Thursday, December 30, 2004

Is Creating a Budget The First Step?

The New Year is just around the corner and with it comes the time honored tradition: New Years resolutions. No doubt, millions of Americans will resolve to improve their financial situation somehow: save more, pay down/off credit cards, start a college fund, etc.

Before a person can run, they must learn to walk. But, before that, they need to learn how to sit up, which means they need to know how to crawl, roll over, push up off the ground, etc. The point is: before anyone has grandiose plans of saving, investing, paying down debt, etc. some basic questions must be answered:

Before one builds a budget, it is imperative to know how much money comes in, where it goes, and what is left over. The old axiom: if you don't measure it, you can't manage it rings true. Would it be reasonable to set aside $300/month for groceries without knowing that you average more thant $450/month?

By understanding where the money goes, only then can realistic, rational decisions be made about the future. Often times, the light goes on and someone says: I spent $400 last month on my lunch breaks!?? It is moments like these that are the most revealing about where we think our money goes versus where it actually goes.

It is that disconnect between perception and reality (about our financial situation, monthly expenses, etc.) that makes us think everything is okay, but in reality things are different. It is this perception gap that can be bridged by developing a budget, based on a few months worth of data.

Wednesday, December 29, 2004

Tax Payment Act of 1943

Many Americans are wage earners, meaning they get a paycheck on a regular and consistent basis. The gross pay is one thing, and net pay is another. What's most important to us is that our net pay gets deposited into our checking accounts. (Business owners and independent contractors are required to file and remit taxes quarterly.)

A little known fact about our tax system is that the concept of 'withholding' income taxes was not always a fact of life. Between 1913 and World War II, an income tax existed; however, taxes were not withheld from paychecks. Instead, when April 15th came around, most Americans wrote a check to the US Government for the full amount taxes, not the net difference (as we do today).

The reason for this change in the tax regime was to fund our efforts in World War II and to a lesser extent, pay for the New Deal programs enacted during the 1930's. Here is a link to the US Treasury website explaining the history of taxation. Below is an excerpt from the website:

Another important feature of the income tax that changed was the return to income tax withholding as had been done during the Civil War. This greatly eased the collection of the tax for both the taxpayer and the Bureau of Internal Revenue. However, it also greatly reduced the taxpayer's awareness of the amount of tax being collected, i.e. it reduced the transparency of the tax, which made it easier to raise taxes in the future.
What an understatement! By withholding the tax at the time of pay, Americans slowly forgot just how much they paid in taxes. Any tax increase (or decrease) while amounting to a sizeable amount over a year, is hard to miss when your net pay changes by only 10's of dollars.

(Editor's note: I have a sneaking suspicion that every administration gets to put out their message on the facets of government. I wouldn't be surprised if this historical overview is part of that larger message, especially in light of the ambititious plans Presiden Bush has for the tax code and Social Security in his next term .)


Imagine having to save $5,000, $10,000, $20,000...to pay the tax man at one time! That seems daunting. But have no fear: our employers are effectively agents of the IRS in that they compute and remit each our payroll taxes each pay period. (A slip up on the employer's part will most certainly invite an IRS audit!)

Because of this, the income tax return has become simply a reconcilitation between what was withheld (and remitted) and what is actually owed, with the difference being owing more or receiving a tax refund. Most people get excited about their refunds. So excited in fact they take out a loan to get the money "now" and use the refund to pay the loan "later" at usurious interest rates. (The best situation is to owe a few extra dollars, essentially an interest free loan from the government. A huge refund, on the other hand, is an interest free loan to the government.)

If you are consistently receiving huge refunds or owing significant amounts of money, contact your payroll department and have them walk you through IRS Form W-4.

For those so inclined, here is an in-depth paper on the Tax Payment Act of 1943. Warning: it is a bit heady and hard to follow.

Parents, their Children, and Money

Just where do children learn their financial skills? And what are their parents teaching their kids?

TIAA-CREF conducted two (not so recent) surveys on these topics:

2001 Parents, Children and Money Survey

1999 Youth and Money Survey

The general gist I get from both of these surveys is a disconnect between how people view themselves versus what they are actually doing. My setiments also coincide with the general conclusions of both surveys.

Generally, parents and their kids think they understand money matters and believe they manage their money well. However, disconnects are noted by the surveys:

In my previous post "Mandatory Viewing for My Children" marketers and media companies are becoming more scientific in their approach. With the adults not fulling understanding the basics about their credit cards, is it any wonder that credit card debt continues to grow as well as bankruptcy filings?

I recommend reading the Executive Summaries of both reports.

Tuesday, December 28, 2004

Mandatory Viewing for My Children

Frontline (in my opinion) is one of the best news-magazine shows. Better than 60 Minutes (no Dan Rather, no books to push). I seem to recall that I once watched a show on how a few major media companies are the Merchants of Cool.

I bring this up because a major source of influence on our children's perception of 'what's cool' comes from television and the media. At a young age, the little consumer is being developed and habits are being formed. I can attest. Wherever my daughter sees something Disney in a store, she has to have it, even if it is shampoo!

When my children get older, I plan on sitting down with them and watching this video (online). I hope it will at least give them a sense of self-awareness about themselves and that they are being molded and persuaded into something they may not even know.

I have also found some additional segments that I think are equally valuable and worthwhile viewing:

The Persuaders: How marketing and advertising not only influence what we buy, but how we view ourselves.

Secret History of the Credit Card: Explores the credit card industy and Americans ever increasing credit card debt.

I fully admire our capitalist system. It seems though that financial education and acumen are in decline and the marketers and credit card companies are getting more and more sophisticated...the battle is becoming lopsided.

A little bit of knowledge could go a long way.

Monday, December 27, 2004

Bankruptcy: Current Headlines

Bloomberg has an article describing pending legislation in Congress that would modify the existing bankruptcy laws. Before going any further, I should note that the studies I cited in previous posts attempted to answer 'why' people file bankruptcy and also to quantify the debtor's ability to repay.

The answers to these questions are important for legislators to consider in developing new laws. Primary changes, favorable to the lenders, are 'means tests' which would evaluate the debtor's ability to repay.

The law the banks want would apply a means test to individuals seeking bankruptcy. Those, like the Rhodeses, whose family income is above the median for their state would be subject to the test, and might not be able to file for the kind of debt-canceling protection, known as Chapter 7. Instead, they'd have to file a Chapter 13 bankruptcy, in which they would be required to repay some debt while being allowed to retain assets.

About 11 percent of those who filed for Chapter 7 would have failed the means test, according to a 1998 study funded by San Francisco-based credit-card servicer Visa International Inc.


Visa International is a consortium owned by banks and other financial institutions. While I don't doubt that some borrowers have the ability to repay their debts, it comes off as misleading to the reader to cite a study by an organization effectively owned by the same companies that are suffering losses. (Yes, the typcial Bloomberg reader may know these things.)

One aspect I am curious about is the recent trend towards of major banks securitizing a pool of consumer debt and selling it to investors. This accomplishes a couple of things: raises funds for additional loans and transfers an element of the risk of loss to the investor. Tightening up bankruptcy laws would make these securitized loans more attractive to investors, but this article does not consider this aspect of many of the major lenders business.

Bills have been introduced in recent years that propose changes to the existing laws, but have been unable to pass. This year the outlook is different. Reasons cited are the seats gained by the Republicans in Congress and the ascension of Henry Reid to the Minority Leader in the Senate.

Republicans gained four Senate seats in the election, giving them 55 out of 100; three former House Republican lawmakers who won Senate seats -- John Thune of South Dakota, Jim DeMint of South Carolina and Richard Burr of North Carolina -- voted in favor of the bill in the past. In addition, a long-time supporter of the legislation, Senator Harry Reid of Nevada, was elected Senate Democratic leader; New York-based Citigroup Inc. has a credit-card processing center in his home state.

The financial institutions cite growing loan losses and abuse by debtors of the current bankruptcy laws. Chapter 7's, or straight liquidations, currently do not require any evaluation of the debtor's ability to repay their obligations. Pending legislation may change that.

The biggest boon to creditors from the proposed legislation is that many consumers will be discouraged from filing under Chapter 7, said Edward Janger, a professor at Brooklyn Law School. The bill allows creditors to demand a hearing before a judge to determine whether a person filing for bankruptcy would fail the means test and should instead file under Chapter 13. The cost of hiring an attorney to prepare for and attend the hearing would deter many applicants, he said.

I am not against banks or any companies for that matter seeking to improve their bottom line. That is the economic system we live in. However, by imposing a 'means test' based on one's income levels in an attempt to effectively determine whether one's abusing the system seems shaky, especially when numerous studies cannot pinpoint the actual reasons people file for bankruptcy.

I do not think the borrowers are blameless either. Although it is next to impossible to determine the nature of the debt seeking to be discharged (ie consumer goods, life's necessities, major purchases, etc.) it does seem likely that many individuals lack the basic concepts of money management skills.

The lack of individuals financial acument, coupled with the constant deluge of credit-card marketing, seems to be a 'perfect storm'. The ever increasing bankruptcy filings and losses by lenders is ample evidence of the fallout.

If I had to choose sides, I would start with asking the borrower/consumer/individual about their financial affairs and goals in order to assess their 'money-skills'. Sadly, these skills are lacking in today's society.

Sunday, December 26, 2004

Bankruptcy: Some Studies

The US Bankruptcy court compiles statistics on bankruptcy filings. The general thrust of the data is by chapter (type), by district (location), and by legal entity (business and non-business).

This blog's general focus is on the individual. Therefore, the statistics of interest are the 'non-business' (individual) filings. For the period between 1990-2003, non-business bankruptcies have increased. In 1990, there were 718,000 filings. By 2003, there were 1.265 million filings.

During this timespan, Chapter 7 liquidations have remained approximately 70% of the total filings. Here is the link to the webpage and the link supporting the above information.

There is no disputing the notion that bankruptices have increased during this period. There have been year over year declines in absolute filings, but by and large, the trend is upwards.

While it is interesting to look at the gross numbers, the devil is usually in the details. This is where the analyses of the US Bankruptcy Trustee is useful. This section of the Trustee website provides links to various studies and reports that shed some light into the numbers.

Here, we can search for reports that analyze the consumer bankruptcy filings. What is lacking, however, is the general economic climate in which to put the data into a larger context. Nonetheless, these studies are very useful.

The first study that jumps out is titled Credit Card Debt in Chapter 7 Cases. I have noted a couple of salient points from the study:
A question that was examined in this study was the relationship of medical bills to overall debt. The conclusion here was that unless specifically listed, it was impossible to determine if medical expenses (or any expenses for that matter) were included as part of the total credit card balance.

Another article titled Exploring the (Complex) Causes of Bankruptcy, attempts to reconcile various studies' conclusions on the reasons that individuals file for bankruptcy. The overall thrust of this article was to provide insights in the 'why' of filing to develop better policies in the bankruptcy arena.

The most striking element of this article is a graph that shows the percent increase/decrease in bankruptcy filings corresponds to the percent increase in consumer debt (with a lag factor built into the filings.) Again, however, the correlation is there. However, the reasons for filing are not.

Another 'study of studies' on consumer bankruptcy, Personal Bankruptcy: A Literature Review (written by a Congressional Budget Office analyst), explores this issue as well. My general thoughts on this article are that (again) it is difficult to pin down exact causes for bankruptcy filings, and while many studies have attempted to answer this question, the underlying data captured in bankruptcy proceedings and varying bankruptcy laws accross the states makes this task more difficult.

Was this review useful? It's hard to say. From a big picture perspective, it is difficult to determine why people file for bankruptcy, although there is a correlation between debt growth and bankruptcy filings 1-2 years later. Unsecured debt, specifically credit cards, is also a factor in consumer bankruptcy.

Did I cherry pick my observations? Perhaps. However, I really wasn't sure what I was going for. I personally am biased against credit cards and also believe that credit cards used improperly can lead one to financial ruin.

It also stands to reason that the more debt one carries, especially high interest debt relative to income, the more strained the borrower becomes. Further, credit card debt is debt that can grow (negatively amortize if you will). By only paying the minimum each month, the balance will increase over time.

In summary, it is difficult to explain (in general terms) the causes for increases in bankruptcy filings in a given timeframe. Over time, the change in debt levels will cause bankruptcy filings to increase 1-2 years down the road. Credit cards are significant factors in consumer bankrupty filings.

Bankruptcy: The Basics

The US DOJ kids website defines bankruptcy as "statutes and judicial proceedings involving persons or businesses that cannot pay their debts and seek the assistance of the court in getting a fresh start. Under the protection of the bankruptcy court, debtors may discharge their debts, perhaps by paying a portion of each debt." (I chose the kids website to keep the concept simple and easy to understand.)

There are five types of bankruptcy: 7, 9, 11, 12, and 13.

Chapter 7 (Liquidation): The debtor’s non-exempt assets, if any, are liquidated to pay off the creditors. Can be filed by either a business or individual. No-asset cases are where the debtor has no non-exempt assets available for liquidation.



Chapter 9 (Adjustment of Debts for Municipalities): Similar to a Chapter 11 reorganization, but on a municipality (city, county, school districts, etc.) can file under Chapter 9.



Chapter 11 (Reorganization)
: The debtor proposes a reorganization plan to keep the business alive and pay creditors over time. Usually filed by businesses, but individuals can as well.



Chapter 12 (Adjustment of Debts for Farmers)
: See Chapter 13. Filed by ‘family farmers’ as defined in the Bankruptcy Code.



Chapter 13 (Adjustment of Debts)
: A debtor can adjust their debts, keep their property, and repay their debts over a period of 3 to 5 years. Filed by an individual.

Here is the link for the above information.

The Bankruptcy Code is a federal law and all bankruptcy filings are made through the federal court system, specifically through the US Bankruptcy Court. The court tracks various statistics, by period as well as by district. The link for the statistics is can be found here.

An important component of the bankruptcy process, aside from the court, is the trustee. As described in the US Trustee Program’s website, their mission is to

The United States Trustee Program acts in the public interest to promote the efficiency and to protect and preserve the integrity of the bankruptcy system.



It works to secure the just, speedy, and economical resolution of bankruptcy cases; monitors the conduct of parties and takes action to ensure compliance with applicable laws and procedures; identifies and investigates bankruptcy fraud and abuse; and oversees administrative functions in bankruptcy cases.

This mission also allows the trustees to compile statistics on bankruptcies as well. The link to general information and statistics can be found here.

While there are many more elements to bankruptcy procedures and nuances, the intent of this post is to lay the groundwork for further exploration of the statistics gathered by the US Bankruptcy Court and the US Trustee Program as it relates to individuals.


Saturday, December 25, 2004

Ratio Decidendi

I'm not quite sure what to write down. What do I want to accomplish? What am I trying to prove? Do I know what I want to do with this?

I like taxes. I like personal finance issues. I like budgeting. I like to bank online and save money. I like to work with my spouse on these issues, although while we share the same goals, I tend to make things too complex and lose her interest and sometimes her patience. I like to look at the 'big picture' and delve into the details on these subjects and subjects that move the markets.

I admit it. I'm a typical accountant/CPA. I need a place to put my thoughts down onto paper. Writing them down helps with thinking through the issue. This is more about money and taxes and budgets though.

Economics is really the study of human behavior: why do we make the decisions we make? In today's society, those decisions often involve a monetary or time factor associated with them. Measuring those decisions is a goal of economics.

How we make those decisions is the crux of economics. What makes us tick, or better put, what makes us spend/save? I can talk budgets, money, taxes, and saving until I'm blue in the face, but these 'topics' are really the net results of the decisions we make.

This is a rough idea of what this blog is about: understanding taxes, personal budgets, the relationship between net income, the markets and net worth and 'all things money'. I don't quite know where to begin or where this will go, but the journey itself is just as important.




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