Home Ownership Shelter, or Burden?
The other area of concentrated distress is subprime mortgages, which increased their share of the American mortgage market from 7% in 2001 to over 20% in 2006. According to the Mortgage Bankers Association, the delinquency rate was 22% in the fourth quarter of 2008, compared with only 5% for prime loans.
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“Perhaps the most compelling argument for housing as a means of wealth accumulation”, argues Richard Green of the University of Southern California, “is that it gives households a default mechanism for savings.” Because people have to pay off a mortgage, they increase their home equity and save more than they otherwise would. This is indeed a strong argument: social-science research finds that people save more if they do so automatically rather than having to choose to set something aside every month.
Yet there are other ways to create “default savings”, such as companies offering automatic deductions to retirement plans. In any case, some of the financial snake oil peddled at the height of the housing bubble was bad for saving.
The debate over whether home ownership is a wise investment or not, is contentious (more so in the last year than it was several years ago). I believe in most cases it probably is wise, but there are certainly cases where it is not. If you put yourself in too much debt that is often a big problem. I also think you should save a down payment first. If you are going to move (or have good odds you may want to) then renting is often the better option.
The “default saving” feature is one of the large benefits of home ownership. That benefit is destroyed when you take out loans against the rising value of the house. And in fact this can not just remove the benefit but turn into a negative. If you spend money you should have (increasing your debt) that can not only remove you default saving benefit but actual make your debt situation worse than if you never bought.
Related: Your Home as an Investment – Nearly 10% of Mortgages Delinquent or in Foreclosure – Housing Rents Falling in the USA – Ignorance of Many Mortgage Holders
Life Insurers Profit as Retirees Fear Outliving Cash by Alexis Leondis
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Payouts among insurers vary significantly, said Weatherford of NAVA. Monthly payments range from $629 to $745 for a $100,000 investment by a 65-year-old male, according to a survey of six issuers by Hueler Companies, a Minneapolis-based data research firm and provider of an independent annuity platform.
An annuity is a comforting in that you cannot outlive your annuity payment. However, there are drawbacks also. Having a portion of retirement financing based on annuity payments does help planning. Social security payments are effectively an annuity (that also increases each year, to counter inflation). While living off social security payments alone is not an enticing prospect, as a portion of a retirement plan those payments can be valuable. If you have a pension that can also serve as an annuity.
It can make sense to put a portion of retirement assets into an annuity however I would limit the amount, myself. And the annuity payout is partially determined by current interest rates, which are very low, and those now the payout rates are low. If interest rates stay low, then you lose nothing but if interest rates increase substantially in the next several year (which is certainly possible) the payout for annuities would likely increase.
Choosing to purchase an annuity is something that should be done after careful study and only once you understand the investment options available to you. Also you need to have saved up substantial retirement saving to take advantage of the option to buy enough monthly income to contribute substantially to your retirement (so don’t forget to do that while you are working).
Related: Many Retirees Face Prospect of Outliving Savings – Spending Guidelines in Retirement – Retirement Tips from TIAA CREF – Social Security Trust Fund
Fluke? Credit crisis was a heist by James Jubak
Of course, just because the plan blew up on the looters, taking off a financial finger here and a portfolio hand there, you shouldn’t have any illusion that they’ve retired. In fact, in the “solutions” now being proposed — by Congress — to fix the global and U.S. financial systems, you can see the looters at work as hard as ever.
He is exactly right.
Answer: Because the federal government had forced them to back off. An aggressive interpretation of the definition of insurance could have let state insurance agencies regulate the derivatives contracts that AIG’s financial-products group was writing out of London. These were, in fact, insurance policies that guaranteed the companies taking them out (banks, other insurance companies, investment banks and the like) against losses on securities in their portfolios.
But Congress had made it very clear in the Commodity Futures Modernization Act — supported by then-Federal Reserve Chairman Alan Greenspan, steered through Congress by then-Sen. Phil Gramm, R-Texas, and signed into law by President Bill Clinton in December 2000 — that most over-the-counter derivatives contracts were outside the regulatory purview of all federal agencies, even the Commodity Futures Trading Commission.
With the new law on the books, the market for credit default swaps exploded from $632 billion outstanding in the first half of 2001, according to the International Swaps and Derivatives Association, to $62 trillion in the second half of 2007.
Question: Wasn’t anybody worried about the risk to the financial system posed by a market that dwarfed the assets of the sellers of this insurance?
Answer: Worry about leverage? You’ve got to be kidding.
In 2004, the Securities and Exchange Commission, after hard lobbying by Wall Street, reversed its 1975 rule limiting investment banks to leverage of 15-to-1. The new limit could be as high as 40-to-1 if the investment banks’ own computer models said it was safe.
Understanding the people paid lots of money to politicians and then (after they got lots of money) those politicians enacted laws that endangered the economy to favor those giving them lots of money. Now maybe these politicians just like letting exceptionally wealthy people endanger the economy for personal gain. Maybe they think that is a good idea. I tend to think instead they do what those they give them lots of money want. But maybe I am wrong on that.
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The recent performance of investments can be discouraging. However, the most damaging reaction to your financial future is to reduce your contributions to retirement savings. IRAs and 401(k)s are great ways to save for retirement. In fact the recent performance has convinced me to increase my contributions. This is for two reasons.
First, I had been somewhat optimistic in my guesses about investment returns. The current decline means that investments in the S&P 500 have returned about 0% over the last 10 years. That is a horrible performance and it will take many years to even bring that up to a bad performance. So if you reduce your long term investment performance expectations you need to add more while you are working (or reduce your retirement expectations – or work longer).
Second, I think now is a very good time (long term) to be investing. I think the declines in the markets (both the stock market and real estate market) now provide good investment opportunities. Of course I could be wrong but I am willing to make investments based on this believe. And I believe there are plenty of place real estate prices may still be too high, but I believe there are also good buys.
A third reason worth considering is the damage done to the economy over the last 10 years and the costs of dealing with that today. Those costs are going to have long term impacts. Likely the economy will be stressed paying for the over-indulgences of the past for quite a long time. That means the risks to those in that economy will increase. And therefore having larger reserves is a wise course of action to survive the rough times ahead. Those rough times include a substantial risk of inflation. Investing to protect against that risk is important.
I would recommend starting with at least a 200 basis point increase in retirement contributions. For example, if you were saving 10% for retirement, increase that to 12%. If you have not added to your IRA for 2008, do so now (you have until April 15th to do so). In fact, if you haven’t added to your IRA for 2009, do so now.
Related: How Much Will I Need to Save for Retirement? – Nearly half of all workers have less than $25,000 in retirement savings – Investing – What I am Doing Now
I make a point of showing the discount rate changes by the Fed don’t translate to mortgage rate changes. I do so because many people think the discount rate does directly effect mortgage rates. But the Fed announced today, actions that actually do impact mortgage rates.
Federal Reserve to Buy $1.2T in Bonds, Mortgage-Backed Securities
If you are looking at refinancing your mortgage now (or soon) might be a good time, rates were already very low and will be declining. And if you own long term bonds you just got a nice increase in your value (bond prices move up when interest rates move down).
Related: Lowest 30 Year Fixed Mortgage Rates in 37 Years – Low Mortgage Rates Not Available to Everyone – Why do we Have a Federal Reserve Board?
In normal markets commercial paper is very safe. The very short term business borrowing is made possible by money market funds and provides businesses with short term financing at low rates and provides investors some return for short term cash holdings. But the recent credit crisis does not a normal market make. Companies that depended on the commercial paper market now are thinking about the risks of such dependence.
Coca-Cola Flees Commercial Paper for Safety in Bonds
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By lessening their reliance on commercial paper, borrowers are paying higher interest rates to avoid the risk of not being able to roll over the debt every few weeks. With the gap between short- and long-term debt rates the widest in at least two decades, the cost of swapping $1 billion of 30-day paper with long-term debt can cost more than $75 million in additional annual interest
Related: Where to Keep Your Emergency Funds?
World-Beating China Rally Doomed by PetroChina’s Hong Kong Gap
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Restrictions on foreign and local investment that prevent arbitrage with H shares helped make mainland equities more expensive.
It is pretty odd that there is such a large premium that local Chinese investors must pay to own stocks in the same companies available to foreign investors. There has been a discount on the Hong Kong shares (H-shares), of maybe 20-30%, for years. But it seems that either the H-shares are cheap or the Chinese shares are too expensive (or maybe a little of both). I am positive on the outlook for China both in the short and long term. Though investments there do have substantial risks (as they do anywhere). I would imagine this premium for Chinese (A-shares) should also largely disappear over the next decade as the market is allowed to become one (and at least allow arbitrage between to the two markets to reduce the premium).
Related: Capitalism in China – Easiest Countries for Doing Business 2008 – China and USA Exports and Imports Drop Sharply
The economy has structural problems. The solution at this time is not to convince people that everything is fine and just go spend money you don’t have. Personal debt is much to high. The practices that allowed huge anti-competitive and economy endangering institutions to threaten the economy have not been addressed. Hundreds of billions of dollars have been given to those who caused the credit crisis. Making the federal debt problem even worse.
Some suggest we need to regain consumer confidence. Unfortunately that fixes nothing. That “strategy” is just to convince people problems don’t exist and buying what you can’t afford is fine. Just convince people to go spend more money, run up their credit card debt, borrow against their house, as long as everyone believes it can continue. That can work for awhile but it then fails due to structural issues. And the solution becomes more and more difficult the longer such a strategy is used. The same way a ponzi scheme eventually implodes.
If you could convince those in a ponzi scheme (and new investors) that they should just be optimistic it can continue. But eventually people ask for their money to buy something and none exists and the scheme fails.
With an economy, after structural problems are addressed then you need to convince people to be less fearful and to be more optimistic. Because often by that time people have become so fearful that they are not taking even reasonable steps. They don’t buy even though they have the money in the bank and have a real need for the purchase. When this happens, convincing people that the economy is stable is important. However, cheerleading and convincing people to just continue to run up their debts to spend more is not wise when the economy is already far to in debt is not wise (though it is politically expedient).
The USA needs to stop living beyond its means. That is the most important factor to long term economic strength. But the focus doesn’t seem to be on doing this, instead it seems to be on printing money to paper over the problems. There are many great strengths of the economy and those have allowed huge federal deficits, huge personal debt, monopolistic practices, destabilizing financial risks taking… Even with that things have been quite good. But those areas need to be addressed over the long term.
Related: Let the Good Times Roll (using Credit) – Families Shouldn’t Finance Everyday Purchases on Credit – Living on Less
Ex-Leaders at Countrywide Start Firm to Buy Bad Loans
Its biggest deal has been with the Federal Deposit Insurance Corporation, which it paid $43.2 million for $560 million worth of mostly delinquent residential loans left over after the failure last year of the First National Bank of Nevada. Many of these loans resemble the kind that Countrywide once offered, with interest rates that can suddenly balloon. PennyMac’s payment was the equivalent of 38 cents on the dollar, according to the full terms of the agreement.
Under the initial terms of the F.D.I.C. deal, PennyMac is entitled to keep 20 cents on every dollar it can collect, with the government receiving the rest. Eventually that will rise to 40 cents.
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Phone operators for PennyMac — working in shifts — spend 15 hours a day trying to reach borrowers whose loans the company now controls. In dozens of cases, after it has control of loans, it moves to initiate foreclosure proceedings, or to urge the owners to sell the house if they do not respond to calls, are not willing to start paying or cannot afford the house. In many other cases, operators offer drastic cuts in the interest rate or other deals, which PennyMac can afford, given that it paid so little for the loans.
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But a PennyMac representative instead offered to cut the interest rate on their $590,000 loan to 3 percent, from 7.25 percent, cutting their monthly payments nearly in half, Ms. Laverde said.
This is one way the economy cleans up messes. A foolish organization lends money (or buys mortgages, loans…) to lots of people that couldn’t pay back and they then sell those loans at a big discounts. The new owners of the loans now have this mortgage that the homeowner can’t afford. But the cost of the mortgage to them wasn’t anywhere near the amount the homeowner owes. So the new buyer can make a great deal of money just by getting the homeowner to start paying again (even if it is at a much lower rate). They can also make money by foreclosing and then selling the property but truthfully if they can get the homeowner to pay that is likely a much better quick profit for them (and they can then sell the performing loan to someone else – I would imagine). Who knows if PennyMac will make a ton of money this way, but I fully expect many organizations to do so.
Related: Nearly 10% of Mortgages Delinquent or in Foreclosure – Learning About Mortgages – How Much Further Will Housing Prices Fall? – Jumbo v. Regular Fixed Mortgage Rates: by Credit Score
A documentary of the mortgage crisis by CNBC: House of Cards. It is a bit slow and simple but still for people that don’t really understand the basics of what happened it is interesting.
Related: Nearly 10% of Mortgages Delinquent or in Foreclosure – Ignorance of Many Mortgage Holders (2007) – How Not to Convert Equity – mortgage terms