BC Budget assumptions: nice try

Three weeks ago the BC Budget was released. The basis for the revenue and cost projections for the budget was an average 6.2% unemployment rate in 2009, falling to 6.0% in 2010.

I previously posted on this topic here. For the assumptions in the budget, see this pdf page 87.

How are we doing so far? Well, three weeks after their projection, unemployment has now hit 6.7%--up 0.6% from January. I'll put up the graphs later, but it appears to be going hyperbolic. [UPDATE: here it is! I think my 10% by 2010 prediction is looking likely.]
In short, the $495 million dollar deficit projection has now been blown out of the water.

I'm not clairvoyant here. I just observed that housing starts were going to plummet leading to construction employment to go back to pre-bubble levels. If you do the math, you can see what will hapen to employment. But, I'm sure all we'll hear from the usual economic commentators and our government leaders is another chorus of 'hoocoodanode'.

Enough with the koolaid and the rose coloured glasses! Can we please all open up a can of reality soda and get on with what has to be done?

BC Budget: Junky assumption

I didn't look at the BC Budget in too much detail, but something on the radio caught my ear. Sure enough, I confirmed it on this pdf on page 87.

The BC Budget hinges on the projected unemployment rate averaging 6.2% in 2009. Have a look at the January 2009 numbers here. The January number is 6.1%. Does anyone really think that we won't see that go higher in February and then farther up from there?

I think the budget projection is pie-in-the-sky. I would say a more realistic projection, given the construction sector dry-up, is 8.7% by the end of 2009, with an average of 7.5% for the year.

The 2010 projection is 6.0%. By then, most condos under construction will have completed. Construction employment will be back below historical averages. The Olympics will be over as well. Unless every other sector suddenly pulls up the slack, there is a serious risk of double digit unemployment rates. 6.0% is a total joke.

US Financials Falling Like Dominoes

Sept. 14 (Bloomberg) -- Lehman Brothers Holdings Inc. prepared to file for bankruptcy after Barclays Plc and Bank of America Corp. abandoned talks to buy the U.S. securities firm and Wall Street prepared for its possible liquidation.

Lehman and its lawyers are getting ready to file the documents for bankruptcy protection tonight, said a person with direct knowledge of the firm's plans. A final decision hasn't been made, though none of the other options being considered appeared likely, the person said, declining to be identified because the discussions haven't been made public.

Sept. 14 (Bloomberg) -- Bank of America Corp. agreed to buy Merrill Lynch & Co. for about $44 billion, a person with knowledge of the deal said, after shares of the third-biggest U.S. securities firm fell by more than 35 percent last week and smaller rival Lehman Brothers Holdings Inc. neared bankruptcy.

Bank of America and Merrill reached a deal in principle, according to the person, who declined to be identified because the deliberations were private. A final merger agreement hasn't been signed yet, the person said. The boards of Merrill and Bank of America approved the transaction this evening, the Wall Street Journal reported, citing unidentified people familiar with the matter.

Sept. 14 (Bloomberg) -- American International Group Inc., the insurer struggling to avoid credit downgrades, is seeking a $40 billion bridge loan from the Federal Reserve as it tries to sell assets, the New York Times reported.

The insurer has turned down a private-equity investment because it would have meant handing over control of the company, the Wall Street Journal said on its Web site, citing unnamed people. AIG may get access to the Fed's borrowing window in an ``extreme liquidity scare,'' Citigroup Inc. analyst Joshua Shanker said in a Sept. 12 research note.

Economics 101: Opportunity Cost

I have had many discussions with people about how to evaluate the potential purchase of a home and it never fails that the discussion comes around to something like this:

Person: "I'd like to buy a rental property."

Mohican: "Make sure you are buying something that costs less than the rent you will generate."

Person: "I have done the math and if I put 20% down ($100,000) I can buy a house with a basement suite and the rent ($2200/mo) will carry the mortgage ($2200/mo)."

Mohican: "Really, that sounds interesting. Have you factored in taxes, insurance, maintenance, and any unexpected loss of income ($500 / month+)? Additionally, have you factored in the loss of income from your downpayment ($400 / month+)?"

Person: "Hmmmm . . . . I guess I'd have to pay the property taxes and stuff but the house will always go up in value so if I get stuck and can't make those payments I can just sell it."

Mohican: "What about the downpayment? How much could you earn on that every month if you invested it?"

Person: "The money is in a savings account right now and I don't know how much it earns, I think it is 4%."

Mohican: "My suggestion is that you have a look at your math again and assume that you don't have a downpayment. Would this potential purchase look as attractive with 100% financing? Additionally, I suggest that you find a property where the rent will cover ALL of the expenses, including taxes, insurance, maintenance and a buffer for lost income."

Person: "But that is impossible. No property is that cheap."

Mohican: "No property in Vancouver currently has those characteristics but that hasn't always been true nor will it always be true and Vancouver isn't the only place to invest. You are considering purchasing a $500,000 property which yields approximately 4%. This is the same yield as your savings account but with much more risk than a savings account. If I were looking at the same property I would only be willing to pay $330,000 for it, which would give it a yield of about 6%. This increased yield would compensate me for the risks I am taking on by owning the property and for an adequate return on my downpayment."

Person: "But real estate is so powerful because of the leverage component. You are ignoring that."

Mohican: "Yes, I am ignoring it because I can use leverage with all sorts of investments including dividend paying stocks and income trusts where the cash flow would cover my borrowing costs. So to be fair we should evaluate all investments without leverage first so we have a fair comparison and so the investments stand on their own merit."

Person: "I don't understand."

Mohican: "Let's assume we can find a property that yields 4%, which you have done. The price to earnings ratio of that property is 25. We can find a stock with a lower price to earnings ratio that also pays a large enough dividend to pay for our borrowing costs. An initial screen produces dozens of companies that meet these characteristics so based on that we should not purchase the property but the stocks instead."

Person: "But my brother lost his shirt in the stock market and he's made tons of money flipping houses. He owns 5 properties right now and he is buying more all the time."

Mohican: "It sounds like your brother is a speculator/gambler and he'll probably lose his shirt in real estate too. He may have made some money recently but that is no garauntee that the profits will continue. If you are buying for cash flow you should consider the metrics I have put forward but if you are buying for capital gains I can't help you evaluate the investment merits because there are none."

Person: "But real estate always goes up."

Mohican: "No it doesn't. If you are naive enough to believe that you deserve to lose money. Go do some more homework and investigation if you want to be a professional investor. Ameteurs jump in without doing their homework, professionals know all of the knowable facts before jumping in."

Person: "That sounds like work, I think I'll just buy the property."

Mohican: "See you later."

From Wikipedia:

Opportunity cost is the loss of potential gain from the best alternative to any choice. Thus, opportunity cost is the cost of pursuing one choice instead of another. Every action has an opportunity cost. For example, someone who invests $10,000 in a stock denies oneself the interest that one can easily earn by leaving the $10,000 dollars in a bank account instead. Opportunity cost is not restricted to monetary or financial costs: lost time, pleasure or any other benefit that provides utility should also be considered.

Opportunity cost is a key concept in economics because it implies the choice between desirable, yet mutually-exclusive results.

Example

If a city decides to build a hospital on vacant land it owns, the opportunity cost is the value of the benefits forgone of some other thing which might have been done with the land and construction funds instead. In building the hospital, the city has forgone the opportunity to build a sports center on that land, or a parking lot, or the ability to sell the land to reduce the city's debt, since those uses tend to be mutually exclusive. Also included in the opportunity cost would be what investments or purchases the private sector would have voluntarily made if it were not taxed to build the hospital. The total opportunity costs of such an action can never be known with certainty (and are sometimes called "hidden costs" or "hidden losses", what has been prevented from being produced cannot be seen or known). Even the possibility of inaction is a lost opportunity (in this example, to preserve the scenery as-is for neighboring areas, perhaps including areas that it itself owns).

It can also apply to time; one might use a limited vacation time to travel to a place of cultural enrichment or to do household improvements. Thus the two-week road trip might preclude repairing or painting one's house that year. To the vast majority of people, time has value.

Evaluating opportunity cost

Opportunity cost needs not be assessed in monetary terms, but rather can be assessed in terms of anything which is of value to the person or persons doing the assessing (or those affected by the outcome). For example, a person who chooses to watch, or to record, a television program cannot watch (or record) any other at the same time. (The rule still applies if the recording device can simultaneously record multiple programs; there is going to be a limit, and if the number of desired programs exceeds the capacity of the recorder, some of them will not be saved, and thus cannot be seen.) In any case, at the time the person chooses to watch a program, either live or on a recording, they cannot watch something else, and if they are not able to record another program showing at the same time, the opportunity to view it is lost (presuming the particular program is not repeated). Or as another example, someone having a video game can choose to watch a program or play the video game on the TV; they can't do both simultaneously. Whichever one they choose is a lost opportunity to experience the other. Or for that matter, a lost opportunity to engage in some other activity entirely (exercising outdoors, or visiting with family or friends, as merely two examples).

The consideration of opportunity costs is one of the key differences between the concepts of economic cost and accounting cost. Assessing opportunity costs is fundamental to assessing the true cost of any course of action. In the case where there is no explicit accounting or monetary cost (price) attached to a course of action, ignoring opportunity costs may produce the illusion that its benefits cost nothing at all. The unseen opportunity costs then become the implicit hidden costs of that course of action.

Note that opportunity cost is not the sum of the available alternatives, but rather of benefit of the best alternative of them. The opportunity cost of the city's decision to build the hospital on its vacant land is the loss of the land for a sporting center, or the inability to use the land for a parking lot, or the money which could have been made from selling the land, or the loss of any of the various other possible uses—but not all of these in aggregate, because the land cannot be used for more than one of these purposes.

However, most opportunities are difficult to compare. Opportunity cost has been seen as the foundation of the marginal theory of value as well as the theory of time and money.
In some cases it may be possible to have more of everything by making different choices; for instance, when an economy is within its production possibility frontier. In microeconomic models this is unusual, because individuals are assumed to maximise utility, but it is a feature of Keynesian macroeconomics. In these circumstances opportunity cost is a less useful concept.

Subprime Primer

Bob Rennie is a (very well) Paid Shill

I heard a panel of financial market analysts on CKNW this morning comprised of Michael Campbell, Michael Levy, Helmut Pastrick and Bob Rennie. I am amazed every time I hear the silver tongued Bob Rennie open up his mouth. I believe that Bob actually believes the crap he says about Vancouver being able to weather the financial storms that are hurtling around the world right now and that our economy is an invincible fortress built upon ever increasing real estate wealth.

At times, during the few minutes I could tolerate, it seemed as if the 3 actual financial industry players were about to say - "What is this guy doing here?" After all Bob Rennie is a marketer, not an economist. He wouldn't know a price/rent ratio if it hit his Rolls Royce on the hood.

Bob, after being lobbed softball questions by host Bill Good, spouted the usual nonsense about the Vancouver Olympics, world class city, blah, blah, blah. Are you nucking futs? Blind? Deaf?

Rant off.

Canadians in Hock

Tip of the hat to reader '/dev/null' for forwarding this news story. Credit card debt is obviously a major problem for many Canadians. It is hard for me to comprehend how much revolving debt many people have and they don't even realize that they are enslaving themselves to the cheap crap they bought on the card.

Growing credit debt is crushing Canadians: study
Updated Tue. Nov. 13 2007 8:46 AM ET CTV.ca News Staff

A new study of Canadians' credit debt finds that a whopping 25 per cent owe between $10,000 and $40,000, and 28 per cent don't even know the interest rate they pay on their main credit card.

The report by Credit Canada and Capitol One was timed for release during their Credit Education Week, and is designed to raise awareness of good financial management.

Laurie Campbell, of Credit Canada, said the numbers -- which don't factor in mortgage debt -- were surprisingly high.

"The numbers are quite startling, even I was quite surprised, but nevertheless, this is truly what we're seeing," Campbell told CTV's Canada AM.

"Savings rates at an all-time low and debt rates at an all-time high so this financial literacy week in my opinion is long overdue."

The study, which questioned 4,000 respondents about their personal credit debt practices, found a disconnect between Canadians' debt levels and retirement plans.

When asked about their total outstanding debt from credit sources and loans, respondents said the following (figures don't include mortgage debt):

$0 -- 16 per cent
$10,001 to $20,000 -- 13 per cent
$20,001 to $40,000 -- 12 per cent
$100,001 to $200,000 -- 9 per cent
$300,001 to $500,000 -- 1 per cent

Two per cent of Canadians said they had six credit cards; while six per cent had five credit cards; 12 per cent had four cards; while the majority, 25 per cent, had two credit cards.

Twenty-two per cent of Canadians said they had only one credit card.

When it came to the average balances people said they carried on their credit cards, 36 per cent said their monthly balance was $0 because they paid off their credit card each month.

Eleven per cent said their monthly balance was between $1,001 and $2,500, 9 per cent had a balance of between $2,501 and $5,000 while 1 per cent had the highest monthly balance of between $20,001 and $30,000.

When asked how their credit card habits could be best described:

50 per cent said they pay their credit card off in full every month.
37 per cent said they pay the minimum requirement each month
10 per cent said they do not have a credit card.
3 per cent said they sometimes/often miss the minimum required payment.

"Certainly what happens with a lot of people is they look at their statement, they see a minimum payment, and say that's what I have to pay and unfortunately they don't look further to find out what the implications of only paying the minimum payment are," Campbell said.

When it came to budgeting, 53 per cent said they have no budget. Another 31 per cent said they have a budget and stick to it, and 16 per cent said they have a budget but rarely stick to it.

When asked when they thought they would be able to retire, respondents said the following:

13 per cent -- never
3 per cent -- between 71 and 76
24 per cent -- between 56 and 60
29 per cent -- between 61 and 65
14 per cent -- between 66 and 70

"The majority of people expect to be able to retire at 60 or 65," Campbell said.

"I don't know how they expect to retire if they're not saving, so there's a real dichotomy between the way people see their future and the way they're handling their money."

When asked what their top concern was regarding credit and debt management, 26 per cent said they worried about not being able to deal with unexpected emergencies.

Campbell said the goal of Credit Education Week is to raise awareness among Canadians about credit debt and how to deal with it, through providing free advice and online resources.

While a strong Canadian dollar has lulled many Canadians into a sense of financial security, people must be cautious, she said.

"People are very optimistic which is a very wonderful thing but you also have to plan for your future and think about where you're spending your money and put your goals in place, that's the most important thing."

Gong Show - Gambling

I know that a lot of people have a serious gambling problem and many other people are on the verge of having a serious problem. Gambling is an unbelievably foolish behaviour and I fail to understand why it is so attractive, yet the casinos are packed, there are lineups to buy lottery tickets, and people waste billions of dollars a year on this pastime. For today's gong show, I am gonging gambling, the gaming industry, and the government for encouraging and operating the defrauding of billions.

"Canadians lost $14.5-billion to the country's gambling industry in the last fiscal year, a new study has found. The economic report commissioned by the Canadian Gaming Association found the industry made more than $15-billion in revenue last year, including $700-million on non-gambling activities such as food and drinks.

The remaining $14.5-billion constitutes the amount Canadians spent on gambling activities — such as playing slot machines at casinos, buying lottery tickets and placing race track bets — minus the prize payouts. Profits were also found to be massive, pegged at $10.6-billion, including commissions and taxes. Roughly $7.4-billion enriches provincial coffers and $3.2-billion goes to charities.

The gaming industry includes casinos, lottery, horse racing, charitable gaming, bingo, slots and video lottery terminals. The study, conducted by HLT Advisory Inc., found that gaming revenues are on par with profit generated by spectator sports, television, movies, books, magazines and performing arts sectors combined."

To put the $14.5 billion into context, Canadian put $20 billion into mutual funds last year.

Update: Are you a compulsive gambler?


Did you ever lose time from work or school due to gambling?
Has gambling ever made your home life unhappy?
Did gambling affect your reputation?
Have you ever felt remorse after gambling?
Did you ever gamble to get money with which to pay debts or otherwise solve financial difficulties?
Did gambling cause a decrease in your ambition or efficiency?
After losing did you feel you must return as soon as possible and win back your losses?
After a win did you have a strong urge to return and win more?
Did you often gamble until your last dollar was gone?
Did you ever borrow to finance your gambling?
Have you ever sold anything to finance gambling?
Were you reluctant to use "gambling money" for normal expenditures?
Did gambling make you careless of the welfare of yourself or your family?
Did you ever gamble longer than you had planned?
Have you ever gambled to escape worry or trouble?
Have you ever committed, or considered committing, an illegal act to finance gambling?
Did gambling cause you to have difficulty in sleeping?
Do arguments, disappointments or frustrations create within you an urge to gamble?
Did you ever have an urge to celebrate any good fortune by a few hours of gambling?
Have you ever considered self destruction or suicide as a result of your gambling?

Most compulsive gamblers will answer yes to at least seven of these questions. Contact Gamblers anonymous for help.

Gong Show - Bubbles

I'm gonging bubbles this week because they grossly misallocate resources for a period of time and because many people are impoverished because of this misallocation.

From Wikipedia:

An economic bubble (sometimes referred to as a "speculative bubble", a "market bubble", a "price bubble", a "financial bubble", or a "speculative mania") is “trade in high volumes at prices that are considerably at variance from intrinsic values”. The intrinsic value is a theoretical calculation that aims at reflecting the fair value by taking into account hypotheses of future returns and risks.

The bubble is usually followed by a sudden drop in prices, known as a crash or a bubble burst. Both the boom and the bust phases of the bubble are examples of a positive feedback mechanism, in contrast to the negative feedback mechanism that determines the equilibrium price under normal market circumstances. Prices in an economic bubble can fluctuate chaotically, and become impossible to predict from supply and demand alone.

Economic bubbles are generally considered to have a negative impact on the economy because they cause misallocation of resources into non-optimal uses. In addition, the crash which usually follows an economic bubble can destroy a large amount of wealth and cause continuing economic malaise. A protracted period of low risk premiums can simply prolong the downturn in asset price deflation as was the case of the Great Depression in the 1930s for much of the world and the 1990s for Japan. Not only can the aftermath of a crash devastate the economy of a nation, but its effects can also reverberate beyond its borders.

Another important aspect of economic bubbles is their impact on spending habits. Market participants with overvalued assets tend to spend more because they "feel" richer (the Wealth Effect). Many observers quote the housing market in the United Kingdom, Australia, Spain and parts of the United States in recent times, as an example of this effect. When the bubble inevitably bursts, those who hold on to these overvalued assets usually experience a feeling of poorness and tend to cut discretionary spending at the same time, hindering economic growth or, worse, exacerbating the economic slowdown. Therefore, it is imperative for the central bank to keep its eyes on asset price appreciation and take measures to curb high levels of speculative activity in financial assets. This is usually by increasing the interest rate; that is, the cost of borrowing money.

When the bubble occurs in equity markets, it is called a stock market bubble. It is usually very difficult to differentiate a stock market bubble from an ordinary bull market except in hindsight.
The cause of bubbles is often disputed although some experts believe that the cause of bubbles can be explained by the "greater fool's theory." The greater fool's theory explains the behavior of a perennially optimistic market participant (the fool) who buys an overvalued asset in anticipation of selling it to another rapacious speculator (the greater fool) at a much higher price. The bubbles continue as long as the fool can find another (greater) fool to pay up for the overvalued asset. The bubbles will end only when the greater fool becomes the greatest fool who pays the top price for the overvalued asset and can no longer find another buyer to pay for it at a higher price.

Other experts argue that the cause of bubbles is excessive monetary liquidity in the financial system. Excessive monetary liquidity (easy credit, large disposable incomes) potentially occurs while central banks are implementing expansionary monetary policy (ie. lowering of interest rates and flushing the financial system with money supply). When interest rates are going down, investors tend to avoid putting their capital into savings accounts. Instead, investors tend to leverage their capital by borrowing from banks and invest the leveraged capital in financial assets such as equities and real estate. Simply put, economic bubbles often occur when too much money is chasing too few assets, causing both good assets and bad assets to appreciate excessively beyond their fundamentals to an unsustainable level. The bubbles will burst only when the central bank reverses its monetary accommodation policy and soaks up the liquidity in the financial system. The removal of monetary accommodation policy is commonly known as a contractionary monetary policy. When the central bank raises interest rates, investors tend to become risk averse and thus avoid leveraged capital because the costs of borrowing may become too expensive.

Still others say that economic bubbles are mainly driven by the greed and irrational exuberance of overly bullish investors. They argue that investors tend to extrapolate past extraordinary returns on investment of certain assets into the future, causing them to overbid those risky assets in order to attempt to continue to capture those same rates of return. Overbidding on certain assets will at some point result in uneconomic rates of return for investors; only then the asset price deflation will begin. When investors feel that they are no longer well compensated for holding those risky assets, they will start to demand higher rates of return on their investments.
Due to this phenomenon, some regard bubbles as related to inflation and thus believe that the causes of inflation are also the causes of bubbles. Others take the view that there is a "fundamental value" to an asset, and that bubbles represent a rise over that fundamental value, which must eventually return to that fundamental value. There are chaotic theories of bubbles which assert that bubbles come from particular "critical" states in the market based on the communication of economic factors. Finally, others regard bubbles as necessary consequences of irrationally valuing assets solely based upon their returns in the recent past without resorting to a rigorous analysis based on their underlying "fundamentals".

Gong Show: Income Taxes

Okay, today I'm bringing the Canadian Income Tax system to the gong show for you to decide if it gets the gong. Here are the reasons why I think the Income Tax system should get the gong:

1) It is more complicated than necessary
2) It penalizes people for being innovative, for being more productive and for working harder.

I'm not talking about abolishing income taxes here but my biggest gripe is with the fact that our income tax system penalizes people who are trying to improve their family's well being and the general well being of our country. Let us use an example:

Imagine Bill. He owns his own company and he works hard to find new ways to serve his customers through better products and services. Lets pretend that Bill, because he works hard, makes a personal income of $100,000 per year. In BC, under our tax system, ignoring personal deductions, he pays $28,187 in income taxes, leaving him with $71,813 to feed, house, and cloth his family. This seems alright since Bill is a proud Canadian and doesn't mind paying some tax to help run his country and his average tax rate seems reasonable at 28.1%.

Bill is considering implementing a new service in his company and he would earn an extra $100,000 per year if he implemented this new service. His customers would be very well served and this would be a tremendous innovation for his industry. The drawback is that Bill would have to invest a little, risk losing his idea, work longer hours and be away from his family in order to implement this innovation. Bill does some figuring and looks at what he should do since his family could really use the money to pay for braces, education, a family vehicle and a family vacation. Bill figures that if he implemented his new service and worked the extra hours he would earn $100,000 extra per year, bringing his gross income up to $200,000. He also figures that he would go from paying a reasonable $28,187 in income taxes to paying an excessive $71,339 in income taxes and he would go from a net income of $71,813 to a net income of $128,661 - an increase of only $56,848 for all that investment, risk and effort - leaving him with an average tax rate of 35.7%.

Unfortunately, for his customers, Bill decides that the investment, risk, and extra work is not worth $56,848 per year and makes the choice to postpone the implementation of this service until it makes more sense.

This situation is actually all too common in Canada because successful and innovative people like Bill make economic choices everyday based on the net benefit to them, their company, and their family. Our tax system unfairly taxes the people who would likely create new jobs, invest in equipment and provide innovative new services given the right incentives. I'll talk more about our tax system again soon.

Find out your own personal tax rates here.

What do you think? Gong?

Gong Show #6 - Carrying a Credit Card Balance

This week's gong show isn't a dubious financial product but rather a dubious financial behaviour. The financial behaviour of carrying a balance with a credit card company is sure to cost a lot of money, make the user poorer, make the credit card company shareholders richer, and increase unnecessary consumption.

Paying for things with a credit card isn't bad in itself. It is one of many ways to conduct financial transactions and a very convenient one at that. Using a credit card for necessary purchases and collecting points or getting cash back is actually a very smart financial behaviour provided the user pays the credit card balance in full every single month. This is where most people get into trouble, they don't have the cash to pay the balance in full when their bill arrives. Those stainless steel appliances lose their lustre quickly when you have been paying interest at 17% for two years after you bought them on that shiny new Visa card.

Lets play with that scenario for a moment. Your dishwasher broke, now you need to buy a new one. You have the cash and can afford the $500 for a nice new dishwasher that will work just dandy but your at the store and that set of stainless steel appliances really catches your eye. The salesperson does a great job at persuading you to buy the new set and you are convinced that your life will be 10 times better with these shiny new marvels of modern technology. You plunk down the Visa and $5000 later you walk out of the store convinced you have done the right thing. Remember now that you could only afford to pay $500 but you paid $5000. Its 4 weeks later and now the bill arrives with a balance of $5000 and you only have $500. You wake up at this point and think, "Wow, how am I going to pay this off." then you look over at your appliances and think, "It was worth it. I will pay it off later." and you pay $500.

The fun really starts at this point and this is when the credit card company starts salivating at the prospect of you paying off those appliances for the next 3 - 4 years. If you were diligent and paid $160 per month for 3 years and managed not to buy anything else impulsively you would have paid $1277 in interest plus the $5000 in principal. That sale price on the appliances isn't so attractive now that you have added 25% to the total cost.

The big problem for most people is that they never actually pay off their purchases and they end up 10 years later still paying interest on the appliances they bought and have long since lost the showroom lustre. This is because two years into the plan they broke down and convinced themselves that they deserved a vacation and put that onto their card and two years after that the car's transmission needed replacing and so on and so on. It never ends unless you get real disciplined, buckle down and stop spending. Pay off that credit card balance as soon as possible. Go without things until you do. Reward yourself only after you have fully paid off the card and saved up for a new purchase.

Good old fashioned common sense will go a long way. Refuse to pay interest on consumable items and depreciating assets except as a last resort. You will be the one rewarded in the long run.

Gong Show #5 - Financial "Planners"

For the gong show today I am gonging so-called financial planners who actually don't write financial plans. Why call yourself a financial "planner" if you don't actually write a financial plan for your client? Aren't you just a glorified salesperson?

I fail to understand why someone is permitted to be called a financial planner if he/she doesn't actually write financial plans. Most of these so-called financial planners do sell investment and/or insurance products but fail to integrate the implementation of these products into a complete financial picture for their clients.

This is in stark contrast to what a real financial planner will do, which is follow these six steps:

1. Setting goals and objectives is the first step of any financial planning process - if you do not know where you are going, how can you know when you get there, or even decide which route to take? Setting goals and objectives is the foundation of any sound financial plan.
   No matter where you are heading, you need to assess where you are now, and what you already have in place for the journey.
2. Data gathering will ensure that your personal documents are up-to-date and that you know your current financial situation.
3. Heading in a general direction won't guarantee success in reaching your final destination. Before heading out on your journey, do your analysis and find solutions. This strategy will assist you in reaching your stated goals and will provide you with a roadmap to help you achieve these goals.
4. Your financial plan should confirm that your goals are achievable, and appropriate recommendations will help define what you need to do to ensure that you reach these goals.
5. A financial plan is only helpful if the recommendations are put into action. Implementing strategies will assure you reach your destination.
6. Finally, follow-up and annual reviews are critical to ensuring you maintain a clear focus in order to succeed.

Gong Show #4 - CMHC

The Canada Mortgage and Housing Corporation (CMHC) is getting brought to the gong show this week to see what you say about whether they should get the gong.

Who is the CMHC (according to the CMHC spin)?

"Canada Mortgage and Housing Corporation (CMHC) is Canada’s national housing agency. Established as a government-owned corporation in 1946 to address Canada’s post-war housing shortage, the agency has grown into a major national institution. CMHC is Canada’s premier provider of mortgage loan insurance, mortgage-backed securities, housing policy and programs, and housing research."

What do they do (according to the CMHC spin)?

"CMHC works to enhance Canada's housing finance options, assist Canadians who cannot afford housing in the private market, improve building standards and housing construction, and provide policymakers with the information and analysis they need to sustain a vibrant housing market in Canada."

Why they get the gong (according to me without the spin)?

The CMHC gets the gong from me because I don't think 90% of what they do matters anymore and could be taken care of by the private sector. This would include insuring mortgages and offering those mortgage products to the investing public via mortgage backed securities. Why does a monopolistic government corporation need to do this in a free country like Canada?

We have financial institutions that would gladly make a profit by competitively offering this same service while not risking taxpayers money via government gaurantees on the mortgage backed securities of the CMHC. This would likely result in greater product diversity, lower prices, and more flexibility to the public.

Additionally, as a taxpayer, I am not comfortable risking my hard earned tax dollars to insure these type of lending practices and these silly mortgages loans. These silly mortgages that CMHC insures include interest only, stated income, 100% financed, and second homes. I fail to understand how any of this is in our national interest or why it should be government backed. Why do my tax dollars support the buyers of Canadian Mortgage Backed Securities? Why can't Bay Street and Wall Street take those risks instead of the Canadian public?

Finally, the CMHC's programs have actually made housing more expensive by reducing the barrier to entry (downpayment) to zero. These people, without a downpayment, have bid up prices of real estate in the past few years and made some Canadian real estate markets unnaffordable.

What do you think?

Gong Show # 3 - High MERs on Mutual Funds

One of my pet peeves as a financial planner is high management fees or MER's (Management Expense Ratios) on mutual funds, especially mediocre mutual funds. This hurts my client's portfolios and takes away from achieving their goals. Canada has some of the highest fees on mutual funds in the developed world and for the most part they are unnecessarily high. Most investors do not understand that the management expense ratio directly takes away from their return and that if a fund has a high fee structure then there will always be a headwind on their potential returns.

A cursory analysis finds that out of the 3783 mutual funds in Canada, 424 have a MER of 3.0% or higher, and 1470 have a MER of 2.5% or higher. There is virtually no reason why a MER should be over 3% and a MER over 2.5% should be looked at with some critical eyes. Granted, some funds have a performance fee added in to the MER but this represents very few of these 424 funds over 3%. The major culprits for high fees are "Investors Group", "Stone & Co", and most of the novelty international sector funds of all the other major fund companies, including CI, Trimark, Fidelity, AGF, Dynamic, etc.. A management fee of over 3% is intolerable in my opinion and actually anything over 2% should be rationalized and value should be shown with long term out-performance. The trouble with most of these high fee culprits is long term UNDER-PERFORMANCE.

High Management Fees on Mutual Funds get the big gong from me for keeping Canadian investors poorer than necessary and for unfairly padding the pockets of investment advisors and mutual fund companies.

The Gong Show #2 - Liar's Loans

For this weeks Gong Show, I am presenting the 'Stated Income' mortgage or as its also known - the Liar's Loan. What is a 'Stated Income' mortgage you ask?

This is the marketing pitch from a leading Canadian mortgage company:

"You are independent. And so is your income. But what you make on paper isn't always what you can bring to the table. So when it comes to affording the home you want, getting the mortgage you need can be a trying experience. It doesn't have to be that way. There are different ways of measuring worth. After all, shouldn't your business be your business? Now, there's a mortgage that assumes you are as good as your word. The mortgage is a stated income mortgage tailor-made for self-employed Canadians. It offers an easier mortgage approval process that accommodates your income situation. When it comes to getting the home of your dreams, something as simple as a T4 shouldn't get in your way. All it takes to qualify is your word on income, some employment verification and an assurance that your lending ratios, credit and tax liabilities are in good order."

Stated income loans are also called 'liar's loans' because they almost invite the borrower to lie about his or her income. The practice of mortgage brokers selling this product hasn't really been epidemic in Canada (yet), but in the US and other countries the use of stated income mortgages has balooned well outside the intended target user of the product. From well heeled self employed persons to 23 year old wannabe Donald Trumps.

This financial product seems to me like it should get the gong because of its susceptibility to fraud and misuse. What do you think? What do you think of the CMHC (the federal government) insuring these mortgages?

The Gong Show #1 - 40 Year Mortgage

If you aren't familiar, the Gong Show was a television variety show spoof that was broadcast from 1976 until 1980. Each show presented a contest between amateur performers of often dubious talent, with a panel of 3 celebrity judges. If the judges considered an act to be particularly bad, they hit a gong to end it immediately.

I am introducing what I hope to be a regular Thursday post called "The Gong Show" in which I will feature a dubious financial product that I think deserves to be gonged. There are many financially suicidal products out there so I have a feeling that I won't run out of material any time soon.

For this weeks gong show I am featuring the 40 year amortization mortgage. Available at most Canadian financial institutions and mortgage companies now, the 40 year mortgage is certain to get the gong from prudent financial managers who think that enslaving yourself to a mortgage is not a good use of the freedom we enjoy in Canada.

Lets see, if you purchase your first home at age 30 and because real estate prices are so nuts the only way you can afford the monthly payment is by going with a 40 year mortgage, you will be paying off your home until age 70. Hmmmm . . . . well, gosh, golly, I never knew it could be so good, sign me up!

What do you think? Should the 40 year mortgage get the gong? Why?