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Here’s a good post explaining in simple terms why renting can be better than owning.
Most important part:
So to sum up why I rent: Shares right now cost 16 times earnings and over long time periods return 7% a year after inflation. Houses right now cost 19 times their “earnings” and over long time periods return zero after inflation. And they look likely to return less than that for a while.
This piece was written from the American perspective. Not that I think they need to be educated anymore as to the pitfalls of owning property.
The Canadians though are a different story. I moved to Toronto a little over a year ago and can easily afford a house. But like the author above, I choose to rent for the exact same reason. I go to open houses all the time, but I’ve yet to see even one single property that offers an attractive rental yield. At current prices, I can generate a higher income by putting my money in the bank than by buying a house or condo.
Of course, even with an unattractive yield, I could still make the argument for buying property if I were to believe that prices were to keep going up. Except that I don’t believe. The market has turned. And while there’s plenty of pundits who tell us that we’re headed for a “balanced” market, history suggests otherwise. Bull markets are generally followed by bear markets — not balanced markets. You always need a “greater fool” to push up property prices and I suspect even fools are starting to wise up to the market’s current situation.
This reads like it comes from The Onion — but it’s from The New York Times:
“If money isn’t loosened up, this sucker could go down,” President Bush declared Thursday as he watched the $700 billion bailout package fall apart before his eyes, according to one person in the room … In the Roosevelt Room after the session, the Treasury secretary, Henry M. Paulson Jr., literally bent down on one knee as he pleaded with Nancy Pelosi, the House Speaker, not to “blow it up” by withdrawing her party’s support for the package over what Ms. Pelosi derided as a Republican betrayal.
No time for wry comments. I’m angered by the bailout package in its current form. A banking rescue package is urgently needed, so why is Paulson dicking around with a package that does not sufficiently punish the shareholders of the banks. Of course it’s going to raise concern. And the democrats rebuttal to help homeowners? Ridiculous— and besides the point. The only issue that both sides should be focusing on is systematic risk. Period. Read my earlier post on “Bailouts for Dummies” to understand why a rescue plan is a necessary evil in the first place.
“In a report issued Wednesday, Merrill Lynch Canada economists said many Canadian households are more financially overextended than their counterparts in the United States or Britain. They said it’s only a matter of time before the “tipping point” is reached and the housing and credit markets crack in Canada.”
I normally try to focus on fact rather than opinion but I feel compelled to link to this story because this is the first time I’ve seen an economist who says what happened in the US could happen here.
I also must admit my irritation of the countless statements by pundits as to the sustainability of the Canadian property market. I sure don’t remember the pundits in Las Vegas, Florida and California telling people to sell their houses there two years ago. Still, to be fair, YatterMatters presents both sides of the story here.
It seems that many Canadians still believe that the property market is just fine. Canadian Mortgage trends points out: “We’re seeing a lot of applications for 100% financing as the Oct. 14 deadline* approaches.” It worries me that more Canadians aren’t more worried about what is happening down south. Read my early post, “The Great Canadian Housing Myth” to see why “Canadian property is affordable” arguments are nonsense. You can also check out my foray into “financial humor” via: “Never Let the Facts Get in the Way of a Good Housing Bubble.”
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* Deadline for getting those 0%-down 40-year mortgages.
The media is making too much of Warren Buffett’s $5bn investment in Goldman Sachs, with a particularly silly headline at the Financial Post: Buffett bets on Wall St. revival.
The key thing to understand is that Buffett is not buying common stock. He is investing in preferred stock — preferred stock that yields 10%. And to sweeten the deal they’ve thrown in some in-the-money warrants with a five-year life — worth at least US$1bn at current levels.
For those of you who have forgotten your Accounting 101, it’s common equity that absorbs losses first. Goldman’s share price would have to go to zero before Buffett loses a single penny on a preferred stock investment. So Buffett is not so much betting on a “revival for Wall Street” as he is betting on the fact that Goldman will have enough common equity (or be able to raise it going forward) to protect Buffett’s preferred stock investment.
If Buffett was so bullish on the market, methinks he’d be buying the common.
With next week’s bailout of the US financial system comes the inevitable complaints by those who are angry that taxpayers will be footing the bill. A bailout will cost less than the alternative. Let me explain through a simplified example. The numbers are representative only:
For every $100 a bank might loan or invest, it typically will have funded only $7 of that figure via shareholders equity.* What that means in plain English is that banks are borrowing most (93%) of the money that they use to lend or invest.
If the bank makes too many bad loans & investments, it is the bank’s creditors who will lose — after the $7 in equity is wiped out. It’s simple math. And who are the creditors?
YOU! (if you have any US dollar deposits, that is.)
You are the creditor by virtue of the fact that you deposit money with banks. The bank then takes that money and lends it other people, including (maybe) you. The bulk of the banking system’s creditors are depositsΦ by people and corporations.
Given the lack of liquidity in financial markets, many banks do not have enough cash to meet creditors’ demands. What’s more, with doomsday predictions as to the value of banks’ loans/investments, there does not appear to be enough of an equity cushion to absorb the losses that would be incurred — even if those assets could be sold! So it’s you — the depositor — who is at risk of absorbing these losses.
But things can get worse if the government does not keep the financial system functioning. Imagine a world in which you woke up tomorrow and found that you could not withdraw your money from your bank. How would you buy your double latte? Because of the inter connectivity of the financial system, asset values would fall further as your bank sold off assets so that you could buy your lattes. Other banks would then have to write down the value off their assets. Other banks would fail. And so on. And so on. In a system without a functioning banking system, asset prices fall well below fair value. Imagine the panic that would ensue: people hiding money under mattresses, cats marrying dogs, republicans endorsing gun control — Armageddon.
Can you imagine how things might get worse than they might otherwise get — if the government (i.e. the taxpayer) did not come in to “rescue” the system?
This is Banking Crisis Management 101.^
Either way, you pay. But in one scenario you pay by losing your deposits. And in the other scenario, you pay as a taxpayer. But in the second scenario, the bill should be less than it would otherwise have been.
But even better: because the bill is being funded by government debt, it won’t be you who pays it off. It’ll be your kids.
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*Investment banks have much less equity for that same $100.
ΦBy “deposits” I mean all borrowing of the banks: customer/corporate deposits, short-term paper, bonds, etc.
^Note that it’s important in the rescue plan that the government does not overly protect shareholders of the banks. Shareholders should lose everything before the government (i.e. the taxpayer) comes in. But the system must not be allowed to fail.
UPDATE: As details emerge about the bailout over the weekend, there’s increasing negativity about the plan. Paul Krugman has a good piece in the NY Times. It appears that shareholders may be getting off the hook. This is plain wrong. It rewards the idiot bankers who created this problem in the first place. Shareholders do not need to survive in order for the banking system to work. Aleph blog sums it up here as he calls on his readers to oppose the plan. Key point:
What we don’t want to do is provide a place for companies to dump lousy assets at inflated prices. Instead, a new RTC should be a last resort place that the assets of failed companies go to until they are disposed of. Common and preferred equity should be wiped out, and bondholders should take haircuts. New loans should be senior to all old loans, similar to the situation with AIG.
Lots and lots of very important stuff:
UK places 4-month ban on short selling — US places short-term ban on short selling — US to set up entity/fund to buy bad loans off banks — China to use government funds to prop up stockmarket.
Some viewpoints by smart people: Click here.
Fury in the blogs: Click here and here.
The Big Picture is interesting. So is Aleph.
Markets have rallied very sharply on the news of these interventions. Some thoughts:
- Buying illiquid bad assets off banks is ultimately a necessary evil. The system must not be allowed to break down. The sooner the better. As long as there is no moral hazard — i.e. bank shareholders must pay penance — it is a good thing. If done correctly, the government will provide new equity to the banks so they can keep functioning, and apply losses from problem assets to current shareholders. The government would also (hopefully) then require the banks to sell their problem assets, so that the market can look at the bank in question — and go “OK, now I know it’s clean.” This is Banking Crisis Management 101. It means banks can lend. It does not mean that individuals/corporations will want to borrow.
- Banning short-selling could have unintended consequences if the industry is forced to shut down hedges. For example, how will equity market-neutral funds function? And if they choose to close the short end of the hedge don’t they have to close (sell) the long side too? Oops.
- Short-term rules are risky. What happens when the government allows short-selling to resume?
- While economic purists hate government intervention, sometimes intervention does help. During the Asian Financial Crisis, Malaysia intervened heavily in currency and capital markets and was heavily criticized by financial pundits for not letting free market forces be. In the end though, its intervention “worked.” Its economy did not suffer as much as its peers. Hong Kong also intervened, coming in heavily to support the stock market in one spectacular day during the crisis. That “worked” too.
Markets tend to overshoot on the way up and on the way down. A broken financial system would mean more downside, all things being equal. But short-term burst aside — Does this mark the resumption of the bull market? Well, I have two answers for you:
1) If the perception that markets have been rising because of good fundamentals and falling because of evil hedge funds is accurate, then perhaps, yes, everything will continue upwards. I think though that things are a little more complicated. For instance, if you’re going to argue that “evil” hedge funds push down the market, then you should also consider that hedge funds push up the market too, or have we already forgotten that hedge funds are supposedly the reason oil prices got to $140? They sure are crafty, those evil hedge funds.
And whatever role the hedge funds have played in bull/bear markets how can we ignore the simple fact that loans were made by greedy bankers to people who could not pay? Or that until a few months ago, corporate heads and the man and the street were talking about commodity shortages and peak oil (or was that peak potash? — I often can’t tell the two charts apart).
It seems it’s not just the hedge funds that are manic-depressive risk-taking speculators.
And what role did you play? Did you buy stocks in a rising market because you understand the fundamentals or simply because you thought it would go up further? Does that make you a fundamental investor or a speculator?
This article in NY Times is worth a read, key point here:
On Tuesday, the Reserve Primary Fund, a giant money market fund whose parent helped invent that investment, said its customers would lose money. Instead of each share being worth a dollar for every dollar invested, it said its customers’ shares were worth only 97 cents.
A couple of months ago, I was looking into putting some excess funds into money market funds. When I asked to see a chart of the history of the performance of the funds, my banker told me, “it’s always one dollar.” Nor did he have a prospectus that detailed what type of securities the fund was investing in. This annoyed me. After a few attempts to educate him on why I needed this information, I opted for a high-rate savings account on my US dollars. On my Canadian dollars, I found something a little more interesting: a GIC Broker.
GIC brokers — in case you have not heard of them — do for deposits what mortgage brokers do for mortgages. Because they do business on the wholesale level, you can get 100 basis points or more on your Canadian dollar savings than you would from your bank. As long as you keep the balance (principal and interest) below $100,000 and ensure the broker places with a CDIC member institution, your money will be protected by the CDIC — even if the bank learned its lending practices from Fannie Mae. Details about CDIC protection here.
You can read about GIC brokers here. FYI – I’m pretty anal about these kinds of things and was at first hesitant to send my money to some GIC broker I’d never heard of. I was happy to see one firm on the list that I knew to be legitimate. I’m getting 4% on 1-year deposits through them.
The following story is 99% true:
One evening many years ago I was having farewell drinks with my boss — let’s call him “Calvin.” Calvin was an extremely successful and well-known equities analyst. I was a junior in the firm and I was moving elsewhere to take on greater responsibilities.
Calvin had always been as much a mentor to me as he was a boss. I suddenly felt nervous at the realization that going forward I would be without his counsel. There was something I had to know. Something I had never asked him before.
Me (lifting my head off the bar): Calvin?
Calvin looked at me but did not answer.
Me: Calvin? You know in those morning meetings. When you pound on the table and you scream to buy. You always seem so confident, like you know the future.
Calvin was always great in those morning meetings. So cool, so convincing.
Calvin smiled.
Me: I’ve never once had that feeling.
Calvin turned away.
Me: Calvin? I need to know something. Please tell me the truth. Do you really believe what you say?
I know this sounds awfully lame but my skin was hot, my heart pounding and my eyes glistening with my need for honesty — for THE truth. Calvin felt my sincerity — my yearning for the answer. Pushing the stripper off his lap, he turned to me and said:
Don’t ever tell anybody I told you this but I learned a long time ago that the secret to longevity in this business is to:
a) Choose a view on your sector: bullish or bearish. I’d suggest “bullish” since bull markets usually last longer than bear markets.
b) Hold that view FOREVER.
c) POUND on the table that you’re right – especially when the markets are moving against you.
d) Remind people of how you pounded on that table, once the markets have turned in your favor.
e) Only talk about your successful calls.
f) And the most important thing: ALWAYS have a view and ALWAYS make the client believe that you know the future.
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Why am I telling you this?
A lot of people can’t see through analyst/broker/fund manager/talking head’s glib predictions. They want to know the future and want to believe someone else must already know the future.
They don’t.
On that note, while I’ve tried to keep this blog neutral in terms of investment advice, the reality is the blog has had a a bearish tone since its inception. The reason? I can’t help it — not when so few people are saying Sell. Not when there’s so many schmendrick analysts and reporters glibly telling Canadians that everything will be OK. Not when there’s a very real chance that it won’t be. Just look around the world. Look at history. Educate yourself. Protect yourself. Diversify. Know your risks.
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Oh – and Calvin? He screamed BUY the whole way down during the internet bubble collapse. Not that it effected his personal finances though, he’s comfortably retired now.
Oh —and the 1% of the story that wasn’t true? There was no stripper. Sorry.
Clickworthy — (not)
This entry at the Globe and Mail on bank stocks annoyed me. My key un-favorite part:
One of the best opportunities in years for dividend investors also happens to be a safe zone amid the current stock market mayhem. Bank stocks, treated as toxic waste not too long ago by investors, have actually been edging up in price lately. Act soon if you want to buy them while they still offer an unusually complete package for investors focused on dividends.
I have no problem with dividend investing. The problem I have is with this “calm in the eye of the storm” attitude among market watchers. Fannie and Freddie Mac are gone. Bear Stearns and Lehman and Merrill Lynch are gone. What other evidence do market watcher need to see to understand that banks — all banks — are highly leveraged businesses? The Canadian economy has been rising for years, so the banks seem safe. But in a deteriorating economy, the opposite holds true.
I wrote about banks a few weeks ago. You can read about them here.
One other thing. As you all know, Lehman Brothers filed for bankruptcy protection over the weekend. Still, I can’t imagine shareholders are complaining too much. They may have lost every penny of their capital investment but they did at least receive that nice juicy third quarter dividend of $0.17 — paid just few weeks ago.
Big story of the day:
“OPEC oil ministers agreed Wednesday to curb overproduction by more than 500,000 barrels a day, in a compromise meant to avoid new turmoil in crude markets while seeking to prevent prices from falling too far.”
“The statement noted that “prices had dropped significantly in recent weeks driven by a weakening world economy … with its concomitant lower oil demand growth, coupled with higher crude supply, a strengthening of the U.S. dollar and an easing of geopolitical tensions.” And it warned of the possibility of further price erosion, forecasting a possible “shift in market sentiment, causing downside risks to the global oil market outlook.”
But what happened to peak oil!? I thought there wasn’t enough oil to meet all the demand that’s going to come from Chinese peasants-turned-automobile owners.
Ahhhh – that’s it! There’s so much demand for the gloop that our good friends are rationing the stuff — it’s for our own good.
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