Observations

Given what we see all around us in the last few weeks, I couldn’t help it and I dug deep into my blog posts, and found this.

Nov 4, 2007 5:29 PM
Mortgages, Stocks, Real Estate, Jobs and Risks
from My China Experience by Amiram Hayardeny

I recently met this guy, a young successful professional who just bought a house. Nothing very exciting about that (no offense of course). We were talking about the housing market in general, and in California in particular. I asked the innocent question: “how do young people buy a house these days? It must be extremely expensive”. To which he said, to my great surprise: “not at all, I just bought one”. He went on and described the zero down payment, ten years interest only mortgage loan he found. Happy person, living in a house in which he will have no equity ten years from now, having paid interest only and putting no down payment on the house. I pushed on. What if, I said, what if something goes wrong? What if you lose your job? No problem, he said, I’d get another job in no time. In fact, he said, my expertise is sought throughout California, I would be hired in a matter of minutes. I didn’t let go. What if, I said, what if you, God forbid, get sick? My family will help, he said. They would probably rather help than see their son or sibling homeless. My both hands shot up to the air, I surrender, I said, but one more question please. “Shoot”, he said. I asked if it didn’t bother him that for ten years he will pay no principal whatsoever, which shall leave him with no equity in his own home after ten years of payment. At this point he laughed. He said that it’s nothing short of madness to pay principal, while everyone knows that the money can perform a lot better in the stock market.

So the reasoning is this: take the money that you would have paid in principal, and invest it in the stock market. After ten years, you should easily be able to pay off the principal, and still have a ton of money leftover – the result of your great profits off the stock market and the constant rise in real estate prices. Obviously, he said, within ten years, the house will be worth a lot more than it does today, and thus my equity will be worth a lot more, and I’d have a lot of change to spare. Just before I turned around, I said “and what about the risk?”. “What risk”, he said.

And after this conversation I realized. The American real estate, as well as the stock market have come up with the only possible conclusion given the surrounding business reality, the business news, the Federal Reserve, the analysts, the mortgage bankers: “whatever happens, someone is going to save my neck”. If there’s a “credit crunch”, the Fed will lower the rates, creating more opportunities to take cheaper loans, and kick the economy. Because no matter what happens around the world, America is driven by its economy, and its economy only. The legend says that one day after President George W. Bush Sr. had lost the election to Bill Clinton, a big sign showed up just outside the White House saying: “It’s the Economy, Stupid”. Seems that the message have been read. The future is not important, in order to survive the present, the economy must do well. In fact, it must do better than that. It must show growth, opportunities, it must be outstanding, not just good. Then again, if a bright young man has no reservations about mortgaging his own future for his present well-being, why should a country?

A crazy idea hit me. Is it really possible that some people think that they can’t lose? Is it possible that from what they see they concluded that no matter what, the stock market will only go up, and so will the prices of the houses? And that there will always be a great job waiting for them somewhere? Is it possible that some people will be driven to take even higher risks as a result of the thought that they can’t lose? Have we completely forgotten the bubble? Short reminder: people did buy property only to find that they owe the bank a lot more than the property’s worth, and people did find themselves in the position of foreclosure when they couldn’t pay their monthly payments. It does happen.

This isn’t about investment tips and ideas. This is about understanding the difference between economic stability of a country and an individual. Risk taking for a pension fund which manages many billions of dollars and a household. Economies rarely collapse. Individuals often do. There is a chance that the house in which you live will lose value overtime, and that some of your investments will evaporate.

Years ago, a friend of mine made a bid on a house. The negotiation process was long and hard, during which a large amount of money was released from some investments. My friend thought that if he found the right investment, he could make a few bucks until the money is needed for the house (I’m talking about the old days, when people used to put down payments on their houses). To make a long story short, he used a common friend who worked on Wall Street at the time, and chose a stock on which he put much of the money. The company went under, the stock lost much of its value. The house was bought but with a lot less equity, and the friendship disintegrated.

Assuming that the stock market will always go up, that the job market will always be good for you, that your house’s value will only go up, is basically assuming that there’s no risk. This assumption is wrong, and risky. As in the world of the Corrida or the bull fighting, the bulls don’t always lose…

Obviously, I had not KNOWN at the time that the real estate market would trigger such an outstanding collapse in the US, leading to the complete destruction of Lehman Brothers (just as an example), I mean who could have known?  But it does strike me today that Nouriel Roubini guessed right.  And when I saw him this week on CNN looking straight to the camera and saying that the Fed’s sleeves are empty (to add my own paraphrase here: no more monetary rabbits out of the diminishing hat), watching in awe the riots in London, and the “concerns” about French banking, I can’t help but wondering.  Is it possible that the Fed was covering one hole by digging another?