ProVise Management Group, LLC, a SEC Registered Investment Advisor

 

PROVISE BULLETS ©

(July 30, 2010)

 

 

• The Financial Reform Bill finally passed Congress and was signed into law by the President last week.  Like any legislation consisting of 2,300 pages, there is a lot to like as well as an equal amount to dislike.  One of the most unique aspects of the bill is the rule making and regulations that need to be written to “fill in the blanks”.  In other words, the regulators are now going to be lobbied as hard as Congress was by the banking industry, Wall Street, and insurance companies.

 

Perhaps two of the most important aspects of this bill, and those which were least reported in the popular press, had to do with personal financial advice.  First, Congress told the SEC to come up with rules for a common version for a standard of care when providing personalized investment advice to individuals; making everyone (financial planners, stockbrokers, insurance agents, etc.) who provide these types of services do so with a fiduciary standard of care.  When working with ProVise as a Registered Investment Advisor, that standard of care has been in use for more than 20 years.  It means that the client’s interests must be put ahead of anything else and any conflicts of interest must be disclosed and managed, unlike stockbrokers who have been able to work with a much weaker suitability standard.  Unfortunately, the rules must still be written by the SEC regarding this fiduciary standard of care.  Thus investors who do not work with a firm such as ProVise may not receive the benefit of this very important legislation until the rules are finally written and implemented.  The second provision was a mandate from Congress to the GAO to do a six month study about the regulation of financial planning as a distinct business.  That is to say, insurance agents are regulated by states, stockbrokers are regulated by FINRA, and Registered Investment Advisors are regulated by the SEC.  The question now becomes – should the practice of financial planning itself be regulated in some unique way? 

 

Now, let’s turn to portions of the bill about which you have probably heard in the newspapers and on television and look at the potential implications.  Please keep in mind that we strongly believe in the “law of unintended consequences”.  We are concerned that many parts of this bill will be susceptible to unintended consequences.

 

One way that consumers will reportedly benefit is by the creation of a new watchdog organization – The Consumer Protection Financial Bureau.  This organization will exist inside the Federal Reserve and thus, the Federal Reserve is significantly expanding its power and responsibility.  The Bureau has the responsibility to watch over financial products and services (this is where the GAO study may put financial planning), such as mortgages, credit cards, student loans, pay-day loans, etc.  The automobile dealerships and pawn brokers, through their lobbyists, were able to exempt themselves from this oversight.  The Consumer Protection Financial Bureau will be directed by an independent board, but its budget will be a part of the Federal Reserve.  Thus, the Federal Reserve will have a lot to say about what the Bureau does and doesn’t do. 

 

In another aspect of consumer “protection” there are more regulations about the charges associated with debit cards, which have been a tremendous source of income for banks.  As control on these fees goes into effect, banks will look to other sources to make up for this lost revenue.  We might be saying “goodbye” to free checking and the other free transactions currently offered.  When it comes to making loans, the new bill creates a “novel” situation.  Applicants actually have to prove that they can afford to make the mortgage payments and still cover the ancillary costs of owning a home, i.e., taxes, insurance, etc.  One of the major abuses that occurred during the real estate heyday was the placing of non-qualified people into high risk and very expensive loans by various mortgage brokers.  One of the “dirty little secrets” rarely disclosed to the borrower at the time was that these “high risk” loans also paid a much higher commission to the mortgage broker.  This will no longer be permitted.

 

Let’s turn to some of the risk that will now be avoided.  First, there was the concern of being “too big to fail”.  The government walked a very fine line between keeping the panic from the markets and making taxpayers bail out the companies that took on that risk.  Under the new bill, companies that are getting into trouble which can potentially cause a threat to the economy (we wonder who will make that decision), can be liquidated by the FDIC and the liquidation will be paid for by the banking industry.  Although the FDIC is the organization which would break up the company, it is the Federal Reserve and the Financial Stability Oversight Council (another bureaucratic organization created by the new bill) that will actually make the final decision.  The liquidation will have to be paid for by Wall Street and the banking industry.  In another ironic twist, these firms will have to write their own “Living Will” or as some would say, “funeral plans” as to how they would shut down if they start to go under.  Many have argued that this provision does not keep a company from being “too big to fail”, but will actually encourage some companies to take significant risks.

 

In looking at derivatives and hedge funds, the government has tried to rein in these two largely unregulated investment vehicles.  In the future, most over-the-counter derivatives will have to be traded publicly and have a clearing house.  There are also rules to be created as to how the financial markets will handle these which, in turn, will limit the ability of hedge funds and private investment companies to participate in these types of investments.  Hedge funds must now register with the SEC.   Any Wall Street firm that puts together any of these types of derivatives must itself carry some of the risk.  The bill also creates the Office of Credit Ratings (yes, more big government) which will be responsible for watching over the credit rating agencies.  You might recall that many of these rating agencies gave high ratings to some of these extremely risky derivatives.  The rating firms have largely been insulated from the turmoil and it has been hard for investors to sue them.  The new bill makes it easier for this to happen in the future.

 

Suffice it to say, the bill is the most sweeping financial reform legislation since Glass-Stegall Act.  As we mentioned, much of the “teeth” of this bill will come in the form of rules and regulations and we will need to monitor these closely.  We will keep you informed.

 

• With three months to go in the current fiscal year, the deficit for the U.S. Government topped $1 trillion, which may seem bad until you compare it to last year’s deficit.  At the same time last year, the deficit was $1.09 trillion.  No matter how you measure it, it continues to mortgage our future.  For the year, it is anticipated that the deficit will be about the same as last year – around $1.45 trillion.

 

• The Employee Benefit Research Institute (EBRI) released its retirement readiness study a couple of weeks ago and, for the most part, the news was not good.  For people who earn less than $30,000 per year the EBRI study indicated that 64% would run out of money within 10 years of retirement.  For people who earn between $30,000 and $70,000 about one-third would experience the same catastrophic situation, but it would take about 20 years.  Even for people who earn more than $70,000 per year, one in 10 were expected to run out of money in retirement.  The older someone was the greater the possibility of running out of money.  The “youngsters” (ages 29 to 45) had about a 45% chance of running out of money in retirement, about the same as people between the ages of 46 and 55.  The Baby Boomers who were on the front end of that curve (ages 56 to 62) had a 47% chance of running out of money.  If there was a silver lining in the study, that 47% number was 60% seven years ago (at the last downturn in the market).  People need to save more and they need to start as early as they possibly can.  One of the biggest reasons people are expected to run out of money is the runaway cost of healthcare.   

 

• In looking at the notes from the last Federal Reserve Board meeting, they have toned down their forecast for the economy this year.  But, we want to emphasize, they simply toned it down.  They didn’t turn negative.  They are still calling for 3% to 3.5% growth as opposed to the 3.2% to 3.7% projected in April.  As a consequence, they also made a small adjustment in their expected unemployment rate, raising it by the end of the year to a range of 9.2% to 9.5% from 9.1% to 9.5%.  The Federal Reserve Board saw no inflation on the horizon and some members are concerned about deflation.  It could be argued that, with the lower salaries that new college graduates are receiving this year, there is some downward pressure on wages.  We submit that the downward pressure is not as much a result of deflation as it is simply a function of the larger pool of potential employees.  Thus, the law of supply and demand is coming into play.  On the positive side, the Board said they believe exports would continue to remain strong in spite of the European troubles and they saw an increase in business spending.  It probably won’t be until some time next year that more positive numbers creep in, but again, we want to stress – we are still talking about growth – albeit slow.  As we have mentioned several times before, in our opinion, this slow steady growth potentially helps avoid a so-called “double-dip”. 

 

• The IRS is cracking down on appraisers who are over-valuing assets for charitable contributions and/or under-stating the value of assets for estate tax purposes.  Not only is the IRS cracking down, but there are now penalties with a fine equal to the smaller of 10% of any estate tax understatement or 125% of the appraisal fee with a minimum penalty of $1,000.  If there is significant and continuous abuse by an appraiser, he/she could actually be suspended and kept from practicing before the IRS.  (Source:  Kiplinger Tax Letter)

 

• While governments at all levels are struggling to pay their bills, some basic services and programs are absolutely mandatory.  For example, at the local level, governments are expected to provide safety with police and fire departments, and education.  Education is so important that it is also paid for at the state and national level.  As expensive as college has become, and as difficult as it is to get into some universities, the U.S. is no longer a leader in the number of people with college degrees, as only 40% of 25 to 34 year olds obtained an Associate’s degree or better.  Canada leads the developed world with 56% of its population having a college degree.  Amazingly, almost 70% of those who graduate from high school go on to finish some level of college, but only 57% achieve a Bachelor’s degree.  It should not come as any surprise that the rates for minorities are even lower.  We have become a great country because we have had great institutions of education at all levels and if we don’t get back to these roots, it will have a social and economic impact that won’t be pretty.  (Source:  College Board)

 

• As many of you know, ProVise and its employees are very involved with community activities; and all of us at ProVise would like to take a moment to congratulate one of our own...  Bruce Fyfe and his wife, Wanda, as well as other members of their family have been very involved with the Homeless Emergency Project (HEP) for a very long time.  In fact, Bruce is currently Chairman of the Board, a position he has held for a number of years.  HEP has been in existence since 1986 and has provided homeless children and low income individuals and families with housing, food, clothing, and support services necessary to allow them to become self-sufficient and to improve the quality of their lives.  The program came to the attention of Dave Nemeth of the nationally syndicated show Daytime.  Recently, he and his camera crew interviewed Bruce and others from HEP regarding the various services and programs offered, with a special emphasis on the HEP Thrift Store.  Daytime is seen in 114 markets and can be viewed locally on weekday mornings on channel 8.  We are pleased to report that this piece on Bruce and HEP will air on Friday, August 6th at 10:00 a.m.  We hope you get a chance to watch it, but if you miss it, you can go to the Facebook page of HEP where it will posted once the show airs.  Congratulations Bruce!  This is great exposure for this wonderful program.

 

As always, we encourage you to give us a call if you would like to discuss anything further.  We will visit again soon.

 

RAY, KIM, ERIC, BRUCE, and LOU

 

©7/30/10 ProVise Management Group, LLC

www.provise.com