Nothing Is Your Fault Or, Student Loans Are Killing Our Economy, Part CXXV

April 25, 2012

 

This picture was taken in 1992, right when the loan balances were at their highest. No word on how much the wedding cost, or if the betrothed paid for it out-of-pocket.

 

We’ve got a fantastic investment idea for you, one that you’re a fool if you don’t take advantage of. It’s a no-brainer, really. Refusing this investment would be like turning down matching funds from your employer for your 401(k). In fact, it’s even more fundamental than that. Refusing this investment would be like turning down a raise. “Do you want more money?” “No, I’m good with less, thanks.” Saying no to this investment would be like simultaneously spitting on the flag and tearing up a Bible. (Note: On the first draft that showed up on the page as “tearing up a Buble”, which would be awesome. Thank you, Mr. Qwerty, for putting the “I” and the “U” keys next to each other and making such comedy possible.)

And if you need more incentive, the President himself does it.

The investment? Student loans! Yes, they come with a mandatory interest payment, but who cares? Investment! In your future! (As if you could have an investment in your past or your present.) Keep repeating buzzwords as necessary!

If you needed any further proof that our economy is doomed and that you should save yourself and your loved ones first, read this quote from the chief executive himself:

We only finished paying off our student loans off about 8 years ago. That wasn’t that long ago. And that wasn’t easy–especially because when we had Malia and Sasha, we’re supposed to be saving up for their college educations, and we’re still paying off our college educations.

To recap: the President of the United States has a B.A. (from Columbia, which is not inexpensive) and a law degree (Harvard, which is less so). He started attending Occidental College in 1979 before transferring, and received the law degree in 1991. He financed at least one of the degrees, and paid back the loans in 2004.

So it took him somewhere between 13 and 25 years to pay off his education. Let’s split the difference and call it 19.

Also, while paying off the loans, he and his wife decided it’d be a good idea to take on more expenses – in the form of a couple of children. Those children, by the way, now attend an elementary/middle school that costs them a combined $64,920 to attend every year (includes hot lunch).

Let’s take the last part of that quote again:

We’re supposed to be saving up for their college educations, and we’re still paying off our college educations.

“We’re supposed to be saving up for their college educations”, as if it’s a moral imperative on a par with “we’re supposed to feed and clothe them.” No one even questions the value of this anymore: going to college is at least as important as anything else you can think of.

The above quotes come from a speech to, appropriately enough, a bunch of college kids (at the University of North Carolina); none of whom spent the previous weekend passing around the bong and sleeping through lectures. President Obama didn’t get into the financial details of his and the First Lady’s loans, but we do know that they took somewhere around 2 decades to pay off.

But that’s OK, because a college degree enables you to earn more money, right? It should be obvious that whatever increase in salary these borrowers enjoyed because of their educational status, it was more than negated by the price of the loan. 19 years is practically half a regular working life, and it’s being spent committed to paying down the debt incurred to ostensibly enrich that life in the first place. How much further could we take this? Would it be OK to work for 42 years, and spend 41 years paying off student loans? Why not? Investment (in your future)!

Some of you wags are bringing up objections. We can hear them already. Let the debunking begin:

1) “He was a law professor. An intellectual. The smartest man alive, in fact. What was he supposed to do, drive a truck?”

So by virtue of being smarter than someone who began working sooner and accumulated no debt in the process, the smart person…incurs obligations that take 2 decades to pay off? Fine, you lead 1-0.

2) “Well, he ended up as President. Therefore incurring student loan debt was the right move.”

By that logic, you can defend everything he did before the 2008 election. Snorting coke while organizing the community? +1. Attending a church presided over by a lunatic preacher with insane opinions? Another +1. Kids, put down the shovel and instead pick up the mirror and the straw. Then join the Westboro Baptist Church. Ticket to success, right there.

Finally, for fairness and balance, let’s include another quote about tertiary education from another man running for president:

When I went to school, we didn’t have a federal student loan program, and I was able to work my way through college and medical school because it wasn’t so expensive.

Never mind. Those are clearly the ramblings of a crazy person.

Seriously, why was college so much cheaper when Ron Paul was studying?

1. College hadn’t been rammed down our throats as mandatory. It was perfectly acceptable to brag that you were going to learn a trade after high school.

2. The government wasn’t involved.

The costs are allowed to skyrocket because you can keep kicking the can down the road. When no one has to pay the bill for decades, why even think about it? The same applies to healthcare: not post-2014 healthcare, but healthcare as it’s currently constituted.  When a 3rd party – the government, an HMO – gets between the provider and the payor, who knows (and who cares) what things cost? It’s not your problem. “My insurance is handling it.” Sure, insurance is supposed to reduce individual risk, but it increases collective risk. Give 100,000 people the same policy, same coverage, same premium and same benefits, and many of them will take risks they wouldn’t have otherwise. At that point, why not smoke and/or ride a motorcycle unhelmeted? Again, it’s not your problem. It’s someone else’s.
Furthermore, if you declare bankruptcy, the courts won’t discharge your student loans. From the lender’s perspective, this is great. If you can fog a mirror and have a Social Security Number, they’ll lend you the money.
But if the government got out of the picture, and the lenders risked losing money, they might start asking tough questions: like, “How will you pay this back with a B.A. in women’s studies?”
Would the government get out of the picture? A lot depends on who’s in charge, and what his own experience is.
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DOW HITS 7634! What now?

February 24, 2012

The father of irrational exuberance. If Bush had just yanked his hands down, a lot of problems could have been avoided

 

Huge, breaking, earth-shattering, paradigm-shifting, cliché-inspiring news this week, as the Dow Jones Industrial Average finally pawed its way back over the critical 7634 mark. No longer will we have to suffer in a world where the sum of the prices of 30 blue-chip stocks multiplied by a constant will begin with 7-6-2 or some lesser string of digits. Instead, let’s all stop at this milestone and take a needed respite.

Oh, sorry. Yeah, we were using base-12. Would you prefer we used base-10? Fine, but we’re going to use a different currency, euros. Which would make the Dow level 9807. No wait – let’s use base-12 and euros. That’d make the Dow level 5813. Isn’t this fun?

Most of the stock market “news” results from humans having 5 fingers on each hand and needing a way to count things. There isn’t any appreciable difference between a Dow at 12,999 and a Dow at 13,000, except that the latter burns a different array of bulbs in a digital readout and gives mathematically challenged journalists a chance to write headline fodder. Stop believing that this is in any way important.

From our favorite purveyors of loaded rhetoric, the Associated Press:

The Dow passed 13,000 about two hours into the trading day.

And from another AP story:

The average was above 13,000 for about 30 seconds before dropping back. It reclaimed the mark just after noon.

In the words of Anti-Nowhere League, “So (expletive) what?” They’re talking about this like it’s the moon landing, calibrating the event by time and duration so future generations will have a historical record of it.

Furthermore, the mere addition of one point to the Dow then becomes the catalyst for everything that follows. One more AP story, and a stunning example of why reading the news with a trusting eye is worse than not reading it at all:

The 13,000 level is a psychological milepost, but in a market built on perception, it could influence more cautious investors to pump more money back into the stock market, analysts said.

“You need notches along the way to measure things, and that’s as good as any,” said John Manley, chief equity strategist for Wells Fargo’s funds group…

Dan McMahon, director of equity trading at Raymond James, called the 13,000 marker a “positive catalyst, and that’s what we need to get us through the next range.”

Sounds like these Wall Street guys are as susceptible to “decimal bias” as the rest of us, right? No. McMahon continues:

In the end, he said, it’s just “a big round number.”

Which shows that the claims that “analysts said…it could influence more cautious investors to pump more money back into the stock market” is an unmitigated lie. Or if not a lie, then at least an unprovable assumption. Sure, Dow 13000 “might” influence investors to buy stocks. It also “might” turn the milk in your fridge sour. You don’t think so? Then show why it can’t.

CBS News has a video clip with the wonderfully objective title: “Dow 13,000: Time to Invest?”, which itself summarizes why financial illiteracy is pandemic. Yes, first let’s overpublicize a rise, however modest, in the Dow level. Then, let’s imply that people should buy stocks. Because that’s when you want to buy, when prices are rising.

You want superlatives? The Dow is now at its highest level since May 2008. When the Dow was at 12,990, that was its highest level since…May of 2008. Add the inexorable effects of inflation, however modest, not to mention whatever fees you paid for your index fund, and if you’d bought before May of 2008 you’d still be behind. If, however, you were dollar-cost averaging and buying units regularly since then, including when the market hit a local nadir of 6627 in March 2009, you’d be ahead. The Dow’s most recent movements, i.e. what it’s done in the past week, mean nothing.

We’ve talked early and often about the need to handle your financial transactions in a cold, calculating manner. Save the emotion and the irrationality for your personal, non-monetary life. When everyone else is chasing something, step back and ask why. When everyone else is fleeing something, same thing. And when a numerical quirk becomes front-page news, bumping Iranian oil embargoes to the second line, think about what that really means. To the extent that it means anything.

Yet another reason why our use of exclamation points on this site is so judicious. If a bunch of talking empty heads filling time in a TV studio have somehow convinced you that a .06% rise in the Dow is a reason to get your money out of your beer fund and put it towards stocks, we can’t help you. Besides, you don’t want to be helped.

There’s a time to get going, and a time to sit back (apologies to St. Francis.) If you don’t have an investment plan yet, run to the nearest brokerage house, bank, or human resources office and get one. It’s never too early to start.

But once you’ve invested, which we’re presuming you have, don’t drown in the details. Try to look at your portfolio quarterly. That recommendation is like Tolstoy’s challenge to not think of a white bear, but if you can do it, you’ll not only have greater peace of mind, you’ll be able to notice measurable differences in your portfolio more easily. It’s the same reason why parents marvel at how quickly their nieces and nephews grow, rather than how quickly their own kids do.

Getting excited, depressed, or even having an opinion about Dow 13,000 is mayfly syndrome. But you’re a human, with a lifespan tens of thousands of times longer than your typical mayfly. Even a giant daily swing in the Dow is utterly irrelevant, let alone one of just a few points.

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We Learn Nothing

January 13, 2012

We’re going to need more chairs

 

Not that many years ago, real estate was regarded as a safe investment. Now it’s the butt of jokes. What happened?

Fannie Mae (formerly the Federal National Mortgage Association) is one of the government-sponsored enterprises entrusted with making it easier for people to afford homes. Its sibling, Freddie Mac (né Federal Home Loan Mortgage Corporation), is another. A cousin, Ginnie Mae (Government National Mortgage Association) does pretty much the same thing, the big difference being that Ginnie Mae doesn’t pretend to be a private company.

One-paragraph summary:

You borrow money from ABC Bank to buy a house. Now you have a house, and ABC has your promise that you’ll pay them, say, $250,000 (with interest) over the next 30 years.

(On second thought, there’s no way in hell we can do this in one paragraph.)

That promise, from ABC’s perspective, is an asset. Of course it is, it’s money coming in. An annuity, if you will. ABC can then sell that asset to a secondary lender (ABC is the primary lender, duh) such as Fannie Mae.

ABC now has cash from Fannie Mae, cash that ABC can loan out. Loaning out money is the very purpose for a bank’s existence, thus ABC is happy with this situation. If ABC loans that money out to someone else for a mortgage, then if all goes according to plan, now you and that other person will own houses, instead of just you.

Fannie Mae was founded by the federal government in the 1930s, under the principle that having as many people as possible owning houses (and, by extension, owing banks money) was a goal worth pursuing. The logic went that with more liquidity – i.e., more money to be loaned out – not only would more people be able to afford homes, but mortgage interest rates should lower, too. A self-perpetuating cycle of easy loans for everyone!

I don’t understand what Fannie Mae is getting out of this. Wouldn’t they have to pay a premium to ABC for the transaction to be worth ABC’s while?

Yes. Fannie Mae pays the bank a ¼% servicing fee for the life of the loan.

Oh, I see. So Fannie Mae loses money on every loan. Sounds like a great way to do business.

Fannie Mae gets to borrow from the U.S. Treasury at extremely favorable rates. Currently ¾%. So with the average 30-year mortgage going for about 3.96%, Fannie Mae comes out way ahead.

So it’s the U.S. Treasury that’s losing money on every loan.

Yes! Isn’t “capitalism” great?

Now, Fannie Mae doesn’t just hold onto that money. It assembles your $250,000, your neighbor’s $281,384.34, and several other mortgagors’ loans into a multimillion-dollar mortgage-backed security. Then it sells that mortgage-backed security to an underwriter. The underwriter pays a higher interest rate to Fannie Mae than the ¾% at which Fannie Mae borrows from the U.S. Treasury, so Fannie Mae is happy. The underwriter is happy, because it has cash on hand (again, to loan out) and is paying a fairly favorable interest rate. But that rate is artificially low, because it’s based on the artificially low rate that Fannie Mae borrows from the U.S. Treasury at.

Isn’t this creating money out of thin air?

It’s creating “liquidity” out of thin air, which is almost the same thing.

With the creation of Fannie Mae and its relatives, the federal government effectively lowered the requirements for a prospective homeowner to get a mortgage. To the point where people who weren’t yet ready to own houses were owning houses. Some of whom were never going to be able to pay their mortgages back, and who got foreclosed upon.

Well, couldn’t lenders just charge those people sufficiently high interest rates that it’d be worth the increased risk to lend to them?

Of course not, this is America.

In the ‘90s, the government ordered Fannie Mae to keep a minimum percentage of its loans in mortgages for “low- and moderate-income” borrowers. By 2007, fully 55% of Fannie Mae’s loan originations were with such borrowers. The government then prohibited Fannie Mae – which is to say, the primary lenders who sold loans to Fannie Mae – from charging “predatory” rates.

So lenders were left with two choices: continue doing business with Fannie Mae, and risk losing money on bad clients; or don’t do business with Fannie Mae, and set their own high rates for borrowers with poor credit histories who didn’t deserve to borrow money at prime rates (the infamous “subprime market”.)

If lenders went with option B, they could create their own mortgage-backed securities, with higher interest rates and higher volatility. Those privately fostered mortgage-backed securities then hit the market, at which point people stopped buying Fannie Mae’s mortgage-backed securities (at their comparatively low interest rates.)

So Fannie Mae started offering higher, more competitive interest rates. The free market at work, right?

Sure, except Fannie Mae and Freddie Mac only pretend to be private corporations with stockholders and everything. The federal government goes to great lengths to explain that Fannie and Freddie are not branches of itself. Functionaries can quote you the 1968 act that led to Fannie Mae being named an “independent” company. In reality, the government wanted to remove Fannie Mae’s obscene levels of debt off the national balance sheet (cf. Abraham Lincoln, a tail ≠ a leg). Investors and customers alike continue to treat Fannie Mae as a branch of the government, with an implicit government guarantee if not an explicit one. Put it this way: if your elected representatives committed billions of dollars of your tax money to AIG, General Motors and Chrysler, they’ll do it for Fannie and Freddie. Again.

Which would you rather invest in, assuming each had the same credit rating: private or Fannie Mae mortgage-backed securities?

The latter offered returns similar to the former, only with that implicit guarantee. Therefore people bought more of them. To create more mortgage-backed securities, Fannie Mae made more and more low-interest, sketchily underwritten loans. A private bank like Lehman Brothers can die a quick death and leave the remaining banks healthier. But there’s no concept of culling the herd when it comes to Fannie Mae.

(There is nothing government can’t ruin. Vote Ron Paul.)

Meanwhile, because of the low mortgage rates Fannie Mae was responsible for spawning in the first place, millions more people bought houses than otherwise would have. Too many people chasing too few houses means prices rose. A “bubble”, if you will. Then borrowers started defaulting, and lenders realized that they didn’t have enough collateral to cover debts.

When there’s downward pressure on primary mortgage loans, and upward pressure on secondary mortgage loans, something has to give. Add to that the underqualified people who couldn’t make their mortgage payments, and thus got foreclosed on, and the result was even more houses sitting empty. By 2008:

  • Fannie Mae and Freddie Mac either owned or guaranteed half the residential mortgages in the country.
  • As “independent businesses”, “free of governmental control”, and publicly traded, their stocks began to drop. In the case of Fannie Mae, 99.66%:

 

It’s almost impossible to lose a higher percentage than that, yet Freddie Mac managed:

 

 

  • As investments, Fannie Mae and Freddie Mac were effectively worthless.
  • The Secretary of the Treasury, operating under the orders of his boss, lied through his teeth and told the public that Fannie Mae and Freddie Mac were financially sound. No one who’d examined the issue could possibly believe this, but the public at large might have.
  • Someone owned Fannie Mae’s and Freddie Mac’s mortgage-backed securities. Actually, lots of people. Foreign governments, retirees’ pension funds, etc. The argument went that if Fannie Mae and Freddie Mac were officially deemed worthless, disaster would occur. As if requiring half a trillion dollars from American taxpayers didn’t qualify as a disaster.

So the federal government did exactly that, putting you on the hook for every horrible decision made by entities that created no value in the first place, and distorted the market by their very existence. It would have been less damaging to have simply cut a five-digit check to each family that wanted a house and didn’t have the money for it.

Fannie Mae and Freddie Mac aren’t subject to the same capital and diversification requirements that private banks are. Nor do Fannie and Freddie ever have to worry about having their loan portfolios reviewed by regulators, nor rely on those same regulators to give them a safety and soundness rating.  

Today, Fannie and Freddie continue to have a hand in most residential mortgages. They still lose staggering amounts of money – $14 billion and $22 billion last year, respectively. And as we’ve seen, their stocks now trade on the over-the-counter bulletin board, the Canadian Football League of securities trading.

Fannie Mae’s chairman made $6 million (of your money) last year, Freddie Mac’s $4 million. Yet none of those Occupy Wall Street vermin protested outside their respective headquarters. Merry Freaking Christmas.

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