Home Equity had Best Count as "Savings" - 'Cause That's All the Savin' We're Doin'
From the Thoughts from the Frontline newsletter.
[All emphasis added.]
"Central Bankers of the World, Unite!"
That at least seems to be the theme from the central banker's playbook. The US Federal Reserve, The European Central Bank and now even the Bank of Japan all seem to be in a mood to tighten the global money supply. [...]
One of the more important aspects to global growth has been the "quantitative easing" policy of the Bank of Japan. Basically, they have put about Y30 trillion into the world since 1999, with Y20 trillion of that coming since 2003. They have flooded the world with liquidity, at almost exactly the same time as the US Fed was aggressively lowering rates. Japan has been a main source of capital and savings for the world. Now that looks like it is going to change. [...]
[T]he European Central Bank [has] raised interest rates, and optimistically projected European growth to be higher. European Central Bank President Jean- Claude Trichet said, "...projections for the annual average rate of growth are in a range between 1.7 and 2.5% in 2006 and between 1.5 and 2.5% in 2007." While we should note that if the Bush administration made such a proclamation, it would be considered a disaster, this is actually an increase in the estimates for Europe. When combined with his recent and frequent use of the word "vigilant" every time he talks about inflation, it seems to indicate that the ECB is not through with its rate increases. Cheap European money and credit is on its way out the door.
And with the recent strength in the US of the ISM numbers, it appears the US economy is going to turn in a very respectable GDP number this quarter. It makes a rate hike this month a lock, increases the probability of a hike in May and maybe one more in June. I am not alone in that thought. Market expectations (using CBOT futures prices) suggest that there is a 100% chance of a rate hike in March, a 78% chance in May, and a 67% in June. Futures pricing even suggest a better than even chance for a fourth rate hike in August! [...]
In short, all three major central banks, and a lot of smaller central banks, are going to either tighten their money supply or continue to raise rates or both. Yet, investors and banks continue to lend money and demand less risk premium. Such a combination does not usually end in happiness. It reminds me of Mad Magazine's Alfred E. Neuman. "What? Me Worry?"
When central banks tighten simultaneously, bad things can happen. Think of the tightening in 1997 and then the Asian and Russian problems in 1998, or the serious tightening in 1999 and 2000 and the stock market corrections in 2001-2003.
Reduced liquidity and rising interest rates are slowly being translated into higher mortgage rates, slowing the rise in home prices and cash out refinancing. As I wrote last summer, the Fed is clearly bent on stopping a housing bubble in its tracks. They hope to be able to engineer something similar to what has happened in both the United Kingdom and Australia, where both countries experienced an even greater housing price increase than in the US, their central banks raised rates and yet did not see a falling of home prices or a bursting of a bubble. Home prices in those countries simply went flat.
Are higher interest rates having an effect on the housing market? The clear answer is yes. RealtyTrac (www.realtytrac.com), the leading online marketplace for foreclosure properties, [recently] released its January 2006 Monthly U.S. Foreclosure Market Report, which shows 103,540 properties nationwide entered some stage of foreclosure in January, a 27% increase from the previous month and a 45% increase from January 2005. The report shows a January national foreclosure rate of one new foreclosure for every 1,117 U.S. households, continuing an upward trend in which the national foreclosure rate rose in every quarter of 2005.
An interesting series of stories on foreclosures in the Charlotte Observer in North Carolina illustrates the problem. As they report, FHA loans are failing in Charlotte at nearly twice the national level. But the reasons for failure are interesting. Many of the failures are on the lower end of the economic scale. A new mortgage industry grew in the mid-1990s, offering loans at higher interest rates to people who don't qualify for traditional loans. Such loans account for about 10% of all home purchase loans but result in at least 24% of local foreclosures, the Observer found.
More than 40% of failed loans in Charlotte involved an arranged gift from a charity to cover the borrower's down payment. It's a practice the FHA is reviewing because such loans fail 76 percent more often. Further, more than 20% of foreclosures resulted from defaults on loans taken after the home purchase. The cash out financing was at such high interest rates that it pushed the families into economic problems. Let me state that I am all for lenders willing to make home loans to riskier type accounts. The stability of an area is improved when you have more home owners, and I am all for people having a chance to own their own homes. But it will involve more defaults. In certain streets in Charlotte, up to 20% of the homes are in foreclosure. That does not help property values for the remaining home owners.
The Fed is going to get what it wants: home price increases are going to come down and then go flat. [...]
A large number of homes in hot markets have been bought by "investors," using adjustable rate mortgages with little or no equity. They intend to either flip the house or rent them. The increased cost of holding those homes is going to make it difficult for those investors who do not have some deep pockets. Right now, in many of the hot markets like San Francisco, LA, New York, Miami, DC and Las Vegas, it is much cheaper to rent than to buy. According to an article in [the] Financial Times, the extra cost of ownership to renting in those markets is anywhere from 50% to almost 100% more!
Let's recapitulate. Cash out refinancing is dramatically slowing down, and as interest rates rise, will slow down even more. Home price increases are also going to slow down and stop. The Fed is going to continue to increase rates until that trend is well and truly broken. Rising rates make homes less affordable so fewer homes will be sold. Since much of the recent growth in the US economy relates directly to housing, that growth is going to slow down. Consumer spending is also slowing as a result.
And then along comes Japan and suggests they are going to start to take away the world's liquidity punch bowl. They will not do so rapidly, but do it they will. This will eventually have an effect on financing costs world wide. It helped while they were easing and it will have the opposite effect as they take that easing policy away. [...]
This is just one more reason why I think we are going to see a slowdown in the economy that latter part of the year. And it is one more reason why I think the broad equity markets are going to have a very difficult period.
I want to close with this rather troubling survey released this week by the Financial Services Forum. The headline for the press release was "Survey finds that half of all Americans worried about retirement security." There is a good reason for them to be worried. [...]
This is in response to the question "How much did you save last year for retirement, including such savings plans as IRAs and 401ks?" Read it and weep.
[31% of people aged 50 - 64 saved $ 1,000 or less, and an additional 12% saved less than $ 5,000. Among those who had saved $ 25,000 or less, those aged 35 - 49 saved at a rate 50% higher than those aged 50 - 64 did. 33% of those aged 50 - 64 didn't give an amount, for various reasons.]
Assuming the 33% that did not respond breaks out more or less in the same percentages as those who did respond, we find that 67% of the people aged 50-64 saved less than $10,000 last year. Over 40% saved less than $1,000!!! [...]
Interestingly, only 51% of those age 50-64 are worried about retirement. This tells me that a lot of people are not really focused on their retirement, or have some very unrealistic expectations about how well they will live on Social Security. This squares with other surveys I have written about. A majority of Americans expect to work either full-time or part-time after retirement. The above data suggest they will not have a choice, as their savings will not be there.
~ John Mauldin
Same source, different week:
Americans are clearly the richest people on earth. Or are they? With some $50 trillion in stocks, bonds and real estate, we are watching our net worth grow each year. Some argue that the low US saving rate is not a problem as real net worth is growing fairly rapidly. But not for the average family.
A survey by the Federal Reserve Board's Survey of Consumer Finances offers us the most detailed recent look at the balance sheet of U.S. households. The median family has about $3,800 in the bank, do not have a retirement account, has a home worth $160,000 with a mortgage of $95,000. No mutual funds, stocks or bonds populate their investment portfolios. They make (jointly) $43,000 and struggle to pay off their $2,200 in credit card debt. That means 50% of Americans are in worse shape than the above. It is not a pretty picture.
[All emphasis added.]
"Central Bankers of the World, Unite!"
That at least seems to be the theme from the central banker's playbook. The US Federal Reserve, The European Central Bank and now even the Bank of Japan all seem to be in a mood to tighten the global money supply. [...]
One of the more important aspects to global growth has been the "quantitative easing" policy of the Bank of Japan. Basically, they have put about Y30 trillion into the world since 1999, with Y20 trillion of that coming since 2003. They have flooded the world with liquidity, at almost exactly the same time as the US Fed was aggressively lowering rates. Japan has been a main source of capital and savings for the world. Now that looks like it is going to change. [...]
[T]he European Central Bank [has] raised interest rates, and optimistically projected European growth to be higher. European Central Bank President Jean- Claude Trichet said, "...projections for the annual average rate of growth are in a range between 1.7 and 2.5% in 2006 and between 1.5 and 2.5% in 2007." While we should note that if the Bush administration made such a proclamation, it would be considered a disaster, this is actually an increase in the estimates for Europe. When combined with his recent and frequent use of the word "vigilant" every time he talks about inflation, it seems to indicate that the ECB is not through with its rate increases. Cheap European money and credit is on its way out the door.
And with the recent strength in the US of the ISM numbers, it appears the US economy is going to turn in a very respectable GDP number this quarter. It makes a rate hike this month a lock, increases the probability of a hike in May and maybe one more in June. I am not alone in that thought. Market expectations (using CBOT futures prices) suggest that there is a 100% chance of a rate hike in March, a 78% chance in May, and a 67% in June. Futures pricing even suggest a better than even chance for a fourth rate hike in August! [...]
In short, all three major central banks, and a lot of smaller central banks, are going to either tighten their money supply or continue to raise rates or both. Yet, investors and banks continue to lend money and demand less risk premium. Such a combination does not usually end in happiness. It reminds me of Mad Magazine's Alfred E. Neuman. "What? Me Worry?"
When central banks tighten simultaneously, bad things can happen. Think of the tightening in 1997 and then the Asian and Russian problems in 1998, or the serious tightening in 1999 and 2000 and the stock market corrections in 2001-2003.
Reduced liquidity and rising interest rates are slowly being translated into higher mortgage rates, slowing the rise in home prices and cash out refinancing. As I wrote last summer, the Fed is clearly bent on stopping a housing bubble in its tracks. They hope to be able to engineer something similar to what has happened in both the United Kingdom and Australia, where both countries experienced an even greater housing price increase than in the US, their central banks raised rates and yet did not see a falling of home prices or a bursting of a bubble. Home prices in those countries simply went flat.
Are higher interest rates having an effect on the housing market? The clear answer is yes. RealtyTrac (www.realtytrac.com), the leading online marketplace for foreclosure properties, [recently] released its January 2006 Monthly U.S. Foreclosure Market Report, which shows 103,540 properties nationwide entered some stage of foreclosure in January, a 27% increase from the previous month and a 45% increase from January 2005. The report shows a January national foreclosure rate of one new foreclosure for every 1,117 U.S. households, continuing an upward trend in which the national foreclosure rate rose in every quarter of 2005.
An interesting series of stories on foreclosures in the Charlotte Observer in North Carolina illustrates the problem. As they report, FHA loans are failing in Charlotte at nearly twice the national level. But the reasons for failure are interesting. Many of the failures are on the lower end of the economic scale. A new mortgage industry grew in the mid-1990s, offering loans at higher interest rates to people who don't qualify for traditional loans. Such loans account for about 10% of all home purchase loans but result in at least 24% of local foreclosures, the Observer found.
More than 40% of failed loans in Charlotte involved an arranged gift from a charity to cover the borrower's down payment. It's a practice the FHA is reviewing because such loans fail 76 percent more often. Further, more than 20% of foreclosures resulted from defaults on loans taken after the home purchase. The cash out financing was at such high interest rates that it pushed the families into economic problems. Let me state that I am all for lenders willing to make home loans to riskier type accounts. The stability of an area is improved when you have more home owners, and I am all for people having a chance to own their own homes. But it will involve more defaults. In certain streets in Charlotte, up to 20% of the homes are in foreclosure. That does not help property values for the remaining home owners.
The Fed is going to get what it wants: home price increases are going to come down and then go flat. [...]
A large number of homes in hot markets have been bought by "investors," using adjustable rate mortgages with little or no equity. They intend to either flip the house or rent them. The increased cost of holding those homes is going to make it difficult for those investors who do not have some deep pockets. Right now, in many of the hot markets like San Francisco, LA, New York, Miami, DC and Las Vegas, it is much cheaper to rent than to buy. According to an article in [the] Financial Times, the extra cost of ownership to renting in those markets is anywhere from 50% to almost 100% more!
Let's recapitulate. Cash out refinancing is dramatically slowing down, and as interest rates rise, will slow down even more. Home price increases are also going to slow down and stop. The Fed is going to continue to increase rates until that trend is well and truly broken. Rising rates make homes less affordable so fewer homes will be sold. Since much of the recent growth in the US economy relates directly to housing, that growth is going to slow down. Consumer spending is also slowing as a result.
And then along comes Japan and suggests they are going to start to take away the world's liquidity punch bowl. They will not do so rapidly, but do it they will. This will eventually have an effect on financing costs world wide. It helped while they were easing and it will have the opposite effect as they take that easing policy away. [...]
This is just one more reason why I think we are going to see a slowdown in the economy that latter part of the year. And it is one more reason why I think the broad equity markets are going to have a very difficult period.
I want to close with this rather troubling survey released this week by the Financial Services Forum. The headline for the press release was "Survey finds that half of all Americans worried about retirement security." There is a good reason for them to be worried. [...]
This is in response to the question "How much did you save last year for retirement, including such savings plans as IRAs and 401ks?" Read it and weep.
[31% of people aged 50 - 64 saved $ 1,000 or less, and an additional 12% saved less than $ 5,000. Among those who had saved $ 25,000 or less, those aged 35 - 49 saved at a rate 50% higher than those aged 50 - 64 did. 33% of those aged 50 - 64 didn't give an amount, for various reasons.]
Assuming the 33% that did not respond breaks out more or less in the same percentages as those who did respond, we find that 67% of the people aged 50-64 saved less than $10,000 last year. Over 40% saved less than $1,000!!! [...]
Interestingly, only 51% of those age 50-64 are worried about retirement. This tells me that a lot of people are not really focused on their retirement, or have some very unrealistic expectations about how well they will live on Social Security. This squares with other surveys I have written about. A majority of Americans expect to work either full-time or part-time after retirement. The above data suggest they will not have a choice, as their savings will not be there.
~ John Mauldin
Same source, different week:
Americans are clearly the richest people on earth. Or are they? With some $50 trillion in stocks, bonds and real estate, we are watching our net worth grow each year. Some argue that the low US saving rate is not a problem as real net worth is growing fairly rapidly. But not for the average family.
A survey by the Federal Reserve Board's Survey of Consumer Finances offers us the most detailed recent look at the balance sheet of U.S. households. The median family has about $3,800 in the bank, do not have a retirement account, has a home worth $160,000 with a mortgage of $95,000. No mutual funds, stocks or bonds populate their investment portfolios. They make (jointly) $43,000 and struggle to pay off their $2,200 in credit card debt. That means 50% of Americans are in worse shape than the above. It is not a pretty picture.
posted by Oroborous at 3:09 AM
13 Comments:
Oroborous:
Interesting article, in the sense calamitous writing is often interesting. I'm not sure I agree with all your conclusions, though.
I was puzzled at the Mr. Mauldin's treatment of Japan's 30 trillion yen. IIRC, that reflected, as did a virtually 0% interest rate, a desparate attempt to get the moribund Japanese economy moving. That would seem to have at least earned a mention, but didn't.
Further, as you may well remember from Misunderestimeasurementation, relying on the magnitude of some numbers may not be very useful.
For example, you cite the "... struggle to pay off $2200 in credit card debt." Apologies for the self reference, but that number happens to be somewhat lower than what I am "struggling" with. But my particular instance goes no way towards demonstrating your point. Fifteen years ago, many, if not most, of my transactions were cash or check, and my credit card "debt" was half what it is now.
Roll the clock forward, and my family writes roughly 5 checks per month, and rarely pays cash for anything. My increase in credit card debt is solely due to moving daily living expenses from one payment system to another. So, on the face of it, my credit card debt really doesn't mean anything, except that it might not be a good time to buy a check printing business.
Beyond that, someone with a $160,000 mortgage is probably paying something less than $15,000 per year on that mortgage, which is darn close to the recommendation that people keep their mortgage cost to below 1/3 of annual income. That means the average family has to make do on roughly $28,000 after housing costs (but before taxes).
From where I sit, the median family could do better -- a retirement account would be nice -- but it is scarcely horrible. Particularly because one could argue that, since the median family is probably in their mid-40s, that same median family will own that $160,000 home outright by the time they retire. Subsequently selling that house, then downsizing to a home owned outright, means social security income won't be very much less than their monthly income after housing and taxes now.
IMHO, the critical factor is homeownership. Those that own their homes outright when they retire will be comfortable even on social security income, because their housing costs will be close to nil.
Those that don't own their home, and do not have substantial savings or a pension, are in a pickle.
To me, that means we need to treat home equity as a form of retirement savings.
"It is not a pretty picture."
There are a wide variety of statistics stated in the articles that sound worse on their own than they do in a broader context. For example, what is the age distribution of median and below families? Clearly, many people just out of college with small children would be quite happy with the median statistics listed. There's a life financial cycle for most people where expenses are high and income low during their 20s, followed by increasing incomes and dropping expenses through their 50s (at which time they begin to accumulate some assets), followed by dropping income. Thus one would expect the median picture to look a bit insecure because the majority of people still have the asset accumulation phase in the future.
A second example is "31% of people aged 50 - 64 saved $ 1,000 or less." How many of those are already retired (in which case they would by definition no longer be saving)? How many of the remainder aren't planning on retiring - at least not until they're into the final downward spiral (in which case fairly low levels of assets are probably adequate)?
How about the historical context? Were people (at the median and below for various ages) in significantly better shape in the past? It seems like a rather difficult and subjective comparison, especially in aggregate, but I rather doubt the current picture is all that much bleaker than in the past.
Next, the question remains as to whether all these people in aggregate are being stupid, or if they're actually making rational choices given their personal preferences. I suspect the latter, admittedly because that's my personal preference. The idea of scrimping and saving and providing less for one's children when one is young just so one can retire earlier and/or be somewhat less miserable in one's old age is just plain silly in my subjective opinion. Granted, genetically, my life expectancy is short enough that my outlook makes more sense for me than others, but I suspect that people in general have a pretty good idea of the tradeoffs they're making and are simply prefering consumption now as opposed to saving for later for a wide variety of reasons.
But in the end, these are just articles that point out supposed problems for which there are no solutions, furthering our "State of Fear" as Michael Crichton likes to call it. In other words, even if I agreed with the analysis, what would I possibly do about it?
Bret:
I hope you beat the heck out of your genetics.
All of your points make sense. I would add one other: the free rider effect.
Most people in the pre-retirement age brackets have surviving parents. Many of those parents will bequeath significant assets to their survivors.
How much sense does it make to scrimp and save when it will eventually be rendered redundant?
Although I tend toward the pessimistic end of the scale, I see a lot of sense in what Skipper and Bret say. But I would guess by the level of intelligence and education of the Daily Duck members and commenters that we are all in the top 20% income bracket. Just by extrapolatiing from other people I know or know of, from 1 to 3 degrees of separation, I can say that there are quite a number of people barely scraping by. But our economy is such that scraping by today is much better than scraping by has ever been in history. Noone will starve or be denied medical care. Very few will become homeless.
One factor not mentioned in the article is the unlikelihood of the Bush tax cuts being made permanent. I don't think that the markets have priced that in yet.
Skipper:
I'm sorry, I should have been more clear.
All of the post is from the writings of John Mauldin, just from two different editions of his newsletter.
He did have more to say about Japan's expansion of their money supply, and the zero interest rate policy, but I edited it out.
It concerned the effects of such on Japan, and I wanted to focus on the world and America.
The post's top link will take you to that article.
I don't think that we should restrict ourselves here to the same rules that Orrin & Co. have chosen to adopt; self-refer away.
I agree about transferring payment systems. It's an unusual month in which I write even a single paper check.
However, I think that Mr. Mauldin is talking about revolving balances, not charges paid in full each month.
If one's credit card debt is increasing every month, that's not replacing checks with credit cards, that's acquiring new debt.
Further, I think that he used "struggling" because the number of credit card delinquencies is increasing, although it's far from a crisis.
In fact, many Americans are so close to their credit limits, spend so much of their income, and have so little in savings, that one can count on credit card delinquencies increasing every time the cost of gas goes up substantially.
The "non-pretty picture" is the 50% of Americans that are in worse shape than the median family, not the financial situation of that median family itself, who after all have a net worth of perhaps $ 60,000.
To me, that means we need to treat home equity as a form of retirement savings.
If by that you mean that Americans as a whole should stop withdrawing equity from their homes, in amounts based on unrealized and unsustainable gains in market value, and spending that "free" money on consumer goods, then I wholeheartedly agree.
However, from an historical perspective, there's something to be said for only nominally owning a home, and pulling the equity out to invest in the stock market.
Despite the past few years, over the long term stocks have CRUSHED owner-occupied residential real estate as an investment vehicle.
However, given that a lot of people would badly fumble the home equity/stock investment transfer, there's a lot to be said for KISS, and (mostly) slow and steady equity growth.
Shucks, most people don't currently understand the underlying risks of withdrawing home equity based on their home's nominal value, nor that the entire lending industry has tacitly colluded to maximize appraised home values.
Most people in the pre-retirement age brackets have surviving parents. Many of those parents will bequeath significant assets to their survivors.
How much sense does it make to scrimp and save when it will eventually be rendered redundant?
That seems to me like a pretty flimsy basket in which to place all of one's hopes for a comfortable future, an only slightly better plan than hoping to win the lottery.
In the first place, to count on retiring on an inheritance, one must be very confident that one's parents won't spend all of the money themselves, lose it by investing badly, or leave it to an animal shelter instead.
Further, how many ways will the money have to be split ?
While I don't know what the average number of beneficiaries per estate is currently, the "Boomers" acquired that sobriquet because their parents had a lot of kids.
My guess is that the mean split will be three ways.
Also, a benefit of controlling one's own retirement funds is predictibility and ease of planning.
Who knows when one's parents are going to die ?
What if one of them lives to be 120 ?
Finally, for the average middle class household, there usually isn't much left over after end-of-life medical, nursing home, and burial expenses.
Therefore, I'd say that for the average Jane, she'd be best off treating any possible inheritance as a bonus, rather than a retirement fund.
Bret:
[T]he question remains as to whether all these people in aggregate are being stupid, or if they're actually making rational choices given their personal preferences.
I suspect that people in general have a pretty good idea of the tradeoffs they're making and are simply prefering consumption now as opposed to saving for later for a wide variety of reasons.
Based on my reading on this and other sociological subjects, I would disagree.
People in general don't have a great grasp of relative risks and probabilities, which is why actuaries get paid so much - the type of person successful in that field isn't common.
Also, humans have a tendency to prefer immediate gratification to deferred, and to procrastinate regarding tasks and projects that won't cause immediate harm if left undone.
Those natural traits are also the major reasons why American society has found itself having to cope with an obesity problem that is only going to intensify over the next few decades - unless the pharmaceutical industry really does find a magic fat-busting pill or potion.
So, I doubt very much if most people are consciously deciding against funding their retirements; it's just their last priority, and so it gets short shrift.
..these are just articles that point out supposed problems for which there are no solutions...
In this case, I think that the solution might be pretty simple: Spend less, save more.
For 40% of the near-retired, saving $ 2,000 a year would be a big step up, and according to the U.S. Census Bureau, for at least half of that 40% it wouldn't be a big challenge from an income standpoint; it's more of a problem of perception or organization.
...even if I agreed with the analysis, what would I possibly do about it?
Society-wide, nothing, but hopefully articles like this cause people to ponder their own individual plans for retirement, and assess whether any changes in behavior need to be made, to stay on track.
Duck:
I would guess by the level of intelligence and education of the Daily Duck members and commenters that we are all in the top 20% income bracket.
I wish, comrade.
Unlike you deep-pocket fellows, my household's income is only in the top third nationally, and for my age group, only in the top 40%.
A mitigating factor there is that our cost of living is extremely low.
Also, my household net worth is very low, probably somewhere in the second quintile, depending on which study you like.
Still, I'm quite happy.
We have and have had enough to help anyone who needed it, including every single family member at one time or another (some far more substantially than was wise), and a couple of friends, as well as some worthy organizations.
Plus, I've been semi-retired for four years, and have been able to largely do what I like, when I like, which is quite nice.
Oroborous:
I'm sure my responses to this article are colored by absolute faith in the hive-mind. Granting your assertions that people in general are astonishingly lousy at correctly assessing actual risk, much of what you talk about is more in the realm of certainty than risk.
Mr. Mauldin may well be talking about revolving balances. However, the best way to demonstrate that is to cite the change in unpaid balance interest payments over time. Absent that, the quantity itself doesn't mean much.
As far as half the people being worse off than the median family, it is hard to draw much of a conclusion from that. First of all, there is no information about the distribution's Sigma (I hope I'm remembering my statistics properly; Bret will undoubtedly correct me, otherwise.) Additionally, because there are really several distributions here -- saving rate, income, net worth, equity, etc -- those that fall on one side of the median on one distribution may well fall on the other side of another. If high income people are disproportionately represented on the high side of the credit card balance curve, then there really isn't much of a problem.
[hypocrisy]Taking equity out of a home to buy consumer goods is foolish.[/hypocrisy]
Which is precisely what I am planning to do this year. My wife has decided that fourteen years on a car is plenty, and that it is well past time to get a new one. (Being something of a car geek, that is one well-maintained car that could easily go another ten years. But as they say on the adds, your mileage may vary.) So I will become guilty of violating my own notion of common sense.
But considering the ways of paying for the car -- cash (which means selling investments), a conventional loan, or a home equity loan -- doing the latter is actually the most sensible solution. Due to tax law, I only have to make about 4% on the investments to overcome the net interest I'll be paying.
There is a risk of withdrawing equity based upon the home's value, but that risk is only realized at the time the home is sold. If, as in my case, the intent is to pay off the loan without selling the house, then that risk is irrelevant -- my decision to draw on equity is based solely on expectations of future income.
No doubt it is silly to excessively generalize based upon personal experience, particularly given my two belts & three braces approach to this sort of thing, but the numbers cited must include a fair number of people on different sides of the various distributions, and making sound decisions thereby.
Unfortunately, those people end up making the perception of an impending crisis worse, despite the effect being precisely the opposite.
Inheritance.
Everything you say is true in the aggregate, but people make decisions individually. All Boomer parents lived through the Depression. A large number of them have substantial net worth, and their experience makes them temperamentally disinclined to spend away. Individuals have a pretty good notion -- if not explicit knowledge -- of their parent's worth and intentions. Inheriting nothing more than the net worth of a paid-off house, even split three ways, goes a long way to solving the savings problem for a whole lot of folks.
It's their kids who have to worry.
[Duck] would guess by the level of intelligence and education of the Daily Duck members and commenters that we are all in the top 20% income bracket.
An interesting guess. I would have guessed the same, and added that, internet wide, well over 90% bloggers and commenters are also white males. The male part is pretty easy to figure out, ethnicity is far more of a guess.
Since blogging and commenting is essentially free, and there are no gender/ethnicity barriers to entry, this is a real puzzle.
[skipper]: It's their kids who have to worry.
If the inheritees leave nothing of that inheritance for their children, agreed. But I would think, based on the demographics, that the Boomer's children will be better served by their inheritance than their parents are. When my parents pass on, the inheritance will be split six ways. I'm not expecting much, and I'm including none of that inheritance in my retirement planning. But I think that my daughter, who will inherit my house & wealth plus the house I bought for her mother plus her mother's antique glassware collection, will be golden in her golden years.
[Oroborous]:Plus, I've been semi-retired for four years, and have been able to largely do what I like, when I like, which is quite nice.
You are truly wealthy if you have that much command of your time.
I'd agree with Oroborous that the average Joe/Jane is not making a very wise assessment of their financial needs based on their circumstances. I have to confess that I could have done a much better job over my working lifetime, and should be in a better position at my age than I am. But I'm still above the median, which means that we've all benefitted from economic circumstances to a much greater degree than from our own fiscal habits.
I mentioned before my friend who recently lost his house to foreclosure. Although he was hit by a lost job and some uncovered medical expenses for his wife, I was shocked by the level of his own irresponsible fiscal habits. Last year I visited him at his house, which he had bought four years earlier for a price that I would have gagged on (his mortgage payment was more than I am paying for my house and my wife's house combined). He was three years unemployed/underemployed at this point, and the both the mortgage company and other creditors were hounding him into bankruptcy, and yet he still had his garage heater running full blast! He had the largest power tool collection that I had ever seen, some of it purchased on credit after he had been laid off! The idea of selling these tools hadn't seemed to occur to him.
I don't think he is that far out of the mainstream of American consumerism. I think that there are a lot more people like him that would be economically done in by an unexpected period of unemployment or medical bills.
Oroborous wrote: "People in general don't have a great grasp of relative risks and probabilities"
I'd agree. However, from my futures trading days, I think that on average, people are far too risk adverse. I think this is especially true for Europeans, perhaps less so for Americans.
"...humans have a tendency to prefer immediate gratification to deferred..."
Well, that's exactly my point. If they have a preference for immediate gratification, then it is by definition rational for them to consume now, and would be irrational to save more for later just because some anal retentive, pucker butted, bean counting, actuarial type such as the articles' author thinks they should. What's key to this debate (and also what's always missing), is whether or not the average utility for individuals in aggregate would be maximized by saving more for later as opposed to consuming more now. It's of course extremely difficult to measure things such as total lifetime utility of consumption, but from my personal observations of other people, they seem to much more greatly enjoy the dollars they spend when they're 20 relative to the dollars they spend when they're 80. Thus, with a goal of maximizing lifetime utility, it's better and more rational to consume when young.
"...I think that the solution might be pretty simple: Spend less, save more..."
That won't happen unless incentives are changed. Will anybody here at the Daily Duck do anything differently after reading the articles? I doubt it. Neither will anybody else. They'll just be concerned for everybody else and for society as a whole.
I've been trying professionally for almost 40 years to figger out how people make a living, and I'm no closer to understanding it now than I was then.
I mean, I don't get to look at their bank accounts, but I can observe where they live, travel, what they drive etc.
And usually I can have a pretty good idea of what their imputed income ought to be.
A lot of people seem to live a lot better than I could on the same income.
I just don' get it.
Skipper:
I wouldn't say that taking out a home equity loan to purchase a necessary consumer durable, that you intend to keep for a decade, is either foolish or risky.
Spending the money on a big screen TV or a vacation can be both.
+++
While blogging is nearly free, and has very low barriers to entry, it also has a limited appeal.
It is most satisfying to those who are intelligent, knowledgeable, and enjoy reading. The number of people who are all of those things is but a small fraction of the entire American adult populace.
Those traits also correlate very strongly with high incomes.
But, as far as blogging being very male, maybe it's because you enjoy going to sites which are oriented towards subjects that males dominate.
I could point you towards two dozen female bloggers, who have mostly female commentors, but they're also mostly chick blogs: They write about their families, their work, health problems...
There are a couple of female political or science bloggers.
The on-line community breaks along the same gender lines that the off-line world does, which ain't too surprising.
Duck:
I have to confess that I could have done a much better job over my working lifetime, and should be in a better position at my age than I am.
No kidding, my situation is exactly the same.
I console myself with the realization that I didn't know then what I know now, so even if I'd done better with what I knew, the difference would only be a couple hundred grand.
Plus, as Skipper notes in the "bad news" thread, I can't know what it is that I know now, that I wouldn't have learned, if I'd done things differently then.
So, when contemplating those richer Michaels in other, parallel universes, God bless 'em, but I'm content.
'Course, that present contentment is predicated on my expectations of doing very well in the future, which is probable, but not a given.
If when my life ends I'm in the same situation that I'm currently in, my epitaph will read "D'oh !!"
Bret:
Thus, with a goal of maximizing lifetime utility, it's better and more rational to consume when young.
I don't disagree - which is good, since that sentence describes exactly what I've done.
However, it makes no sense to spend ALL of one's money, leading up to retirement.
While golden-year spending might be of generally lower utility than spending on youth, it seems clear to me that ensuring at least modest comfort in retirement outweighs those extra iotas of pleasure that we'd get from spending every penny before retirement.
Harry:
Always tough to know what's truly going on beneath the surface.
More debt? An inheritance? Cheap lunches?
My guess is that they aren't buying insurance, to start with.
In many cases, that's turned out to be a good guess.
But it doesn't explain everything.
How much does it explain? Well, my direct premiums run around 2% of gross income, and I am very lightly insured for my life. Indirect (health) probably gets the total to 6-8% of total gross.
Since that money, if unspent on premiums, would all be disposable income, it could finance a fair amount of frivolity.
++++
As for myself, I started working in a high inflation period and assumed that was going to be permanent.
It really made no sense to save when inflation ran at 10% and up.
Unfortunately for long-term planning, I was wrong in my expectations.
Fortunately, I like my work and have no plans to retire.
Also, given the load of fatal genetic diseases I got from my dad, I'm not likely to live much longer anyway.
No complaints so far from me.
Bret:
but from my personal observations of other people, they seem to much more greatly enjoy the dollars they spend when they're 20 relative to the dollars they spend when they're 80. Thus, with a goal of maximizing lifetime utility, it's better and more rational to consume when young.
Excellent observation. In terms of net reward, I probably spent far too little when I was younger. Now that I am reaping the benefits of that abnegation, I'm finding I don't really give a darn to spend it on anything.
Oroborous:
BTW, your point on the makeup of bloggers is well made; I was extrapolating from the current affairs type of blog.
The Independent Women's Forum is particularly good.
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