Sometimes It Sucks To Be Right – IRS Wins, Business Founders and Their Families Lose By Carl L. Sheeler, PhD, ASA
About six years ago, I was on a family office panel put on by Opal Financial in Newport, RI. About $2 Trillion in wealth is represented at such events. The gist of my presentation was March 2009 marked the lowest decline in public stock market values since the Great Depression. It was a key tipping point perhaps more extreme given tepid growth in its aftermath. Much of the attendees wealth was derived from investment in distressed assets (real estate, company debt and equity) acquired at steep discounts. These families had the liquidity, patient capital and iron constitutions to wait out the rebound, which came in the form of federal dollars flooding the market, when corporations and banks could or would not take the risk. The subsequent benefit of those with work income (most earnings from efforts) were those who remained or returned to the stock market. Even more so were those with wealth income (earnings from investments) often derived from concentrated risk (owning a business or real estate).
easy-approval home loans and lines of credit from their homes' equity. Risk shifting went to the banks carrying this debt on their books. From a simple financial model, debt is cheaper than equity, so the pre-2008/9 price of stocks were inflated by the leverage. Consumers enjoyed their temporary lifestyles from their work income and access to their equity as if the two were indistinguishable. It was a wild party until the music stopped. The economy was humming because all the income and gains were taxable, but much of the growth was fueled by consumption using debt.
Not so for those in default and those who lost or couldn’t find well-paying jobs. Many are the disenfranchised supporting Donald Trump or supported Bernie Sanders. They’re along the Economic Darwinism bell-curve. They are the Boomers who have insufficient savings to retire so slow the upper-mobility of Millennials who boomeranged back to their parents’ homes and can’t repay their collective $1 trillion in student loans. Then there’s the fixed-income seniors whose accounts’ yields are paying one-twentieth the inflation rate.
Sadly and unwisely, the public's emotional benchmark were these “good times” derived from leverage, not because they had more discretionary income. Yet, it’s unrealistic to expect that feeling of “success” ought to return without a personal change in circumstances. But often feelings sometimes gets confused by fact. The same might be said by the current stock market highs.
There is an aptitude and attitude issue here. First, the wealthy and the corporations had access to significant debt to leverage their investments as long as growth was fueled by even more credit. Much of consumer debt was via
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So, the “recovery” fueled by “cheap” currency has created two anomalies. First, if one can borrow at an interest rate
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half of 7.5% (was the norm for many years for home loans pre -2008), then the 3.75% rate buys twice the home. The same holds true for the “cost of capital” to corporations that de-levered (first reduced their debt), then re-levered (refinanced) at lower interest rates, which served to elevate the value of their shares. Second, the real question ought to be: (a) Is using the period of 2007 as a benchmark for a return to stock market performance realistic?; and (b) Are the current index values properly reflecting consumer demand and company operational fundamentals or is it irrationality more emblematic of the last bubble created by debt and less so by demand?
was to the family by establishing family offices where they could ensure having 24/7 focus on their wealth. Many eschewed private equity and hedge funds and increased their direct investme