Book Review: Automatic Millionaire Homeowner

How important is homeownership to building wealth in the United States? I’d put it on a list of the top five most important things people should do.

Off the top of my head the other four are probably

  1. Stay out of high-interest debt
  2. Automate your savings and investments
  3. Invest in risky, not safe, things
  4. Invest for the long term, greater than 5 years.

As a top five action, why and how is homeownership important? And can it go wrong? Oh yes, it can go wrong. It’s been less than a decade since homeownership went terribly, horribly wrong for many, so even while I want to extol ownership, it’s worth reviewing painful lessons too.

In 2014, the last time the Federal Reserve published their Survey of Consumer Finances, reporting median homeowners’ net worth of $195 thousand compared to renters $5 thousand net worth. Homeowners have nearly 40 times as much net worth as renters.

Of course you scientists will point out that correlation does not imply causation, and also that causation goes both ways. People own a house because they have wealth, AND people have wealth because they own a house. Even so, the mechanism by which home ownership builds wealth matters.

Homeownership works to build wealth because of automation, tax advantages, and leverage.

By automation, I really mean to highlight the way in which paying a mortgage over 30 (or even better, 15) years steadily builds, month after month, year after year, your ownership in a valuable asset, and in a way that matches your monthly budget. Your monthly mortgage payment is a combination of interest and principal, and every bit of principal you pay adds a steady drip into your bucket of positive net worth. Sleep like Rip Van Winkle and then wake up 30 (or even better, 15) years later and boom! You own a valuable asset free and clear of debt.

By taxation, I really don’t want to highlight the mortgage interest tax deduction that everyone seems to know about already, and that quite frankly I’d be happy to see disappear.

Instead, the tax-reducing key to wealth building through a lifetime of home ownership is the capital gains tax exclusion of $250 thousand, or $500 thousand for a married couple. Home ownership doesn’t work like other investments. It works better. If you buy a house for $200,000, and then manage to net $450,000 when you sell it many years later, you have a $250,000 capital gain. Normally, Uncle Sam takes a cut of a wealth-gain like that, like 20 percent, or $50 thousand. But as long as certain conditions are met – you lived there 2 out of the last 5 years – then that entire $250 thousand gain is yours to keep, tax free.

In the bad old days – before 1997 – Congress only let you do this tax trick once in a lifetime. Since then, however, you can do it over and over as much as you like. Now doesn’t that make you love Congress more? Congress is WAY better than cockroaches, traffic jams, and Nickelback, even if it consistently polls worse.

By leverage, I mean that middle class people can’t normally borrow four times their money to buy a valuable asset. If you experience home inflation, that borrowing juices your return on investment in an extraordinary way.

Please forgive the oversimplified math I’ll use as an illustration of leverage: If you invest $50 thousand as a down payment and borrow $200 thousand for a home, and then the home goes up in value by 10 percent, what’s the immediate return on your investment? Hint: The answer isn’t 10%.

If you managed to sell your house with a 10% gain in value, you’d clear $75 thousand after repaying your loan. If you invest $50 thousand in a thing and net $25 thousand on that thing, you have a 50% return on investment. That’s the power of leverage.

When you combine automation, tax advantage, and leverage, you have a powerful wealth-building cocktail from home ownership.

Ready for the cold water to spoil your mojito? Home ownership as an investment can also go terribly wrong.

I was thinking of this recently because I checked a personal finance book out the library that has aged very badly, David Bach’s The Automatic Millionaire Homeowner.

Published in 2005, a few years before the 2008 Crisis, Bach’s book is a combination of good advice, like I reviewed above, and terrible advice.

Bach urges people with weak credit scores to check with their banks about alternative mortgages specifically tailored to them. Bach also describes in detail the opportunities for prospective homeowners to purchase with just 5 percent or 10 percent down, or even “no money down,” rather than seek the conventional 20 percent down-payment mortgage. Bach describes without apology the idea that your house could increase in value by 6 percent per year, every year for 30 years, turning your $200,000 starter home into something worth $1.1 million. In fact much of the book reads, in retrospect, like an excited exhortation to flip one’s way from a starter home to a millionaire mansion through risky mortgages, low money down, and price appreciation as far as the eye can see. Needless to say, that isn’t the way to do it.

I’m not saying low down payments, or buying with weak credit will always go wrong and should be forbidden. I’m just saying that, given what we experienced a few years later, we know it will lead to tears for many. And I’m not saying your house won’t appreciate, I’m just saying that a more normal annual price increase like 2 percent – in line with inflation – is a much better bet.

millionaire_homeowner

Good personal finance books are evergreen, and that one isn’t. If you want a good one however, may I suggest Bach’s excellently readable and important The Automatic Millionaire, in which he extols the concept of automating savings and investments, a key for most middle-class people to build wealth over a lifetime.

 

 

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Book Review: Diary Of A Very Bad Year


I’ll admit to two large biases before praising Diary of a Very Bad Year: Confessions of an Anonymous Hedge Fund Manager.

First, I prefer a personal account by a financial practitioner, rather than a financial journalist’s perspective, nearly every time. This preference, after all, underpins my idea with the Bankers Anonymous site itself.

The acronymic jargon of an ordinary financial practitioner’s presentation, however, typically overshadows his story for the lay reader. Who, except the specialist, can unpack the Re-Remics from the Reverse Repos, the positive carry from the negative basis trades, or FX forwards from a commodity curve in backwardation? Only the rare financier knows his craft so well that he can explain complexity while using language we can all understand.

Second, the Anonymous Hedge Fund Manager (HFM) featured in the book was a client of mine for a short while when I sold bonds on the emerging markets desk for Goldman. His clear language and thinking made a strong impression at that time.

Which explains why, when I read a review of this book a few years ago, I immediately thought of my ex-client. Was he the unidentified HFM? An email query and reply a few hours later confirmed it, yes.

Through a series of interviews with a journalist, HFM gives a wide-ranging but personal perspective on his experience between September 2007 and August 2009, covering the periods of the deepest dive and steepest financial recovery. His interests, while inescapably specific and technical, frequently veer to the philosophical and big picture.

In the free-fall period of late 2008 – when even the most plugged-in hedge fund manager was overwhelmed with unexpectedly bad developments – we experience a real existential question for financial markets: If all private banks were at risk of implosion without the backing of the US Government, what happens when the US Government defaults? Who is insuring it and how do you hedge that risk? Martians were not offering credit default swaps to earthlings.

Diary of a Very Bad Year will not tell you everything you need to know about the Credit Crisis of 2008. It will tell you what a large hedge fund manager experienced, in real time, in a way no journalist on the outside could ever tell you.

It’s the best book I’ve ever read on the Crisis.

I read this a few years ago but was reminded of it because my wife just read Diary of a Very Bad Year this past week. She found it somewhat technical for the non-finance expert – as terms like leverage, credit default swaps, FX crosses, and even ‘hedge fund,’ get thrown around without explanation or definition. But she also appreciated the brilliance and humor of HFM in describing those two awful years, in real time.

The final chapter reveals HFM’s plan to quit New York City and move to Austin, TX with his fiancé.

He’s burned out on the stress of the Crisis and the responsibility of managing a large team and complex portfolio at his New York hedge fund. He dreams of eliminating his management responsibilities, simplifying his life, and shifting his balance, away from working, and more toward living.

When I checked in with him for lunch in Austin a few years ago, he had followed his plan exactly.

diary of a very bad year

 

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I Disagree about JP Morgan But I’m Totally Entertained

A friend and I debated the merits yesterday of Alex Pareene’s recent article on Salon, in which Pareene praises the most recent $13 Billion fine against JP Morgan as justifiable punishment for greedy bankers and a morally-positive disincentive to the banking industry generally.

I totally disagree.

I happen to think, and I’ve written before, that the journalistic narrative demonizing bankers for the 2008 Crisis misleads us about the root causes of the financial crises.  I will argue vigorously for a more complex understanding of what went wrong.

Jon-Stewart-Bank-Yankers-screenshotOn the other hand, and despite my disagreement, Jon Stewart is better at what he does than anybody else is good at what they do (with the sole exception of Nate Silver).  So I’m still totally entertained by his characterization of the massive JP Morgan fine, the Alex Pareene article, and the response of financial journalists.

The first Daily Show video clip is here, in which he features Pareene, and Maria Bartiromo and Jim Cramer:

The second Daily Show clip is here, in which he satirizes the financial media’s “shakedown, jihad, gun-to-the-head” characterization of the JP Morgan $13 Billion fine.

 

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Mortgages Part VIII – The Cause of the 2008 Crisis

On the 2008 mortgage crisis, from my perspective

Ok friends, are you ready?  I’m about to piss you off.

Contrary to the dominant journalistic narrative of the 2008 Crisis – that greedy bankers and their Wall Street enablers tricked the poor and gullible into predatory loans on their homes which led to foreclosures and economic misery – I think borrowers mostly caused the mortgage crisis.

Underwater house.  Who is to blame?
Underwater house. Who is to blame?

 

Obviously this is a deeply unpopular thing to say, and cuts against the grain of “little guy = good” and “big bank = bad,” and it appears at first blush that I’m blaming the victim.  I sympathize with homeowners who lost their jobs and then possibly their homes and clearly many were victims of forces beyond their control.  But I’m still gonna piss you off.

Borrower as “innocent victim” myth

I really just mean to point out that a whole lot of borrowers were not innocent victims, but rather perpetrators of mortgage fraud.  Many of these folks were investors, speculators, flippers, and just Hail-Mary passers hoping short-term real estate inflation could cover their terrible financial positions.

I mean to call out the people who knew they didn’t really have a chance at paying back their loans under ordinary circumstances, except maybe extraordinary price appreciation.  I mean people who got “no income, no asset” loans knowing that income and asset disclosure would tank their chance to borrow a lot of money.  I mean people who, with almost no money down, bought an option to ride the upside of real estate appreciation but who risked no real equity when the market went sideways and then south.

I don’t believe I’m an extremist in this view, I am a realist.

Bankers getting stoopid

Yes, mortgage underwriting standards slipped from “loose” to “stoopid” somewhere between 2004 and 2007, with ARMS, sub-prime loans, interest-only loans, and liar-loans expanding from niche products for niche situations to dominant products crowding out sensible mortgage loans, eventually clogging up the sewage pipelines of global finance.  One of my earliest podcast interviews for this site was with a mortgage underwriter who got out of the business just as the ridiculousness started to take over.

But despite this, and contrary to the dominant journalistic narrative, banks do not make money when they lend money to people who will not, or cannot, pay them back.  Lending to a borrower who cannot pay back the loan is not a profitable strategy.  I’ve never met a banker who wanted to take back someone’s home.  It’s a ticket straight to financial destruction for the bank.[1]

Yes, bankers are profit-oriented, and yes they got briefly stoopid, but banks generally get only a few years to make these kinds of terrible underwriting and financial modeling decisions, after which, the inexorable gravity of finance pulls them down, punishes them, and makes them pay.[2]

Borrowers too acted from a combination of greed and stupidity, taking out loans they should never have taken.

Homeownership is not a fundamental right of citizenship.  It’s a choice that’s right for some people, but financially catastrophic for others, because home ownership is risky.  A mortgage contract confers opportunity, but also demands responsibility.

And yes, I get it, it’s harder to blame the individual borrower who lost her job, her credit and then her home, than it is to blame the overpaid financiers and their banking institutions.  Obviously the underwater and foreclosed borrower is a far more sympathetic character than the slick mortgage bond investor or the bank.  But just because we feel for the little guy or gal doesn’t mean we should misunderstand shared responsibility for the mortgage crisis of 2008.

I understand better than most the terrible mistakes and greed of Wall Street.  I was there, and I’ve written about some of it here.  I’ll be the first to say I think the ongoing coddling of Wall Street and unsolved TBTF problem remains a black mark on the Obama administration.  But if we don’t acknowledge the shared responsibility of predatory borrowers then we don’t learn the right lessons from the mortgage crisis.

Although I disagree with much of his politics, Edward Conard in his Unintended Consequences debunks – better than anything else I’ve read – the flawed journalistic narrative on the mortgage crisis of 2008.

I know I’m going to piss people off when I write this, because it’s impolite to lay responsibility on the individual homeowner who had the most to lose.

Selling mortgages from bank to bank

What about the fact that mortgages get sold and reassigned to banks that didn’t even underwrite the loans?

Recently a neighbor told me a story – with a straight face – that an acquaintance of hers received notice from a bank of imminent foreclosure on her house.  The acquaintance claimed to have made all of her mortgage payments, but the mortgage had been sold to another bank, which hadn’t received her monthly payments.  My neighbor was shocked about the mortgage having been sold to another bank, and wholly believed her friend would lose her home.

I remained outwardly sympathetic and pleasant, but let me tell you what I was really thinking.

To dispose of the last point first, the fact that the mortgage was sold to another bank is irrelevant.  You know why?  Because practically every single mortgage in this country is sold from one bank to another.

Unless you got a mortgage from one of four banks – Wells Fargo, Bank of America, Citibank, or JP Morgan Chase – you can be absolutely certain your mortgage will either be sold or serviced by a different bank.[3]  Look at your mortgage statements.  Is that the bank that gave you your mortgage?  Probably not.

But but but –  I hear the objections to the original point – what about all those mortgage bank robo-signers in the foreclosure mills?  What about foreclosure mistakes, in which people lose their homes due to bank error?

Ah, yes, the myth of foreclosure mistakes.

Foreclosure notice

The myth of mistaken foreclosure

I just do not believe in the myth of mistaken foreclosure.

I say this with confidence for a couple of reasons.

Through my business I’ve invested in many mortgages myself, a great number of which became delinquent.[4]

It takes between 6 months and a few years to enforce unpaid debts.  Thousands of dollars in attorney fees are followed by months of notices, certified mail, and disclosures to homeowners in arrears.  Unlike a Hobbesian life, mortgage foreclosure is nasty, brutish, and long.  If the lender pressing foreclosure misses any steps along the way, you pass directly to Go, do not collect $200, and the foreclosure process can be held up indefinitely.

Look, we live in an extremely litigious society.  There are thousands of consumer rights’ lawyers ready to take on a big juicy target like a bank for mistakenly foreclosing on a homeowner who has faithfully made mortgage payments but who lost his home due to bank error.  Any homeowner who got mistakenly foreclosed upon by a bank is not a homeless loser but holds a golden ticket to financial paradise.

Golden Ticket
Borrowers mistakenly foreclosed upon hold a Golden Ticket

A mistaken foreclosure is a Golden Ticket for the homeowner?

Has this ex-banker forgotten his meds?

No.

If Bankers-Anonymous readers can refer me to a homeowner tricked out of her home, or mistakenly foreclosed upon who remained current on her mortgage,[5] I will find a lawyer who will win millions of dollars for that homeowner from the bank.  If you can find me more than one instance nationwide – let’s just say a few dozen – we will all retire just on the referral fees to the class action lawyers alone.

How much can we make the banks pay?  $100 million?  $200 million? Maybe more.  Some percentage of that would be fine by me.

But it’s never going to happen, because it’s a big fat myth.

Mortgage settlements with big banks

But wait, what about the hundreds of millions of dollars in penalties Wall Street banks have paid in the past 5 years to attorneys general for mortgage underwriting errors or fraud?  Doesn’t that prove Wall Street and the mortgage banks were cheating and predatory?

No.  It proves only that securities firms cannot afford to get crossways with securities regulators.  Not a single mortgage case filed by the government against the big banks in the past 5 years has ever gone to trial.

The banks’ attorneys immediately ask for a settlement, put aside a big chunk of money, and try to move on.
Being sued by the government for securities fraud is such a business-quashing situation that no bank can remain there for long.  Their lawyers just reach for the corporate wallet and ask the regulators what it’s going to take, and then they move on.

Conclusion

I’m not trying to be the mean jerk here by blaming the borrowers.  Clearly homeowners suffered, and they suffered individually more than the bankers.  But we need a clearer-headed analysis of the cause of the mortgage crisis – or at least a more balanced view of where to place the blame.[6]

I think we’ve bought into an imbalanced journalistic narrative, and we draw the wrong lessons for the future as a result.

Postscript to the Conclusion

On this same issue of ‘who to blame?’ the mortgage crisis strongly resembles the internet crash of 2000 and then-Attorney General Spitzer’s campaign to blame internet analysts.  As always, Michael Lewis said it best, in this classic New York Times Magazine article.  If you choose the politically convenient target – mean, nasty, banks and their forked-tongue research analysts – rather than the fact that investors are greedy, working with imperfect information, and should be held responsible for their own investment decisions, then you learn the wrong lessons.  And you end up with a bullying hypocrite for a New York Governor, among other consequences.[7]

In the case of the mortgage crisis, exclusively blaming the banks for loose lending standards leads to, among other things:

  1. Tightened credit restrictions, especially for the poor
  2. Absolving homeowners and borrowers for the consequences of their own financial decisions
  3. Punishing individuals who actually stayed current on their underwater mortgages instead of walking away

So let’s consider the whole picture of responsibility, however unpalatable it may seem.

 

Also, see previous posts on Mortgages:

Part I – I refinanced my mortgage and today I’m a Golden God

Part II – Should I pay my mortgage early?

Part III – Why are 15-year mortgages cheaper than 30-year mortgages?

Part IV – What are Mortgage Points?  Are they good, bad or indifferent?

Part V – Is mortgage debt ‘good debt’ A dangerous drug?  Or Both?

Part VI – Mortgage bond creation on Wall Street

Part VII – Mortgage Derivatives

 


[1] When they don’t get paid back, banks have to start a foreclosure process, which is long, costly, and uncertain.  Then when they do obtain the property, more often than not the bank sells it for a loss.  It’s a terrible situation.  Banks don’t like to own properties.  They want Tuppence.

[2] And then they call up daddy Paulson, and say ‘Daddy, start writing checks!’  Yes, I realize banks got unfairly bailed out.  That too drives me nuts.  But I’m talking right now about the causes of the crisis, not the consequences.

[3] And even if you did get your mortgage underwritten by one of those four, it’s highly likely your mortgage will be reassigned into a mortgage bond structure, often with a different servicer.  For more on the way the mortgage bond sausage is made, I recommend this primer.

[4] In a related piece of news, I’m no longer a hedge fund manager.  Rather, I’m stacking mad chips as a blogger.

[5] “Remained current on her mortgage” is the key clause of this whole thing.  I define a foreclosure mistake as a situation in which the homeowner who actually paid the mortgage, but lost the home.  Yes, lots of people lost their home after not paying on the mortgage, and that’s tragic all around.  But that’s not the bank taking advantage of people, that’s the bank following through on its signed, written contract, which contract has been thrown into default for non-payment.

[6] On this same issue of ‘who to blame?’ the mortgage crisis strongly resembles the internet crash of 2000 and then-Attorney General Spitzer’s campaign to blame internet analysts.  As always, Michael Lewis said it best, in this classic New York Times Magazine article.  If you choose the politically convenient target – mean banks and their forked tongue research analysts – rather than the fact that investors are greedy and working with imperfect information and should be held responsible for their own investment decisions, then you learn the wrong lessons.  And you end up with a bullying hypocrite for a New York Governor, among other consequences.

[7] And then after he’s exposed for what he is, you get him back, as Comptroller of New York City.

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Book Review: The Big Short, Inside the Doomsday Machine

In one obvious respect, The Big Short follows Michael Lewis’s winning formula for a blockbuster book on sports or finance: character sketches so compelling, funny, and sympathetic that he makes an arcane industry understandable by the average reader.

Less recognized, but even more impressive, however, Lewis bucks the dominant trend in media coverage of the 2008 Crisis.  Lewis does what almost nobody else in journalism has even tried over the past few years, namely, he makes the short-sellers the heroes.  He makes us root for:

  • The plucky one-eyed neurologist Michael Burry with Asperger-spectrum personality, whose investors repeatedly tried to betray him
  • Steve Eisman, a down-beat and beaten-down stock analyst covering the least glamorous industry, subprime lenders
  • Two entrepreneurial founders of a seemingly Too-Small-to-Succeed hedge fund Cornwall Capital

Only Deutsche Bank mortgage trader Greg Lippman gets profiled as the arrogant gunslinger that we’ve come to expect from financial journalists, and the profile is so specific that you can’t help but think Lippman must be exactly like that.

Most coverage of the Crisis gives the strong sense that innocent homebuyers were tricked by greedy bankers and their Wall Street enablers into mortgages they could not afford to pay back.  The popular press rarely mentions the basic idea that lending to people who cannot and will not pay back their mortgages is not a strategy or a goal of bankers and their Wall Street enablers.  It happened, but it was not their plan.

Lewis’ has the gumption not to defend, but to celebrate, the few clear-headed folks who managed to profit while the financial herd – bankers and borrowers alike – ran themselves off the edge of a cliff.

Start with The Big Short to get a clear sense for the players, triggering events, and financial technology of the Great Credit Crunch of 2007 and 2008.  It’s as good as anything else written on the Crisis to date.

 

Also see my review of Michael Lewis’ Liar’s Poker – The best book on Wall Street ever.

and see my review of Michael Lewis’ Boomerang – Funny, if not terribly substantive.

Please also see related post, All Bankers-Anonymous Book Reviews in one place.

 

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