BIPARTISAN EFFORT WORKING ON SOCIAL SECURITY
Depending on who you ask, Social Security’s trust fund is expected to run out of money in about a decade between 2032 and 2035. Both the Democrats and Republicans play the blame game without a lot of substantiation. However, the television sound bites play well. But fortunately, some serious-minded Senators (King, I-Maine, Romney, R-Utah, and Cassidy, R-Louisiana among others) are quietly trying to find a way to shore up Social Security, or at least seriously delay the inevitable.
What are they discussing?
- First, increasing the Full Retirement Age (FRA) from 67 to 70 over a period of years. This means taking Social Security at age 62 or any time before age 70 will have an even deeper discount.
- Currently, the maximum amount of wages subject to the 12.4% tax is $160,200 which is adjusted for inflation each year. They are talking about raising this amount to $250,000 and they project that this move alone could eliminate 73% of the short fall. Raising the tax itself is probably off the table although it is the elephant in the room.
- In an interesting twist, they are also talking about funding a sovereign investment trust fund to earn more than the fund has traditionally earned by owning government bonds. This is highly unlikely in our opinion, but what is highly unlikely today could catch fire tomorrow.
The long and short? Congress needs to figure this out. Of course, we have been saying that for over 25 years.
HIGHEST PAYING COLLEGE DEGREES
This month Ray Ferrara, our Executive Chair, spoke to over 100 University of South Florida students who are members of the Investment Club. One of his takeaways was how anxious the students were to get out of school and start a job. He reminded them that they had a lifetime of jobs in front of them, but only four years to enjoy college, so relax, have fun and make the best of those years learning in and out of the classroom. When they graduate, what degrees provide the best income? Here are the top ten according to the New York Fed with the median starting income and mid-career median income:
10) Information Systems and Management – $54,000 and $90,000
9) Engineering Technologies – $62,000 and $90,000
8) Business Analytics – $66,000 and $99,000
7) Pharmacy – $55,000 and $100,000
4 tie) Economics – $60,000 and $100,000
Construction Services – $60,000 and $100,000
Finance – $60,000 and $100,000
3) Miscellaneous Physical Services – $52,000 and $104,000
2) Computer Science – $73,000 and $105,000
1) Engineering – $68-75,000 and $100-120,000
SVB ON THE RUN
One might be forgiven for thinking that runs on a bank, and banking failures, are a thing of the Great Depression and Great Recession and not the present day. One would be wrong, thanks to the highly-publicized failure of a once-obscure institution called Silicon Valley Bank (SVB), which collapsed early this month and was taken over by federal regulators in order to protect the assets of its depositors. SVB’s collapse was the largest failure of a U.S. bank since the 2008 economic crisis. Then over this past weekend, Signature Bank, a New York financial institution was also rescued. More at the end.
Should we be alarmed? Probably not, but we must remain vigilant. Most banks loan money to local residents, small businesses and corporations. However, Silicon Valley Bank (SVB) was unique in the banking industry because it lent to an exclusive group of companies: tech startups and venture-backed health care companies. Over its 40-year existence, the bank grew with the tech industry, becoming one of America’s 20 largest lending institutions, with $209 billion in total assets at the end of last year.
Unfortunately, in addition to its loan portfolio, SVB also invested roughly $21 billion of its assets in long-term bonds paying a low interest rate averaging 1.79%. When interest rates doubled and then rose again, those bonds became much less valuable at exactly the wrong time because venture capital firms were experiencing their own shortfalls and were drawing down the deposits they held at SVB. To rectify the situation, SVB made two announcements: 1) that it had sold a big part of its bond portfolio at a loss, and 2) it proposed to sell $2.25 billion in new shares of the bank to cover those losses.
On this news, some of the venture capital firms decided that it would be safer to move their assets out and triggered a disastrous run on the bank. The bank’s share price went into a free fall, losing 80% of its value in a couple of wild trading days, and California regulators decided they’d seen enough. On March 10th, they moved in to shut the bank down and placed it into receivership.
The Federal Deposit Insurance Corporation (FDIC) guarantees any deposits up to $250,000, which means that most (if not all) of the ordinary people who banked with SVB were made whole on Monday, March 13th. Some Silicon Valley companies and other large depositors may not be so lucky. For example, Roku filed reports saying that it had around $487 million parked at SVB, representing about 26% of its cash holdings. Gaming company Roblox may have been parking as much as $150 million at the bank. Rocket Lab USA reported at least $38 million of its assets were there as well.
The news of an impending takeover sent a wave of anxiety into the markets as investors wondered whether this might be a sign of widespread weakness in the banking industry. The stocks of smaller and regional banks took a brief and probably short-term tumble in their share prices.
Over the weekend, the FDIC, the Fed and the Treasury Department began to stabilize the banking system and calm the markets. By stepping in, they guaranteed that all deposits would be made whole at both SVB and Signature Bank. HSBC announced they would buy SVB’s U.K. unit. Meanwhile the banking markets continued to be volatile and the immediate storm seems to have waned.
The most likely outcome is that the SVB mess is a healthy new examination of risks and exposures, which will give the regulators time to sort out hidden risks before they lead to more collapses.
BIDEN 2024 BUDGET PROPOSED
President Biden laid down the gauntlet last week and unveiled his fiscal 2024 budget which purports to reduce the deficit by $3 trillion over the next ten years while increasing taxes by $4.8 trillion. The President would spend the difference over the next 10 years to support programs he favors. While there is little chance of success with a Republican House, it sets the political stage for a debate on fiscal responsibility that will likely be a big topic between now and the 2024 election. The President sees taxing the “super” rich to reduce the deficit and to fund social programs while reducing defense spending. The Republicans have talked about cutting expenses but have not offered any specifics and promised to not touch Social Security and Medicare. Now they have no choice but to come forward with a plan of their own. How does this new budget increase taxes? It is impossible to cover them all, but here are a few.
- Income taxes – The proposal is to add one more tax bracket for those making $400,000 or more. The top rate would be 39.6% instead of 37%.
- Capital gains – These are currently taxed at a top rate of 20% and for some taxpayers they must add the 3.8% Obamacare tax. The new budget visualizes increasing this tax to 39.6% which means capital gains would be taxed at ordinary income rates. To shore up Medicare, the plan is to increase the Obamacare tax to 5% for those with an income greater than $400,000. Net effect? The top Federal tax rate for capital gains could be as much as 44.6% which is almost double the current top rate. At death, the unrealized appreciation of an asset is stepped up to the current value. The President’s plan would tax this unrealized appreciation before the assets are transferred to heirs. Effectively, it is an additional estate tax.
- Tax on billionaires – Biden’s budget proposes to tax those who have a net worth greater than $100 million at a minimum income tax rate of 25%. They too would pay the 5% proposed Obamacare tax.
- Super-sized IRAs – Biden sees IRAs as a middle-class benefit that has been abused by the “wealthy.” He would limit the amount that those making over $400,000 per year can hold in their IRA(s).
- Child tax credit – This is designed to increase from $2,000 per child to $3,600 for children under the age of six and $3,000 per child six and above.
- Real estate – Many real estate investors do a 1031 tax exchange when they sell a property by buying another “like-kind” property. In effect it delays paying capital gains. Biden’s plan would eliminate this well used tax provision for singles with capital gains over $500,000 and double that amount for a married couple.
- Estate and gift taxes – This would make the use of trusts less beneficial and limit discounting when doing valuations.
- Stock buyback tax – Under current law when a corporation buys back stock it must pay a 1% tax. Biden would increase this to 4%.
STUCK BETWEEN A ROCK AND A HARD PLACE
The previously mentioned bank failures have put the Federal Reserve in a difficult position. With concerns over the stability of financial systems bubbling to the surface, the Fed has stepped in to ensure depositors and provide banks with loan facilities to shore up liquidity. This response is inflationary in nature and runs counter to its offensive attack on inflation. In an admittedly hyperbolic tone, the Fed is now firmly stuck between fighting inflation and triggering a financial crisis.
This has been the risk of monetary tightening all along and it’s a risk that the Fed directly positioned itself for by keeping monetary policy too loose for too long. We do not believe a financial crisis is in play as banks are generally well-capitalized with strong liquidity profiles and prudent lending standards. Of course, there are always a few bad actors, and in this case, they might be enough to force the Fed back into monetary easing. While the banking industry (and it’s depositors) will come out of this relatively unscathed, an end to the war on inflation is now even further out than before.
LOOKING AHEAD: THE HOUSING MARKET AND MORTGAGE RATES
For most people, a house will be the single biggest purchase of their lives, and with around 65% of Americans being homeowners, it comes as no surprise that many consider the housing market a leading economic indicator. Accompanying historically low mortgage rates, home values increased dramatically in several states between 2019 and spring 2022. Mortgage rates were as low as the mid-2%s in 2021, which only helped fuel the home-buying frenzy and push home prices even higher. However, since March of 2022, mortgage rates exceeded 7% due to the pressure from inflation and the Federal Reserve raising interest rates.
Looking ahead, potential home buyers still face some headwinds with limited inventory, and mortgage rates sitting above 6% with potential increases this year. Even so, there are some silver linings. Homes are staying on the market for more than 3 weeks longer than in early 2022 and there are fewer buyers to outbid. This means more room for negotiations and concessions. While sellers are usually most sticky on the price point, the buyer can open the negotiation by offering to finish an ongoing renovation or receive a credit on the closing costs.
Whether you are looking to purchase a property now or in the next year, it is wise to have a good grasp on your finances and to line up the financing for the home. Cash is still king but having at least 20% down will make you a serious contender in the seller’s eyes.
Housing Market Momentum Stalls as Critical Spring Season Approaches – WSJ
Home-Price Growth Slowed in 2022 – WSJ
Is Now a Good Time to Buy a House? – WSJ
PROVISE WEBINAR – SAVE THE DATE
The next ProVise Webinar will take place on Wednesday, March 29th at 4 pm. We will be discussing in depth the tax proposals made by the President in his 2024 budget and their implications to our clients at both a personal and economic level. Details to follow in a few days.