Net Present Value

This morning, we were talking to Modern Domestic about how hard it is for people to make rational, informed decisions about money – on everything from grocery shopping to refinancing a mortgage.

She said when she shops for Wonk the Plank’s Cheerios and has to pick between the different box sizes, she learned (under Wonk the Plank’s tutelage) to make sure she was always paying the lowest cost for the cereal and to not be fooled by different specials or box sizes.

Mmmmmmmmm...

Before we were dating, she would just pick the lowest posted unit price (the little calculation most stores post along with the cost of the item) and keep on shopping. She had no idea that 2 for 1 specials and other promotions can throw those numbers off and require the buyer to do some mental math. Still, at least she was checking the unit prices, something some folks never bother to do.

24.3 cents per fluid ounce!

So if people botch small and uncomplicated choices all the time, imagine the capacity for expensive mistakes when we set Cheerios aside and consider something like a mortgage, full of fine print and bewildering different options.

Wonk the Plank decided to give Modern Domestic a little test. “Suppose,” we said, “Wonk the Plank offered to pay you $5 a year for the next ten years. That’s a total of fifty dollars. But we won’t do it for free. How much would you be willing to pay us today for that $50?”

Modern Domestic thought hard and told us she would offer $25. She was clever enough to realize that money in the future will be worth less than it is today, but still, she was mostly taking a guess. “Is that way too much to offer?” she wanted to know.

That is actually a pretty reasonable try, we told her, but the point is that there’s an exact answer (with certain assumptions about interest rates, to all you haters out there) about the net present value of Wonk the Plank’s $5 payments.

Yikes!

Nobody panic, it’s just a formula for figuring out the present value of a stream of future payments. In our example, we’re going to plug in $5 for C, 4% as our interest rate i and 10 as the number n of times we’ll pay Modern Domestic the money.

$38.60! So while Modern Domestic’s guess wasn’t too bad, it could still cost her thousands if she were guessing about refinancing a mortgage or paying off a car loan. Folks, do the math before you make a such a decision. If you’re not sure how to do it, enlist someone you trust (NOT anyone trying to sell you something) to help you figure it out. You can still shop for Cheerios on your own, but for decisions with more serious implications, you should get help.

Indigestion

Last week Wonk the Plank was reading through Merrill Lynch’s quarterly report, and man, was it ever boring. (They usually are.) Merrill, in case you don’t remember, is the failed investment bank that was sold in a shotgun wedding to megafinancial company Bank of America.

We were plodding through the tail end of of Thursday’s filing, our little lids growing heavier as the legalese grew tougher and tougher to take. But suddenly, we saw a paragraph that snapped us out of our stupor (we added the italics for emphasis.)

Other Events

On January 16, 2009, due to larger than expected fourth quarter losses at Merrill Lynch, the U.S. government and Bank of America entered into an agreement in principle in which the U.S. government would provide protection against the possibility of unusually large losses on a pool of Bank of America’s financial instruments. As of the time of filing this document, Bank of America has not entered into a binding agreement with the U.S. government.

What are they talking about? Why was Wonk the Plank so astonished? As the filing explains, Bank of America had a little case of indigestion when it tried to swallow Merrill Lynch whole. The smaller Merrill’s balance sheet had soured so badly that Bank of America was ready to call the whole thing off.

So, in a smoke-filled back room, the government promised to guarantee some losses on a $118 billion package of grotesque mortgage backed securities, the culprits behind the whole financial crisis.While Wonk the Plank knew about all this beforehand, we had no idea the deal was more understanding than deal.

While on Friday, Bank of America announced it plans to terminate the government’s guarantee, it seems to Wonk the Plank that someone ought to have draw up a binding agreement for a $100 billion plus deal. Does anybody wonder what would happen if the tables were reversed? If the big shots at Bank of America faced a billion-dollar bill based on an “agreement in principle” but no signed contract, we somehow doubt they would honor it. More likely, they would shirk any back-room promises, and they would do it with a smile.

The Magic Way

We enjoyed this deconstruction of the lastest Geithner plan for big banks like Citigroup and Bank of America from businessinsider.com founder Henry Blodget. Blodget’s post was an instructive and simple explanation of why Geithner’s plan is bunk.

The Geithner plan involves converting the government’s preferred shares, acquired in the first round of the bailout, into common shares. The manoeuvre  will boost an important yardstick of the banks’ financial health called Tangible Common Equity. The best part(and biggest selling point) of this plan is its cost, $0. Since the government already owns preferred shares, it can convert them for free.

Still, Wonk the Plank didn’t need to read Blodget’s excellent post to know something was very wrong with the secretary’s plan because we don’t believe in Magic Ways.

The streets here in DC are mostly a grid of letters and numbers, but once Wonk the Plank astonished Modern Domestic by showing her a shortcut down a diagonal street. She was so charmed by the discovery that she christened it “The Magic Way.”

So very magical!

So this is Geithner’s big plan, to tell us all there’s a Magic Way that we’ve all overlooked all these years to make Citigroup and the rest much stronger than they actually are. We feel like we have been repeating ourselves, but alas, to no avail. One more time: There is no Magic Way to help banks out that doesn’t involve decidedly unmagical pain for someone else. Changing mark-to-market accounting rules is not a Magic Way. Converting preferred shares into common is not a Magic Way. These are sideshows, not Magic Ways.

Wonk the Plank thinks it’s funny that most people, when it comes to personal finance, understand that there aren’t any Magic Ways. Those same people, though, who understand so clearly that they can’t pay $200 in bills if they only have $100 in the bank, don’t seem to realize that those same rules apply to big giant companies like General Motors and Bank of America, or even the U.S. government.

 Banks can’t be made more valuable just by pushing numbers around on a piece of paper. Anyone who tells you differently is vouching for the existence of a Magic Way.

Truth, Justice and the $9.15

A financial institution can carry out any practice, however unethical, so long as they disclose it in advance in the giant wall of fine print they make new customers agree to. In violation of this rule, American Express charged some customers a 2% fee for foreign currency transactions.

A group of enterprising lawyers launched a class action suit on behalf of a cardholder named Edward LiPuma, arguing that the disclosure of the fee was incomplete, and they won.

Even though the suit was settled back in 2005, the glacial pace of the American justice system means that it took until this week for Wonk the Plank to receive our cut of the $75 million settlement.

That'll teach 'em.

Sadly, our recovered fees won’t even compensate us for the administrative burden of filling out the claim forms and depositing the check.

Revenge...errr... Justice is a dish best served cold!

By the way, American Express is still charging the fee, but now they disclose it more readily.

Reading The Tea Leaves

The convoluted, opaque nature of our tax code allows anyone to make unsubstantiated claims, no matter how preposterous, without fear of being challenged.

Wonk the Plank thought about that as we read that tax levels are at historic lows in the Washington Post, even as tea parties are held around the country to protest excessive taxation.

What’s wrong with this picture? People make contradictory generalizations about the tax code all the time, and no one calls them on it. The system is so complex that we can’t look at it ourselves to determine what’s fair or not fair. Instead, we leave it to think tanks and academics (often with ideological axes to grind) to give us contradictory answers about who’s getting a free ride and who is paying too much.

Even a question like “Do high income earners pay a greater share of their income in taxes?” can become the subject of a lame flame war between think tanks.  (Sorry Tax Foundation. You guys are usually solid but that kind of idiocy has no place on your blog.)

Slime

The cost of complying with our grotesquely bloated tax code is measured in so much more than dollars and cents. For example, there are the homeless people who need the powers of Wonk the Plank just to figure out their tax returns.

Then there are people who are almost paralyzed by the fear of doing something improper on their tax returns, like a woman we assisted recently. She had worked briefly as an independent contractor and was absolutely, 100% entitled to deduct her business expenses, meager though they were.

But Wonk the Plank really had to coax her into doing it. There’s a whole culture of sliminess associated with preparing business tax returns, which are full of greasy gray areas where exaggerations and out and out lies will go undetected. Our taxpayer thought at first that it would be better to bypass the whole sordid mess, pay higher taxes, and wash her hands of the affair.

Instead of shoveling out ever more regulations to intimidate people like Wonk the Plank’s taxpayer, how about a simple, transparent tax system so people can pay their fair share and still get to sleep at night?

Broken Record

Basically all of Wonk the Plank’s rants about tax justice say the same thing. We should adopt a simple, transparent, fair tax system with a broad base, instead of what we’ve got, which is a Byzantine system with high rates but confusing loopholes carved out for almost everyone under the sun.

Last night, Wonk the Plank was checking giving a final review to a tax return another volunteer prepared for a very kind 77-year-old woman. At the last minute, we realized that the other preparer had forgotten Maryland’s special exclusion for pensioners:

Complete the Pension Exclusion Computation Worksheet shown in Instruction 13 in the Maryland resident tax booklet. Be sure to report all benefits received under the Social Security Act and/or Railroad Retirement Act on line 3 of the pension exclusion worksheet – not just those benefits you included in your federal adjusted gross income.

To receive the benefit of the pension exclusion, be sure to transfer the amount from line 5 of the worksheet to line 11 of Form 502, and complete the remainder of your return, following the line-by-line instructions.

Oh, is that all? Wonk the Plank’s catch saved our retired taxpayer about $370 and probably would have gone uncorrected. It was especially galling to us because we are nearly certain that we’ve flubbed this very issue in the past – for other elderly taxpayers that were just as kind as the lady we helped last night.

Is This A Great Country Or What?

Once in a while, Wonk the Plank lurks the tax forum on Craiglist and lets the bizarre questions and answers just wash over us like a cool rain. We watch as 4-5 posters provide answers (often contradictory) and, for the easier questions that we are familiar with, pick out the right answers. Sometimes we will even be able to recognize the grain of truth in an otherwise garbled answer…

This is how most of us get information about taxes: asking friends, neighbors and – if we get desperate enough – perfect strangers on the internet to help us understand the tax rules. Since no transparent and understandable set of tax rules exists, information is passed down from the high priests of tax law to the taxpaying proletariat in a bizarre game of telephone.

Today, while Wonk the Plank was out preparing taxes at the MLK library, a homeless man stumped us, asking why he didn’t get the $300 rebate credit included in his 2008 tax return. (The rebate recovery credit is given to anyone who somehow didn’t qualify for a stimulus check in 2007 that was eligible in 2008 instead.)

Wonk the Plank’s taxpayer had only a little more than $500 in annual income, so he didn’t meet the $3,000 minimum test, making him ineligible for either 2007 or 2008. It took Wonk the Plank (with several years of experience doing returns) about 15 minutes of research to figure out that this was so.

When a homeless man with $500 in annual income can’t understand his tax situation without help, the tax system is pretty effed up.

R&D at AIG

With Congress mulling a confiscatory “Bonus Tax” that sounds like something straight out of Atlas Shrugged,they’ve summoned AIG interim CEO Edward Liddy to Capitol Hill to give ‘em the old razzle dazzle.

Liddy, he reminds us in an opinion piece in this morning’s Washington Post, joined AIG in September 2008 to try to clean up the mess there. His annual salary is $1, he reminds us. Oh, and he did he mention he only became CEO in September?

Meanwhile, Treasury Secretary Geithner promised to trim AIG’s $30 billion aid package by $165 million, the amount of the bonuses in question. We know Geithner is smart enough to know realize his recapture is just and sooth the nerves of the dullards who don’t understand that money is fungible. We wonder if it bugs the Secretary to engage in such an intellectually dishonest manoeuvre for the sake of politics and if it’s distracting him from the real work of fixing the economy.

Anyways, it promises to be a spectacle and you can bet Wonk the Plank will be tuning in.

Plank Of Household Status

Our tax code has relatively high rates but is chock full of deductions and credits for everything under the sun. It’s like a big supermarket with high prices, but where almost everything is on sale.

Once in a great while, a taxpayer will find himself in aisle 4 needing a can of sesame oil but stuck paying full price.

That’s what happened to Michael, a DC resident whose taxes Wonk the Plank prepared recently. He was a single man fully supporting his live-in girlfriend…meaning he almost could file under the advantageous “head of household” status. Unfortunately, that almost meant a difference of more than $500 on his tax refund.

We can miss out on big savings when we don’t do the things the tax code tells us we should do, like borrowing exorbinant sums to finance higher education or renting instead of owning a home.

Michael jokingly asked Wonk the Plank how much he would save if he married his girlfriend. We gave him our usual advice: our strong recommendation that tax consequences should not dictate those kinds of decisions.