Thursday, February 04, 2010

Homes are not an Investment

People pay Credit Cards before Mortgages

As part of their marketing over the past 20 or so years, the housing industry has touted homes as an "investment". Now, participants in the housing industry, primarily mortgage companies have to reap what they have sown.

Investments produce cash flow. Houses held for personal consumption are not investments. Houses cost a lot of money to maintain and over time they depreciate in value. They are simply a place to live that have some emotional value attached. As such, if people are taught that a house is an investment and that investment creates a poor return, they are likely to stop paying for or maintaining their investment. This is exactly what has happened. Many people are walking away and short selling their houses, moving into cheaper houses or apartments, and are applying all the cash they have saved to pay down credit cards and other installment loans.

A person who pays to maintain an investment that produces negative cash flow and is worth less than the equity should think twice about making their next payment. If the housing market were like the stock market, banks would have made millions of margin calls and secured their interests a long time ago. Instead we have an akward phase of lenders and borrowers saying "if you pretend its worth more, then I'll pretend its worth more". Unfortunately for lenders, the borrowers are in the optimal bargaining position because the lenders are essentially unsecured for a portion of their loan. So, once the borrowers decide that the "investment" is not worth the cash flow strain, the borrower simply sends the keys to the bank and says "Thanks, but no thanks. It was nice while it lasted."

A bad credit score is not the end of the world. The government will find a way to recreate this mess in the future by inflating the money supply and creating programs to lend to people with poor credit scores. Today, bad credit = good credit just like fixing health care = fixing the economy. Misguided logic always works in a land of doublespeak. The first rule of trading is to let your winners ride and cut your losers short. So when an investment is not an investment, then treat it as an investment and dump the sucker.

1 comment:

Dr. Cole Bradburn, DC said...

Great article and incredibly true. We have had our common sense marketed away by people wanting to benefit from the loss of our financial autonomy. Once you are indebted, you've signed away a portion of your freedom. Investments create positive cash flow. "Investing" in a house/home makes about as much sense as "investing" in a 401k. You are not in control of your money, and you cannot use it how you wish. Great read Jim.