Keith Van Horne, The Sub Prime Mortgage and Financial Literacy

The Answer: Keith Van Horne, the Sub prime Mortgage Market, Financial Literacy
The Question: (hermetically sealed in a Mayonnaise Jar) Name three reasons the Economy is in bad shape?

Twenty years ago, late-night legend, Johnny Carson’s all seeing Karnack would give the answers to questions before they were asked to the enjoyment and laughter of millions in his TV audience. Unfortunately, the above question and answer isn’t funny, but is true in many ways.

How did so many people “get talked into” sub prime mortgages without fully understanding the potential risk that they faced when rates escalated? You could blame financial literacy, because as a nation we failed to teach people how to budget, how to balance a checkbook and how to save for retirement.

And, what about our children? What are we teaching them when they want to spend hundreds of dollars on MP3 players, phones, gaming systems, designer purses and shoes? The examples they follow come from the headlines and “Unreality” shows on TV which makes entitlement a divine right. It also comes from seeing people like Keith Van Horn.

Nets forward Keith Van Horn landed $4.3 million after being involved in a sign and trade from Dallas in the Jason Kidd deal Feb. 19. Van Horn, who was enjoying post-basketball life in Colorado at the time of the trade, did not play one game for the Nets after he was acquired.

I don’t have a problem with Keith Van Horn. He worked hard for his money (or did at one time.) It is another example of how “Deal or No Deal”, the lottery, and Texas Hold’em has replaced the Passbook saving account, Christmas Club and “Saving for a Rainy Day ”as a strategy for financial security.

Robbing from the future to pay for the past.

A disturbing trend is emerging as workers begin borrowing from tomorrow’s retirement accounts to pay for today’s lifestyles (Investment News):

With the economy deteriorating and prices for gas and heating fuel skyrocketing, consumers who are seeking new sources of cash are increasingly jeopardizing their retirement income by taking out loans from their retirement plans.

The number of such loans has been growing at double-digit rates, according to top plan providers. [...]

The T. Rowe Price Group Inc. reported that loans from retirement plans it manages were up 10% in each of the past two years, and the trend has continued in 2008, with loans in January and February up 6%, compared with the first two months of 2007. [...]

The Merrill Lynch Retirement Group of Pennington, N.J., reported a similar trend in its proprietary business of 1,500 clients, representing 2.6 million participants and $103 billion in assets.

The firm, a subsidiary of New York-based Merrill Lynch & Co. Inc., said that between the first and fourth quarters of 2007, the number of general-purpose loans from 401(k)s increased 14%, while residential loans decreased 40% and hardship withdrawals jumped 42%.

"We do a lot of education on our website and in statements," said Kevin Crain, managing director for business retirement and corporate market integrated benefits at Merrill Lynch. "They have the right to take out loans, but we want them to think about some of the issues." [...]

Fidelity Investments reported that the number of loans taken by participants in 401(k) plans administered by the Boston-based firm's retirement services division increased in 2007 by just under 4% from 2006, according to company spokesperson Jennifer Engle. Fidelity declined to disclose the number of plans or assets it has under management or the number of participants.

The company also saw a 17% increase in hardship withdrawals between 2006 and 2007. In total, the number of participants making hardship withdrawals is just over 1%, Ms. Engle said.

As Alicia Munnell, director of the Center for Retirement Research at Boston College in Newton, Mass., points out in the article, "If you take out a loan and repay it over five years, the [401(k)] plan suspends your contribution for five years. You'll end up with 82% of what you would have if you left the money there."

Unfortunately, many 401(k) plan particiapnts believe that because their accounts hold their own money, they are doing themselves no harm by self-borrowing. The problem is that no one — including themselves — will lend them money later in retirement if there’s not enough to be had for a comfortable retirement. By borrowing today, they are robbing their accounts of the ability to grow, including years or even decades of the investment power of compound interest.

Asset managers, investment companies, 401(k) platforms, financial advisors, take note: Unless you step to the plate and explain to participants how much harm they are doing, they will continue to cannibalize their own futures to pay for their past mistakes.

What’s needed: a proactive educational program that financial advisors or even plan sponsors can use to to teach plan participants that a 401(k) loan really is a last-resort measure. Don't burglarize your own house — borrow from someone else before you borrow from yourself.