United States Territorial of Puerto Rico

You’ve probably read that the island territory of Puerto Rico formally defaulted on its municipal debt obligations, over the weekend of August 1^st and 2^nd, an unsurprising event that has been expected by insiders for more than three months.  What did surprise everybody was the fact that the Puerto Rican Public Finance Corporation (PFC) found a way to make a partial payment on its $58 million in interest obligations—even if the amount was only $628,000.

Going forward, the situation is rather bleak.  The Moody’s credit rating service has noted that, according to the debt contracts, interest payments can only be made if and when the PFC has appropriated funds for them.  Since the PFC has not done so, there appears to be no legal requirement for Puerto Rico to pay the debt, or any legal recourse for bond holders.

A number of mutual fund companies are probably wishing that they had read these contracts more closely before buying a big chunk of the territory’s $70 billion in debt on behalf of their shareholders.  Puerto Rican muni bonds were once considered to be the Swiss army knife of the muni world, since they qualify as tax-exempt in all 50 U.S. states and therefore can be placed into any state-specific muni fund portfolio.  They also paid significantly higher interest than most states were offering—between 9% and 21% right before the default on 20-year issues, as high as 5% on 2-year notes.  The national averages among all U.S. states are closer to 2.85% and 1%, respectively. 

How much of the default are you, personally, on the hook for?  Very little to none at all unless you’re invested in broker-sold Oppenheimer funds.  Oppenheimer manages nine of the ten funds with the greatest exposure to these daredevil investments—$5.1 billion according to the Morningstar mutual fund analysis service.  The other fund with high exposure is the Franklin Double-Tax Free Income Fund, which currently has about 60% of its shareholders’ money tied up in the Puerto Rican fiasco.  Ten of Wells Fargo’s 14 municipal bond funds have also wagered on Puerto Rico’s debt, as have 20 of Eaton Vance’s 27 muni funds.

As mentioned, the default is not exactly a shock.  Puerto Rican bonds, once sold as high-rated paper, have been sliding down the ratings scale for years, causing losses for investors all along the journey.  A $5 million class action lawsuit was filed against the brokerage firm UBS as far back as 2013, alleging that older investors were urged to take out loans in order to load up on risky Puerto Rican bond funds that brokers touted as safe and secure.  An estimated $500 million was ultimately borrowed to buy into the mess, and investors in those funds suffered at least $1.66 billion in losses when the suit was filed—two years before the recent downgrade.

Meanwhile, the Vanguard and BlackRock organizations eliminated their small positions in the territory late last year.

The Brink of The Greek Exit

Well, the Greek voters were asked, once again, whether they would accept additional austerity measures that were demanded by their creditors, including the European Central Bank, the International Monetary Fund and the European Commission.  And once again they voted—this time overwhelmingly (61.31% to 38.69%)—to hunker down and move the country to the brink of a Grexit from the euro currency.

Their choice may not have been hard to make.  Virtually all of the $264 billion that has been loaned to the Greek government have actually been paid to the European banks who unwisely loaded up on Greek debt before 2009—and the loans and extensions, to them through Greece, has kept the European banking system solvent during the crisis.  Virtually none of that money has gone back into the ailing Greek economy.

Over the past three years, the Greek government, following many of the demanded austerity measures, has actually reached the point of budget surplus, aside, of course, from the debt repayments.  The cost: a skyrocketing unemployment rate that has reached 25.6%, including 60% of the nation’s young workers, and a steep recession which economists seem to agree would only get steeper if the country accepts the austerity demands.  The Greek economy has shrunk by 25% over the last five years.

But the hardship continues.  Anticipating a shift from euros to drachma, Greek citizens have staged the mother of all bank runs, trying to get as many euros out of the system as they could before they were exchanged for lesser-value drachmas.  The government limited the amount of their own money that citizens could withdraw to approximately $67 a day, and has now shut down the Greek banking system at least through end of day Tuesday.   Reopening the banks could be problematic, since they don’t hold nearly as many euros as depositors have put into them.

Some are betting that the European Central Bank will provide guarantees and financial support to keep the banks from collapsing and taking the Greek economy down with them.  But you can expect Germany to push back hard on this idea.

Will Greece leave the Eurozone?  Nobody knows, but the vote suggests that the citizens of Greece have had enough of European (read: German) control over their economy and political decisions; indeed, some observers saw the extremely hard line at the negotiating table as a ploy to destroy Greek’s ruling Syriza party by forcing Greek voters to abandon it.  There are sizable numbers of people in other European countries who feel the same way about losing control over their own affairs, who are closely watching how the European Union responds. 

The discussions will be tricky.  If the European Union offers further concessions, then you can expect Spain (unemployment rate: 23.1%) to ask for less stringent austerity and some space to get its own economy moving again.  Portugal could be next. 

And, of course, if Greece leaves, and begins to experience economic growth again, then those citizens in other countries could demand that their leaders also cast off the layer of oversight and control coming from Brussels.

What should you watch for?  Greece is already technically in default as of Tuesday, on $1.7 billion in payments.  At the end of July, it will own the next payment, in the amount of just under $4 billion.  One compromise possibility is that the European Union, led by Germany, will reluctantly allow Greece to extend its payments, and also put together some kind of an aid package for the Greek economy that would help it become more able to make payments in the future. 

How does this affect you?  Once again, you’re going to see turmoil in the markets, and a temporary decline in the value of the euro on international markets.  You’ll hear pundits and economists speculate about the “fate of the Eurozone,” and eventually, one way or another, everything will settle down again without affecting in any way the underlying value of the stocks you own.  We’ve all seen this crisis a few times before, and each time the predictions of some form of doom haven’t come true.  This “crisis” is very real to the Greek people, but the world will go on no matter how it’s resolved.

“Greece Exit” Vote Coming

Any way you look at it, the standoff between the nation of Greece and the leaders of the European Union is a mess.  But it may not be quite the problem that the press is making it out to be.

 In case you haven’t been following the story, the gist of it is that the Greek government, over a period of years that included the time it hosted the Summer Olympics, issued more bonds than, in retrospect, it could possibly pay back.  The total debt outstanding peaked at somewhere around $340 billion, which is actually more than the $242 billion in goods and services that the entire Greek economy produces in a year.   You’ve no doubt heard about a series of bailouts organized by the European Union, the International Monetary Fund and other groups which have collectively extended loans and extensions amounting to $217 billion to date.  As you can see from Figure 2, on the right-hand side, roughly $4 billion in payments are due in July and more than $3 billion in August, after which time the payment schedule becomes somewhat more forgiving through 2022.

 

There are three problems with this picture.  First, it has become apparent that Greece doesn’t have the money to make the July and August payments.  Second, in return for additional debt relief, the various creditors are asking that the Greek government do more than just balance its budget (which it has).  Their demands seem a bit harsh and somewhat picky when they’re organized in a list: Greece would have to reduce pension payments to current and retired workers by 40%, raise the retirement age to 67 in 2022 rather than 2025, phase out supplemental bonuses for poorer retirees in 2017 rather than 2018, and cut back on early retirement immediately.  (The proposals also include additional taxes on consumers but not businesses.) 

And third: the newly-elected Greek government, led by Alexis Tsipras of the Syriza party, ran on a platform of rejecting any further budget concessions and compromises.  This turned out to be an extremely successful political strategy: the party won 149 out of the 300 seats in the Greek Parliament in what is regarded as a rousing popular mandate.

Negotiations predictably broke down, and now the Syriza leaders are asking the Greek citizens to vote on whether they will accept the or reject the austerity measures that the EU creditors are demanding.  Polls suggest that the voters would like to keep their country in the Eurozone but that they oppose any additional budget reductions.  In other words, nobody knows how the referendum will end.  If the citizens of Greece reject austerity, it will present the European Union with a difficult choice: back down and continue to help Greece ease out of the crisis (which would be politically difficult to sell, especially to German voters), or deny the concessions that Greece needs, and effectively force Greece out of the Eurozone.

If the latter happens, then the future becomes a bit murky.  Greek banks have been shut down in advance of the July 5 vote, strongly suggesting that Greek leaders, holding a “no” vote, would no longer use the euro as its currency. They would print drachmas, which, in those frozen bank accounts, would replace euros at par.  The drachmas would immediately lose value on the international markets, which would allow Greece to undercut its competitors in the export markets.  Meanwhile, Greece could default on all or portions of its debt, and offer to pay drachmas instead.

Who loses in this scenario?  Everybody.  The European banks holding Greek debt, and private investors, are the obvious losers.  But closer to home, any Greek citizen who didn’t get his/her money out of the bank before the freeze will have to accept a haircut on the deposits, as drachmas will inevitably be worth less than euros.

At the same time, many Greek banks are holding massive amounts of Greek government debt, which they need as collateral for European Central Bank loans that are keeping THEM (the banks) afloat.  Alternatively, Greece could offer everyone 50-70 cents on the dollar in debt repayments, and would probably get mostly takers from creditors who would like to put this whole saga behind them.

Do YOU lose in any of these scenarios?  If either side blinks, then the situation goes back to business as usual.  If Greek voters agree to give the EU what it wants, then some economists believe that the Greek economy will go into a steep recession, but your personal exposure to Greek companies is almost certainly minimal, and the problem will be temporary.

If Greek voters vote “no,” the EU negotiators remain intractable and Greece leaves the Eurozone, then you can expect breathless and sometimes scary headlines and short-term turmoil in European stocks, with some investors panicking and others uncertain.  But the smart money says that the Eurozone is strong enough to sustain the loss of one of its smallest economies, and Greece, too, will survive. 

The irony, which nobody seems to have noticed, is that after accepting many of the earlier austerity measures, the Greek government is actually running a budget surplus without the debt payments—something U.S. citizens can only dream of.  If the additional austerity measures do, eventually, get put in place, the subsequent recession would reduce tax receipts and push Greece back into deficits again. 

If you’re a Greek citizen who hit the ATM machines after they had run out of money, then this is a pretty big crisis for your long-term financial situation.  Otherwise, like most so-called “crises,” the possibility of a “Grexit” and the upcoming special election in Greece is more about entertainment than about making or losing money in your long-term portfolio.

The Value of Objective Planning

What is the value that people get when they work with an objective, client-focused financial planner?

Most planning firms are reluctant to toot their own horns—partly out of modesty, and partly out of a conviction that you probably have better things to do than read about how they help you with your financial life.  But every once in a while, it’s a good idea to stop and think about what you get for what you pay.

This list is organized in rough order of value, and if you feel you aren’t getting any of these benefits, please let us know immediately.

1) An independent financial planner helps protect you from financial predators.

It’s a touchy issue in the profession whether advisors who put their clients’ interests first should be “bashing the competition,” but in fact the Wall Street firms that pretend to offer financial planning guidance are seldom (if ever) looking out for the best interests of their customers.  When you work with a broker (also known, on the business card, as a “vice president of investments,”) you will be presented with separately-managed accounts that look like mutual funds except they share their fees with the brokerage firm, plus a lot of investments that have to pay people to recommend them—never a good sign for the end investor. 

And since the investment markets are extremely complicated, it’s usually hard for a layperson to know when there are much better alternatives than the “opportunities” being presented.

2) An independent financial planner helps you keep track of--and make more efficient--your financial affairs. 

It is not uncommon for financial planners to talk with clients who once had a will drawn up, but they’re not sure exactly when.  Now that you mention it, they’re curious about what, exactly, it says.  There’s an insurance policy in a drawer somewhere, and it may be term or it may be a cash value contract; all the client knows for sure is that he writes a check to the insurance company every year.  Upon inspection, it turns out the auto insurance policy he happens to own is way more expensive than the lowest rate available in the market, and the homeowner’s policy hasn’t been updated since the Clinton Administration. 

And the investments are not uncommonly a hodgepodge of what a broker sold the client based on what he was told by his bosses to recommend at different times during the relationship.

Hopefully, this was never you.  But it does offer a certain peace of mind to know that everything is organized, in one place, and that somebody is paying attention to the details.  Because in your financial life, the details matter.

3) An independent financial planner will stand between his/her clients and the dysfunctional emotional decisions that everybody makes with their own investments.

         

Do you remember how it felt when Lehman Brothers went down, and the U.S. government was bailing out General Motors?  Many people sold everything at the bottom, and then waited, and waited, and waited to get back into the markets until it was “safe.”  They never dreamed that the markets would go on a six year bull run that would take us to new record highs. 

The Morningstar organization has calculated the difference between investment returns and investor returns—that is, between the returns people get vs. what the markets (or individual mutual funds) have delivered.  Results?  It is not unusual, during various time periods, for individual investors to get about half the returns of the market.  How is that possible?  They may be moving the portfolio around, or buying an attractive-looking hot fund or selling a great fund that’s going through a rough patch.  They may sell out at the bottom of a scary period, or go all-in when the markets are about to take a nasty tumble. 

For many of us, the best approach is to find good, solid investments and stay the course through thick and thin, ups and downs.  But it’s very hard to do those things on your own.  An independent advisor provides a dose of objectivity right when you need it.

4) An independent financial planner is a strong advocate for your future.

You know the statistics about the savings rate in America (the 2000-2008 numbers hovered around 0% of income, spiked briefly after the Great Recession and are now back in the 1% range again).  But the keepers of these statistics don’t tell you that they probably overstated the actual rate, because they didn't include things like increasing credit card balances or home equity loans.  When people put money in their savings account, and at the same time run up more debt, it counts as an increase in their savings.

The problem for most consumers is that there is no voice in their environment advising them to pay themselves a fair percentage of the income they earn.  Instead, they’re bombarded by messages which make powerful arguments to do the opposite: to buy this, that or something else.  The entire advertising community conspires to take those dollars out of their hands before they ever hit an investment account.

Advisors become that rare voice speaking out in favor of saving.  And in some cases, they help identify expenditures that are not in line with your stated future goals.  Which leads us to:

5) An independent financial planner helps people identify what is important in their lives and prioritize their goals.

         

How many people do you know who have taken the time to identify what they really want out of life? 

The incredibly sad truth is that the vast majority of people in our advanced, prosperous society have not taken the time to figure out what they really want out of the all-too-brief time they will spend on this planet.  And because they don’t know their destination, they will never reach it.  They are, in a very real sense, at the mercy of whatever agenda others have for them.

An independent financial planner will ask questions in your initial interview which help you recognize what you don’t know about what you want, and help you identify your most personal goals and desires.  That, alone, can be a priceless service.

6) An independent financial planner can help people turn seemingly impossible goals into a routine that can achieve them.

After years of running retirement planning spreadsheets, and working with successful individuals in the community, advisors eventually master one of the truly magical lessons of life: that any enormous goal can be broken down into manageable, monthly increments, and achieved by routine and persistence.  You save X amount of dollars every month in a portfolio that gets something close to what the market offers, and you will retire with a sum of money that seems impossible to you now. 

Clients who have goals that they don’t believe they can achieve are put on a schedule that will get them there as a matter of routine.

Of course, this list doesn’t include specialized services like making retirement planning projections, charitable planning, creating special needs trusts for a disabled child, evaluating disability and long-term care insurance—and it doesn’t mention the comfortable knowledge that you can call an expert for advice on virtually any financial subject, and you’ll get an answer that is not tainted by a sales agenda.

The point is that the services offered by an independent financial planner can have enormous value to people who are motivated to enjoy successful, prosperous lives.  An independent planner’s only goal is your success and prosperity, which should not be—but is—unusual in our financial world.