BUY NOW, SAVE LATER

Buy Now, Save Later

BLOGGER:  BEN PIERSON

Seriously, if you have savings and good job security (even if we hit 11% unemployment that means we’re still at 89% employment after all), go out and spend.  I don’t consider this a civic duty or patriotic act – I consider this a selfish one.  America is on sale.

Barring us slipping into a depression – not very likely considering the scope of worldwide government intervention – this is the best all around sale event we’ll see for at least the next decade.  By that point if you follow the plan, you’ll have saved again and be ready to again take advantage of the next cycle of sales.

In economics there is a term called consumption smoothing.  Essentially what this means is that if we knew exactly how much money we would make during our entire life, we would be happiest spending the same amount every year.  We would find a lifestyle that fits and then ride happily (happiest) into our sunsets.  For the first time in my life (I’m 30), I now see the greater wisdom behind this.

Economic cycles have gone on for thousands of years.  There will always be a next “up” and there will always be another “down”.  End of story.  The angel (and angle) lies in the details.  During those “up” periods, everyone has money and is buying.  Supply and demand says:  if more people are trying to purchase a finite set of goods, the price of these goods will go up.  So during the up cycles, goods generally cost more.  Houses cost more, vacations cost more, and cars cost more.  In a down cycle, houses become cheaper, vacations become cheaper, and cars are cheaper….  And so if you have money during these times, go out and spend!  It’s all on sale!!

I know someone who just took his family of four on vacation to Jamaica.  7 days at an all-inclusive resort, including airfare:  $2,200.  Yup, only $2,200 total for all 4 people.  I’m not saying $2,200 isn’t a lot of money to most of us, but the point is this vacation would have cost him over $5,000 anytime during 2004-2006.  I’m sorry if you paid $500,000 for a condo in Palm Beach over the last three years, because you can now buy that same condo for $300,000 or less.  One friend who works in Manhattan lived about a 45 minute train ride away in order to avoid Manhattan rents.  Well guess what?  Several buildings downtown now offer two months rent free and the rental prices themselves have gone down.  Thanks to his having saved up over the last two years he is now living in Manhattan at 30% off what he would have paid two years ago.

I’ll be the first to admit that I’ve done a very poor job of this myself.  Like many of you, perhaps, during the good times of the last several years I spent more and saved even less… the exact opposite of what I should have been doing.  In the midst of an economic boom of course it’s tough to think prudently and save up for a rainy or opportunistic day.  It’s tough not to take the $5,000 vacation when that’s what your neighbor is doing.  Well, Love thy Neighbor but don’t act like them.  When times turn good again, save save save!  Practice prudence and practice patience.  The boom times may go on for years, but they WILL end once again.  You may get jealous of your neighbor’s tan once or twice, but you’ll last laugh when you pay half as much for the trip he just took.

Arin Goldman wrote a great post earlier (http://blog.imagineage.com/?s=spend) on this question of spending.  Not to ruin the ending but she bought a pair of boots on sale and, slightly tongue in cheek, considers it her contribution to economic stimulus.  Certainly every extra bit of stimulus helps right now, but that’s not what I’m telling you to do.  I’m saying be selfish.  That shirt won’t be 70% off forever.  That car might not be this cheap again for years.  Do be prudent and don’t spend money you don’t have.  But if you have it, now’s the time – America’s on sale.

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Incentive Systems: The Mortgage Industry

Incentive Systems: The Mortgage Industry

BLOGGER: BEN PIERSON

 

“People respond to incentives in predictable ways.”

 

This is the first rule I was ever taught during my high school economics class and remains one of the most powerful I’ve ever learned.  I’m reminded of this rule often, in all contexts.  And, this applies to the mortgage industry.

In some sense, a cornerstone of our society is that we are all role players.  In the industrial revolution we discovered the value of specialization.  Instead of one person making each whole shoe by themselves, one person would cut the leather, another would hit the same nail in each time, and yet another would sew the same spot each time…  We rely on predictability; we rely on people fulfilling their role.  It’s up to us to understand what each person’s role is and how each person is predictable.   

So what does this have to do with mortgages, you ask?

Mortgages provide a good example of how the incentive system got screwy. People acted rationally, oversight was negligible and consequences became severe.  Mortgage brokers were paid based off how many mortgages they originated (‘sold’).  It made zero difference to their payout if any – or all – of the mortgages end up defaulting in two or three years.  The future risk would be the bank’s problem since the mortgage broker has already gotten paid and the mortgage now belonged to the bank.  Banks didn’t want this risk either (they were conscious to some extent of the risk in the mortgages they were selling), so would take all of these mortgages and resell them to, say, an Investment Bank (eg Lehman, Merrill, etc), who would then package the mortgages up and resell them again (eg. Mortgage Backed Securities and CDOs).  The individuals working at the mortgage broker, bank, and investment bank all get paid off revenue.  They all get paid at the point of sale, with little exposure to the future risks.

So to sum this up, you have a system where the people working at almost every layer are exposed to vast reward with finite risk.  And we now have terms such as the NINJA Loan (No Income, No Job, No Assets… no problem!) with the corresponding mortgage malpractice that has now come to light. 

To give an example to better explain this, like many others, if I am driving at 4am, the only car on the road, I will likely drive fast.  What keeps me from going very fast was the risk of getting caught.  The mortgage system and those working in the field aren’t any different.

The calls for tighter restrictions and regulations on banks and hedge funds are, for the most part, erroneous as fairly comprehensive restrictions and regulations already exist.  The problem is there’s little to no enforcement and the enforcement which exists is painfully inadequate.  I’ve only been on Wall Street for 8 years, but since the beginning I remember people making fun of how woefully inadequate the S.E.C. is.  In addition to the S.E.C., the Ratings Agencies (Standard & Poor’s, Moody’s, Fitch, etc…) were supposed to help regulate companies as well.  So, you’d think there was an adequate system in place to keep problems like we are in right now from happening.  Right?  Wrong.

Most people who played a part in all this mess – Mortgage Brokers, Banks, Investment Banks, and Ratings Agencies – were really acting as we should anticipate the would given the incentive structure involved with them.  Failings must be placed in a large part on then regulatory bodies like the SEC and Ratings Agencies who were set up explicitly to be outside of the ‘incentive system’.  One must also then throw blame on the government – and rely on them to fix this – for it would seem the problem grew from the innate nature of the structure.

Should you want to read more on the rating agencies’ role, here are two comprehensive (very detailed) articles:

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ajs7BqG4_X8I

http://www.bloomberg.com/apps/news?pid=20601109&refer=home&sid=ah839IWTLP9s

Certainly this is a very complicated issue which has touched us all in some way.

What do you think?

 Leave a comment…

To find out about Ben, click here to read his bio.

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