As I sit writing this article in late October, 2008, to say that the economy in Michigan is experiencing a bumpy ride seems an understatement of the obvious. The housing market, although in stabilization mode, continues to be impeded by tougher lending qualification standards and fear about liquidity amongst homeowners. The workforce continues to get crunched as most recently illustrated by Chrysler LLC’s announcement that it intends to lay-off 25% of their salaried workforce within the next several months and the whispers heard around town that the federal government is considering loaning part of the money needed to fund a General Motors-Chrysler merger. Clients who are invested in the stock market (either inside or outside) of their retirement accounts are experiencing short-term turbulence that they likely have never seen before.
The real question for family law attorneys practicing in Michigan however is not whether or not their client’s finances seem to be in trouble, but how (if at all) it should affect the way that their divorce is handled by their attorney.
Negotiating the Marital Home
Let’s take a look at the situation Joe and Jill find themselves in. They, like many others bought a house they could barely afford 5 years ago, with a sales price of $250,000. They took out what was called a non-standard adjustable rate loan in the amount of $225,000. Their lender assured them they’d be able to re-finance it with no problem when the rate was set to ratchet up in five years. Today, they find themselves in the midst of a divorce, unable to re-finance their loan and saddled with a problem. Their house has been appraised at $175,000 ($50,000 less than the outstanding loan) and their mortgage payment has increased from $1,000/mo to $1700/mo. Sound familiar? Should Jill’s attorney’s advice today be any different relative to the home that it would have been had Jill been her client 5 years ago?
Suppose that Jill wants to retain the home as its sole owner, her first step should be to contact a mortgage specialist to see if she can qualify to re-finance the home into her own name. Five years ago, perhaps she could have obtained a sub-prime loan with little to no income verification. However, one of the outcomes of the recent housing and financial crisis has been stricter standards to underwrite loans amongst lenders and the complete elimination of the sub-prime market. It would me most unfortunate if Jill agreed to keep the home and then found out after she signed her Judgment that she was unable to re-finance the current loan (with ever increasing monthly payments).
Suppose on the other hand that Joe and Jill decide to put the home up for sale. How likely is it to sell before the divorce is final or even relatively soon thereafter? More importantly how do they come up with the money to make up the difference between the amount they owe on the loan and the significantly lower sales price?
There are no easy answers unfortunately. The most important advice Jill’s (and Joe’s) attorney can give is to analyze all the options thoroughly before agreeing to any settlement. If either party wants to keep the home and plans to re-finance, they need to make sure they will qualify. If the parties want to put the house up for sale, Joe and Jill need to understand what will happen to their financial obligations if the house doesn’t sell within an allotted period of time. If one or both parties can afford to hold onto the home until the market rebounds, that may be the best scenario for all concerned. In one case our office advised on, the wife wanted the house but the husband believed the appraisal to be grossly undervalued. As a compromise, they agreed to stipulate to the appraised value, however, they also agreed that if the house was sold within 2 years for a value more than the stipulated amount, they would split the increase after deducting the closing costs and any principal payments made by the wife.
Of course, it never hurts to involve a financial advisor when couples are weighing options for how to handle the house. Difficult financial situations call for creative solutions and often, financial experts trained in divorce issues can be of particular assistance and may relieve attorneys of potential liability exposure.
Investment Account Swings
What has always passed for good sense with regard to investing is the same today as it is in a flat or expanding stock market. For those with short term investment horizons—i.e. those who need access to their money for whatever reason, short term dollars should be invested in secure positions. Plainly, if you needed to withdraw $10,000 from your investments for your child’s tuition next year, that money should be sitting in a CD, money market or cash position. Yes, you might miss out on a short term increase if the market were to soar forward during that time frame. However, you wouldn’t lose anything either. To put money earmarked for short term needs into the stock market isn’t investing—it’s gambling.
To extrapolate that to divorce cases today, if either your client or his/her spouse may need to access investment or retirement account funds (via a QDRO and subsequent distribution) shortly after the divorce, that money should be moved to secure positions today. In fact, even if your client doesn’t need to access those funds in the near future, the question of whether or not to move funds into secure positions during a divorce must be raised.
Consider this fact pattern. A husband and wife are getting a divorce. The husband earns $250,000 plus in salary and wife has been a stay-at-home mom who has minimal income earning potential. The marital estate is worth $2 million. Husband’s million dollar share can easily remain invested in the market as he doesn’t plan to retire for 15 years (a long term investment goal). However, wife will likely want to reposition her accounts to take into consideration her new and drastically different investment goals and need for cash. In this situation, it also would seem to be prudent to advise the parties to move their assets into secure positions pending the divorce action.
In another case, the husband and wife are trading the house for the retirement accounts. They’ve agreed that the wife will retain the marital home and the husband will keep the retirement account, both of which were of equal value as of September, 2008. Now, however, the retirement account has lost 30% of its value and the husband wants the wife to take out a mortgage to make up the difference. This too was a situation in which it would have made sense to liquidate the retirement account to cash positions.
Should the repositioning of dollars in a marital estate while a divorce is pending be considered capitulating to market panic? I believe most financial experts would offer an adamant “no”. The backlash against a well-known market guru for stating that money needed over the next five years should be moved immediately out of the stock market is aimed at investors with long term investment goals. In the financial planning world, it’s always been widely accepted by rationale advisors that money needed within a short time frame should never be invested in stocks.
The “million dollar” question is “How should attorneys advise their clients”? The answer is a simple one. Attorneys need to educate their clients about the potential risks of leaving their money invested in non-secure assets pending a divorce while advising them of the potential pitfalls of selling funds to cash. The negatives include the lost opportunity cost of missing out on short term market gains. They also include (for investments outside of retirement accounts), potential transaction costs and possible tax consequences (capital gain/loss) issues related to sales. However, in many cases the negatives will be outweighed by the positives. To go one step further, if attorneys advise their clients to move their money into secure positions and they fail to do so, it might be wise to send out a letter stating that the advice was given and not followed at the client’s choice.
For those that feel this might be an over-reaction to the situation at hand, it might be helpful to keep in mind that one of the largest malpractice cases ever filed on behalf of a single party was filed in 2004 in Michigan against a family law attorney who was accused of not protecting his client’s marital estate from stock market declines. The client did not prevail; however, regardless of the size of the marital estate, it seems prudent for all attorneys to raise this issue with their clients.
Of course, there are no real absolutes. Every divorcing couple shouldn’t aim to keep the marital home intact. Similarly, there are cases when it still doesn’t make financial sense to move investment holdings into cash. The main issue for attorneys is to initiate a dialogue about how this market may be affecting each of their open cases with their clients and with opposing counsel to protect themselves and their clients interests.