From The Outside Looking In

This past weekend, Team MonGo did our quarterly review of the family's finances. In the current environment, it has been tempting to keep track of things on a more frequent basis but... given the economic volatility, that would impair my enjoyment of life!

The trend that I want to create is a closing of the gap between my expenses and income. Right now, we are deficit spending - not quite at the rate of our national governments (!) but I'd like to stop eating into savings as soon as possible.

I'm conscious of the fact that we are fortunate to have savings to back us up. This most recent review provided empathy for folks that are struggling to cover their expenses. Watching your bank account tick down when you have a mortgage, young kids and are unsure about your job... that would be extremely tough.

Five years ago, I was living off a mortgage on my house in New Zealand. It's a weird situation to go into a bank, explain you work for a loss-making start up and would like to borrow money so you can get through the next year. I was able to sort myself out relatively quickly. I suspect it would be a very different conversation today.

Removing all personal guarantees and paying down my personal debts was the single best investment I made in the last five years - quite possibly my career. In the current market, I continue to believe that the best investment you can make is removal of personal debts, and reduction of net income deficits.

There's a new page on the site menu - Colorado Endurance Guiding.

As a camp counsellor, mountaineer, ultrarunner and Epic Camper... I have been offering these services for over twenty years. Drop me a line if you want us to support you from our base in Boulder, Colorado.

Back to our personal planning, over the last nine months, we've identified, prioritized and trimmed our spending. On a quarterly basis here was the process:

• First quarter -- no change in style of living; just get a grip on what is going out the door.
• Next quarter -- trim 100% of 'luxury' spending; travel; luxury purchases; vacations; capital items.
• Recent quarter -- consider discretionary items: child care; food purchases; utilities; payments to non-minor dependents; adjust insurance deductibles to save on premiums but still cover catastrophic events; re-negotiate every third party contract when it comes due.

If we index family expenditure at "100" as at June 2008, we were still at 100 at September 2008, down to 60 at December 2008; and are at 48 (March 2008). I have a plan to get us to a cost basis of 35 but am going to wait until June, or September, of this year to see how things play out.

The process was similar in my business life except I was a lot more aggressive on the cost control (I removed 95% of third-party expenditure in two months). A big part of that reduction was caused by the insolvency of a major client that appeared on both sides (revenues & expenses) of my Income Statement:

• Q4-2008, I eliminated every single third party cost possible and brought as much as possible in house.
• Q1-2009 was spent with a focus on creating revenue producing options and building our brand name through continuous sharing of useful information.

The most effective marketing method for a consulting business is sharing your in-house knowledge with potential customers. In reviewing draft Q1 financials for the athletics "division", we went from a loss of $14K per quarter in 2008, to a profit of $4K in Q1-09.

Collectively, Monica and I are making minimum wage but... I absolutely LOVE the work and get totally fired up helping EC's clients. Helping people achieve their goals is incredibly satisfying. 1999-2007 was about premium positioning for many industries. 2008 onwards is going to be increasingly about delivering value through positive experiences (rather than goods consumption).

I have a clear view of the path to take the next steps for our business and personal lives. By chipping away, being open to change and accepting that we are going to step-up our work ethic... I can see an end to deficit spending.

From a renewed basis of long-term financial stability, we can consider "what's next" -- perhaps rebuilding my fitness to prepare for the 45-49 age group!

So that's is a bit of background on what's been happening on the Income Statement side of my life. Next, I'll share some ideas about the Balance Sheet side and end by offering ideas on steps being taken by our government and central banks.

What hasn't helped our personal situation is that the yield on our savings is down by 2/3rds over the last year. The prudent investor has seen equity portfolios and fixed income yields crushed.

I missed three fundamental changes over the last year:

• Interest rates going to zero - I was in favor of aggressive hedging right up to the point where it didn't matter. I completely failed to see a debt-deflation scenario where rates would be pushed to historical lows.
• Prime property markets - prime markets are down ~20% from their peaks. Because volumes have dried up, they have not fallen as much as I had expected. My view continues to be that Prime Markets will come off 50% from their peaks but, to date, I have been wrong. Inventory is building rapidly and fundamentals indicate a big shift downwards is possible.
• Insolvency - Bankruptcies are up but far from what I predicted last year (when I wrote about a wave that would come in Q4-08). I have been thinking about the "why" behind the lower level of bankruptcies. I believe the lack of insolvency appointments is due to the weakness of our banking industry. Lenders are not calling loans because they do not have the capital base to withstand discretionary write-offs. As we recapitalize the banking sector, I expect we will see zombie borrowers going to the wall. The only companies that are failing (so far) are those that need new funds to continue trading.

Having missed the above, I am certain that I am fooling myself in some way right now. Just not sure how!

We don't have any leverage in our lives so the current deflation "works" for us. By that statement I mean that my family's purchasing power is increasing. However, it is impossible to convince myself that a slowly shrinking capital base is worth "more". One of those quirks of human nature -- we don't "see" effective purchasing power. We tend to anchor on nominal values.

That said, the fact that diesel is cheaper these days has made me "happy" every time I fill up my Sportsmobile. It's not rational but I can't help myself -- I look forward to buying fuel because it is so less painful than a year ago.

Haven't reached the point where I drive more though!

On the flip side, I took the pain of asset write-offs, and write-downs, in 2008. It "hurt" at the time but I am getting "used to" my new portfolio level. I am out of any equity-linked investments (considering getting back in at some stage) so don't have any emotional attachment to index gyrations. As a potential buyer of assets, I prefer it when prices fall. This is a bit more rational than my response to gas station visits.

With the changes in our lives over the last year, I have been engaging in self-analysis about the way we have lived and a career of close to twenty years in the financial services industry.

On Tuesday, I read the Vanity Fair article on Iceland and watched the Stewart interview with Kramer -- I then connected the dots back to the man-in-the-mirror.

In the paragraph above, I have likely included over 80% of my peer group so, to avoid excommunication... know that the realization is one of introspection. I am not pointing fingers, simply laying out the deepest flaw in the sustainability of the way we have been living.

Just like discussions on nutrition... we are going crazy on others to avoid having to face the truth in ourselves.

What is the marketing message of the financial services industry?

• "Invest wisely"
• "Trust us"
• "We'll do the work for you"
• "Do the right thing"
• "Be prudent"

What is missing from the above?
Any sustained effort on our part! Hand over the money, kick back and achieve financial freedom. The root cause of the systemic meltdown is a shared belief that there was a way to avoid sustained work over time.

It is nearly a decade old but a hardass swim coach taught me what really matters:

• Be The Best
• Just Do It
• What Is, Is

The pain, and hubris, we are sharing stems from being sold an idea that we didn't have to work hard.

If you think you work hard in the financial services industry, pull the tailwind of leverage off your back, and try to compete in the real economy.

Humbling, eye opening and incredibly fulfilling!

I'm pretty sure that the Secretary of the Treasury didn't read my blog on Investing Billions, but I managed to get a copy in front of his peer group. It will be interesting to see how his plan for toxic assets works out. When I wrote that blog, there was a little voice that said "who are you to share your ideas on world affairs".

Even bringing up the topic again gives little twinges in my mind. However, I still believe that engaging the private sector is our best shot at getting out of this mess.

Sometimes we only need to bring a thought into the world for it to happen. Another reason why it pays to choose wisely and nurture the traits that we want to grow in our communities.

Consider the following:

• The government instructing banks to lend and tracking total lending (not quality of loan book)
• Forced mergers, in a world where we already have too many firms that are too big to fail
• The government supporting industries that produce goods that we don't want to buy
• Government committees actively allocating capital across our economies
• Government officials seeking to vary private contracts and confiscate wealth
• Favored industries being protected from the failures of their own management teams

We are being sold the above as necessary to preserve our way of life.

Our past way of life is likely gone -- a ponzi economy is unsustainable. Far better for us to face up to that fact, change the way we live, pull together and work our butts off.

Even if we could go back, do we really want to set ourselves up for an even bigger adjustment later?

Living in Hong Kong, I watched China through the 90s... as their government tried to hang on to the (failing) State Sector, they used all of the above. The only thing that kept that country moving was the work ethic of her people. Similarly, what will turn-it-around for us is the tremendous value of our Human Capital (expressed as education, innovation and productivity).

We are prolonging the period of adjustment that is necessary to move through the Great Unwinding. The connected, and politically powerful, are using their positions to maintain the status quo and avoid change. Giving government more control in our lives, while natural in fearful times, is not the path to improved productivity through innovation and hard work.

One final thought on the discussion surrounding the US Federal Reserve creating money. With the massive contraction in global liquidity, I suspect that the central bank's actions are limiting the rate of money supply decline -- rather than increasing total money supply. The Federal Reserve balance sheet charts that we are seeing on Fox News don't show the massive reduction in the size of total balance sheets, particularly in the financial sector.

As our financial sector gets back on its feet, we will likely see a further contraction in global money supply as they wipe out zombie borrowers. Additionally, if you take the wealth and consumer spending effects that my family is experiencing across, say, a billion consumers... then I continue to see deflationary trends.

Prices move at the margin -- we have a significant minority of overleveraged and fearful players. These economic players combine with increasing real asset and consumer goods inventories. Top it off with rising unemployment in all major economies. Until this fundamental position shifts, prices are going to trend down.

Our leadership understands this and are doing their best to address these points. Bernanke seems thiner every time I see him on TV. You can't fault these guys for lack of effort.

The best thing to come out of the Republican Party in the last month was an op-ed that I read in the WSJ that noted... "Perhaps we should see how bad this thing is going to get BEFORE we greatly increase entitlements and the role of government in our lives". Obama doesn't need to get everything he desires to serve our collective interests. Fiscal prudence, in terms of future entitlements, should at least be considered.

For now, I am going to focus on what I control as well as our family's desired outcome.

Staying positive and chipping away!
gordo

PS -- I promise lighter fare next week. Needed to get this out of my mind.