Saturday, May 26, 2012

Financial Risk at an Opportune Moment

Here we are, 2012, and mortgage interest rates are at a low we'll probably never see again, 3.5% on thirty years. They're comparable to inflation.  Neither index has anywhere to go but up, especially given our nation's financial foolishness of borrowing, spending, tax-raising, and can-kicking.

Combine low mortgage rates with property prices still shocked and locked from 2008, and a financial risk-taker probably sees this as the prime opportunity to make money off of borrowed money in the romanticized market of real estate.  Land.  They aren't making any more of it. 

Here's the playbook:
  • Sign on long term for as much as you can handle to purchase assets whose market price can only go up (or can they?) 
  • The funny thing about (fixed) mortgage interest rates- they're fixed for the term of the loan, and the term of the loans are long. 1982 was thirty years ago. Mortgage interest rates were 13-14%. The Clash released Combat Rock. 
  • Should I Stay or Should I Go?
  • Lock in your costs at today's ridiculously low rates and be a baron down the road.  If your bet is right, you'll be sitting pretty.

What could go wrong?

Ask those who were flipping houses during the 2000-2007 real-estate bubble.  The game was to buy on short term financing, refurb (or not- sometimes the houses appreciated regardless) and flip.  Double down on the next few properties.  Lather, rinse repeat.  And then the bubble burst, leaving the risk-takers with interest-only-balloon and other unique short term loans and properties they couldn't move.  What to do?  It's no fun to declare bankruptcy mid-life and start all over.
Debt is funny.

When financing investments it is a risk, a bet that you can beat the cost of financing with your return.  Debt is a time machine getting you what you want now at a fixed additional cost and, well, indebtedness (and opportunity cost) for the future.  Your cash-flow is committed until the investment matures, for better or worse.  What are you risking?  Debt on a dead investment.  If you can't pay that, you're risking savings, retirement money (you do know that you're responsible for your own retirement, don't you?), bankruptcy.

It seems quaint to look back a mere five years (when interest rates were a relatively astronomical 7%) and consider that we defined and justified (let's be honest- rationalized) our homes as investments.  My, how times change.  Today we look at the same loan as what it truly is- a debt to be paid to acquire an asset many are upside-down on and will be for a while.  Despite fortunate refinancing and aggressive principal pay-down, we're still hoping for market prices to float us back to sea.

Does your neighborhood look like this?

Cash (dare we call it capital?), however, is an interesting investment instrument in comparison to a financed investment.
  • You can make a wiser call on your investment because, man, you feel the pain of spending that money and will be more cautious than when spending time-machine money.
  • If things go wrong, you can weather the storm or, worst case, cut bait at a loss.
  • Your cash-flow is not affected; other sources of income (other investments, your wages and earnings, savings) continue to carry you in tough times.
  • The assets you purchase with cash are yours.  They are a positive on your balance sheet.
And so here we are.  The cost of the bet is 3.5% per annum.  Indicators are that we're bottomed out, yet the risk is still the same. One thing can go right.  Many things can go wrong.  Are you willing to get caught with financed investments?

Rush was also busy in 1982, and had this to say about the Subdivisions we find ourselves living in today:

Some will sell their dreams for small desires
Or lose the race to rats
Get caught in ticking traps
And start to dream of somewhere
To relax their restless flight
Somewhere out of a memory of lighted streets on quiet nights...

Tuesday, May 22, 2012

A random and apropos thought from Hayek

When I get the chance, I chip away at F.A. Hayek's "The Road to Serfdom."

When I get the chance: because there's so much to learn, so much to pursue, so much to do.
Chip away: not because it is unclear, but because it is so rich.  A mere paragraph gets my mind wandering and scribbling notes in the captions, then on post-its, then on to full blown writin.

From Chapter 6, "Planning and the Rule of Law"

Where the precise effects of government policy on particular people are known, where the government aims directly at such particular effects, it cannot help knowing these effects, and therefore it cannot be impartial.  It must, of necessity, take sides, impose its valuations upon people and, instead of assisting them in the advancement of their own ends, choose the ends for them.  As soon as the particular effects are foreseen at the time a law is made, it ceases to be a mere instrument to be used by the people and becomes instead an instrument used by the lawgiver upon the people and for his ends.  The state ceases to be a piece of utilitarian machinery intended to help individuals in the fullest development of their individual personality and becomes a "moral" institution - where "moral" is not used in contrast to immoral but describes an institution which imposes on its members its views on all moral questions, whether these views be moral or highly immoral.

Hayek earlier compares this type of law, these specific orders to general rules, genuine laws, where the precise results cannot be foreseen and which are by definition, impartial.

Let's pause, shall we? 

Were you to be concerned with right-wing religious zealots enforcing their morality upon you, you'd certainly see Hayek's point.  But what if you were concerned with left-wing secularists enforcing their morality upon you, such as the HHS mandate for insurance coverage of birth control?  Are these not the same concern?

Are we not becoming a "moral" state?  It seems every crisis or scandal is used for its circumstances to create new regulations and laws to prevent such a crisis, scandal, or wrongdoing from happening again.

Well. There are a lot of circumstances. Butterflies flap their wings in China and hurricanes occur in the Bahamas, you know?

Shall we have regulations for every circumstance where something goes wrong?  If so, the state becomes a moral power rather than a liberal one, where moral laws predetermine what is permissible rather than being a reliable, liberal framework in which possibilities are open for the citizens to pursue, take risk, succeed and fail.

Freedom from failure is not freedom.

Let's continue now and complete Hayek's paragraph, which encapsulates the point of the book- a warning in 1944- a warning in 2012- a warning in all times to those who yearn for freedom and the responsibility that goes with it rather than freedom from responsibility:

In this sense the Nazi or any other collectivist state is "moral" while the liberal state is not.
Here's to freedom.  Here's to classical liberalism. As opposed to, say social liberalism.  Or many of the other isms even Ferris Bueller was wise enough to be concerned about.