(c) View from Silicon
Valley, 2006. All rights reserved.
I want to start out by saying I respect John Mauldin. He has
been in the investing business a long time and reaches more readers every Friday night (and probably again on Monday afternoon)
than I reach in a year (or maybe ever). However, I was reading one of Mr. Mauldin's pieces a few weeks ago(#) and, contrary to my usual reaction, found myself exclaiming out loud, "Are you kidding me?" Normally, I fantasize
this will be my tag line in a long career as an ESPN commentator but it also seemed to apply here.
Specifically, the
passage which grabbed my attention was: "(O)n a percentage of disposable income basis, the mortgage and consumer credit
debt are not all that out of line with what they were 25 years ago. In 1980 consumer debt service payments was 5.61% of
disposable income. Today it is 5.85%. Mortgages have risen from 8.13% to 10.76%. Now, there are clearly a lot of households
who are in much worse shape. But as a nation, we are not all that bad. We have a debt load we can now handle... "
Let
me be clear, as stated, this is factually true. (And Mauldin is not the only person making this overall argument.)
However, I expect better from him. Something which acknowledges the wider view that a lot of people are taking
on a lot of debt. Maybe a comment on the touts claiming paying off a mortgage is somehow foolish. Something which
didn't allow one to infer maybe he buys into the "spin" emanating from vested interests denying the housing bubble.
Not to mention the relative position - and trend- of interest rates! I can think of nothing more appropriate than, "Are
you kidding me?"
Mr. Mauldin's bemused remembrance last week of his father commenting "Don't confuse me with
the facts," demands the rejoinder, "Figure don't lie, but liars can figure." Before I descend any further (and before
I get another note from Mr. Mauldin complaining I am not fairly representing his point of view), let me disclose my bias by
recounting my own experience from the early '80's.
I bought my first house in 1982. Adjustable rate mortgages
had fallen to ~15% and the bank agreed to give me a 10%-down, one-year adjustable, negative amortization loan to buy a house
in a fast-growing suburb of Atlanta. (Maybe you thought "Neg-Am" loans were a recent invention?) I was a couple
years out of college, moving up in the world professionally, marginal tax rates were 70% (OK, 69.13%) and I was tired of moving all the time. (I recall counting 17 "lock, stock and barrel" moves during college and the
years after.)
Under 1982's tax code, at the end of each year you were better off to first pay down all or part of your
negative amortization balance (deducting 70% plus reducing your balance accruing at 15%) instead of, or at least before, investing
in an IRA. (Where you get the same 70% but a CD "only" paid ~8.6%, down from 18.6% in 1980. You might find a deal from an S&L aggressively taking advantage of the new lending regulations and paying ~12.5% but that leads to another story line-- titled "RTC.")
A little over two years later, I changed jobs and had to move
again. Even though a brand-new shopping mall had been built a couple miles from a house I bought when it was considered
to be the remote boondocks, I ended up paying two mortgages for the eight or nine months(!) it took to sell. I walked
away from the eventual closing with ~$500 more than my down payment. Based on many of the blogs out there, I should
claim this was a "my 'investment' made nearly 10%." In truth, this was a significant loss --maintenance, utilities,
taxes and interest, not to mention double mortgage payments, all burned cash while it sat empty. It was the first
time in my life I laid awake nights worrying about money.
Besides proving what a dinosaur I am (and how long I've been
bad at investing in real estate?), there a few points to be made here:
1) A debt load 4% higher and a mortgage load
32% higher today than in 1980 is anything but benign. When the defense of these increases includes, "mortgage debt is
rising because we have a lot more homeowners... and more people on a percentage basis own homes," it makes these "disposable
income basis" increases stand out even more. New buyers are taking on so much debt that they are driving up the nationwide
averages!
Claiming 1980 vs. 2006 relative debt loads are comparable implies there is also a comparable risk.
2)
An adjustable rate mortgage in the early-80's was often the only way to get into a house, but the risk was considered acceptable
since rates were declining from all-time highs. (1980 rates were the absolute peak.)
Slightly related factoid:
In 1980, a one-month CD paid up to 18.6%!
3) An adjustable rate mortgage in the 2000's is often the only way to get into a house and its
considered "smart" to take the risk because "house prices only go up." If rates do rise, buyers expects to refinance,
at a lower LTV, based on this "inevitable" appreciation.
Although I am sometimes a "prig," I do not dispute Mauldin's
observation it's a free market and people are free to spend their money on houses --even when the decision is not rational!
4)
Today, we're emerging from generational lows in interest rates, yet mortgage debt service is already 32% higher than at the
rate peak in 1980! The direction of future interest rates and debt service in 1980 was decidedly down. Today,
if rates do go down it will be a sign of a failing economy, not a stabilizing one.
5) At risk of distracting myself,
energy prices in 1980 were also declining from all-time highs. The cost to drive your car or heat your house actually
declined throughout the decade. Today's energy prices are also high, but expected to rise further.
Finally getting
to the part relevant to Silicon Valley: Santa Clara County saw ~6% of 400Ku houses change hands in 2004 followed by ~5%
in 2005. Up to 82% of these sales used ARMs and reports claim 25%, to even 50%, were for second homes or "investment."
This limited volume used "creative" financing and drove the median price from $520K (Dec.'03) to $700K (Dec.'05) or +35%.
Admitting Mauldin's point, of course the ~89%+ of properties which have not changed hands are now sitting on those 35% gains
and, mostly, in great shape.
However, the interest rate trend, or energy price trend, for that matter, hardly
figure to be the leveraged buyer's friend they way they were in the early-80's. If even a small percentage
of these 11% fall behind, the impact on local prices may be dramatic.
Conclusion: To describe the 1980 vs. 2006
debt and mortgage loads as comparable is ignore the bigger picture. Citing facts which minimize, or even omit entirely,
the risk factors involved in current debt loads is not what we need here in Silicon Valley. We recommend people consider
the bigger picture.
