Tuesday, September 30, 2008

False truths

By Carl

My good friend,
Britisher, makes a very cogent observation in comments from yesterday's post:

Im a technical ignoramus when it comes to high finance but...isn't this while mess ALL about debt? Debt incurred by gambling on future profits based not on tangibles but on "prospects"?.

It seems to me that for years now trade has not been based on identifiable tangible need ( barter as it were) so much as on desire.

I mean a lot of the money at stake is surely imaginary. A lot of the wealth accumulated was imaginary. Investments were made without any supporting collateral and then more investments were made on those investments that weren't supported by anything so everyone shuffling money got rich by pure accumulation.

In short investment banks started 'printing' money and trading that money for other money and more money which was also 'printed'.

This mess is actually a market adjustment.

Am I right? Or partly right?

Yes, Virginia, there was a Santa Claus.

I'm going to get financially technical for a moment, but bear with me. I think I can make it understandable.

All investments are speculations. When you purchase an investment, any investment, from your house to a 1952 Mickey Mantle baseball card to a diamond ring, you are placing a bet.

See, factored into the price you pay for your house/card/diamond/stock is what are called "future cash flows". These can either be income, like a dividend or an interest payment, or capital gains, meaning your purchase is going to go up in value.

This future income or profit is discounted and added to the cost of the investment (what it physically costs to create). In most investments, that cost is minimal (it is not in the purchase of a house).

As Michael Kinsley points out in

How is the country any richer if the exact same stock of existing housing is suddenly worth, say, 20% more? Other markets produce things. They sell what they produce. When prices go up, they produce more. Not so with real estate, for the most part. This market consists primarily of trading the same thing again and again. And you know the old saw about land: They're not making any more of it. Real estate is the only major consumer market in which how much you'll pay someone depends on your belief about how much someone else will pay you. In this market, prices go up when people believe they will continue to go up. To restore confidence would mean restoring belief in the greater fool.

And he's right, of course. Land is a fixed commodity, but there is plenty of land in the country, believe it or not, since half the population lives within 150 miles of a coastline. Yes, you want to be close to your job, but on the other hand, the way the economy is trending and the way workforces are being distributed and outsourced, you might want to live away from a city and telecommute now.

Land prices should probably fall back further, based on this alone.

But I digress. Kinsley's larger point, that buying a home is betting that you can get a sucker to pay even more for it after you've lived in it and aged it, is valid. Not only valid, but has been the basis of real estate sales since postwar America in the 50s.

Too, the perception that, by mortgaging nearly 100% of the cost to purchase you are in effect playing with house money, feeds into this conceit. You are gambling with money you have little responsibility for, because if you walk away from the mortgage, hey, the bank will foreclose, sell your house, pay off your mortgage and you still have a little left over, if the system works "the way its supposed to".

That's not to trivialize foreclosures: they are painful processes and usually occur because of some other trauma to the family/owner: job loss, medical expenses, or divorce. But if you know the bank will be "taken care of", you have one less worry on your plate while dealing with the primary problem in your life.

The trouble is, as Brit points out, it's all a fucking illusion. All of it. Rather explicity, I might also point out.

When you purchase a house, you should be paying what you think it is worth now to you, to live in, to spend some time in, to establish a domicile. We're not talking about buying a stock. Stocks are like going to a casino: you shouldn't do it unless and until you can afford to lose all of the money you invest.

This is why brokers are formally referred to as "broker-dealers" because they're dealing cards at a blackjack table, and they hold all the aces. The investment game is rigged in their favor and so any bets you might make have to be carefully picked for you to beat the house.

A house is different. A house is real money for a real necessity. If it goes up in value, then that's a bonus. But that shouldn't be the reason you go out and buy a house. You should buy a house because you need a house.

Now, you're sitting there thinking I'm kicking the American homeowner while he's down. I am, but I'm also not, because I don't blame people for wanting to believe what they want to believe, or for believing that house prices would always go up.

That's what we've all been told. And there's where the blame lies. Who told us? The bankers, brokers and developers who right now stand to be bailed out. The people who marketed "zero money down, interest only loans" without warning us that in five years, you'd have to start paying down principal AND that interest rates would like double or even triple! There is no way in the world your income can triple in five years, unless you are extremely fortunate.

The difference here is, while those banks and you gambled that you might earn enough money in five years to actually pay down your loan, or that your house might accumulate enough new value to pay off the mortgage on a sale, you couldn't have known better, while they should have!

They are financially savvy and you are not. Or at least they are supposed to be, which is why they are supposed to be licensed mortgage broker-dealers. But past history dictates that even the "experts" are not expert when things get complicated enough.

Hell, even I couldn't have foreseen the depth of this crisis, altho I had an inkling and indeed let my "inner pessimist" run amok on this blog about the coming collapse of the American economy.

There's a bitter lesson to be learned from all this: nothing, no part of your life, is without risk, is not a gamble of one sort or other. Houses were supposed to be the safest investment you could make. Indeed, they were the single largest investment you could make.

You have to start thinking about what you buy and how much you pay for it in terms of purchasing a car (the second largest purchase most people will make in their lifetimes, and an object lesson): what can the actually asset you are buying do for you?

See, cars only lose value when you drive them off the lot, at least for the first twenty years, and even then, you have to have taken immaculate care of them for them to earn back your original purchase price, even. The rational decision with a car is to buy one you can drive into the ground, making it cost as little as possible for the value attained from it (hauling groceries, taking vacations, commuting). You want to drive the car so much that the cost to own per mile is as small as possible.

So it should be with your house. You ought to buy a house that means something to you in twenty years, that makes it worth the purchase price, and forget that it *might* increase in value enough for you to retire on.

And screw the economic royalists and their attempts to shove down your throat some illusion. You're better than that!

(Cross-posted to
Simply Left Behind.)

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