Subprime synergism

The always well-done Sunday New York Times business section offered me two great reads this week. That they're actually related to each other is even better.

First, actor and author Ben Stein offers a little perspective on the unfolding subprime mortgage crisis.

The 10-cent version? Yes, a lot of people were too eager and too greedy in conjuring qualified mortgagees out of thin air. But that's not the whole story -- "subprime mortgage" doesn't deserve to be a dirty word, since the financial vehicles allowed a large number of people to do what is, at its essence, a very good thing: buy and keep their own homes. Subprime mortgages represent about 10-15% of all U.S. mortgages, and so far, about 10-15% of subprime mortgages have gone into default. The unraveling is going to be painful, but let's not pretend that every single U.S. homeowner has suddenly stopped paying off his mortgage, Stein writes.

Not that there aren't pockets of truly astounding real estate implosions across the U.S.A. as this excellent feature on real estate in Merced, Calif. by David Streitfield shows. A suburb of San Francisco, Merced's an excellent microcosm for the worst aspect of the U.S. housing boom, and serves as a cautionary tale of what might be to come. Prices are down about 50% from their 2005 peak. This bleak quote is probably the piece's money shot:

With as many as 2.5 million homes in the United States entering foreclosure this year and, at best, sales of only 5 million existing houses, the foreclosure price is becoming the rule in many areas. In Los Angeles County, whose 10 million people make it the most populous county in the United States, a third of the sales are foreclosures.

How is this all going to play out? I have no idea. But like anything else, I think the reality will be somewhere in between the outcomes predicted by the sky-is-falling doomsayers and the "everything is fine...keep shopping" optimists.

Extreme makeover: Foreclosure edition

Not much I can really add to the story that a house built in 2005 for a down-on-their-luck family on the TV show Extreme Makeover: Home Edition has gone into foreclosure.

The four-storey mini-mansion, built for the Harper family with the help of 1,800 volunteers and residents from Lake City, Georgia, will be auctioned off to the highest bidder on August 5th. The house was used as collateral for a $450,000 loan that went into default.

Sad, really. Obviously in retrospect, it's not always the greatest idea to shower people in dire financial straights with windfalls like this because they don't always know how to handle it, but this whole story also says some particularly sad things about the worsening state of the U.S. economy in general.

Darts and laurels

When you work in the media (and by association, hang out with journalists) while also being one of those weird people who actually enjoys talking about financial topics, it makes two things more likely to happen. No. 1, the odds that your drunken ramblings might ever see the light of mainstream publication are infinitely increased. And No. 2, how they're received is likely to be all over the map...

I'm "in the news" (so to speak) a couple of times at the moment, and I figured I'd be remiss if I didn't point my loyal readers (Hi mom!) toward the fruit of my overactive brain.

My good friend Andrea is under the mistaken impression that I somehow know what I'm talking about when it comes to financial topics, so she's enlisted me to answer a few basic questions about opaque financial topics on her new financial blog, Unspending. This week, we're talking about net worth: what is it, and why does it matter. This may or may not become a recurring feature, since believe it or not, there's few things I enjoy more than chatting about things like personal finance. So if Andy's pleased with the results, expect more topics to be discussed in a rough Q&A format over there. So far, the early reviews of my thoughts appear to be positive.

But clearly, that's not a universal view. Another friend, who works at the Toronto Star, has been writing an 8-part series about the process of jumping into the real estate market for the first time. I'm something of a contrarian when it comes to real estate, as my B.S.-detector tends to go into overdrive when I'm at a cocktail party and overhear someone bragging about how "you can't lose money in real estate." At any rate, Robyn and I have been having an ongoing debate about Toronto real estate for a few weeks now, the distilled version of which, it turns out, is the focus of her series' final installment: Home, Sweet Home.

As impossible as it is to poke holes in such air-tight financial advice (from a financial advisor, no less) as "never pay off your mortgage," the point I was trying to make isn't so much that real estate is a bad investment, but more that it's quite often a good idea to at least question the conventional wisdom of the massive financial move you're making -- not to mention that 40-year mortgages might not be your best friend.

No matter. Though I'm clearly the villain of the piece, it's all in good fun. And I doubt it'll be the last time anyone takes mock umbrage with something I say.

Boom and bust

OK. So you've no doubt heard the news that Canada's housing boom is slowing. "Canada's Housing Boom Officially Over," if memory serves, was the early headline on the Globe's story about resales tumbling 22% in Toronto during the first quarter (although I note they've since toned down the doomsaying a tad.)

As I've said before, as a non-owner looking to buy at some point in the relatively near future, I'm not holding my breath for an outright crash. Toronto is a vibrant city with a fairly strong, diverse economy and a growing population. All the elements for a natural increase in house prices are there. But that's not to say I don't look at charts like this and wonder where it's all headed.

Still, I'm not nearly as pessimistic as this U.S.-blogger is. As much as the schadenfreude drips off the page, I have a hard time arguing he doesn't make a few rational points.

Ultimately, I don't expect any pain here to be anywhere near as bad as it's been in pockets of the U.S. I raised my eyebrows at the advent of 30+ and 40+ year mortgages in Canada, but the fact is, they still remain a tiny part of the overall picture in Canada.

But as long as there are people like my real-estate obsessed colleague telling me how she's already "made" $11,000 on the condo she bought in March (because the identical unit one floor up just sold for that much more) I know there's still a ready supply of people looking to join the game, confident that the music isn't about to stop.

Depending on a greater fool than I to come along in a few years time and take it off my hands isn't the strategy for me. I'm going to wait and see how this plays out.

Can debt be a safety net?

Normally, I dismiss the countless unsolicited financial products I get in the mail every month out of hand, but I'm tempted to bite on a particularly persistent one. In the deluge of pitches I receive from my bank, Royal Bank, every month, one of the recurring items is an offer of an unsecured line of credit. They're offering $10,000 at a rate close to prime, if I recall correctly.

I currently have a high-interest savings account that doubles as an emergency fund and condo downpayment fund. If something like a job loss were to happen now, that's what I'd be dipping into to tide me over. But when I eventually come around to buying a place of my own, I'll probably be inclined to empty the entire thing (so as to maximize my downpayment) and knowing myself, I know I'll be tempted to pour every spare cent I have into paying off the mortgage after that -- at least for the first year or so, until I've convinced myself I'm not actually about to get fired on a daily basis.

The long and the short of it is, when I liquidate the fund to buy real estate, I'll find myself in the position of not having an emergency fund, at least in the short term, to pay for those unexpected emergencies. (I'm told having three months' expenses is a good guideline.)

What I'm thinking of doing at the moment is to sign up for this unsecured line of credit as a sort of insurance policy. It doesn't cost anything on a monthly basis unless I take money out of it (which I wouldn't do as long as I had that $10K in savings I currently have) at which point I'd pay interest on the withdrawals. That way, should the need ever arise, I'd dip into the line of credit, as opposed to the emergency cash that's I'd already have wisely invested into minimizing my mortgage.

I suppose this is all moot until I actually need it, but I'm tempted to sign up for it now. I'm sure the rates offered by banks on unsecured loans start to change once you've borrowed six figures to buy a house, so my reasoning was to sign up now while I'm an excellent credit candidate.

Any thoughts on this? You don't have to remind me of all people that, as a general rule, debt = bad, but is it not better for my long-term financial wellness to not have 5K or more sitting around in a savings account when that money could be put toward paying down a future mortgage? I suppose there might be some negatives in terms of credit rating to consider, but the thought of having several grand sitting in a bank account while I have a six-figure debt to pay off doesn't sit right with me -- and I haven't even taken the plunge yet. It just seems a waste to hoard cash for a rainy day that might never come.

Is this not a situation where debt is actually the smart financial decision?

I'm a bad little asset allocator...

Asset allocation -- it's the cornerstone of any long-term investing plan and it's a topic I find myself thinking about a lot of late, mainly because I think I'm cheating on the fixed income portion.

For newbies, asset allocation refers to the ratio in which you keep the funds you have in different investment vehicles. At it's most basic level, asset allocation means deciding how much of your total nest egg you earmark for safe fixed-income instruments like bonds, GICs and high-interest savings accounts, and how much you put into stock market equity, which generally holds the potential for higher returns, but also a higher risk of losing capital. Other asset allocation models are even more complex, including things like real estate, precious metals, etc. into the total financial outlook, but generally speaking most asset allocators stick to a fairly striaghtforward strategy like the one above. The idea is to diversify so that all your investments don't move up and down in lockstep -- as one investment moves up in value, you sell off a little and buy into the classes that haven't done as well to hedge your bets over the long term.

An oft-quoted rule of thumb for asset allocation is that the percentage you devote to fixed income should be equal to your age -- the idea being that the older you are, the more conservative you want to be, so the less risky, more capital-preserving investments you're going to want to gravitate towards. That framework always sat right with me.

If that's the case, I should be directing 26% of my net worth (currently at $29,443 according to my NetworthIQ report for this month) towards fixed income products. In my case, the vehicle I've chosen is a high-interest savings account with ING. So my fixed-income holdings should be at around $7,655 if I were a good little asset allocator. As it stands, I'm way above that level, with more than $11,000 sitting around in cash, gaining interest every month. I generally like to roll the dice a little bit and devote more funds towards equities while I'm young, so I was surprised to find myself devoting nearly 40% of my net worth, effectively, to cash, but then I realized that number is skewed a little for three main reasons.

No. 1 -- I plan on buying real estate at some point in the next 18 months. So I'm filling that high-interest savings account with as much money as I can under the pretense that I can't afford to lose this as I need those funds to be around for a downpayment fairly soon. Secondly, while my ING account is my de facto house fund right now, it was originally started as my emergency fund where I stashed enough cash to cover my expenses for three to six months should the need arise. It’s since ballooned well beyond that, as I said, now doubling as a downpayment fund. But I still want to keep those few thousand dollars worth of "just in case" money in there, not really as an investment per se -- more like peace of mind.

The third reason I find that section of my portfolio larger than it should be is that I can't shake the nagging feeling I have that the stock market, particularly the TSX, is a tad overvalued. Things have been too good for too long, so my natural inclination is to keep a lot of cash on hand both to minimize my losses and also be able to buy back in after a correction -- something recent events seem to suggest might be happening as we speak.

This is the area where I think I'm "cheating" at my asset allocation. Technically, your asset allocation is supposed to change as your circumtances change, so I guess I'm just responding to the stimuli of my own situation the way you're supposed to. But at its core, the whole reason asset allocation works is because it forces discipline on to an investing plan. It's meant to veer you away from making decisions like piling more money into the latest hot sector or emerging market -- or the flipside, where you panic and sell off all your holdings in a particular class because of a bad quarterly statement. Indeed, you're supposed to shave off some of your winners and pad up your losers to come up ahead in the long run.

At any rate, I don't really see myself cutting back on my cash allocation, as all three factors I listed are strong actors on my decision-making process at the moment. But it still doesn't sit right that here I am, making excuses why it's OK for me to veer from the long term asset allocation plan "just this once." I'm consoled by the fact that if anything, I'm being overly cautious, as opposed to aggressive, by having a lot of money tied up in low-yielding investments. At the end of the day, nobody ever went broke by having too much money in their savings account.

Questions and comments welcome as always

Stocks vs. Real Estate -- a stream of consciousness post

More and more, I find myself warming up to the idea of buying a condo in the near future, which means I've been spending a lot of free time thinking about the benefits of investing in the stock market vs. investing in real estate. It's an interesting internal debate for my conscience to be having with itself, since it appears to have brought two fundamental impulses of mine to the forefront -- and in many ways they seem diametrically opposed to each other.

I'm naturally debt-averse. This means that all things being equal, I don't like owing money to anyone -- ever. It's the reason I pay my VISA bill on time every month, it's why I'd never even consider buying stocks on margin, and it's the reason why my natural instinct, when presented with a mortgage balance of around $200,000, is to pay it off as fast as humanly possible. I suppose deep down that shows I'm a natural pessimist, convinced that my financial world is going to come crumbling down at any moment, so I cling for any solid ground I can find to stand on when bad stuff happens. It's odd because I'd consider myself to have a fairly optimistic outlook on life in general, but I can't deny I have a "sky is falling" attitude a lot of the time when it comes to financial matters. My hatred of debt is clearly a powerful force in my finances. But on the flip side…

I don't like putting all my eggs in one basket. I suppose as an extension of that pessimism, I like feeling the safety of having a lot of little piles of money, spread out across numerous sectors, bank accounts, and investments. That way, when any given one happens upon some sort of calamity, I don't get totally wiped out.

At the end of the day, these two impulses could be considered complementary, rather than contradictory. But within the context of the Canada Revenue Agency's Home-Buyer's Plan, which allows you to withdraw up to $20,000 from an RRSP towards the purchase of your first home, I'm having trouble reconciling them.

On the one hand, being able to cash out my nearly $12,000 in RRSP would allow me to make a bigger downpayment, which would mean my mortgage is smaller to begin with, which means I'm able to pay it off sooner. This makes GIV #1 happy. But I like the make-up of of my RRSP at the moment, and think it's well-situated to perform well both in the short and long term. So GIV #2, the spread-your-wealth-around part of me, wants to keep those equity investments, both because they'll give me exposure to better-than-real-estate growth potential, but also because they'll be separate from my home equity. Again, if things were to go sour in real estate for me, I'll feel better having those couple of grand in equities to fall back on down the line.

If I'm honest with myself, I suppose I don't actually want a condo, in and of itself. I have the same domestic instincts as most people. I'd like a back yard, a little patio: a well-used barbecue I can call my very own. All things being equal I'd probably prefer a little house for myself, but in Toronto, where I'm currently living, the housing market is so expensive that an above-average imcome can't really do it anymore. Which is why the city has talked itself into the concept of cube-style condo living. Ads like this just scream 'It's affordable! It's hip! It's urban! It's incredibly claustrophobic and hermetically sealed!' to me. So really, the only reason I'd buy a condo would be for the financial benefit of building some equity. A lot of things we buy we do so for emotional reasons, like a new car, new clothes, or a vacation. But for me, at this stage in my life, the urge to own is strictly a financial impulse. Too much personal finance blog-reading, I guess...

I guess where that urge to own comes from is people's general acceptance of the belief that real estate is inherently "safer" than other investing, because it's tactile, and long-term. We can touch it, we can see it, ergo, it's worth something. It's a concept one commenter in this MoneySense investing forum hit squarely on the head:

…With real estate most investors are very comfortable holding it for long periods of time, if they have to (or flipping it quick if they get lucky, usually less common). In the stock market, after a couple of statements of declining values, most new investors run for the exits, petrified that they will be left with valueless assets and an incredably huge debt. It won't happen, but the fear is real all the same and stock market investments can be sold at the click of a mouse. No listing, no staging, just one click and your out...

In other words, if I own a home and I see the real estate market crumbling around me, the last thing most people do is sell out of panic. Most think the opposite -- why sell now at a loss? I'll just wait a few years and get out then, but I'm in no hurry. I can live in this thing in the meantime. But with stocks, we see that statement lose 10-20% and we have to fight the urge to log on to our online brokerage and sell for whatever we can get, sometimes unsuccessfully. I definitely see a lot of myself in that.

I don't expect to come to any sort of decision on this subject any time soon, since I'm nowhere near buying because I haven't built up the 25% downpayment I mentally need before taking the plunge. But there are certainly some interesting big-picture thoughts swimming around my head at the moment.

A $200,000 rectangle of concrete on the 40th floor of a Toronto skyscraper isn't the kind of thing I'd want to be getting into blindly.

Unbelievable stat of the day

Food for thought comes, this Monday morning, in the form of an interesting Jim Stanford column in the Globe and Mail.

This being RRSP season, Canada's major financial institutions are ramping up their campaigns to make us all feel like we're going to die penniless and alone unless we collectively buy XYZ hot new sector-based mutual fund. But Stanford urges us to see through the hype and take any expendable cash we have this time of year and put it into an investment we can truly enjoy for years to come -- the family homestead.

We've all seen the Stats Canada surveys showing how many billions of dollars in unused RRSP contribution room Canadians allow to languish every year ($400-billion since 1991, at last count) and we've all seen the breathless press releases from CMHC, telling us how healthy the housing market is, with a seemingly endless supply of willing new buyers in almost every region.

The numbers back those observations up, and that's no coincidence, Stanford writes. As a whole, we're consistently eschewing the stock market in favour of buying, or upgrading, our own homes. Stanford offers what was, to me, and amazing statistic:

More Canadians own their own home than hold even a dollar's worth of RRSPs.

In and of itself, that's an amazing factoid. But what's really telling about this, to me, is how skewed the numbers are when you drill down a little. The average RRSP is worth $30,000, Statcan says. But since so many people don't have one, in reality, there's a lot of people on either extreme. So if you have an RRSP, chances are it's either fairly small, or impressively large. Put another way, out of ten people, chances are one person has an RRSP worth $300,000 while the other nine have none. Presumably these are the same 62% of Canadians who own their own home. I hope so, for their sake.

Stanford embraces the new trend, essentially saying the best thing people can do for their own financial health is to own their own home and work for well-funded public and workplace pensions. I'm not sure if I agree with that sentiment -- but certainly an interesting perspective on the issue.

Conservative investors take more risk?

Conventional wisdom has it that conservative investors are more likely to save up a solid downpayment in the neighbourhood of 25% of the value of the home before jumping into the real estate market, while riskier people are the ones who sign up for no-money-down, 35-year mortgages and the like.

But an interesting post out there in the pfblogosphere is aiming to try to turn that notion on its head.

This post makes the contention that truly conservative investors are in fact more likely to go for 0% downpayment options, where the purchase price of the home is 100% paid for by the bank.

Basically, the argument is that in 100% financing deals, the bank is the one swallowing 100% of the risk -- both that the buyer won't be able to pay off the mortgage, and that the value of the asset will depreciate.

The reality is the conservative financing option is 100% financing. You have pushed all risk to a third party -- the bank! In doing so, you remain completely liquid -- the true goal of a conservative investor.

I'm not sure I buy the argument myself (the author's job as a mortgage broker clearly gives him an agenda that colours his opinion, IMHO) but it's certainly an interesting viewpoint.

My own nature tells me the best plan is to save up a significant amount of the purchase price for a downpayment, as a hedge against some calamity happening later on -- like losing a job, having to move, or a real estate crash.

So that's what I'm doing. Apparently that makes me a risky investor. :)