Juggling Dynamite

We were pleased to read another review of Juggling Dynamite recently by someone who clearly gets the message. “Rich by Habits” articulates a key theme of the book: it is the little decisions that we make every day about our finances that dictate most where we will end up on the wealth scale in the future.
Whether we make 50k, 500K or 5 million a year, we still have to make choices every day about how much and where we will spend our income. We invest our finite time and energy resources into the things that we do to earn a living. The income that we receive from our efforts now represents the net reward for the expenditure of our finite energy. When we waste our money on frivolous things, depreciating assets, or self-destructive over-indulgence we are really making a statement, conscious or not, about the value we attribute to our very life force.
Sales marketing has brainwashed people into thinking that we can consume and indulge our every aspiration now without compromising our financial security for the future. Every week people ask me how they can have enough money for their retirement. The answer…drum roll….spend less, save more and be very careful with how we invest our savings once we get some. The truth is not everyone should have a big house full of new furniture and two new cars in the drive!
It used to be that home ownership was a sign of financial discipline because people had to typically save at least 25% of their own capital first before they could ask to borrow a mortgage and buy a house. In order to save for their first house people used to go without cars and expensive clothes, without dining out, without trips, without whatever they could avoid, in order to amass some savings from their income. Once they had developed the self-discipline to amass the savings, it was then considered evidence of the “character”, “capacity” and “collateral” criteria for borrowing money in the first place.
Not anymore. Today people are encouraged to borrow more than 100% to buy a home–no money down. On top of that, lax lending standards have approved the same people for new car loans, leases and a multitude of other cards and credit lines. We now have a whole society of apparent wealth and equity without actually having—well any! Not surprisingly many people find themselves with lots of “stuff” and absolutely no financial discipline, no personal habits that will enable them to amass money and keep it.
The madness has to stop. We need to re-learn the habits that many of our grandparents developed after the Depression– they learned to be frugal and careful. They bought based on what they had the money for, not based on what payments they could juggle. Our children are depending on us to teach and lead by example. If we lead well, these are lasting lessons that will serve them for a life time. And that’s a whole lot more lasting and valuable than any of the Made in China junk they beg us for daily, only to toss under the bed.

“We started the year with a more pessimistic view of the housing and home improvement markets than many. It turns out we were not pessimistic enough.” —-Frank Blake, Home Depot chairman and CEO, Nov 13, 2007.
Today the Home Depot Inc. reported a 26.8 percent drop in third-quarter profits and revised its financial outlook Tuesday, saying a decline in earnings would be larger than expected as the housing market continues to deteriorate. The nation's largest home improvement store chain predicted a decline of as much as 11 percent in earnings per share from continued operations because of persistent “softness in the housing market.”
Meanwhile Monday Yale University economist Robert Shiller, co-developer of the S&P/Case-Shiller Home Price Indices, told Reuters he believes the housing market's slide is by no means nearing its conclusion. Shiller said not only are forecasts of a bottom in 2008 probably wrong, but 2008 could see a decline even worse than that of 2007. “There is a probability of a continuing decline for a period of years, bringing prices in many cities down in the 10s of percent,” he said. “The bottom is hard to predict. I do not see it imminent and it could be five or 10 years too.”
The billion dollar question for Canada, is how long until our real estate markets follow the US market down? and how far will our Canadian property values correct? Canadians have also bought too many things on too much credit for the past several years. Every week I receive emails from Canadians that are struggling to keep their head above water and are beginning to lose the fight. Meanwhile debt ratios in many parts of the UK and Europe are even worse than in North America. The damage of this credit bubble has been pervasive and will continue to spread.
It is time for anyone who has not yet seen it to rent the movie “Fun with Dick and Jane.” Jim Carey and Tea Leoni did a remake of the 1970's original a couple of years ago. In many cases, the resolution will be to give back the fancy leased cars and other financed toys and drive and live in what people can actually afford. It is not an easy adjustment, but it will be honest, liberating and ultimately healthier to let go of the facade and pay down the debt.

Since 2005 we have been sceptical of the earnings reports coming out of many financial companies and other service industries and sectors that feed off of the credit gravy train: think consumer discretionary, homebuilders, and housing related companies, even the extraordinary, seemingly endless demand for commodities. Our scepticism was based on a belief that there was a false demand in the system supported by reckless spending and credit abuse.
Today The Big Picture, echoes this point as follows:
“There have been many investment theses over the past few years about the market which supported the bullish side of the ledger: Earnings were high, stocks were cheap, risk was moderate, the Fed model favored stocks over bonds.
Regardless of whether you found these arguments persuasive or not, global markets have gone higher. While the U.S. indices may have lagged the rest of the world's bourses, they too, have powered higher.
Here's the odd factor: It turns out that many of the arguments made in favor of U.S. domestic growth have been based on an assumption that turned out to be false. To wit: The Financials, the largest sector in the S&P500, had legitimate, sustainable, normalized risk-based earnings.
That basic premise turned out to be wrong.
Picture a race car driver, going way too fast in the first half of a track. He puts up record breaking lap times, only to crash and burn in the last turn. His driving coach would say his risk-adjusted speeds were irresponsible.
That's how I perceive what has been going on with the Financial sector. It wasn't Fraud, but rather a reckless disregard for Risk that led to outsized returns on many big cap stocks in the group.
Merrill Lynch (MER) just wrote down $8 billion dollars, erasing 5 years of profits. Citigroup (C) dinged $11 billion. Washington Mutual, (WAMU) Countrywide Financial (CFC), Bear Stearns, GMAC — there seems to be an ongoing parade of mea culpas that are erasing not just quarters of profits, but years of earnings. And there are likely to be many more of these, as tier 3 assets get priced appropriately.
What's truly astounding is that we may only be seeing the tip of the iceberg. Its possible that the big brokers and banks have $1 trillion in toxic debt on their books to be written down. That would equal decades — not years — of profits to be wiped out.”
When we back out the false demand from funny money and mortgage equity withdrawls from over-priced housing, we believe we will eventually see that the past few years of this expansion have been more mirage than real.