Wednesday, March 9, 2011

Felix Salmon shoots the elephant in the room

A few years ago, there was an infomercial for something called the AIM (Automated Investment Management) System. The developer, a disreputable-looking character with a cheap suit, a bad comb-over and the absurdly modulated voice of a smooth jazz DJ, explained to the 'interviewer' that with his system you would automatically sell a stock when it peaked and buy when it bottomed out.

Though the whole thing was scripted down to the last chuckle, you still half-expected the 'interviewer' to ask the obvious question, "If you have a sure-fire way of beating the market, why are you wasting your time selling audiotapes on basic cable at three in the morning?"

Linda Stern's recent column, "Saving up for a big down payment? Sucker!" raises similar questions. Fortunately, Felix Salmon is here to go off script:
This, in a nutshell, is everything that was wrong with the housing market before the crash — everything that we want to avoid going forward. Can’t Linda look around at the current devastated state of many people who bought with little or no money down, and see the dangers here? Evidently not. Instead, she seems to think it’s a bright idea to borrow more money than you need, to the point at which you’re pushing the envelope of what you can reasonably afford. And then take the cash you’re not using for a down payment, and “put your money to work for yourself.”

I barely know where to start on this. Here’s one way of thinking about it: banks are not charities, and that they expect to make money from their loans. They have a cost of funds which is lower than the mortgage rate that you’re paying; the difference between the two rates is their profit. You, however, if you follow Linda’s advice, have a cost of funds which is your mortgage rate: if you wind up getting a lower return on your savings than you’re paying on your mortgage, you would have been better off just using the money for a down payment. Needless to say, if there was an easy way of getting a higher return on capital than the mortgage rate, the banks would have done it already, rather than lending you the money. And it’s pretty delusional, frankly, to think that you can invest better than say JP Morgan. Yes, there are tax benefits to having lots of mortgage-interest payments. But they’re not sufficient to make the difference here.

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