would imagine it is difficult to say no - and frankly, the sentiment was good. Owning a home is the American Dream, after all.

Still, even in 1999, there was plenty of warning about the possible pitfalls. From the New York Times on September 30, 1999:

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980’s.

”From the perspective of many people, including me, this is another thrift industry growing up around us,” said Peter Wallison a resident fellow at the American Enterprise Institute. ”If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.”

Imagine that.

And remember that at the same time this was happening, the “blame the Republicans for this entire mess” crowd can point to the Gramm-Leach-Blilely  (I like to point to it a lot, actually), which overturned Glass Steagall and allowed conservative banks to hook up with investment companies. That gave investment companies access to more conservative bank money.

Can you imagine the conversations in the halls of Washington DC back in the day? “If you guys want to loan to everyone and their uncle, you’re going to have to convince the banks to lower their lending standards. They can’t do that because they can’t take the risk, but if you pass this bill and let investment companies get in on the action, those geniuses should be able to invest well enough to make up for the possible increase in default risk.”

Without doing a bunch of research to verify, I am 100% confident that a statement very close to that was made at some point, because it actually makes sense.

But the one thing that politicians in the late 90’s would not have wanted to say in public if they wanted to get re-elected is, “no, we can’t support reaching out to lower and middle income people to increase home ownership” because what that really meant was “no, we can’t support reaching out more to minorities.”  Again from the New York Times in 1999:

… at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

So. All of that is one big long coffee driven rant that comes back to this: Take all of the Congressional finger waving and tongue wagging for what it is - a photo op. The housing and mortgage meltdown wasn’t a surprise. Maybe Fannie Mae and Freddie Mac could have fought harder to warn the government and the public about the inevitable failure of what was going on, but their voices would probably have been drowned out by the politicians who needed a strong looking economy in order to get re-elected.

The same politicians who need to blame someone now.

Now that the days of 0% balance transfers and no balance transfer fees are likely a thing of the past, I thought it might be interesting to actually price out the true cost of a rate reducing balance transfer. I’m going to use a hypothetical, of course, so let’s lay out this story …

Mr. Oscar Grouch has been challenged in the past with his spending habits. Slimey, his pet worm, isn’t all that expensive to care for, but Fluffy, his pet elephant, is pricey. He also has a longtime girlfriend, Grundgetta, and we know how expensive girlfriends can be. Last but not least, Oscar invested in some kind of superfly technology that allowed him to open up some new dimension so that while he looks like he just lives in a regular old trash can, in actuality he has quite the luxurious pad, complete with an Olympic sized pool, a skating rink, and a bowling alley.

A few decades of these spendthrift habits has resulted in not a little bit of debt for Mr. Grouch, but he has recently committed to a goal of eliminating it entirely. Good for him!

In order to reduce his debt as quickly as possible, Oscar has decided to first look around in gratitude at what he already has and then curtail his spending dramatically when it comes to new purchases.

He has also organized all of his bills and put together a cash flow calendar so that he can match up his incoming and outgoing money efficiently and will not be surprised by a dip in his account or overspend when his balance looks good.

Finally, after pondering whether to knock out his lowest balances first in order to get a thrill of accomplishment, as recommended by some financial personal finance advisors, or to knock out the ones with the highest interest rates first in order to lower the actual interest paid over time, as recommended by others, Oscar decides to go with getting rid of the high rates first.

By the way, I’m going to use calendars at Bankrate.com for this illustration - they have a lot of tools that anyone can use at no charge.

Beyond just focusing the bulk of his extra payments to the highest rate card (while paying the minimums to lower rate cards), Oscar figures he can get more bang for his buck by doing a balance transfer. He takes the $5,000 he has on a card charging him 13.99% interest and moves it to another company offering him 1.9% for the first six months. He is planning on being able to pay $500 per month towards that card, which means that he’ll pay it off in eleven months if he leaves the account with his current bank:

With this balance transfer, he figures that right off the bat, he’s saving $50 a month in interest, and that’s true. Changing his rate to 1.9%, his payment schedule looks like this instead:

By switching to a card with a lower rate, Oscar saves $303. 79, which is great! Except that …

1. Oscar didn’t include balance transfer fees in his original payoff amount, and
2. The low rate only applies for six months.

In the good old days, balance transfer fees used to either not apply or would be something like 3% of the amount being transferred, up to a max of $75 or something like that. Now, it would be very unusual to receive a no-fee balance transfer offer, and there is no maximum. Taking that into account, Oscar’s real starting balance is $5,150 and his payment schedule looks like this:

Oscar is still ahead by about $151 by transferring his balance, but we still have to take into account the change in his interest rate after six months. If Oscar is a customer at Chase, he might get an offer with verbiage kind of like the rate increase notice I recently received, which said:

Default APR - The Prime Rate* plus up to 26.99%, with a maximum of 29.9% (0.08216% daily periodic rate). This rate is currently the maximum rate.

*Estimate variable APRs above are based on the 5.00% Prime Rate on August 15, 2008. The “Prime Rate” is the highest (U.S.) Prime Rate published in the Money Rates section of The Wall Street Journal as described in your agreement. These changes to your APRs do not affect any higher APRs currently in effect on your account.

That means nothing, really, except to let Oscar know that his minimum rate will be somewhere between 5% and 31.99%. Just for the sake of argument, let’s go with an almost-worst case scenario and assume that in month 7, his rate jumps to 29.99% (the max Bankrate.com will take is 30%). There isn’t a Bankrate calculator that can do this switch up that I know of, so I’m going to mash a couple together for you because I’m just that nice. Flipping his rate from 1.9% to 31.99% midstream makes his payment schedule do this:

Interesting, hmm?

Even with a flip to 29.99% starting in month 7 and a 3% balance transfer fee, Oscar’s payoff time and amount didn’t really change much - within one dollar or so.

This illustration is not meant to show that balance transfers are useless - I could have chosen different starting interest rates for Oscar’s initial debt and come up with more pronounced differences in the outcomes between sticking with the rate he had versus going with a balance transfer, fee and all.

Without going into more tables, had Oscars original rate been 8.99%, it would have cost him an extra $130.74 to take the balance transfer offer. He’d be better off sticking with his current rate.

If, on the other hand, his credit card company recently bumped his rate up to, say, 26.99% as a business decision, then moving his money, fee and all, to take advantage of this balance transfer offer would save him $382.64.

You can do your own analysis of the differences in payoffs with online calculators and a handheld calculator, and if you need help, please feel free to ask me. I can walk you through it and I promise it’s not difficult. Remember too that there are other issues that arise with balance transfer offers, such as whether low interest balance transfer balances will be paid off at all if you are carrying other debt on the same card, so please see this post for more information.

Two recent stories regarding consumer debt caught my eye because I read them practically right after each other …

From the Associated Press on December 2, 2008:

… the average debt per borrower for the second quarter stood at $1,742, up 7.7 percent from $1,617 in the third quarter of 2007. Debt per borrower increased 1.4 percent from the second quarter, when it stood at $1,717.

And then from MarketWatch on December 5, 2008:

Total seasonally adjusted consumer debt decreased by $3.54 billion, or a 1.6% annual rate, in October to $2.58 trillion, the Federal Reserve reported Friday. Consumer credit rose at a 3.1 % pace in September after dropping a record 3.0% in August. Non-revolving credit - such as auto loans, personal loans and student loans - had the biggest drop in October, falling by $3.3 billion, or 2.5%, to $1.60 trillion. Credit-card debt fell by a slim $181 million, or 0.2%, in October to $976 million.

So, total debt is down, but for every person who has credit card debt, the average amount has gone up. The timing is a little off here, since the first story is talking about the second quarter (July through September) and the second is talking about October, but I think the general message is probably still valid.

That isn’t particularly good news for the economy, is it? Spending on goods and services like cars and education is dropping, but an increase in the average amount of revolving debt means that people are using credit cards to pay bills and that’s not sustainable over the long term.

What’s going to end this cycle, I wonder - and how bad is it, really? Although the delinquency rate on credit cards is rising, it’s still very low - just over 1%. Overwhelmingly, people are still paying their bills. Certainly spending is tightening up, which impacts corporate revenues and of course jobs, but the only solution to that can’t be for everyone to spend more and put themselves more in debt.

I don’t want to blame the rich, but a part of me wonders why every crazily compensated CEO out there hasn’t taken a voluntary paycut to help save some jobs.  According to the AFL-CIO, average total compensation of S&P 500 companies in 2007 was a little over $14 million. That figure includes perks like stock options and a cut in those doesn’t really translate to a saved job here or there, but that’s not the point. Also according to the AFL-CIO, the average CEO to worker pay ratio (how much the CEO makes compared to the average wages of all other employees) was about 42 in 1980, meaning that the CEO made forty two times as much as the average pay of everyone else. In 2005, that ratio had jumped to 525, and then dropped to 364 in 2006.

Again, considering that these ratios depend on a rather arbitrary valuation of stock options, I’m not sure how accurate they are, but the change is pretty stunning. Sure, these guys are required to turn a profit in huge companies, but are they really worth that much more now than they were in the 80’s? Comparing a CEO to a worker making $50,000 a year, is a CEO making $18,200,000 in 2006 really going to be able to do that much better than a CEO making $2,100,000 in 1980? I think that would be difficult to justify - do you as well?

Sorry for the tangent, this was going to be a very short post about debt but I got to pondering …

So, follow along with me for a moment.

Let’s say Bert and Ernie, long time roommates and friends, decided in 2005 to buy a brownstone on Sesame Street instead of paying rent for a basement apartment. They go to their friendly not-in-their-neighborhood mortgage broker to get qualified for a loan. Bert and Earnie have to do apply for the loan with stated income since neither of them has a regular day job, but this isn’t a problem in 2005.

Since the real estate market in New York City, and especially the always popular Sesame Street area, is outrageous. they also ask for low teaser rate ARM with an interest only feature. Their intention is to still live in the basement but to rent out the rest of the place in order to pay the mortgage, which will be a great cash cow after a few renovation expenses out of the way. Once they get going, they’ll refinance to a fixed rate, principal and interest loan.

The mortgage broker’s firm takes their mortgage, along with all of the other ones they’ve originated that month, and sells them to an investment firm that bundles them up into a different packages, and sells them to investors. Some packages are comprised of loans given to people with perfect credit and who makes lots of money and are therefore considered at very low risk to default. Others include mortgages like Bert & Ernie’s stated income interest only variable rate loans. The low risk ones pay slightly lower rates to investors, and the high risk ones pay higher rates. Both, however, somehow end up with excellent credit ratings from debt rating firms.

Fast forward three years.

Bert and Ernie have done their renovations and have been looking for tenants, but the economy has hit the skids. Monsters are leaving Sesame Street left and right, or moving back in with their parents. The only person with a stable job is Oscar (there will always be trash) and he’s content in his can. Bert and Ernie can’t find anyone to move in, and the rate on their mortgage just flipped up 2% and will go up another 2% next year.

Thank goodness for the bailout!

By choosing from one of several programs, Bert and Ernie were able to modify the terms of their loan in order to bring their payments to a reasonable level and avoid foreclosure.

The story doesn’t end there, though. Now that their loan payments have been modified downward, the cash flow that comes from that loan ultimately to the investor that purchased the package it’s in has also declined. To add insult to injury, since the returns on the investment have gone down, the current investor can’t even sell to another party without taking a hit on the principal amount either.

Multiply that by the 400,000 real loans that may be modified by Bank of America and you end up with one very ticked off investor who is suing the bank. From Business Week:

The battle over the mass modifications of troubled mortgages has begun in earnest. On Dec. 1, William Frey, a private investor in mortgage-backed securities, filed a lawsuit in New York State Supreme Court alleging that the proposed modification of some 400,000 home loans originally underwritten by the defunct lender Countrywide Financial is illegal.

The lawsuit , which seeks class-action status, was filed against Bank of America (BAC), which bought Countrywide in late 2007. It argues that most of the Countrywide loans are not Countrywide’s or Bank of America’s to modify, but rather are owned by trusts that bought them through securitization—the process of financing home loans through the public markets by parceling them out to investors.

Now, Mr. Frey isn’t just any old investor. He owns a broker dealer that specializes in mortgage backed securities and would therefore be particularly impacted by widespread loan modifications. His personal net worth would likely be affected as well as that of any clients who had invested with his company.

Mr. Frey says that he has not put together any securities using subprime mortgages in years because he believed them to be too risky, which was a good move, but the current economic downturn and bailout efforts are impacting more than just the subprime market.

His feeling is that the loan servicers are going to  modify loans instead of foreclosing and that these modifications are a breach of the contract that mortgage backed securities companies essentially set up with investors. In other words, when investors bought these highly rated securities, they were counting on a “business as usual” economy where people who couldn’t pay their bills would be foreclosed and even that wouldn’t happen very often, but they could generally count on the return on their investment staying consistent.

He also believes that changing the game half way through when it comes to mortgaged backed securities will hurt the secondary market for these products and therefore reduce the lending pool for Americans to purchase homes.

He’s not wrong and as the manager of a firm that makes its living on these products, it’s almost required that he step and try to defend the interests of his investors, but he’s no saint either. Essentially, he’s asking for a bailout for his investors - at taxpayer expense, of course:

Frey says a more reasonable, albeit unpopular, solution would be for the government—that is, taxpayers—to ante up another $500 billion to buy all of the troubled loans from mortgage-backed securities pools in order to keep the public market for financing mortgages viable.

Buy out ALL of the troubled loans in order to shift the risk from private investors to taxpayers. Nice thought, Mr. Frey. And yet, to be fair, I kind of see his point. It’s enough to give a girl a headache.

But for the record? I still think my plan is better.

Is the economy stressing you out? Are you worried about whether or not you’re job is safe, if your home value is declining so fast that you’ll be underwater on your mortgage, if your company is going to cut back on medical benefits? Are you concerned about where you will cut corners if necessary, and is the nightly news a constant stream of scary economic data?

If you answered yes to any or all of the above and have kids at home, consider how that might be impacting them.

Kids may be ignorant of the details of your financial situation or about personal finance basics in general, but they’re not stupid. They know when their parents are on edge about something even at a very young age. Empathy is instinctual, as anyone who has made smile at a baby in order to elicit a smile in response knows.

I can’t tell you how to convey your situation to your child - you know your kid’s personality better than I do - but I can give some general suggestions, and being the buttinsky that I am, here they are …

Keep your discussions age appropriate. An elementary school aged child and a junior in high school are worlds apart in regards to how much they need to know. A younger child may only need to know that sometimes parents have less money than others and this is one of those times. An older child, especially one who may be looking forward to a car or college in the next year or two, can handle a few more facts about the situation and deserves to know if there are plan changes on the horizon.

Be prudently positive. Fear engenders fear, and much of your fear and pessimism may be unnecessary. Stick to the facts of your situation, keeping in mind that “the economy sucks” is not really a helpful fact.

Enlist their help. Children want to help, they really do. If you are open with your kids, you will probably find that they are willing to join your team to do whatever they can to make things better. If your conversation is about how your income has gone down but your bills haven’t, ask your children if they have any ideas about how to save money. Depending on their age, you may have to guide the conversation a bit. For example, for younger children, you might need to mentally go through each bill and ask them for suggestions - “Electricity costs money every  month, and everything that is plugged into an outlet uses electricity, sometimes even when it’s turned off. What could we do to save money on those?” Don’t forget about the vampires!

Stay as positive as possible. The most important lesson you can impart to children in most times of trouble is that much of their reality is in their control. Teaching them that your family has been victimized is not helpful.

Come together. Going to movies, staring face forward, and munching on your popcorn in silence is less of a “quality time” family event than a board game, and much more expensive. Going out to eat in a loud crowded restaurant where everyone has to mind their manners** is less a family event than everyone hanging out in the kitchen making dinner together. Popping the kids in the gym’s on-site daycare while you go do an hour on the treadmill is less a family event than taking a free walk.

Be grateful - and give. Although it can be difficult to think about giving things away when times are tight, do it anyway. If you have clothes that children have outgrown, donate them to a charity or turn to your local Freecycle group. The lessons here are plenty - gratitude that you have enough to give away, sharing with others who are not as fortunate as you are, learning how to acquire items for yourself that are less expensive than buying new, and community coming together.

Turn off the TV. Watching economic news is pointless, really and truly. It will just depress you. Other programming may be more entertaining, but when it comes interrupted with commercials trying to convince you to spend and take on more debt, what’s the point? It can be confusing for kids as well. They see toys they want to get and those families on TV look so happy and obviously able to afford all of the goodies. By inference, if your family can’t afford to buy them, something must be wrong with you. Try the library instead for your video watching needs.

Although every day should be an chance to teach your children about personal finance, times of economic hardship are, let’s say, a more poignant opportunity. Handled correctly, tough times can be a blessing as families turn to each other for strength, support and love - all of which are free.

**This is not meant to imply that children should not mind their manners at the dinner table at home, it’s just not quite the same!!

As we move through this newly admitted recession that everyone already knew about, news about mortgage bailouts and auto bailouts and who-knows-who’s-next bailouts comes fast and furious.

For example, credit card companies have asked to be allowed to write down principal, a request which was denied by regulators in November because it also included a request to allow borrowers to defer paying income tax and lenders to defer including those losses in their financials. The government has decided that it is imprudent and misleading for credit card companies to not post the losses they would experience immediately, and that makes sense.

In the mortgage industry, however, the standards are a little different. If a homeowner loses a home to foreclosure or has a modification to a loan that includes reducing the principal owed, income taxes on the forgiven amount are waived. This law was originally enacted to cover debt forgiven in 2007, 2008 and 2009 but has since been extended to 2013. From the IRS website:

Homeowners whose mortgage debt was partly or entirely forgiven during 2007 may be able to claim special tax relief by filling out newly-revised Form 982 and attaching it to their 2007 federal income tax return, according to the Internal Revenue Service.

Normally, debt forgiveness results in taxable income. But under the Mortgage Forgiveness Debt Relief Act of 2007, enacted Dec. 20, taxpayers may exclude debt forgiven on their principal residence if the balance of their loan was less than $2 million. The limit is $1 million for a married person filing a separate return. Details are on Form 982 and its instructions, available now on this Web site.

[...]

The debt must have been used to buy, build or substantially improve the taxpayer’s principal residence and must have been secured by that residence. Debt used to refinance qualifying debt is also eligible for the exclusion, but only up to the amount of the old mortgage principal, just before the refinancing.

Debt forgiven on second homes, rental property, business property, credit cards or car loans does not qualify for the new tax-relief provision. In some cases, however, other kinds of tax relief, based on insolvency, for example, may be available. See Form 982 for details.

Combined with the tax relief, mortgage holders should be aware that there are several options available if house payments are a burden. FHASecure and HOPE for Homeowners are available now, and the newly announced Streamlined Modification Program will go into effect December 15th.

Under the Streamlined Modification Program and similar in some ways to FHA Secure and HOPE for Homeowners, borrowers with loans from certain providers (some of which can be found within the same list as lenders who are working with HOPE for Homemakers, but not all - contact your lender to see if they are participating) may be able to renegotiate the terms of their mortgage to avoid foreclosure or bankruptcy.

In order to qualify, homeowners must be delinquent 90 days already, owe at least 90% of the current value of your home, live in the home as a primary residence, not have filed for bankruptcy, and be paying more than 38% of their gross monthly income towards their mortgage.

The adjustments to mortgages may not necessarily include debt forgiveness, though. Participating lenders are going to resist debt forgiveness as a first alternative, opting instead to either lower interest rates or extend the terms of a loan. In other words, a thirty year mortgage may turn into a forty year mortgage, which means on a $150,000 mortgage at 5%, the interest actually paid over the life of the loan would go from about $140,000 to nearly $200,000, assuming the borrower actually stayed in the house that long.

Even with that rather hefty “penalty,” the new program may be a lifesaver to many families who just need to bridge this economic downturn - but only if used prudently and honestly. Interest-only loans and variable rate loans were also ways for families with faltering cash flow for one reason or another to be able to bridge a tough gap, but over the course of the last several years, those same loans were also a much too easy way for borrowers to buy more house than they could afford or to use the money they “saved” to spend lavishly elsewhere. This new program could be gamed to do the same thing, and it could be quite expensive for the economy as a whole. No, check that - it WILL be quite expensive.

How could someone work the system to take advantage of this program? Simply, really. All a homeowner needs to do is not pay the mortgage for three months and show that their gross income is not enough to support their loan payment. How could the income number be accomplished?

• Max out a home equity loan, if it hasn’t been slashed already, by drawing on the entire amount. It doesn’t need to be spent, it can just sit in a bank account. Remember, it’s INCOME, not assets that count in this equation.
• Go from a two income family to a one income family, especially if one spouse is in a field where jobs are easy to replace such as healthcare or education. The goal is to reduce income just long enough to qualify for the program.
• For self-employed people with unverifiable present income, be pessimistic! The same people who may have fudged on the high side to qualify for a loan in the first place can now feel comfortable with the “glass half empty” approach.

Of course, anyone who tries to get a loan modification through this program has to certify that they’re not being shady, but really, it’s getting to the point where it’s difficult to define “shady” when you see the auto execs rolling into DC to beg for money in their corporate jets, AIG doubling salaries and paying out hefty cash awards, and credit card companies doubling rates virtually risk free to themselves. The tradeoff for people with otherwise stellar credit reports between taking a hit for missing a few payments in order to reduce a monthly payment (or ideally, the entire principal amount of the loan) versus racking up more credit card debt or raiding a 401k plan may be worth the effort.

For a quick overview of the program, go here - Consumer Affairs Streamlined Modification Program Fact Sheet.

Seeing an increase in bankruptcy filings probably isn’t much of a surprise in this economy, but the increase is all the more compelling because of this (from USA Today):

The sagging economy sparked 106,266 consumer bankruptcy filings in October, the first time monthly filings topped 100,000 since the bankruptcy law changed in 2005, the American Bankruptcy Institute said Tuesday.

During the first year after the new law took effect, personal bankruptcy filings plummeted dramatically, and since then, have risen gradually. In October, though, filings jumped 40% over the same month in 2007.

The change in the bankruptcy rules, which was mostly a nice little gift to imprudent lenders everywhere, substantially decreased Chapter 7 filings in particular by making it much more difficult to qualify. Chapter 7 bankruptcy is a liquidation bankruptcy, which means that certain debts can be erased entirely, while Chapter 13 bankruptcy is a reorganization bankruptcy, which means that debts will still be repaid under the watchful eye of the court over a certain amount of time. Whatever is still left at the end of the payoff time may be erased.

Those who earn an income above their state’s median will generally not qualify for a Chapter 7 bankruptcy under the 2005 change in the law, which meant that people either needed to go through the much more time consuming and less “immediate gratification” process of Chapter 13 … or (more likely) just not file at all and try to get by some other way, maybe through family loans or debt settlement programs or by playing a little shell game with balance transfers and home equity loans.

The fact that bankruptcy filings are increasing, and according to the article, increasing in the Chapter 7 category specifically, means that 1) the debt switching game is over, as people are losing their home equity lines due to falling home prices and tightening offers at credit card companies, and 2) people are losing their jobs, putting them below the median price that qualifies them for liquidation instead of reorganization.

Although it would be devastating to the credit card industry, I think the bankruptcy laws need another review when President-Elect Obama gets into office. The law changes in 2005 were clearly a desperate effort to save an industry and an economy that had lost its mind, much to the detriment of the consumer who was being lied to the whole time about the “strength” of the economy, and reversing some of provisions of the law would be a good first step towards that Main Street bailout that most of us seem to find quite elusive.

I have to admit, this kinda pisses me off. From Associated Press:

Big banks have formed an unusual alliance with consumer advocates to urge the government to allow huge portions of credit card debt to be forgiven, a turnabout from recent years when the banking industry lobbied strenuously to make it harder for consumers to erase their credit card debts in bankruptcy.

The new pilot program — which the banks hope will become permanent — could involve as many as 50,000 people struggling with credit card debt. On an individual basis, the amount of debt to be forgiven would rise according to the severity of the borrower’s financial situation, up to a maximum of 40 percent.

[...]

Under the groups’ proposal to U.S. Comptroller of the Currency John Dugan, whose Treasury Department agency oversees national banks, a pilot project would allow big credit card companies to sharply reduce the amounts owed by consumers in over their heads who don’t qualify for the repayment plans now available.

Nearly all the biggest credit card banks have agreed to such a pilot program in which lenders would forgive as much as 40 percent of the amount consumers owe, allowing them to pay back the remainder over time.

The test program could reach as many as 50,000 borrowers, said Scott Talbott, senior vice president at the Roundtable. Borrowers would have to be in a counseling program for their credit card debt. The amount of debt to be forgiven would be determined case by case, depending on the borrower’s financial condition; those receiving close to the maximum forgiveness level would be nearing a personal bankruptcy filing.

And there would be a tax benefit. Borrowers would be able to defer payment of income taxes they owe on the forgiven part of the debt until after the remainder was paid off. The lenders could wait until then to book their loss on the forgiven debt.

OK, you know what? Our family could have bought a huge flat screen TV, we could have cars that don’t have 100,000 and 200,000 miles on them, and we haven’t been on a vacation that didn’t involve family in … well, ever. My husband and I have gone on a couple of weekend trips in the last SIX YEARS but that’s it.

While I think I’ve been pretty consistent in saying that I empathize with people who dealt with sleazy mortgage brokers, believe credit card companies have been way too lenient with the offering of credit in the first place, and know sometimes people get caught up in illnesses or accidents that just tank them financially, but dammit - this looks like a blanket pardon to me, and that means there are people who have been completely irresponsible and are getting a nice little “get out of bankruptcy free” card.

I hope this “plan” isn’t administered as willy nilly as this article makes it sound, that’s all I’m saying.

Old news - catching up after a week spent in and out of hospital, elections, in-laws in town, tummy bugs … but let me just say … I certainly hope so.

From the San Francisco Chronicle:

The top federal prosecutor in Los Angeles indicated Thursday that charges are coming soon from a sweeping investigation of banks and subprime lenders for their role in the nation’s mortgage crisis.

“I think we are going to see some fairly dramatic results in the near future,” U.S. Attorney Thomas O’Brien said. “Mortgage fraud is an extremely important issue to me and to the people of this district.”

A grand jury is investigating at least three mortgage lenders - Countrywide Financial Corp., New Century Financial Corp. and IndyMac Bancorp Inc. Prosecutors are looking at whether mortgage fraud and other white-collar crimes were committed.

Contrary what many think about personal responsibility being at the heart of the mortgage industry crisis, it’s simply never been that simple. This banking debacle with securitized debt offerings and busting housing prices is not just about people being stupid and greedy and wanting to get more house than they could afford. Sure, some of those people were out there, but a general “blame the victim” mentality is petty, short sighted, and plain wrong.

Stay tuned.