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Boxwood out to allay the ultra-wealth debt squeeze

Thomas Coyle

17 February 2009

Advisory helps families stay liquid enough to keep what they worked to get. The economic crisis triggered by the decline of the U.S. residential-mortgage market in 2007 has made itself felt to different groups of people in different ways and to different degrees.

For some members of the middle class it has meant a year of dismaying 401(k) and 529 reports and little more; it could be argued that recent high oil prices were a source of more distress than the effect of deflated property and capital markets. For others in the middle class, however, the downturn has meant postponed retirements, increased indebtedness, lost jobs, lost homes and the stark prospect of starting over in the face of a sharp and persistent recession.

Similarly, the recent reversals have cost some wealthy Americans money -- as much as 30% of the value of their assets evaporated last year, according to recent one survey of U.S. millionaires -- without placing them under more serious constraint. But other high-net-worth and ultra-high-net-worth individuals and families are in serious trouble with de-valued assets and falling incomes threatening their lifestyles and long-term aspirations.

Great expectations

Think of the Wall Street executive who spent the years between 9/11 and 2008 bringing in $10 million, $15 million, $20 million a year in cash and investment-asset compensation. Now suppose her 2008 take-home fell -- no stretch this -- to $1 million. For some, such an abrupt drop would be vexing, certainly, but not ruinous. But our executive -- like many wealthy individuals and families -- is in a truly frightening position for having in previous years leveraged investment assets and future cash-flow assumptions in exchange for immediate consumption. Now she finds that her cash flow has been curtailed and her assets have plummeted in value but that her liabilities are -- of course -- constant and as much in need of service as ever.

The result is what investment bankers call a "structural debt squeeze." As a private-client phenomenon it arose from the Federal Reserve 's efforts to keep the U.S. economy from tipping back into recession after 9/11 by lowering the cost of funds to banks. In turn the banks were happy to slash the cost of credit to their big private clients -- who quickly cottoned on to the arbitrage between, on one hand, raising money by selling securities (taking a capital-gains hit in the process) and, on the other hand, raising money by using their securities as collateral to borrow at something like LIBOR plus 50 basis points.

These high-wealth consumers "could get the money they needed without selling their still-appreciating liquid position and make the purchase they desired," Alec Haverstick, a managing partner of Boxwood Strategic Advisors, writes in an article called "Solutions to a Structural Debt Squeeze." Meanwhile current yield on the portfolio might well cover debt-servicing charges "with any distributions partially sheltered by available interest rate deductions," he adds. "This would also allow them to spend future cash flow, which was also increasing exponentially, on consumption rather than on debt service."

And it wasn't just Wall Street types who began acting this way. "This was happening all over the country: in the oil patch, in the real-estate kingdoms of Phoenix and Newport Beach and even in Silicon Valley," says Haverstick "In all these places and more, individuals were converting unrealized paper wealth into hard assets that could add to their quality of life."

Even where tax considerations weren't paramount, it seemed a fair bet to fund the purchase of one appreciating asset with another appreciating asset that the owner gets to retain. Rules against borrowing against marketable securities to buy more marketable securities made improved land the likeliest target of these transactions.

As a result, "individuals wealthy on paper backed up the trucks and filled them with cash," Haverstick writes. "They then carted that money to the Hamptons, to Nantucket, to Vail or to wherever like-minded socio-economic peers were gathering and away from those securities and use another home or the family business as a collateral pool, and then we'll say, 'Now let's go to the bank with a plan that makes sense' -- because, believe me, you don't want to be sitting with the bank without a plan. The point is to help our clients avoid a liquidity squeeze and so live to fight another day." -FWR

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