Category Archives: Retirement Planning

Ideas to help preserve and grow your money

A Reverse Mortgage To Protect Your Retirement Income

home mortgageMy Comments: Confused? Skeptical? A normal response. But as someone with 40 years of experience as a financial planner, a reverse mortgage can be a significant tool to promote financial freedom as we live out our retirement years.

Nov 11, 2015, by Robert Powell

Advisers have long looked down on reverse mortgages: Only the most desperate of Americans — those who failed to save enough for retirement or those who spent unwisely in retirement — would ever need to use such loans.

But a growing body of research is showing that homeowners of all stripes should consider using a reverse mortgage in conjunction with their portfolio-withdrawal strategy. Such loans, where you borrow from the equity in your home, can help you preserve your nest egg, leave a legacy, or both.

The latest research on the subject comes from Wade Pfau, a professor of retirement income at the American College of Financial Services in Bryn Mawr, Penn. In his study, Pfau examined six ways to use a reverse mortgage as part of retirement-income plan and the upshot is that homeowners now have a framework for deciding which strategy might be best for them.

“Strategic use of a reverse mortgage can improve retirement outcomes,” Pfau wrote in his just-published paper, Incorporating Home Equity into a Retirement Income Strategy. “The benefits are nonlinear in nature, as they relate to the synergies created by reducing sequence risk for portfolio withdrawals and to the non-recourse aspects of reverse mortgages that can potentially allow a client to spend more than the value of their home.”

Other researchers, we should note, are also praising the use and value of reverse mortgages, and the need to incorporate housing wealth into a retirement-income plan. Read Robert Merton on the Promise of Reverse Mortgages and the Peril of Target-Date Funds and No Portfolio is an Island.

But before delving further into the strategies examined in Pfau’s study, a bit of background: The financial advice industry is fond of focusing on financial wealth. After all, that’s how most advisers get paid — on assets under management. But the truth of the matter, according to Pfau, is that home equity and Social Security benefits represent, for most Americans, the two biggest assets on the household balance sheet, frequently dwarfing the available amount of financial assets.

“Even for wealthier clients, home equity is still a significant asset which should not automatically be lumped into a limiting category of last resort options once all else has failed,” Pfau wrote. “It is a great shame for the financial planning profession that the conventional wisdom about reverse mortgages continues to remain so negative and to be based on so many misunderstandings about their potential uses.”

Also, be sure to brush up on all things home equity conversion mortgage (HECM) before using one in your retirement-income plan. Thankfully, there are plenty of government websites with plenty of information about HECMs that will give you the working knowledge you need. Those include the Department of Housing and Urban Development’s website, Home Equity Conversion Mortgages for Seniors and the Consumer Financial Protection Bureau’s website, What is a reverse mortgage?.

For now, here’s what you need to know. To qualify for a reverse mortgage:
• You must be at least 62 years old
• Your home must be your primary residence
• You must have paid off some, or all, of your traditional mortgage

In addition, there’s a limit on how much equity you can tap; there are upfront costs to consider; and you’ve got to get a handle on how the loan balance grows and how it gets repaid. And, you ought to know that distributions from a HECM are treated as loan receipt and are not taxable, which could come in handy if you’re trying to manage your income-tax bracket.

The bottom line is this: With a HECM, you get access to a portion of your home equity as cash: either as a line of credit; in monthly payouts, or as a lump sum.

And that, in essence, is what Pfau researched: What happens to your wealth when you use the different reverse mortgage strategies to tap the equity in your home. In his study, he examined six different methods:
• Use home equity first: With this strategy, you’d open a line of credit at the start of retirement, and use this line to pay for all your retirement expenses until the line of credit was fully used up. “This allows more time for the investment portfolio to grow before being used for withdrawals after the line of credit is depleted,” wrote Pfau.
• Use home equity last: Here, you’d open a line a credit at the start of retirement and only use it after your investment portfolio was depleted.
• The Sacks and Sacks Coordination Strategy: With this strategy, you’d open a line of credit at the start of retirement, and use the line of credit, when available, following any years in which the investment portfolio experienced a negative market return, wrote Pfau. “No efforts are made to repay the loan balance until the loan becomes due at the end of retirement,” he wrote.
• The Texas Tech Coordination Strategy: This method is a bit more complicated. With this one, you’d open a line of credit at the start of retirement and then each year you’d analyze whether you can keep withdrawing money from your investment portfolio at the desired rate over a 41-year time horizon. If the remaining portfolio balance is less than 80% of the required wealth you’d tap the line of credit, when possible. And if the portfolio balances is greater than 80%, you’d pay down — provided your portfolio didn’t fall below the 80% threshold — the balance on the reverse mortgage balance. This, Pfau wrote, would provide more growth potential for the line of credit.
• Use tenure payment: Here you’d open a line of credit at the start of retirement and a receive a fixed monthly payment for as long as the borrower is alive and lives in the house. And spending needs over and above that reverse mortgage payment would be covered by the investment portfolio when possible, Pfau wrote.
• Ignore home equity: This strategy makes no use of home equity, and Pfau only examines it to show the probability of a retirement-income plan succeeding when home equity isn’t used.

So what did Pfau find?

“Generally, strategies which spend the home equity more quickly increase the overall risk for the retirement plan,” he wrote. “More upside potential is generated by delaying the need to take distributions from investments, but more downside risk is created because the home equity is used quickly without necessarily being compensated by sufficiently high market returns.”

“Meanwhile,” he wrote, “opening the line of credit and that start of retirement and then delaying its use until the portfolio is depleted creates the most downside protection for the retirement-income plan.”

This strategy, Pfau noted, allows the line of credit to grow longer, perhaps surpassing the home’s value before it is used, which provides a bigger base to continue retirement spending after the portfolio is depleted. Using home equity last does reduce upside potential because when markets are strong the portfolio will grow faster than the loan balance. “Frequently, this line of credit growth opportunity serves a stronger role than the benefits from mitigating sequence risk through the use of coordinated strategies,” he wrote.

See a diagram outlining the strategies Pfau studied.

Nonetheless, use of tenure payments or one of the coordinated strategies can also be justified as providing a middle ground which balances the upside potential of using home equity first and the downside protection of using home equity last, Pfau wrote. “These coordinated strategies can occasionally provide the best outcomes for legacy in some simulated cases when they best balance the tradeoff between using home equity soon to provide relief for the portfolio, and delaying home equity use so the available line of credit is larger,” he said.

But no matter what method you use, do consider the advantages of opening a reverse mortgage line of credit at the earliest possible age. There’s great value, wrote Pfau, in that.

Robert Powell is editor of Retirement Weekly, published by MarketWatch.

Should You Pay Off That Mortgage Before Retirement? Not Necessarily

My Comments: In all my years as a financial planner, the mantra has been to make sure the mortgage goes to zero at about the time you retire and quit working for money. The crash of 2008-2009 has made this very difficult for a lot of people.

Another strategy, not referenced by Kiesnoski, is to use a reverse mortgage if you can. Doing so requires some research, but it may free up cash that’s needed for other reasons, and still leaves you with no mortgage payments to make. Eventually, the property will pass to your heirs, but done properly, they will not be liable if there is another real estate bubble crash.

by Kenneth Kiesnoski Oct 13 2015

Conventional wisdom holds that retirees should not enter their golden years still holding a mortgage. However, Diahann Lassus, president and chief investment officer of wealth-management firm Lassus Wherley, claims “that’s not a one-size-fits-all answer today, because there are many other factors you have to think about.”

Thanks to today’s low interest rates and reasonable long-term returns from investments, it may make more sense for retirees to carry a mortgage for a longer than usual period, she noted. Trouble is, many people are “obsessed” with paying their mortgage off. Either way, there are two parts to any such decision: the math and the emotion.

If you’re considering paying off a mortgage “because it’s really bothering you that it’s hanging over your head, you really want to start thinking about a longer time frame than tomorrow,” said Lassus. She recommends thinking 10 or even 15 years out but still making extra payments each year. However, don’t take money out of 401(k) plans and the like to help pay down your mortgage, she cautioned, “because it will benefit you more for the long term to build those retirement accounts.”

Conversely, carrying a mortgage into retirement offers a lot of financial positives — especially if you have a very low interest rate. “What you can do is invest those dollars (and) your earnings could be significantly higher, which means you’re using someone else’s money to earn more so that you’re able to build your retirement assets over time,” said Lassus. “And that tax deduction makes it even more cost-effective.”

In the end, act only after you’ve looked at the math in terms of investment returns vs. mortgage costs, she said. “But you also have to be able to sleep at night.”

Social Security: 8 Savings Strategies

retirement-exit-2My Comments: My monthly Social Security benefits, coupled with Medicare, are a critical element contributing to our peace of mind as the years roll by. I don’t care if others argue against us becoming a socialist society. To some degree, we’ve been one since 1776.

Aug 14, 2015 | By Suzanne Woolley

(Bloomberg Business) — It’s Social Security’s 80th birthday, and while news about the program’s financial status is rarely upbeat, most Americans are glad it still exists. Women and lower-earning workers rely particularly heavily on the program.

Here’s why you need to pretend it doesn’t exist: Underfunded as it is, Social Security remains a favorite political football and a target for further trimming. At the same time, we’re living longer, and our savings need to last longer. So whatever happens to Social Security, it’s more important than ever to use all the savings strategies at your disposal.

Here are 8 ways to do that, one for each decade of Social Security.

1. Make saving simple
Just how important will your personal savings be in retirement? A chart from the National Academy of Social Insurance, a non-profit group that focuses on “how social insurance contributes to economic security,” show how the Social Security program replaces more than 50 percent of income for low-earning workers. The chart also shows how high earners would need to radically reduce their lifestyle if they need to rely heavily on Social Security income in retirement.

The Social Security Administration calculates income replacement rates for retired workers across a range of income scenarios, from those with very low income to those who hit the maximum annual amount of income taxed by Social Security (in 2015, it’s $118,500). Their calculations assume 35 years of contributing to the program and are based on Social Security’s national average wage index (AWI). For 2015, the average is $47,820.

If you’re lucky enough to be at a company that offers a 401(k), you may already be funneling money into it every pay period. Maybe you can even save enough to get all of the company match, if there is one. Saving 12 to 15 percent of your salary in a 401(k), up to the 2015 contribution limit of $18,000, is what many financial planners suggest.

That assumes you already have a cash emergency fund of three months at the very least. If your budget allows, try setting up automatic deductions from your checking account into other savings accounts, even if it’s just $25 or $50 a paycheck. And if you don’t notice that it’s gone, kick the contribution up a little higher.

If you want someone else to save your money for you, a growing number of online financial companies are offering programs to “personalize” savings. They’re doing this with software that assesses how much you need to keep in checking to pay bills, and then automatically spiriting the excess into savings or investment accounts. Companies with products like this include Betterment and Digit.

2. Keep 401(k) savings sacrosanct
One challenge millennials face that their parents didn’t is handling 401(k) accounts while moving jobs every two to three years. Rather than roll an old 401(k) into a new employer’s plan, many young savers just cash it out, which means paying income tax on it and a 10 percent penalty.

In the year that ended on March 31, more than 40 percent of 401(k) participants between the ages of 20 and 29 cashed out all or part of their plan balance after leaving a job, according to Fidelity. Even for those between the ages of 40 and 49, the cash-out percentage was high, at 32 percent.

Barring a lottery win or a fat inheritance, starting to save early, so money can compound over many decades, is really the only way most younger savers are going to arrive at retirement age with a decent nest egg.

3. Wage war on fees
This means, first, knowing what fees you are paying for different investment accounts. Many people have no idea, particularly when it comes to retirement savings accounts such as 401(k) plans. A Department of Labor rule saying plans must provide participants with fee disclosure has made that information more easily available.

Once you find that information, your plan probably won’t note whether those fees are low, average, or high compared to similar funds. You can get a rough sense of it at or look into a service such as that offered by an Israeli startup named FeeX. Users create an account and connect it to their old and new 401(k) plans. FeeX automatically calculates how much, if anything, a rollover into an IRA, or a switch into a plan’s cheaper fund options, could save in fees.

I tested it out with funds I own in the Bloomberg LP 401(k) plan. It flagged the Harbor International Institutional fund (HAINX), an actively managed fund, which has an annual fee of 0.75 percent. It calculated that, over a couple of decades, I could save $10,864 by switching to a lower-cost alternative in my plan, the Vanguard Developed Markets Index Institutional (VTMNX). Vanguard’s fund charges 0.07 percent annually.

4. Check your asset mix
If you have multiple investment accounts outside your 401(k), or just multiple 401(k)s, it can be hard to know what percentage of your assets are in cash equivalents, bonds, and stocks. What is the optimal mix?

Everyone’s situation and risk tolerance (more on that in a second) are different, but the asset allocation in target-date funds gives a sense of what some large investment companies think is ideal.

For someone who is about 45 and wants to retire in 20 years, the asset mix in the Fidelity Freedom Fund 2035 is 90 percent in stocks and 10 percent in bonds. Ten years in, the stock portion will drop to 70 percent, bonds will be 28 percent, and 2 percent will be in short-term funds. At 2035, when the account holder is 65, the stock/bond/short-term funds split is 56, 34 and 11 (more than 100 percent partly due to rounding). The net expense ratio is 0.16 percent.

Many people think they should start dialing back on equities when they’re 10 years away from retirement. Problem is, if you pare stocks dramatically at age 55 and live 30 more years, your savings may run out. That said, if you suspect you would panic and sell into any dramatic drop in the market — think back to how you felt and what you did in 2008 — moving some money out of equities makes sense.

5. Know your risk tolerance
Financial advisers will say that clients overestimate their risk tolerance, but FinaMetrica, a firm that runs psychometric risk tolerance tests, says it’s the advisers who become more nervous than they expected when markets become volatile. Finametrica says most people are actually pretty good at assessing their risk tolerance.

I am apparently not one of them. I took the company’s 25-question test (anyone willing to pay $45 can take it, or ask his or her adviser to spring for it). After estimating I’d score a 45 out of 100, I scored 39, lower than 85 percent of all scores. As the test report put it, “Most people underestimate their score by a few points. However, yours was an overestimate. When compared to others you are somewhat less risk tolerant than you thought you were.”

To guard against getting too stressed by market swings, investors may want to separate their money in different buckets. Money can be tied to short-, medium- and long-term goals, with each bucket having a different risk profile, says financial adviser Curt Weil.

If the market is swinging wildly and you know your immediate needs are covered in a short-term, conservatively invested bucket, you may feel more comfortable sticking with any higher-risk, higher-return investments in the long-term basket.

6. Be an employee benefits ninja
If you’re offered a flexible spending program or the ability to pay your commuting costs with pre-tax money, take the time to learn about them. You’ll get more mileage out of your money and lower your income taxes to boot. Making the most of tax-advantaged perks is a small way to give yourself a raise in a time of stagnating wages.

Employers have been shifting more costs to employees, often through the use of high-deductible health-care plans. Companies’ adoption of such plans may slow next year, according to a survey of more than 100 large U.S. employers. Employers are waiting to see if lawmakers repeal Obamacare’s “Cadillac tax” on high-cost health coverage, which is a levy on individual health premiums greater than $10,200.

Health care savings accounts (HSAs), which go hand-in-hand with high-deductible health plans, will likely become a greater part of employee’s lives. These are “triple tax-free”—what you put in is sheltered from income tax, it grows tax-deferred, and the money can be used, tax-free, for medical expenses. Companies usually seed the accounts with a few hundred dollars, pre-tax, and your contributions are tax-deductible. You can contribute up to $3,350 for an individual policy and $6,650 for a family plan. And unlike flexible-spending programs, they are not “use it or lose it,” so your money accumulates.

7. Ignore the fancy stuff

There are many benefits to keeping your finances fairly simple, like having a clear picture of where you stand. Unless you’re a seasoned speculator whose retirement is already more than provided for, avoid any investment with the word “leverage” or 2x or 3x (or more) in its name. It’s been said before, but bears repeating: If you don’t understand it, don’t buy it.

8. Eat your spinach
Health care costs in retirement are the most likely expense to send your finances into the depths of hell. Fidelity estimates that in 2014 a couple who retired at age 65 could look forward to $220,000 (in today’s dollars) in health care costs. That number didn’t rise from 2013, but it’s still way more than most people have saved for all of their retirement.

The AARP has a pretty simple calculator, and there are many others, that will scare you into the gym if you aren’t there already. It’s like making money!

Truth be told, I should have switched into the Vanguard index fund long ago, simply because most actively managed funds cannot consistently outperform the market. While Harbor has handily outperformed the Vanguard fund over 10 years — 7.4 percent compared to 4.6 percent — the Vanguard fund’s returns have been similar or better in the past five years. Vanguard wins on fees.

Vanguard’s 2035 target date fund takes a more conservative approach. It starts with 82 percent in stocks and 18 percent in bonds, and in 2025 assets should stand at 66.8 percent stocks and 33.2 percent bonds. Its expenses are 0.18 percent. Those over age 50 can make additional “catch up” annual contributions of $6,000.

Does the Government Steal Your House When You Get a Reverse Mortgage?

My Comments: People of my age are living a lot longer than before, and many of us are still distressed by what we now call the Great Recession. Whatever your financial circumstances, it’s proven once again that in our society, having more money is better than having less money.

Many of us are increasingly frustrated by our inability to travel or maintain a standard of living similar to what we enjoyed just a decade ago. Some of us have ‘downsized’ our homes, realizing that we need less room to remain comfortable. All this leads to the conclusion that a reverse mortgages is a tool to help manage your financial life.

What follows here is an article from a site called I have no idea who these people are but they claim to be a destination site where people like me can promote ideas and offer help. All very good, unless you prefer to talk face to face with someone local who is credible with a known reputation for integrity and skill. (If you are reading this and are interested, you can find out all about me on my web site where this blog post appears.)

One observation before you read further. If you are someone for whom any government involvement is a threat to your freedom, this may not be for you. But understand this: without some regulation and oversight, a reverse mortgage would be just another effort by corporate America to get inside your wallet and take more of your hard earned money. If you don’t pay attention, even with government oversight, you still might end up on the short end of the stick. It was P. T. Barnum who said a century or more ago “There’s a sucker born every minute.”

Reverse mortgages, done the right way, by the right people, and for the right reasons, have the ability to help you find financial freedom. Here’s the text that I found and am happy to share with you:

June 17, 2015 – A reverse mortgage is a loan that enables homeowners aged 62 or older to borrow against the equity in their home without having to sell the home, give up title, or take on a monthly mortgage payment.

These loans are very popular but often misunderstood. A common reverse mortgage misconception has to do with the role the government plays in the loan program. Here we explore 9 things the government does and does NOT do for reverse mortgages.

1. The Government Sets the Rules and Regulations for the HECM Reverse Mortgage

The government is heavily involved in the most popular type of reverse mortgage — the Home Equity Conversion Mortgage (HECM). The government agency that regulates these loans is the Department of Housing and Urban Development (HUD). They are part of the Federal Housing Administration (FHA).

Sometimes these loans are referred to as the FHA reverse mortgage, the HUD reverse mortgage or government reverse mortgages.

There are other kinds of reverse mortgages issued by private banks, but only HECM loans come with the protections and regulations afforded by HUD.

2. The Government Does Not Issue the HECM Reverse Mortgage — Only Approves Banks

The government does not ever issue a reverse mortgage. Borrowers do not get the loan from HUD, the FHA or any other government agency. (So the terms FHA reverse mortgage and HUD reverse mortgage are not accurate terms.)

The government does approve banks to make the HECM reverse mortgage loans. Banks must be licensed by HUD to be able to make HECM reverse mortgage loans.

3. The Government Insures These Loans for the Borrower

With government insurance, borrowers can rest assured that they will receive their loan advances or payments on time and as agreed upon under the terms of the loan. If your lender goes out of business, for example, that insurance protects the borrower from any missed payments. (The key word here is insurance, paid for by you, the borrower – TK)

4. The Government Insures These Loans for the Lender

The government also assumes the loan when it meets a certain threshold based on the amount of proceeds that have been received by the borrower. At that point, the government’s contracted servicer will become the servicer for the loan, rather than the servicer contracted by the lender.

5. The Government Pays for Any Losses on the Loan

If the reverse mortgage borrower owes more on the reverse mortgage than the home is valued at the point the loan comes due, then the government pays the difference.

The federally-insured HECM loan is a non-recourse loan, meaning the Federal Housing Administration (FHA) covers the remaining balance of the loan if the sale of the home does not cover the balance of the loan. (again, think of the above referenced insurance – TK)

6. The Government Determines How Much You Can Borrow

The borrower’s loan amount is based on a formula developed by the FHA and HUD that accounts for the borrower’s age, his or her spouse’s age, the home’s value, existing mortgage debt and current interest rates.

7. The Government Manages the Reverse Mortgage Counseling Process

An important part of the reverse mortgage application process is a mandated counseling session.

These sessions are designed to make sure the borrower understands all aspects of a reverse mortgage. You are also required to explore alternatives to the loan during the counseling.

These sessions can be very useful to borrowers. The government manages and approves the counseling agencies. They are not associated with the banks in any way.

8. The Government Creates Other Rules and Regulations Related to Reverse Mortgages

Perhaps because they will ultimately have to pay for bad loans, HUD creates and administers the rules and regulations that govern the reverse mortgage program.

In addition to determining how much you can borrow and mandating counseling, other rules set by HUD include:

  • Requirements like maintaining home insurance and staying current with taxes.
  • Determining some of the fee and interest structures banks can use for the loans.
  • Mandate of a financial assessment to determine if you can afford to maintain your home after you secure a reverse mortgage. (A new set of rules implemented a financial assessment to help ensure borrowers will be able to remain current on the loan’s taxes and insurance upkeep, to avoid running the risk of default and subsequent foreclosure.)
  • Definition of how spouses are protected by the loan.

The government is constantly monitoring reverse mortgage usage and often evolves the rules related to the loans. They also respond to feedback from agencies like the Consumer Financial Protection Bureau (CFPB) and AARP. Recent changes to the reverse mortgage program have made the financial product even safer for borrowers.

“Although these new requirements are more extensive than past requirements, they will ultimately serve to protect countless reverse mortgage borrowers from default as well as further contribute to making the federally-insured HECM one of the nation’s safest loan products in the market to date,” says reverse mortgage lender American Advisors Group, in a statement.

9. The Government Does NOT Ever Take Ownership of Your Home

Many people believe that the government ultimately gets the house when someone does a reverse mortgage. However, this is not true.

“There are a lot of myths,” Dan Larkin, divisional sales manager with Chicago-based PERL Mortgage, says about reverse mortgages. “Some people think the lender is going to be on the home’s title and will be able to take ownership of the home at some point, and that’s not true.”

Indeed, when taking out a reverse mortgage, the title of the home belongs to the borrower. The Consumer Financial Protection Bureau (CFPB) explains what happens when the borrower passes away or moves from the home:

“If you move out, sell the home, or the last surviving borrower dies, you or your estate will need to repay the loan,” the CFPB says in a statement. “The loan balance will include the amount you have received in cash, plus the interest and fees that have been added to the loan balance each month. To repay the loan, you or your heirs will probably have to sell the house. If there is money left over from the sale after repaying the loan, you or your heirs can keep the difference.”

Additionally, if your family wants to keep the home they can refinance with a regular mortgage and keep the home if they want and it makes financial sense for them.

How to Determine if a Reverse Mortgage is a Good Financial Move

When considering whether a reverse mortgage is right for you, it’s always best to consult with a financial planner or reverse mortgage expert. Additionally, there are online reverse mortgage calculators and reverse mortgage suitability quizzes that can help you assess whether or not a reverse mortgage is a good move for you.

“People often have a lot of questions, and it’s important to speak with someone who understands reverse mortgages and how they will impact the borrower’s financial situation,” Tutak says.

Saudi Arabia May Go Broke Soon

My Comments:  If Saudi Arabia ceases to function and Iran has a nuclear weapon, what are the implications for the rest of the world?

I accept that I’ll be just a memory by 2045. However, the United States may then be the only country on the planet with the ability to both unilaterally feed itself and produce 100% of the energy it needs. Food and fuel are as critical today as they were millennia ago.

Yes, there are environmental reasons to oppose fracking anywhere in the world but you have to admit the technology has the potential to dramatically change existing global economic and political dynamics.

How all this plays out politically with concurrent changes to existing global security arrangements is yet to be seen. It helps explain Russia’s recent moves to be more aggressive and paranoid about their future. As for Saudi Arabia, without oil to pump, they become a ghost town. We need to think about all this as we argue for or against the pending Iran nuclear deal.

By Ambrose Evans-Pritchard 05 Aug 2015

If the oil futures market is correct, Saudi Arabia will start running into trouble within two years. It will be in existential crisis by the end of the decade.

The contract price of US crude oil for delivery in December 2020 is currently $62.05, implying a drastic change in the economic landscape for the Middle East and the petro-rentier states.

The Saudis took a huge gamble last November when they stopped supporting prices and opted instead to flood the market and drive out rivals, boosting their own output to 10.6m barrels a day (b/d) into the teeth of the downturn.

Bank of America says OPEC is now “effectively dissolved”. The cartel might as well shut down its offices in Vienna to save money.

If the aim was to choke the US shale industry, the Saudis have misjudged badly, just as they misjudged the growing shale threat at every stage for eight years. “It is becoming apparent that non-OPEC producers are not as responsive to low oil prices as had been thought, at least in the short-run,” said the Saudi central bank in its latest stability report.

“The main impact has been to cut back on developmental drilling of new oil wells, rather than slowing the flow of oil from existing wells. This requires more patience,” it said.

One Saudi expert was blunter. “The policy hasn’t worked and it will never work,” he said.

By causing the oil price to crash, the Saudis and their Gulf allies have certainly killed off prospects for a raft of high-cost ventures in the Russian Arctic, the Gulf of Mexico, the deep waters of the mid-Atlantic, and the Canadian tar sands.

Consultants Wood Mackenzie say the major oil and gas companies have shelved 46 large projects, deferring $200bn of investments.

The problem for the Saudis is that US shale frackers are not high-cost. They are mostly mid-cost, and as I reported from the CERAWeek energy forum in Houston, experts at IHS think shale companies may be able to shave those costs by 45pc this year – and not only by switching tactically to high-yielding wells.

Advanced pad drilling techniques allow frackers to launch five or ten wells in different directions from the same site. Smart drill-bits with computer chips can seek out cracks in the rock. New dissolvable plugs promise to save $300,000 a well. “We’ve driven down drilling costs by 50pc, and we can see another 30pc ahead,” said John Hess, head of the Hess Corporation.

It was the same story from Scott Sheffield, head of Pioneer Natural Resources. “We have just drilled an 18,000 ft well in 16 days in the Permian Basin. Last year it took 30 days,” he said.

The North American rig-count has dropped to 664 from 1,608 in October but output still rose to a 43-year high of 9.6m b/d June. It has only just begun to roll over. “The freight train of North American tight oil has kept on coming,” said Rex Tillerson, head of Exxon Mobil.

He said the resilience of the sister industry of shale gas should be a cautionary warning to those reading too much into the rig-count. Gas prices have collapsed from $8 to $2.78 since 2009, and the number of gas rigs has dropped 1,200 to 209. Yet output has risen by 30pc over that period.

Until now, shale drillers have been cushioned by hedging contracts. The stress test will come over coming months as these expire. But even if scores of over-leveraged wild-catters go bankrupt as funding dries up, it will not do OPEC any good.

The wells will still be there. The technology and infrastructure will still be there. Stronger companies will mop up on the cheap, taking over the operations. Once oil climbs back to $60 or even $55 – since the threshold keeps falling – they will crank up production almost instantly.

OPEC now faces a permanent headwind. Each rise in price will be capped by a surge in US output. The only constraint is the scale of US reserves that can be extracted at mid-cost, and these may be bigger than originally supposed, not to mention the parallel possibilities in Argentina and Australia, or the possibility for “clean fracking” in China as plasma pulse technology cuts water needs.

Mr Sheffield said the Permian Basin in Texas could alone produce 5-6m b/d in the long-term, more than Saudi Arabia’s giant Ghawar field, the biggest in the world.

Saudi Arabia is effectively beached. It relies on oil for 90pc of its budget revenues. There is no other industry to speak of, a full fifty years after the oil bonanza began.

Citizens pay no tax on income, interest, or stock dividends. Subsidized petrol costs twelve cents a litre at the pump. Electricity is given away for 1.3 cents a kilowatt-hour. Spending on patronage exploded after the Arab Spring as the kingdom sought to smother dissent.

The International Monetary Fund estimates that the budget deficit will reach 20pc of GDP this year, or roughly $140bn. The ‘fiscal break-even price’ is $106.

Far from retrenching, King Salman is spraying money around, giving away $32bn in a coronation bonus for all workers and pensioners.

He has launched a costly war against the Houthis in Yemen and is engaged in a massive military build-up – entirely reliant on imported weapons – that will propel Saudi Arabia to fifth place in the world defence ranking.

The Saudi royal family is leading the Sunni cause against a resurgent Iran, battling for dominance in a bitter struggle between Sunni and Shia across the Middle East. “Right now, the Saudis have only one thing on their mind and that is the Iranians. They have a very serious problem. Iranian proxies are running Yemen, Syria, Iraq, and Lebanon,” said Jim Woolsey, the former head of the US Central Intelligence Agency.

Money began to leak out of Saudi Arabia after the Arab Spring, with net capital outflows reaching 8pc of GDP annually even before the oil price crash. The country has since been burning through its foreign reserves at a vertiginous pace.

The reserves peaked at $737bn in August of 2014. They dropped to $672 in May. At current prices they are falling by at least $12bn a month.

Khalid Alsweilem, a former official at the Saudi central bank and now at Harvard University, said the fiscal deficit must be covered almost dollar for dollar by drawing down reserves.

The Saudi buffer is not particularly large given the country’s fixed exchange system. Kuwait, Qatar, and Abu Dhabi all have three times greater reserves per capita. “We are much more vulnerable. That is why we are the fourth rated sovereign in the Gulf at AA-. We cannot afford to lose our cushion over the next two years,” he said.

Standard & Poor’s lowered its outlook to “negative” in February. “We view Saudi Arabia’s economy as undiversified and vulnerable to a steep and sustained decline in oil prices,” it said.

Mr Alsweilem wrote in a Harvard report that Saudi Arabia would have an extra trillion of assets by now if it had adopted the Norwegian model of a sovereign wealth fund to recyle the money instead of treating it as a piggy bank for the finance ministry. The report has caused storm in Riyadh.

“We were lucky before because the oil price recovered in time. But we can’t count on that again,” he said.

OPEC have left matters too late, though perhaps there is little they could have done to combat the advances of American technology.

In hindsight, it was a strategic error to hold prices so high, for so long, allowing shale frackers – and the solar industry – to come of age. The genie cannot be put back in the bottle.

The Saudis are now trapped. Even if they could do a deal with Russia and orchestrate a cut in output to boost prices – far from clear – they might merely gain a few more years of high income at the cost of bringing forward more shale production later on.

Yet on the current course their reserves may be down to $200bn by the end of 2018. The markets will react long before this, seeing the writing on the wall. Capital flight will accelerate.

The government can slash investment spending for a while – as it did in the mid-1980s – but in the end it must face draconian austerity. It cannot afford to prop up Egypt and maintain an exorbitant political patronage machine across the Sunni world.

Social spending is the glue that holds together a medieval Wahhabi regime at a time of fermenting unrest among the Shia minority of the Eastern Province, pin-prick terrorist attacks from ISIS, and blowback from the invasion of Yemen.

Diplomatic spending is what underpins the Saudi sphere of influence in a Middle East suffering its own version of Europe’s Thirty Year War, and still reeling from the after-shocks of a crushed democratic revolt.

We may yet find that the US oil industry has greater staying power than the rickety political edifice behind OPEC.

Obama’s Climate Plan Makes for Canny Politics

My Comments: In keeping with tradition, the President’s critics are having the usual hysterics about his recent announcement designed to reduce carbon emissions. If I were the owner of a bunch of coal mines, I’d probably be unhappy too.

But for the rest of us who don’t own coal mines, which is virtually all of us, it’s another step toward somehow delaying what appears to be the inevitable, which is rising sea levels. If scientists said there appeared to be an asteroid whose trajectory was likely to cause it to impact with our planet 50 years from now, I’d be upset if politicians said it was nonsense, and refused to allocate funds to perhaps find a remedy.

While the new rules do will not satisfy the far left, governing is the art of the possible, which most on the right have forgotten all about.

by Nick Butler on August 3, 2015 in the Financial Times

Having solved the Iranian problem US President Barack Obama has selected climate change as the next building block in the construction of his legacy.

The contents of his “clean power plan”, which he announced on Monday, are important for their substance and, equally, for their political impact — not just for the Paris climate negotiations in December but more importantly for the presidential election next year.

On the substance, the move is an unprecedented peacetime assertion of political authority over the private sector. Even if some states resist the instruction to cut emissions by about a third from a 2005 base within 15 years, many will obey — with serious consequences for the businesses involved and their investors. Coal-fired power plants will be closed and, with export potential limited, dozens of US coal mines will close as well. No wonder the reaction from the industry is fierce.

The beneficiary will be the solar business. Mr Obama’s plan echoes the initiative launched last month by Hillary Clinton as part of her campaign for the Democratic presidential nomination, designed to increase the amount of solar power generated by 700 per cent by 2027, using regulatory power to boost the market share of renewables.

The number is ambitious but the pace of technical progress means growth could be achieved without a big increase in subsidies or consumer prices. Across the US the costs of solar is falling and beginning to reach “grid parity”— which means they are competitive with the lowest cost fossil fuel without the need for subsidies. Mrs Clinton’s proposal cuts with the grain of emerging reality.

Nuclear and natural gas are left, under Mr Obama’s proposals, to fend for themselves, with no mandated market shares and no subsidies. As things stand, the gas industry can cope but, short of a breakthrough that reduces production costs, new nuclear in America looks almost as lost as it does in Europe.

Missing from the proposals is any new push to develop science that will increase the efficiency of energy supply and consum­ption. That is a pity as low-income consumers in countries such as India need fuel sources that are both low cost and low carbon if climate change is to be beaten. But policies directed to developing such technology may come later — there is, after all, more than a year until the election.

That brings us to the politics of Mr Obama’s plan. It is worthy of Frank Underwood, Kevin Spacey’s Machiavellian anti-hero in the Netflix series, House of Cards . In the black arts of politics, one of the most precious achievements is to define the differences between you and your opponents on your own terms. An­other is to force opponents into positions they wish to avoid. A third is to divide them against themselves. Mr Obama has managed all three in one go.

The Republicans predictably walked into the trap. Marco Rubio, the Florida senator seeking the Republican nomination, instantly declared the policy “catastrophic”. Mitch McConnell, the Republican majority leader in the Senate, who campaigned for his seat last year on the slogan “Coal Guns Freedom”, called for individual states to disobey the new laws. Even Jeb Bush, who has been trying to sound rational on the question, was forced to condemn the president’s initiative as “irresponsible”.

Given the nature of the Republican voter base and the views of big donors such as the billionaire Koch brothers, those who seek the Republican nomination can do little else. The problem for them (and the beauty of Mr Obama’s political play) is that, as they walk in the direction of those who will determine which of them is the candidate next year, they are walking away from the views of the voters who will determine the outcome of the election.

According to the public polls, for instance from the Yale Project on Climate Change, global warming has become a real concern. Coal is seen as dirty and unhealthy. Mrs Clinton, assuming she secures the Democratic nomination, may not win some of the coal states. One of the fascinating subtexts of her initiative, and of the president’s proposals, is the deliberate distancing of the Democratic leadership from organised labor, including the once powerful mining unions. But the calculation must be that she will gain overall by being on the side of the future.

Mr Obama’s proposals are detailed and complicated, and will now be subject to every sort of legal challenge. They are unlikely to be implemented in full. In themselves they will not solve the global problem of climate change, nor force any other country to follow suit. But they do serve to define the direction of American energy policy and also of American electoral politics.

The writer is a visiting professor at King’s College London and a former BP group vice-president for strategy

Rates Must Rise To Avert The Next Crisis

200+year interest ratesMy Comments: Interest rates are the price paid for using money owned by someone else. The rise and fall of that price, which we call interest, is a critical element when it comes to deciding how your money should be invested. For over 30 years they have been trending down and you will soon see that trend reversed. Being prepared will result in greater financial freedom for you.

By Scott Minerd, Chairman of Investments, Guggenheim Partners
As appeared in the Financial Times global print edition, July 16, 2015

In 1898, Swedish economist Knut Wicksell argued that there existed a “natural” rate of interest that balanced the supply and demand of credit, assuring the appropriate allocation of saving and investment.

Should market interest rates remain below the natural rate for an extended period, investors will borrow excessively, allocating capital into less productive investments, and ultimately into purely speculative ones.

This is what the US economy faces today after years of meagre borrowing costs. Policymakers have created a Wicksellian dilemma where investment spurred by low interest rates is driving economic growth, but these inefficient investments support growth at the expense of lower productivity in the economy.

In recent years, this investment has flowed into housing, commercial real estate, and equities, driving asset prices higher, exactly the goal of the Federal Reserve in the wake of the financial crisis. But as the recovery in real estate and equities matures, a darker side of this imbalance between natural and market rates is beginning to emerge. Many investments today using artificially cheap capital are not increasing productivity – they are being made, because money is cheap and the profit motive is strong.

Consider the evidence. This year likely will witness record US stock buybacks; the second biggest year for mergers and acquisitions; the highest percentage of non-investment grade borrowers among new issuers of corporate debt; and a record for covenant-light loan issuance.

In the midst of all this, stock prices are appreciating at the slowest pace since the financial crisis. Why? Because top-line growth is low and productive investments in core businesses are wanton.

Over time, the natural rate of interest should roughly equate to the average return on new capital investment. Distortions in economic activity begin to occur when the natural rate varies materially from the market rate.

The aftermath of the current period of corporate borrowing and splurging will be nasty. Consider that the majority of defaults of US high-yield bonds during 2008 and 2009 were loans originated between 2005 and 2007 – the final three years of the last credit cycle when M&A and leveraged buyouts peaked. Similar to today, credit remained cheap and the Fed was slow to raise interest rates.

We are not back in the frothy days of 2007, but we are leaving the realm of smart investment decisions and moving into the “silly season” when investors become convinced that recession is nowhere on the horizon and market downside is limited.

It is a world where asset prices continue to appreciate and confidence remains strong, while capital chases a shrinking pool of productive investment opportunities. Similar to the run-up to 2007, rising asset prices and malinvestments today may be sowing the seeds of the next financial crisis.

The harsh reality is extended periods of malinvestment result in declining productivity growth, lower potential output, and slower increases in living standards. A failure to normalize market interest rates soon will result in more capital plowed into investments that are less productive and more speculative.

As productivity declines, long-term growth will be stunted. Eventually, inflationary pressures will build, forcing market interest rates to rise. The longer market rates remain below the natural rate the greater the purge will be once higher rates induce a recession, causing a sharp rise in defaults among malinvestments made during the period of cheap credit.

Today looks a lot like 2004 or 2005, when investors were blissfully ignorant of what awaited. It is still early, but I get increasingly concerned the longer I see undisciplined investors clamoring for bonds with suspect credit worthiness at ludicrously low yields. Higher rates, higher prices, or both are on the horizon. Before long, some of those bonds may become toxic waste.

The good news is there remains time to take action. Policymakers can still make adjustments to avoid the worst phase of the credit cycle. To reduce the continued accommodation of these marginal investments, the US central bank should normalize rates soon. For investors, the time has come to consider opportunities to book gains in assets that in the reasonable light of day a prudent investor would never buy.