The face of the river, in time, became a wonderful book . . . which told its mind to me without reserve, delivering its most cherished secrets as clearly as if it had uttered them with a voice. -- Mark Twain

Inside Job in Beverly Hills

Posted: February 28th, 2011 | Author: | Filed under: Uncategorized | No Comments »

Driving through Beverly Hills the Saturday before last, I was transfixed by the spectacle.  It was raining that night.  Droplets of water on my car windows looked like a thousand shimmering diamonds scattered over the blur of designer fashion and dramatic glass storefronts whisking past.  As a lifetime member of the American middle class I wondered who might be shopping at those stores and buying the myriad of bejeweled designer gowns displayed in the windows along Wilshire Boulevard.

“Look! Rolex.”  I directed my husband’s gaze across the street to a modern building without windows.  As an engineer he’s a fan of the precision watches, though not an owner.  We pulled up shortly along the curb and stopped.  As I gathered my things to head out, I noticed a heavily clothed man unfolding a blanket in the shadows of the building next to us.  He laid it on the ground and then arranged himself clumsily upon it.  In the midst of the spectacular wealth surrounding us, this man was lying down on cold wet concrete to sleep.  Something about the stark contrast of his bleak bedding against such an opulent backdrop stopped me in my tracks.  I wrapped an unopened applesauce squeeze pack my son had left in the car earlier that day in a couple of dollar bills, and placed them next to the sleeping figure as we passed.  Then we were at our destination – the last movie theater in town screening the latest documentary from director Charles Ferguson, Inside Job.

I’d been wanting to see the film for ages.  First, because since opting to stay at home as a full time mommy six years ago I rarely get out to see any movies, and secondly because the film offers a comprehensive breakdown of the whole financial crisis we find ourselves in the midst of and an analysis of why it happened.  Luckily the film’s recent Academy Award nomination kept it in theaters longer than the usual run, so I was actually able to get it together to see the picture before it was gone.  With a professional background in film and as an economics writer, for me it promised the best of both worlds… and it did not disappoint.  The film tells the story of how Wall Street greed led to the financial crisis that’s left millions of people without their jobs, homes and life savings.

Much of the information in Inside Job is not new, but seeing it all put together in one presentation creates a profound impact.  The astronomical extent of the corruption and damage to the global economy is driven home very effectively, though even when the film was over I was left with the sense we’d only skimmed the surface looking at how huge and systemic the problem really is.  The audience was surprisingly staid.  I had the hardest time staying in my seat, my level of outrage was so enormous at times.  I wanted to jump up and shout at the screen!  Here is a trailer for the movie.

I won’t present a full film review here, as you can find several online and I’ve provided links to a couple of good ones at the bottom of this page.  Also, since Inside Job won the Academy Award for Best Feature Documentary last night, I’m sure you will hear more about it in the press now. I do want to comment on a couple of points I thought were especially interesting, however.  I find them interesting because I have not seen so much attention paid to them in the press, yet from my perspective they are important to consider when studying the financial meltdown and thinking about where we go from here.  The first is how intensely our current administration remains tied to Wall Street and the banking industry, the second is that academia has been corrupted by greed, and the third is the role addiction played in creating the mess we’re in.

As to the first point, I believe the depth and strength of our government’s ties to big business is overlooked to some degree because the Democratic party is not associated with corporate interests as much as it is with championing social programs for people in need and representing the underclasses.  We just don’t expect a community organizer like Obama to be in bed with the super rich and focused on servicing their interests.  But this is a mistaken assumption, which becomes evident the moment we stop to examine who he has appointed as the keepers of the country’s economy.  In fact, the current administration has been more heavily staffed with Wall Street players and bankers than any in history.  Some of these people were directly involved in creating the mess we are currently in.  Now they are in charge of cleaning up that mess and preventing more trouble.  It seems we have the fox in charge of the chicken coupe here.  Is it any wonder we the people are going broke as banks are bailed out, corporations are showing excess reserves and Wall Street is giving out the biggest bonuses in history?

According to evidence presented in Inside Job, academia is another area that is not what it initially seems.  Academia is often looked at as standing outside commercial interests.  Teachers are public servants.  Research is scientific and empirical.  We have trust in the purity of the academic perspective to such an extent that it is used in court to provide definitive and non-partial expert witness.  Because teachers are not involved in producing profits and catering to shareholders, we believe they are not subject to the pressures and temptations of big business.  They’re obviously not in it for the money, right?  Only, when we look deeper this seems not to be the case.  Inside Job shows how academia has been corrupted in the grip of Wall Street’s influence with teachers from the most prestigious institutions being paid hundreds of thousands and even millions of dollars in Wall Street money to provide faulty witness, publish biased reports, and otherwise further the designs of the ruling economic class.

The third point I want to mention is tied to some research the director referred to concerning addiction.  I find the psychological aspect of economics most interesting, and for some time I have been thinking about the parallels amongst those who chase wealth on the level we have seen in the ruling Wall Street class and the behavior of addicts.  The criminal behavior, ruthlessness, denial and almost sociopathic lack of concern for others displayed in their pursuit of wealth mirrors the drug seeking and other behaviors we see in addicts.  Well, according to the information in Inside Job, it turns out there is indeed a rampant use of cocaine and prostitutes within the Wall Street crowd as well as a deeply motivating sense that nothing is enough.  The appetite for accumulation is insatiable for these people.  “Do you really need six jets?” the film’s director asks one representative from Lehman Brothers.  The denial and sense of entitlement is so powerful amongst these money seekers, it looks just like addiction.  In fact, the film shows medical scans reveal that the high produced from attaining money activates all the same areas in the brain that the high from cocaine does.

My question is if extreme and ruthless material accumulation is an addiction or a mental illness for some people, could it be treated as such?  What about rehab, therapy or a twelve step program for these folks?  Let go and let God?  I kid (mostly), but the disturbing fact is many of those involved in creating the hugest housing bubble in history are guilty of criminal activity that has affected millions of people’s lives.  We have seen a few convictions of corporate misconduct and a few slap-on-the-hand fines doled out, but there have been no criminal prosecutions or even a satisfactory investigation regarding individual responsibility in this fiasco.  As the director of Inside Job points out at the end of the film, many of these same people are still in full business and some are in charge of running the country.

The man sleeping in the building foyer had his back to us as my husband and I made our way to our car after the movie.  I noticed he’d moved to another spot to get away from the encroaching rain.  I wondered if he’d eaten the applesauce I’d left and what he might spend those dollars on.  Booze, maybe.  I thought about how so many people living on the street struggle with addiction and mental illness.  It’s interesting how one man’s drug of choice lands him in a concrete bed in the rain – or maybe even in a concrete cell in a correctional facility – yet another man’s addiction lands him with five mansions, three yachts, a personal helicopter and a life outside the reach of justice.  Granted, we did see Bernie Madoff go to jail, but you have to keep in mind he was ripping off his rich peers!  He chose the wrong group to pick on, I guess… or maybe it was the right group.  Maybe he’s hit bottom and he’ll be able to get some clarity about things now.  Prison saved Robert Downey Junior’s life, by some accounts, as it has for many addicts.  For Bernie Madoff it could turn out to be just what the doctor ordered.  Now, who’s next?

Guardian, The Observer
Inside Job – Review
Philip French
February 11, 2011

It’s Mostly Wonks
Annie Lowrey
January 6, 2011

The New York Times – Inside Job Review
Who Maimed The Economy, And How?
A. O. Scott
October 7, 2010

Democrats Haunted By Corporate Ties
Jonathan Allen and Eamon Javers
April 21, 2010

National Coalition for the Homeless
Who Is Homeless?
July, 2009

Interest Rates: Buy When They’re High

Posted: February 15th, 2011 | Author: | Filed under: Uncategorized | 4 Comments »

News broke this past week that interest rates on mortgage loans rose to the highest they’ve been in 10 months. Interest rates on mortgages tend to follow the yield on ten-year treasury bonds, which spiked recently over concerns about inflation. The average rate for a 30-year fixed home loan now stands at just over 5%. It is good to see mortgage rates rising at last. It heralds the approach of a time when buying a home may once again actually make financial sense.

I’ve written about mortgage rates on occasion in the e-mail newsletter I used to publish before the launch of The Paper Boat, so for some long time readers this may seem a familiar topic. With news of rising rates, I think it is an appropriate one to revisit and bring to the blog now. This is a topic that is surrounded by misunderstanding, as the idea that higher rates make housing more affordable seems counter intuitive to many. Of course I am talking about buying property, not refinancing it. It is always best to refinance when rates are lowest, which in this case was about three to six months ago. However, in the big picture today’s rates are still quite low historically and this remains a better time to refinance than to purchase property.

Despite the drone of advice we hear to the contrary, the old investor’s adage “Buy low, sell high” does not apply to interest rates. These days we hear from the press and advertisers that we must take advantage of the opportunity to buy at low rates before they go up. This has been the much touted advice of the National Association of Realtors, which was the primary source of real estate analysis in the press all during the inflation of the housing bubble. Their message to buy while rates are low has been absorbed and circulated to the extent that now it just seems like common knowledge. You just need to keep in mind this is the same group who’s Chief Economist at the peak of the bubble in 2006, David Lereah, advised that housing would only continue to go up in value exponentially… forever… right before the bubble popped and everyone was thrown into foreclosure and bankruptcy.

Ooops.  Later when interviewed for an article in Money magazine in 2009, he admitted he was just trying to sell houses.

“I worked for an association promoting housing, and it was my job to represent their interests. If you look at my actual forecasts, the numbers were right in line with most forecasts. The difference was that I put a positive spin on it.”

I have a neighbor who has been successful investing in real estate and managing properties. A couple of months ago she asked me if my husband and I are intending to buy property. I told her we were hesitant to buy with real estate still so overpriced and the economy so unstable. She looked at me with pity and suggested with a sort of polite intensity, “You should REALLY look around now if you want to buy. Get pre-approved. The interest rates are the lowest they’ve ever been and I’d hate to see you miss out on this opportunity.” She explained how she’d bought a multi-unit building in the 1980’s, when mortgage rates were up near 18%. That meant the interest on her loan would end up adding a huge chunk to the overall nugget invested on the property, though in fact she did manage to refinance and bring the rate down later. What she failed to factor in is that she bought the property for 80% less than what you’d have to spend buying it today. This steep incline is not due to normal price growth in real estate, but to the lingering inflationary effects of an unprecedented and unsustainable housing bubble that grew out of historically low mortgage interest rates.

Herein lies the crux of the paradox. The interest rate does not act independently to add a layer of extra cost to the purchase of a property. It is a variable in an equation. Contrary to the irrational thinking so prolific during the housing bubble, there is actually a limit to what people can afford when purchasing a home. This limit is directly tied to their available income. So there is a lid to what a seller can ask for a particular property, which is determined by what the pool of potential buyers are willing to pay for it. (Supply and demand!) Because there is a limit to how much a buyer can spend on a property, if the amount going toward interest moves higher the selling price is forced lower. This works in the reverse as well, which we saw illustrated perfectly in the run-up in prices during the housing bubble. As Federal Reserve policy artificially forced interest rates to historic lows, housing suddenly became more affordable. Sellers quickly realized that with the discount this provided to buyers they could easily demand more in their asking prices, which pushed home prices up. So basically when interest rates are low prices rise, and when interest rates are high prices drop relatively.

The appeal of the low interest rate for most is that it makes monthly payments lower. This should not be a consideration when calculating whether or not a property is affordable, but it has in fact become the number one consideration for many people entering the market. In our credit-dependent culture we have come to assess our finances in terms of what seems affordable on a month-to-month basis. This is a mistake. What happens to a house that is purchased when interest rates are low, as they are today? It becomes worth less as rates inevitably rise later. Equity is stripped and the option to refinance may eventually become impossible. In the wake of the housing bubble we are seeing a huge percentage of mortgages underwater – where the buyer is now paying more for the house than it’s worth on the current market – and that number is growing. When a house is underwater it becomes ineligible for refinancing. Where I live, in Los Angeles, we’ve seen a 50% loss of value in many cases since the bubble peaked. People who bought then are paying twice what they should be at this point. Their equity has faded into thin air. As interest rates now begin to rise in an already deflationary climate, they’ll be able to sell for less and less and more homes will fall into foreclosure.  It’s a trap.

If loan cost = price + interest and the loan cost is a fixed value, price and interest must move relative to each other.

Reasons to buy while mortgage interest rates are high:

* Prices are forced up as rates go down, and you gain equity and value
* A low priced home can be refinanced later when rates inevitably cycle to a low point again
* As an investment you can sell later when rates go down and prices are pushed high
* In most cases taxes will be assessed and locked in at a lower rate, due to lower price
* If you have PMI (insurance required with a down payment less than 20%) it will be paid off faster as equity grows faster

Reasons to avoid buying when mortgage interest rates are low:

* High price can only go down and you lose value and equity
* You cannot refinance if underwater
* Risk of becoming trapped and unable to sell
* Trapped at higher tax rate
* PMI payments may be extended as equity is lost

Most serious investors know the time to buy is when rates are high. High rates reflect a market where there is demand and the potential for growth. Buying when rates are high and prices are low leaves the wiggle room needed to remain flexible during tough times. Low interest rates mean there is little demand for the product you’re investing in and a higher risk that the investment will go sour. Low interest rates are really just an incentive to get people to buy something that doesn’t smell quite right.  Remember, when you buy a home at a high price that transaction is fixed forever, but you can always refinance the high number in the loan cost equation when you buy a low priced home with a high interest loan.

Yahoo Finance
Era of Super-Low Mortgage Rates Appears To Be Over
Michelle Conlin and Janna Herron
February 10, 2011

CNN Money
Confessions of a Former Real Estate Bull
Donna Rosato
January 6, 2009