Tuesday, July 12, 2011

A Budget/Debt Tale

July 12, 2011.  With all the hoopla in Washington, I’ve been spending a lot of time discussing budgets. Maybe a little parable is in order:

Ulysses and Simone are married, with five kids (Huey, Dewey, Louie, Sacco and Vanzetti). They support their elderly parents, Franklin, Lyndon and Eleanor. They have some nice property, but a lot of debt; they have about $120,000 in a variety of debts, mostly in a mortgage owed to a big bank (the Bank of Chillicothe). Some of the debt is variable, and some is fixed, but the overall interest rate is low, and U&S have a stellar credit score (800). U&S have a lot of bills, and they’ve added up all their outflows for the year, which come to about $34,560. This wouldn’t be too bad, except they only made $21,620 last year. They borrowed the difference on a home equity line of credit, provided mostly by the B of C.

U&S are looking at this year and are having some serious disagreements about money and budgets (as do many couples). U wants to cut costs, and suggests that S spends way too much on the kids and on wild and lavish things. S thinks that the kids should put more into the family budget, especially Sacco, who has a very good job and makes a good wage. Huey, Dewey and Louie don’t earn enough to help the family, but are supported by U&S, and supporting the older parents is very costly. The cost of supporting the three parents is $7,900 a year for their medical care, and $7,010 a year for their other living expenses. This doesn’t sound like much, but it represents 2/3 of U&S’s income. U&S have a lot of insurance and lawsuits. For example, they’ve been embroiled in a lawsuit with the McCoys, which alone is about $1,000 a year, or $20 a week in legal fees. The total cost of all U&S defense and protection is about $6,890 a year. U&S pay about $1,970 of interest on their debt (mostly to B of C), have other fixed bills of $4,160, and have $6,600 a year of discretionary items. For this year, they have even larger expenses.

Simone’s friends, Barry and Harry, think that Sacco should pay more to the family. They say that if Sacco kicks in more of his pay, U&S can have a lot more money. In actuality, this amounts to only $360 a year, and will surely aggravate Sacco. Ulysses friend, John thinks that Simone should cut back on her discretionary spending. He found a bunch of wasteful items Simone spent money on, like a treadmill for her pet shrimp (she did, but it was ½ of a cent). Harry wants Ulysses to make Simone cut back $360 from her budget. Ulysses and Simone are fighting over whose idea they should use? Cut $360 from Simone’s spending, or make Sacco pay $360 more?

U&S ask a financial wizard (the Wiz) what they should do, make Sacco pay $360, or have Simone cut $360? The Wiz hears the tale and asks if they want some advice. They ask if the Wiz can fix their problem, and Wiz indicates all financial problems have solutions, although some are painful. They say they’re willing to listen and hold hands and ask the Wiz to proceed.

The Wiz clears his throat and starts:

“You’re right about cutting expenses.” (Ulysses gets a grin on his face) “And wasting a half a cent on a shrimp treadmill is silly. However, if Simone cut all of her expenses, all $6,600, you’re still upside down. In fact, if you look at it, if you settle your lawsuits with the McCoys and Hatfields, you’re still in the hole if you just take care of the parents and pay your insurance. In other words, $360 of cuts doesn’t make much of a dent on a $15,000 hole.”

“So you will probably have to make more money.” (Simone now has her turn to smile) “However, merely making Sacco pay more to raise $360 isn’t really going to help much. In fact, raising Sacco’s contribution rate to 70% on his top income won’t fill the hole. You would have to triple the amount contributed by all the kids to fill the hole. And I predict the kids wouldn’t put up with it.”

Ulysses and Simone are silent. “You said you could help us, and now you’re making us feel bad. What kind of Wizard are you anyway?”

The Wiz leans back in his chair and puts his arms over his head: “Does it occur to you that you can’t just keep borrowing money from B of C? What if they decide you’re not a good credit risk? Remember what happened to the Greek family down the street? You need to look at the big picture.”

“Look at your three biggest expenses: you aren’t addressing them. You want to pay for Mom and Dad’s medical costs, and that’s running over seven grand a year. You want to pay for their living expenses, and that’s over seven grand as well. And all your lawsuits and insurances to protect you from threats real or imagined cost just about that as well. It’s great to pay for Mom and Dad, but you need more inflow. Make all of the kids chip in more to take care of the grandparents. Right now, the kids that work pay about 7.6% to take care of the grandparents, parents, and eventually themselves. Up this to 10% and you’ll get a quick $4,000. Have Mom and Dad pay more on their medical premiums. By the way, you seem to be covering a bunch of the neighbors kid on your insurance; quit doing that.”

“Settle the lawsuits with the Hatfields and McCoys, that should save you about $2,000. Cut $500 from Simone’s budget. Go ahead and have Sacco kick in more, he was doing it before anyway. While you’re at it, there’s about $500 more in silly things the kids get away with, like keeping their allowance in the neighbor’s piggy banks. By my math, that gets us $7,360.”

“You’re still in the hole by about seven grand. So here’s what you should do. If anyone comes over to your house as a guest, welcome them and let them enjoy your hospitality. The kids, however, can chip in a little more toward the family, so all the kids can pay an additional 5% on all the stuff they buy, like candy, or clothes. We won’t make them pay on food. I noticed that some of the neighbors kids are hanging around, eating your pizza and sleeping in your garage, make them pay 10%”. The Wiz leaned forward, “And the most important thing is: quit borrowing money to spend!”

Ulysses and Simone are stunned. “This is an awful plan; the kids will hate it.” Simone is looking at her hands. Ulysses is looking at the Wiz. “Would this actually work?”

The Wiz smiles. “Right now, you’re spending $36 thousand while taking in $21 thousand, and borrowing the extra $15 from the Bank of Chillicothe. If you make everybody chip in and cut your spending habits, you’d have expenses of about $33 thousand and inflow of about $33 thousand.” The Wiz leaned forward, “And, as the kids made more money and spent more, you’d actually have extra money coming in, plus with a little inflation, a great thing would happen.”

“What could possibly be great about inflation?” asked Simone.

“As you generated a surplus, you could pay back the Bank of Chillicothe. Except with inflation you’d be paying back with smaller dollars. Eventually you could have the entire debt paid off, and then you could take the money you were spending on interest and use it for research or education, or things that are good for the family.”

The Wiz stood up. “I know this may be tough to swallow, but balancing your budget is essential in the long run. In addition you can’t really grow the family’s finances if you are saddled with giant debt. I have to go to my next appointment; I’m meeting an Italian couple.”

Ulysses and Simone get their brief cases and leave. As they walk out, Simone says “I didn’t like what he said. That isn’t going to work, making everyone pay for things.” Ulysses shrugged. “I hate paying for things, and I know the kids will really hate it. And this idea of not having debt: what a silly notion.”

“What do you want to do?” asked Simone.

“Shall we go out for a nice dinner and drinks? All this budget talk has made me hungry and I want a cocktail.” said Ulysses.

“I didn’t bring my purse.”

“It’s OK, we’ll use my credit card” said Ulysses.

NOTE: Multiply each number by $100 million and you have the federal budget. So, Medicare and Medicaid is about $709 billion, and the shrimp treadmill (yes, there is one) is about $500,000. Raising the upper income tax rates to the pre-Bush tax cut raises $36 billion, which cuts the deficit by 2.4%. China (followed by Japan) are our biggest creditors. Defense, Social Security, and Medicare/Medicaid currently are almost exactly 100% of the revenue inflows (give or take a few billion). You could cut every other federal payment except those three and barely balance the budget. The current budget debates are somewhat absurd: The deficit is over a trillion and half dollars, and borrowing to fill it increases the deficit. Washington needs to have a business 101 lesson: Make more, spend less, grow the business.