Worst Crisis Since '30s, With No End Yet in Sight
http://online.wsj.com/article/SB122169431617549947.html
"...Fed and Treasury officials have identified the disease. It's called deleveraging, or the unwinding of debt. During the credit boom, financial institutions and American households took on too much debt. Between 2002 and 2006, household borrowing grew at an average annual rate of 11%, far outpacing overall economic growth. Borrowing by financial institutions grew by a 10% annualized rate. Now many of those borrowers can't pay back the loans, a problem that is exacerbated by the collapse in housing prices. They need to reduce their dependence on borrowed money, a painful and drawn-out process that can choke off credit and economic growth."
I can understand how this might happen. What I can't understand is what gives people the courage to borrow money to invest it.
WELL, I can imagine for something like a small business - borrow money against your house so you can start a business and hopefully pay off the loan. If your business succeeds, you win. If your business fails, you DROP IT, and hopefully can go back to your "day job" and still make payments to pay off the failed business debt!
Well, so, as risky as that sounds to me, investing in the stock market seems doubly so. If I have a SPARE $10k in cash sitting around in a 2% interest bank account I MIGHT throw caution to the wind, and invest it in something risky like stock. But to BORROW money against my house and INVEST THAT MONEY? NO WAY!
I accept that I live my life in a point of privilege, made it through a 4-year college with no debt, and good job to pay for what I need. I don't need debt.
WELL, I did get pulled into the "low interest rates" of 2003, and purchased rental property, having a friend on Section 8 housing live in it. Being $230k in debt was definitely outside my comfort zone. Taking an adjustable rate mortgage equally so, but I could use a spreadsheet. I could project 5 years fixed interest and test various scenarios of increasing interest. What I found is, even with rental income that FAILS to cover 100% of costs (I'm a poor businessman I guess), I can cover all the bills PLUS extra payments to convert TWO 30 year mortgage into ONE 5 year mortgage (now paid), and perhaps another 5 years to pay the other. At least that assumes I keep my job and income. Risk yes, but small compared to 90% of the population - people with a much higher spending than me, with families to support and all. And worst case, I sell the rental property at a lost, but still have enough equity now to cover any sale price.
It is pretty amazing - technically my debt to income ratio was 3:1 in 2003, but now is down to 3:2. My interest payments now are under 8% of my income, and as long as I have the income, I'm putting something like 35% of my gross income into my mortgage. Smart, not 5 years ago apparently, but gives me security in my future, when I can support a lower income if I want to go back to school or whatever!
So I don't know anything about how financial people think, except not like me! I despise my 401k, stuck in Fidelity Investments, so I contribute the minimum needed to maximize contributions by my employer. So it's all nonsense to me.
I remember when I was a kid (in the 70's) my dad excitely talked about the power of compound interest, how you could retire a millionaire by investing money at a fixed interest rate. I never believed him then, not disbelief in the math, but in the economics of it all.
You have to invest in something that beats the rate of inflation, and higher interest rates means higher risks! If my NET average interest rate (subtracting inflation) over a lifetime is 1%, my $1000 savings when I was 15 years old will be worth a whopping $1817 (inflation adjusted) when I'm 95 years old!
Einstein was right to say compound interest was the most powerful force in the universe, BUT it doesn't LAST! Nature supports compounding for a time, and then CRASHES it all away!
To me the ONLY sound fiscal policy is to INVEST in a lower cost of living in the future. Then whatever income I make THEN, I'll be more likely able to cover my expenses.
So, I'm a fish-out-of-water in the land of montery greed. I'll choose security every time, which means I might yet accidentally get rich, but it'll just be relative to all the fools who overspent and under-invested in security. Wealth is having more than you need.
NOW back to the financial failures, I suppose it makes sense to see if things can yet be cleaned up ONE MORE TIME, but I hope there's enough pain that more people see that there's no free lunch, and debt is a luxury that not everyone can afford to gamble with.
It is most scary to me for the young people graduating from college now, or worse IN college, accumulating debt. At least an education is defendable use for debt, but there's still no guarantees.
"...Fed and Treasury officials have identified the disease. It's called deleveraging, or the unwinding of debt. During the credit boom, financial institutions and American households took on too much debt. Between 2002 and 2006, household borrowing grew at an average annual rate of 11%, far outpacing overall economic growth. Borrowing by financial institutions grew by a 10% annualized rate. Now many of those borrowers can't pay back the loans, a problem that is exacerbated by the collapse in housing prices. They need to reduce their dependence on borrowed money, a painful and drawn-out process that can choke off credit and economic growth."
I can understand how this might happen. What I can't understand is what gives people the courage to borrow money to invest it.
WELL, I can imagine for something like a small business - borrow money against your house so you can start a business and hopefully pay off the loan. If your business succeeds, you win. If your business fails, you DROP IT, and hopefully can go back to your "day job" and still make payments to pay off the failed business debt!
Well, so, as risky as that sounds to me, investing in the stock market seems doubly so. If I have a SPARE $10k in cash sitting around in a 2% interest bank account I MIGHT throw caution to the wind, and invest it in something risky like stock. But to BORROW money against my house and INVEST THAT MONEY? NO WAY!
I accept that I live my life in a point of privilege, made it through a 4-year college with no debt, and good job to pay for what I need. I don't need debt.
WELL, I did get pulled into the "low interest rates" of 2003, and purchased rental property, having a friend on Section 8 housing live in it. Being $230k in debt was definitely outside my comfort zone. Taking an adjustable rate mortgage equally so, but I could use a spreadsheet. I could project 5 years fixed interest and test various scenarios of increasing interest. What I found is, even with rental income that FAILS to cover 100% of costs (I'm a poor businessman I guess), I can cover all the bills PLUS extra payments to convert TWO 30 year mortgage into ONE 5 year mortgage (now paid), and perhaps another 5 years to pay the other. At least that assumes I keep my job and income. Risk yes, but small compared to 90% of the population - people with a much higher spending than me, with families to support and all. And worst case, I sell the rental property at a lost, but still have enough equity now to cover any sale price.
It is pretty amazing - technically my debt to income ratio was 3:1 in 2003, but now is down to 3:2. My interest payments now are under 8% of my income, and as long as I have the income, I'm putting something like 35% of my gross income into my mortgage. Smart, not 5 years ago apparently, but gives me security in my future, when I can support a lower income if I want to go back to school or whatever!
So I don't know anything about how financial people think, except not like me! I despise my 401k, stuck in Fidelity Investments, so I contribute the minimum needed to maximize contributions by my employer. So it's all nonsense to me.
I remember when I was a kid (in the 70's) my dad excitely talked about the power of compound interest, how you could retire a millionaire by investing money at a fixed interest rate. I never believed him then, not disbelief in the math, but in the economics of it all.
You have to invest in something that beats the rate of inflation, and higher interest rates means higher risks! If my NET average interest rate (subtracting inflation) over a lifetime is 1%, my $1000 savings when I was 15 years old will be worth a whopping $1817 (inflation adjusted) when I'm 95 years old!
Einstein was right to say compound interest was the most powerful force in the universe, BUT it doesn't LAST! Nature supports compounding for a time, and then CRASHES it all away!
To me the ONLY sound fiscal policy is to INVEST in a lower cost of living in the future. Then whatever income I make THEN, I'll be more likely able to cover my expenses.
So, I'm a fish-out-of-water in the land of montery greed. I'll choose security every time, which means I might yet accidentally get rich, but it'll just be relative to all the fools who overspent and under-invested in security. Wealth is having more than you need.
NOW back to the financial failures, I suppose it makes sense to see if things can yet be cleaned up ONE MORE TIME, but I hope there's enough pain that more people see that there's no free lunch, and debt is a luxury that not everyone can afford to gamble with.
It is most scary to me for the young people graduating from college now, or worse IN college, accumulating debt. At least an education is defendable use for debt, but there's still no guarantees.
posted by Ares Olympus at 1:31 PM
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