[hrothgar]

1eyedjack, on Feb 26 2008, 04:55 PM, said:

I have no information from which to dispute what you say, but I find it surprising (I find lots of things surprising, mind), and it is at odds with my understanding of the general perception, although my general perception may be coloured by local property market trends. I expect that you calculated the expected return on the stock market by the rise in the index, akin to sticking a pin on the dartboard as an investment policy. Likewise I expect that you calculated the expected return on real estate by a rise in global property prices over a period. A particular individual who is considering this equation in relation to his personal affairs is unlikely to apply so random a policy to either medium. The attitude of the consumer to risk may also be a factor. Traditionally the equity market is regarded as a higher risk investment medium than the property market. If you limit the population of equity products to those with a comparable degree of risk you may find that the expected return drops to something more closely resembling that of the property market.

I look at it in possibly overly simplistic terms: In any financial transaction, cutting out the middle-man is usually the winning option for the purchaser and vendor alike, the only loser being the middle-man excluded from the transaction whose profit foregone can then be shared between the remaining end parties. Taking this analogy to the property market, in order for a tenancy to exist there has to be a landlord. The landlord expects a return on his investment, which will come in part from an expected rise in property prices and in part from rental income. The landlord will have done his own sums to determine that the expected return is sufficient to make it worthwhile for him to be a landlord. That return is at least in part at the expense of the tenant. In this regard the landlord is akin to the middle-man, the exclusion of which would be of benefit to the prospective freeholder. Without doing any sums or market analysis, therefore, I would expect the outright purchase to be the winning option.

The information about expected returns from the stock market compared to the housing appreciation was taken from Forbes or Fortune. You are correct that these were based on averages.

Then again, I tend to be a fairly conservative investor. Most of my funds (say 80%) tend to go into an incredible boring profile.

I'm 40 years old. Right now I have about 30% of my funds in bonds. Mostly tax free munis because its looks like a decent time to buy. The remaining 70% are split between various no load index funds. I split this about 66%-33% between domestic funds (S&P 500 and the like) and international indexes.

This type of profile requires almost no thought. Everything works almost automatically, and you have an incredibly low expense ratio. Moreover, you don't need to worry about exposure to a small number of stocks (You aren't throwing darts)

Admittedly, the remaining 20% is my mad money. This is what I use for silly stuff like going long on urea, copper, oil, and the like. Even though this is "silly money", I don't like to ever take short positions because margin calls are a bitch. I very much prefer going look in an opposite asset (I didn't short the dollar, rather I took a long position in Euros). As I mentioned earlier, right now I'm desperately looking for some way to take a long position on land usage rights for solar energy in either Mexico or Morrocco.

Don't get me wrong... I have nothing against buying real estate. The reason that I studied this all over the last couple monthes was to make an informed decision about whether this might be the right time to buy. From what I can tell, housing prices are still significantly overpriced in comparison with both the rental market and the stock market...

[joshs]

1eyedjack, on Feb 26 2008, 08:55 AM, said:

hrothgar, on Feb 25 2008, 09:18 PM, said:

Comment 2:  I just did a fairly serious cost / benefit analysis studying whether or not it makes sense to buy a house or continue to rent an apartment.  Rent turned out to be the overwhelming favorite.

Rent now, I'm renting a very nice two bedroom apartment for about 1200 a month.  I have plenty of space in a nice town and I'm walking distance to work and the commuter rail lines.  I always heard that you shouldn't buy unless the home price is roughly 100 times your monthly rent.  I'd have to pay 500K for anything comperable.

Maybe rental prices in the Boston market are still artifically low compared to home prices; however, even with all the various savings associated with home ownership its still a lot better to sock away 50 grand a year into mutual funds rather than paying down a mortgage, paying real estate taxes, homeowner's insurance, and either (condo fees or maintenance).  I rather be making interest than paying it to someone else.

Yes, houses are nice.  Yes its nice not to worry about capital gains.  Even so, over 25 years the stock market will typically outperform the Real Estate market 4:1.  Moreover, if I do decide that the real estate market has bottomed out, I can always start investing cash into real estate funds...

I have no information from which to dispute what you say, but I find it surprising (I find lots of things surprising, mind), and it is at odds with my understanding of the general perception, although my general perception may be coloured by local property market trends. I expect that you calculated the expected return on the stock market by the rise in the index, akin to sticking a pin on the dartboard as an investment policy. Likewise I expect that you calculated the expected return on real estate by a rise in global property prices over a period. A particular individual who is considering this equation in relation to his personal affairs is unlikely to apply so random a policy to either medium. The attitude of the consumer to risk may also be a factor. Traditionally the equity market is regarded as a higher risk investment medium than the property market. If you limit the population of equity products to those with a comparable degree of risk you may find that the expected return drops to something more closely resembling that of the property market.

I look at it in possibly overly simplistic terms: In any financial transaction, cutting out the middle-man is usually the winning option for the purchaser and vendor alike, the only loser being the middle-man excluded from the transaction whose profit foregone can then be shared between the remaining end parties. Taking this analogy to the property market, in order for a tenancy to exist there has to be a landlord. The landlord expects a return on his investment, which will come in part from an expected rise in property prices and in part from rental income. The landlord will have done his own sums to determine that the expected return is sufficient to make it worthwhile for him to be a landlord. That return is at least in part at the expense of the tenant. In this regard the landlord is akin to the middle-man, the exclusion of which would be of benefit to the prospective freeholder. Without doing any sums or market analysis, therefore, I would expect the outright purchase to be the winning option.

Robert Shiller did a study on historical US home price appreciation, and found in constant dollars, over the last 100 years, homes have appreciated in value at 1%/year. The S&P on the other hand has been appreciating at more like 7%/year in constant dollars. Thus homes are not great as a pure investment.

(Constant dollars means adjusting for inflation)

The nice thing about owning a home is that its an asset that you can
a. use (you get value from living there)
and
b. borrow against

Its hard to understate the importance of b. Since its hard to move a home, it provides very good colateral for a loan. I read recently, that 70% of all business are started with a 2nd mortgage against their home. (http://www.amazon.co...d_sim_b_title_1)

P.S. Wow, $1200/month for a 2 bedroom in the boston area!

For Comparison here is a sample claculation:

If you put 100K down on a 500K property
Your mothnly Mortgage payment (@6%) would be $2400 which works out (initially) as $2000/month in interest and $400/month in principle. there is also tax and insurance which I will estimate at $600/month and maintance of $200/month (I am probably underestimating this).

the principle amount you are basically paying to yourself, and you get about 1/3 of the interest, tax and insurance back as a tax break, so your net monthly costs are:
2/3*$2600+$200=$2000

Now if you rent, you didn't have to make the $100K down payment. Assuming that you make 6% a year on this money, you are earning $500/month. So your rental net is $1200-$500=$700

So in this scenario, buying requires almost 3 times the monthly spending, even after taking into account the tax credits.
In order to make up for the $1300/month the home needs to appreciate at a rate of 12*1300/500000=3.1%/year just to break even. (Actually its a bit more than this, since the principle portion could have been invested at a higher yield rather than going into the house, but thats a second order effect).

Over time, this required % will go down, since rents will go up, and the % of money you pay as principle also goes up.

[hrothgar]

joshs, on Feb 26 2008, 10:54 PM, said:

1eyedjack, on Feb 26 2008, 08:55 AM, said:

hrothgar, on Feb 25 2008, 09:18 PM, said:

Comment 2:  I just did a fairly serious cost / benefit analysis studying whether or not it makes sense to buy a house or continue to rent an apartment.  Rent turned out to be the overwhelming favorite.

Rent now, I'm renting a very nice two bedroom apartment for about 1200 a month.  I have plenty of space in a nice town and I'm walking distance to work and the commuter rail lines.  I always heard that you shouldn't buy unless the home price is roughly 100 times your monthly rent.  I'd have to pay 500K for anything comperable.

Maybe rental prices in the Boston market are still artifically low compared to home prices; however, even with all the various savings associated with home ownership its still a lot better to sock away 50 grand a year into mutual funds rather than paying down a mortgage, paying real estate taxes, homeowner's insurance, and either (condo fees or maintenance).  I rather be making interest than paying it to someone else.

Yes, houses are nice.  Yes its nice not to worry about capital gains.  Even so, over 25 years the stock market will typically outperform the Real Estate market 4:1.   Moreover, if I do decide that the real estate market has bottomed out, I can always start investing cash into real estate funds...

I have no information from which to dispute what you say, but I find it surprising (I find lots of things surprising, mind), and it is at odds with my understanding of the general perception, although my general perception may be coloured by local property market trends. I expect that you calculated the expected return on the stock market by the rise in the index, akin to sticking a pin on the dartboard as an investment policy. Likewise I expect that you calculated the expected return on real estate by a rise in global property prices over a period. A particular individual who is considering this equation in relation to his personal affairs is unlikely to apply so random a policy to either medium. The attitude of the consumer to risk may also be a factor. Traditionally the equity market is regarded as a higher risk investment medium than the property market. If you limit the population of equity products to those with a comparable degree of risk you may find that the expected return drops to something more closely resembling that of the property market.

I look at it in possibly overly simplistic terms: In any financial transaction, cutting out the middle-man is usually the winning option for the purchaser and vendor alike, the only loser being the middle-man excluded from the transaction whose profit foregone can then be shared between the remaining end parties. Taking this analogy to the property market, in order for a tenancy to exist there has to be a landlord. The landlord expects a return on his investment, which will come in part from an expected rise in property prices and in part from rental income. The landlord will have done his own sums to determine that the expected return is sufficient to make it worthwhile for him to be a landlord. That return is at least in part at the expense of the tenant. In this regard the landlord is akin to the middle-man, the exclusion of which would be of benefit to the prospective freeholder. Without doing any sums or market analysis, therefore, I would expect the outright purchase to be the winning option.

Robert Shiller did a study on historical US home price appreciation, and found in constant dollars, over the last 100 years, homes have appreciated in value at 1%/year. The S&P on the other hand has been appreciating at more like 7%/year in constant dollars. Thus homes are not great as a pure investment.

(Constant dollars means adjusting for inflation)

The nice thing about owning a home is that its an asset that you can
a. use (you get value from living there)
and
b. borrow against

Its hard to understate the importance of b. Since its hard to move a home, it provides very good colateral for a loan. I read recently, that 70% of all business are started with a 2nd mortgage against their home. (http://www.amazon.co...d_sim_b_title_1)

P.S. Wow, $1200/month for a 2 bedroom in the boston area!

For Comparison here is a sample claculation:

If you put 100K down on a 500K property
Your mothnly Mortgage payment (@6%) would be $2400 which works out (initially) as $2000/month in interest and $400/month in principle. there is also tax and insurance which I will estimate at $600/month and maintance of $200/month (I am probably underestimating this).

the principle amount you are basically paying to yourself, and you get about 1/3 of the interest, tax and insurance back as a tax break, so your net monthly costs are:
2/3*$2600+$200=$2000

Now if you rent, you didn't have to make the $100K down payment. Assuming that you make 6% a year on this money, you are earning $500/month. So your rental net is $1200-$500=$700

So in this scenario, buying requires almost 3 times the monthly spending, even after taking into account the tax credits.
In order to make up for the $1300/month the home needs to appreciate at a rate of 12*1300/500000=3.1%/year just to break even. (Actually its a bit more than this, since the principle portion could have been invested at a higher yield rather than going into the house, but thats a second order effect).

Over time, this required % will go down, since rents will go up, and the % of money you pay as principle also goes up.

Hi Josh

Few quick comments:

1. Your numbers are in the right ballpark. You estimation of taxes and insuance seems a bit high and maintance seems a bit low, but this all washes out.

2. You neglected to note that Massachusetts lets you deduct apartment rent from state income taxes

3. On the rent front: I'm living in Natick, which is a bit far from Boston proper. Somerville, Cambridge, even Watertown and the like are a lot more expensive.

Still, its only a 40 minute drive to the harbour and an hour by commuter rail.... More important, I can walk to work in 20 minutes :-)

[mike777]

helene_t, on Feb 26 2008, 07:14 AM, said:

mike777 said:

Bottom line if you do not want the risk of ownership you need to transfer that risk or the PV of the house to someone else...you can right now.

Yes but people tend to live in the house they own, for obvious reasons. They want to be able to make modifications to the house they live in without having to ask a landlord. They want to the increase in value of the house, which comes from their good care for their house, to go to themselves, not to the landlord. They don't want to pay for the overhead associated with renting.

I propose a mechanism that would allow homeowners to keep those advantages without being forced to face the risk associated with fluctuations in the overall house prices.

Helene:

If I understand your basic theory, you want something that keeps the upside of the house gains but something that has no downside risk.

Keep in mind houses go up or down in value for many many reasons not just because what the Nat home market does. I think it would be impossible for an instrument to protect you from all downside risk and still allow for a few upside risks. In real estate I would estimate 90-99% of the reasons for the price of your home to go up or down are local reasons, very local reasons, not worldwide overall housing prices.

Here is just one local example. Four houses out of 12 on my tiny block have been sold or are up for sale the last 12 months. All the prices are up in the middle of a worldwide housing crises.

Perhaps without the crises they would be even higher, who knows.

[mike777]

helene_t, on Feb 26 2008, 07:14 AM, said:

mike777 said:

Bottom line if you do not want the risk of ownership you need to transfer that risk or the PV of the house to someone else...you can right now.

Yes but people tend to live in the house they own, for obvious reasons. They want to be able to make modifications to the house they live in without having to ask a landlord. They want to the increase in value of the house, which comes from their good care for their house, to go to themselves, not to the landlord. They don't want to pay for the overhead associated with renting.

I propose a mechanism that would allow homeowners to keep those advantages without being forced to face the risk associated with fluctuations in the overall house prices.

Let me please try some finance jargon.
Systemic risk
Nonsystemic risk

For simplicity I am going to ignore fat tails, or that in a worldwide nuclear war correlations go to one.

In Real estate let's call Nonsystemic risk, local real estate risk in your home. Let's also assume nonsystemic risk is 95% of all total risk.

Let's call systemic risk, nat and worldwide realestate risk. Assume 5% of all risk.

The neat thing in finance is we can diversify away, nonsystemic risk. We can kill it. We may or may not want to but we have the ability to do so. In fact we can twist it, transport it and do all kinds of neat tricks with it. The same with the profit, we can kill it, transport it, twist it and do all kinds of neat tricks with it.

That just leaves 5% systemic risk in our assumption. Of course we get all our profit or loss now from only systemic risk. Almost all home owners would not want to do this. They much prefer to live with the local risk, which is why in real estate they say there are only three important things in real estate.

1) location
2) location
3) and location

[hrothgar]

mike777, on Feb 27 2008, 12:28 AM, said:

That just leaves 5% systemic risk. Of course we get all our profit or loss now from only systemic risk. Almost all home owners would not want to do this. They much prefer to live with the local risk,

The existence of

homeowner's insurance
fire insurance
flood insurance

and the like would seem to contradict your statement

[helene_t]

mike777, on Feb 26 2008, 10:01 PM, said:

If I understand your basic theory, you want something that keeps the upside of the house gains but something that has no downside risk.

That's not what I had in mind but it's a detail. Maybe some homeowners would like to buy off all risk associated with the general house market while others would like to buy off only the risk of a loss. If that's a big issue (I suspect it is not but what do I know) two parallel instruments could be created. I was using the word "futures" which implies that both positive and negative risk would be bought off. If I had thought off negative risk only I would have used the word "options" (or "warrants").

I think it's quite simple. Contractors buy off market risks associated with fluctuations in raw material markets. That's standard. I just want homeowners to have a similar posibility.

Obviously I am wording this very badly since you can't understand it.

I don't understand your distinction between systemic and nonsystemic risk. If my local market risk is 95% associated with things specific to Lancashire and only 5% with the general UK trend in house prices, obviously I would need a (negative) future on the Lancashire market. If you mean 95% associated with my specific house (like the risk that nobody wants to buy my house because the neighbors have a pitbull terrier) then obviously my suggestion would not work, but then again this whole thread would be somewhat irrelevant.

[mike777]

"I think it's quite simple. Contractors buy off market risks associated with fluctuations in raw material markets. That's standard. I just want homeowners to have a similar posibility."

Ok let me try one more time. The statement you have above is just not true.

You can never have no downside risk and keep all of the upside risk.

Why would I sell you that product? I am only going to sell you a product where I have a high chance of making a profit. I am not going to sell you a product where I have a high chance to loss money and a low chance to make tiny money.

However I will sell you a product where you have a chance to lose lots of money and I have a high chance to make a little money.

Contractors can buy off some of the market risks with fluctuations in raw materials for a short time. If they bought off all of the risk it would cost you 100%.

Same thing is true in any market including housing.

Let me try and explain using a farmer of corn.

Day one I forward sell all of my corn (X bushels of corn) for 100,000$ I lock in my production costs of 90,000$...I got a guaranteed profit of 10,000$ on Day 100 right?

Wrong.

There is a drought, my corn does not grow. Supply of corn is low, demand is high I have to buy X bushels of corn for 110,000$ and deliver the corn.......now I have a huge loss...OR in real life I have to buy back my contract/hedge/insurance at a loss.

Let me put it another way..you can try and hedge away your risk but the cost should be the PV of the loss and carrying costs. I am not going to buy your risk unless I think I can make a profit ..not a loss.

Or to use your negative future example..it costs the PV plus carrying costs.

Or let us use car insurance..what does car insurance cost you?
500$ a year
If your car does not get hit..you lose 100% of your money, 500$ year after year after years yes?
If your car does get hit...it costs you 750$ the next year, yes.

[mike777]

I will try and make some numbers that may be close to real life.
1/01/08 your house is worth 100, 000 euros.
You buy your future to protect your self from market fluctuation for 1000 euros
12/31/08 you sell your house for 100,000 euros.....the market did not change.

You lose 1000 euros the cost of the future
But you also lose 7000 euros 7% the standard cost of selling your house.

In other words it is tough to come out ahead if you hedge away all risk after costs. Simple because you do not get rid of all risk/costs.

[helene_t]

Yes, your example is what I'm thinking about. It will cost the homeowner money most of the time, and it will cost on average, but it will eliminate the risk of a catastrophic loss (in this case: a catastrophic loss due to overall market fluctuations). Just like an insurance. However, the overhead will be much lower than an insurance because there is no need for individual loss assessment. Futures are exercised by a simple computer program, the process is not more expensive than other routine financial transactions.

I think that it, if properly implemented and marketed, could be attractive for many homeowners (not the majority, maybe). Because the option of paying someone for taking the market risk already exists. It's called renting, and some people prefer that to owning. However, by renting you also pay for a lot of other things. Not everybody might want to bundle those things.

[hrothgar]

mike777, on Feb 27 2008, 05:19 AM, said:

Ok let me try one more time.  The statement you have above is just not true.

You can never have no downside risk and keep all of the upside risk.

Why would I sell you that product? I am only going to sell you a product where I have a high chance of making a profit. I am not going to sell you a product where I have a high chance to loss money and a low chance to make tiny money.

Mike

Why do you keep posting this stuff when you clearly have no idea what you're talking about

In this case, you appear to be confusing both

1. Expected value and risk
2. Options, collars, and futures contracts

Lets consider the following simple case:

I own 1,000 bushels of wheat. I want to protect myself against a fall in the price of wheat. I buy a "put" option that gives me the right to sell my wheat for $1 a bushel. I have now effectively shielded myself from any downside risk. If, however, the price of wheat goes up I don't need to exercise the option.

Alternatively, I am a major airline. I am worried that the price of jey fuel is going to go up. I decide to buy a series of call options to purchase jet fuel. I am now insulated against an increase in the price of jet fuel. However, I will still benefit from decreases in the price of jet fuel...

There are also collars (where you sell a combination of both puts and calls) as well as futures contracts where you guarantee that you will sell an asset at a specified price.

By the way... The simply answer to your question regarding why anyone would sell the instrument in question is market asymmetries.

1. Different individuals might have different risk profiles
2. Different individuals might have different beliefs
3. Different people might have different information

[kenberg]

Everyone has his numbers, so I have mine. First, let me just give concrete experience. The numbers are from almost 40 years ago so they will seem perhaps strange.

In 1970 I bought a townhouse for 28K. I am going to estimate some numbers so let's say 30 K. I sold it a few years later and after realtor's fees and such I had a profit of about 6K. A 20% profit? No, much better. I had put down about 6K to buy it. While I lived in it I paid on the mortgage but after the tax breaks it came to about the same as rent. So really I had a profit of about 100% ( If I sell for 36K and have a mortgage of 30-6=24K I get 12K back, I had invested 6K). The note about the study showing that the stock market beats the housing market needs to take this margin buying (if that is the correct term) into account.

Now to look at the current situation. It was, and to a lesser extent still is, possible to buy into a house with much less of a % down payment than when I bought in 1970. If prices go up, the profit percentage thus is even higher than it was back then. Ah yes, but prices might go down. Let's compare stocks and houses.

A person thinks stock X is a good investment ant buys 500K of stock. Oops. The price drops to 450K. Few people are cavalier about losing 50K but we are talking of a person that had 500K to invest and still has 450K if he sells. An annoyance, no doubt. Now suppose a person buys a house for 500K, putting down 30K with a mortgage of 470K(I think this was possible a bit back). The price of the house drops to 450K. This is not an annoyance, it's a disaster. He has lost money he doesn't have.


Now I will get a little out of my depth. As I understand it, this margin buying was a strong contributing cause to the 1929 crash. You could do with stocks what people today do with houses. You thought a stock was going to go up, you bought it by putting down a fraction of the cost. As long as prices kept going up, everyone got rich. This drove people to make ill-considered stock purchases using money that they didn't have, and when things got wobbly panic set in.

I realize that there were some good intentions to allow everyone to buy a house.
But there was, in earlier times, some financial sense in requiring some sort of decent down payment. House prices, over time, go up. Over short periods of time, they may go down. If our hypothetical guy above had put down 100K on his 500K home then when it drops to 450K he won't be happy but he also won't be wiped out, He won't panic, there won't be a foreclosure, he won't move out in the middle of the night with no forwarding address, and so on.


Optimism and good intentions are fine qualities. When dealing with finances, a little realism is also useful. Our banking industry seems to have forgotten that.

[hrothgar]

mike777, on Feb 27 2008, 05:19 AM, said:

Let me try and explain using a farmer of corn.

Day one I forward sell all of my corn (X bushels of corn) for 100,000$ I lock in my production costs of 90,000$...I got a guaranteed profit of 10,000$ on Day 100 right?

Wrong.

There is a drought, my corn does not grow. Supply of corn is low, demand is high I have to buy X bushels of corn for 110,000$ and deliver the corn.......now I have a huge loss...OR in real life I have to buy back my contract/hedge/insurance at a loss.

Here, once again, you're comparing apples and oranges

Futures contracts are used to hedge against fluctuations in pricing
Crop insurance is used to hedge against a bad growing season

Different instruments are used to protect against different risks

Critiquing a futures contract because it doesn't protect an individual against a bad growing season is equivalent to complaining that a "Married with Children" episode doesn't provide enough information about the crisis in Dafur

[joshs]

kenberg, on Feb 27 2008, 07:40 AM, said:

Everyone has his numbers, so I have mine. First, let me just give concrete experience. The numbers are from almost 40 years ago so they will seem perhaps strange.

In 1970 I bought a townhouse for 28K. I am going to estimate some numbers so let's say 30 K. I sold it a few years later and after realtor's fees and such  I had a profit of about 6K. A 20% profit? No, much better. I had put down about 6K to buy it. While I lived in it I paid on the mortgage but after the tax breaks it came to about the same as rent. So really I had a profit of about 100% ( If I sell for 36K and have a mortgage of 30-6=24K I get 12K back, I had invested 6K). The note about the study showing that the stock market beats the housing market needs to take this margin buying (if that is the correct term) into account.

Now to look at the current situation. It was, and to a lesser extent still is, possible to buy into a house with much less of a % down payment than when I bought in 1970. If prices go up, the profit percentage thus is even higher than it was back then. Ah yes, but prices might go down. Let's compare stocks and houses.

A person thinks stock X is a good investment ant buys 500K of stock. Oops. The price drops to 450K. Few people are cavalier about losing 50K but we are talking of a person that had 500K to invest and still has 450K if he sells. An annoyance, no doubt. Now suppose a person buys a house for 500K, putting down 30K with a mortgage of 470K(I think this was possible a bit back). The price of the house drops to 450K. This is not an annoyance, it's a disaster.  He has lost money he doesn't have.


Now I will get a little out of my depth. As I understand it, this margin buying was a strong contributing cause to the 1929 crash. You could do with stocks what people today do with houses. You thought a stock was going to go up, you bought it by putting down a fraction of the cost. As long as prices kept going up, everyone got rich. This drove people to make ill-considered stock purchases using money that they didn't have, and when things got wobbly panic set in.

I realize that there were some good intentions to allow everyone to buy a house.
But there was, in earlier times,  some financial sense in requiring some sort of decent down payment. House prices, over time, go up. Over short periods of time, they may go down.  If our hypothetical guy above had put down 100K on his 500K home then when it drops to 450K he won't be happy but he also won't be wiped out, He won't panic, there won't be a foreclosure, he won't move out in the middle of the night with no forwarding address, and so on.


Optimism and good intentions are fine qualities. When dealing with finances, a little realism is also useful. Our banking industry seems to have forgotten that.

You can buy stocks on margin also. You just don't get the tax break that reduces the effective interest rate... But if you want to count the returns on your highly leveraged investment, ok but lets compare apples to apples. Also, Transaction costs of buying stocks are much lower (you are not paying 6% commissions...)

Ooops, never mind I just read the rest of your post..

[kenberg]

Winstonm, on Feb 24 2008, 02:36 PM, said:

The New York Times is reporting that the Bank of America has proposed to the U.S. Congress a creation of a special government agency to buy troubled debt, thereby eliminating these obligations from the bank balance sheets and transferring the risk of further loss to the taxpayer - a socialization of bad debt.

From the NYT (emphasis added)

Quote

WASHINGTON — Over the last two decades, few industries have lobbied more ferociously or effectively than banks to get the government out of its business and to obtain freer rein for “financial innovation.”

A confidential proposal that Bank of America circulated to members of Congress this month provides a stunning glimpse of how quickly the industry has reversed its laissez-faire disdain for second-guessing by the government — now that it is in trouble.

The proposal warns that up to $739 billion in mortgages are at “moderate to high risk” of defaulting over the next five years and that millions of families could lose their homes.

To prevent that, Bank of America suggested creating a Federal Homeowner Preservation Corporation that would buy up billions of dollars in troubled mortgages at a deep discount, forgive debt above the current market value of the homes and use federal loan guarantees to refinance the borrowers at lower rates.

“We believe that any intervention by the federal government will be acceptable only if it is not perceived as a bailout of the bond market,” the financial institution noted.

The arguments against a bailout are powerful. It would mostly benefit banks and Wall Street firms that earned huge fees by packaging trillions of dollars in risky mortgages, often without documenting the incomes of borrowers and often turning a blind eye to clear fraud by borrowers or mortgage brokers.

If the government pays too much for the mortgages or the market declines even more than it has already, Washington — read, taxpayers — could be stuck with hundreds of billions of dollars in defaulted loans.

As is the usual case with the U.S.A., we like to do things in a "super" manner. Not satisfied to bailout a single failing lender like the U.K. (Northern Rock), the ideas being proposed in the U.S. are more "Northern Rock on steroids".

On which side of this fence do you sit? Bail 'em out or let 'em burn?

Let me try to address the implied question: What should the government do about those who are going to lose their homes. With such questions I find it useful to ask myself: What would I do for a close friend or a family member? Collectively doing more for strangers than I would personally do for a friend strikes me as strange. So would I help? How?

Every case is different, but under some circumstances I would loan some money. There are not many circumstances, really probably no circumstances, where I would just give some money. I certainly would not cosign or in any other way take over the loan.

So if the government can come up with some plan to help those who can reasonably be expected to first get back on their feet and second pay back the money over a period of time, I would listen and maybe support this. The government has made such a muck of the student loan program that I am not so sure I am prepared to trust them with this, but I would not reject such an idea out of hand. Helping people is an idea with merit, but it doesn't always work out as planned.


Of course it is reasonable to see B of A's suggestion as watching out for the interest of B of A. But the fact that I am not interested in helping the irresponsible goons who created this mess does not mean I have no interest in helping some families.

I'm not so interested though in helping the guy who took out a second mortgage on the inflated value of his home and bought a BMW. I drive an Accord.

[Winstonm]

Quote

So if the government can come up with some plan to help those who can reasonably be expected to first get back on their feet and second pay back the money over a period of time, I would listen and maybe support this.

Ken, this is the "bill of goods" being sold for the bailout - what terrible, untoward event has caused these people to lose the ability to pay their mortgage payment?

Employment has been stable. No national disasters to speak of. During the height of the mania, 2005-2007, inflation was tame so that isn't the blame.

People are losing their homes for only one reason - they couldn't afford them in the first place. The majority losing their homes were the last suckers to buy in a Ponzi finance scheme - a game of musical chairs and they were the ones left standing when the music stopped. Everyone thought that home prices would go up forever and they could always sell to the next sucker - no one stopped to think that they may BE the last sucker.

And the banks, ratings agencies, appraisers, and investors who bought the paper all played along, making enormous profits along the way.

But this game couldn't last forever for one simple reason: solvency.

Housing costs simply rose too much compared to wages - it really is that simple.

And all the bailouts in the world are designed to do one thing: protect the capitalizations of the lending institutions - while tossing the remaining losses onto the taxpayer.

If the idea was really to keep everyone in their homes, you could do the same thing by raising wages to match mortgage payments - but funny, you don't see the banks asking for a national wage pay increase. I wonder why?

[Winstonm]

Quote

By EDMUND L. ANDREWS
Published: February 27, 2008
WASHINGTON — President Bush sided with banks and mortgage lenders on Tuesday, threatening to veto a bill being offered by Senate Democrats that would give more bargaining power to homeowners who face foreclosure.

[kenberg]

Largely I agree Winston, although not entirely.

Around here there are townhouses, very modest, not anything special, that are going for a quarter million and up. How could this happen? Speculation fever, of course, but I think that this creative financing idea had a role to play as well. Go back a few years, not many, when the price for the same place was maybe 150. A careful sensible family could save up 30K for a 20% down payment. You didn't need to be a CEO to accomplish this. But the requirement would sort the careful from the frivolous. Enter creative financing. Any fool with a pen, and the bank will supply the pen, could get a loan. Demand goes up, prices go up, and now the sensible careful guy who was prepared to buy the house for 150 with 30 down finds that the price is 250. Oops.

The banking community has always presented itself as careful sensible folks who can be trusted. Probably it was a bit naive to take that at face value but at any rate that is all in the past. Whether they are morons or scoundrels or both, an old quip on skepticism is about to be updated: I'm from the bank and I'm here to help you.

[Winstonm]

Well, Ken, Treasury Secretary Henry Paulson (Former CEO Goldamn/Sachs) had this to say:

Quote

“I’m seeing a series of ideas suggested involving major government intervention in the housing market, and these things are usually presented or sold as a way of helping homeowners stay in their homes,” Mr. Paulson said. “Then when you look at them more carefully what they really amount to is a bailout for financial institutions or Wall Street.”

There is no reason to bail out homeowners who made poor decisions - they relied on being able to refinance or sell - that is risk.

The banks lent them too much money on the premise that the buyer could refinance or sell - that is risk.

Risk is a two-way street.
Can't afford to play, then don't gamble.

[Winstonm]

kenberg, on Feb 28 2008, 08:15 AM, said:

Largely I agree Winston, although not entirely.

Around here there are townhouses, very modest, not anything special, that are going for a quarter million and up. How could this happen? Speculation fever, of course, but I think that this creative financing idea had a role to play as well. Go back a few years, not many, when the price for the same place was maybe 150. A careful sensible family could save up 30K for a 20% down payment. You didn't need to be a CEO to accomplish this. But the requirement would sort the careful from the frivolous. Enter creative financing. Any fool with a pen, and the bank will supply the pen, could get a loan. Demand goes up, prices go up, and now the sensible careful guy who was prepared to buy the house for 150 with 30 down finds that the price is 250. Oops.

The banking community has always presented itself as careful sensible folks who can be trusted. Probably it was a bit naive to take that at face value but at any rate that is all in the past. Whether they are morons or scoundrels or both, an old quip on skepticism is about to be updated: I'm from the bank and I'm here to help you.

Sure, Ken, there were a number of factors that drove prices higher - the entire system engaged in euphoria-driven overoptimism.

Everyone involved has a share in the blame, including the buyers of the houses that were unaffordable.