Year: 2009

Recently I outlined the details of the proposed American homeowner stimulus package otherwise known as the homeowner affordability and stability plan.  This plan will cost about $75 billion and I really have to say that it is a complete waste of money.

What is the package exactly?

Basically this bill will help homeowners who are having trouble paying their mortgage.  There are two groups of homeowners that might qualify:

1. Mortgage payments and interest rate are too high but can’t refinance to take advantage of lower rates because their house value is too low (ie mortgage is greater than 80% of house value).
2. Someone who was able to make their mortgage payments but because of a job loss or the payments have increased, they are about to default.

Read about the Making Home Affordable Refinance and Loan Modification Program.

The first group of homeowners will be helped by the government to refinance their mortgages so the monthly payments are lower.  The second group will be helped by having their monthly payments reduced.

Both groups will be eligible for an incentive if they stay current on their mortgage to the tune of $1,000 per year for 5 years.

What is wrong with this?

I have no problem with Keynesian spending which says that you should spend your way out of a recession – but that spending should be applied in ways that make economic sense.  In my mind – helping a homeowner who can’t afford their house is the same as giving bailout money to a car company and telling them they can’t cut any jobs.  It’s also the same as bailing out someone who bought an expensive car when they were working and after losing their job they can’t keep up the payments.  You can’t keep what you can’t afford – some companies have to lay off employees, some homeowners have to sell their houses and some car owners have to get more intimate with public transportation.

The US government is just going to end up paying the mortgage for a lot of people.  I realize that not everyone of those homeowners bought a 6 bedroom house on a $30k salary but even if they have legitimate reasons for defaulting on the mortgage (job loss, medical issues) the principal remains the same.   Stimulus money should go to businesses and people that can use that money to survive and thrive – it shouldn’t go to anybody who “deserves it” just because they have a heart-breaking story.  That money is intended to help the economy and it should only be used for that purpose.

Foreclosures lower property values

One of the justifications (or selling points) for this bill is that foreclosures can lower the property values in a neighbourhood.  That fact is supposed to make people who can afford their house feel better about their tax dollars bailing out their neighbours.  This is a bit silly – if you can afford your house then does it really matter if the value goes down?  Sure, nobody wants to see one of their largest assets go down in value but it’s not exactly a crisis.

What’s with the incentive?

The section of this bill I found most amazing was the part where the homeowner can get $1,000 taken off their mortgage principal each year for 5 years if they stay current on the mortgage after participating in this program.  I don’t get it – the government is already helping them in a big way – if the program is successful and the homeowner stays current then the government gives them even more money?  That makes very little sense – if the program is successful and the homeowner keeps the house then use the incentive money to help someone else.

No accountability

On the surface this bill does make some sense – it will apply to homeowners that for whatever reason are about to start defaulting on their mortgage.  The idea is that if you can help a person who is about to default (vs a person who has already defaulted) you can prevent some foreclosures.  One of the issues which I assume will play a bigger part as time goes on is the circumstances which have lead to the homeowner’s financial problems.

From what I can tell – most of the qualification criteria has to do with whether a refinance or restructure of the mortgage will make the mortgage affordable for the homeowner.  The reasons leading to the financial problems are not an issue.

My question is – if someone is… about the miss a mortgage payment and has 2 new cars in the driveway, 3 flat screen tvs in the house with full cable packages, has a great looking kitchen because they just spent $50k renovating it (or remodeling it as the Yanks say), has a stay-at-home spouse, kids in private school, a house keeper and they use brand name shampoo – should they still be eligible for this assistance?

My conclusions

If I was an American tax payer and didn’t qualify for this program, I would be furious.  As a Canadian, I really hope we don’t see any of this kind of nonsense up here anytime soon.

About the Author: Mike writes at The Oblivious Investor, where he regularly reminds readers to ignore the noise of the market. If you like this post, subscribe to his blog to read more. I’m a regular reader.

Imagine that you run a business making a physical product. For example, let’s imagine that you’re in the construction industry, and your business makes concrete.

And by some manner of genius, you invent a new formula that allows your concrete be just as strong as the best concrete on the market, while weighing significantly less per cubic foot. And the best part: your concrete even cost a bit less than that made by your competitors.

What would you do to protect your competitive advantage? Probably something like:

• Get a patent for your new formula, and
• Do everything in your power to prevent your competitors from getting their hands on the new formula.

How long do you think your competitive advantage will last? I’d guess it’s a few years at most before a competitor comes along with a new invention to make your formula obsolete.

Now, imagine instead that you aren’t allowed to file for a patent. Also, imagine that you aren’t even allowed to keep the formula secret. Instead, industry regulators require that every 6 months, you publish the precise formula for every product your company makes.

In that scenario, how long could your competitive advantage possibly last?

That’s what it’s like in the mutual fund industry.

If a fund manager is sure that a given stock is going to outperform over the next period, there’s nothing he can do to keep other fund managers from buying that same stock. The idea of patenting “owning shares of Coca Cola” is ludicrous.

Similarly, fund managers can’t keep their holdings a secret. They’re literally required to publish them on a regular basis.  (Quick note: I’m not saying this is a bad thing.) And with as much competition as there is in the mutual fund industry, you can bet that each of the major players is closely watching what the others are doing.

In that kind of environment, even if a fund manager does come up with a legitimate strategy for outperforming his peers, how long could he possibly hope to maintain his advantage before everybody else figures out what he’s doing?

Is it any surprise, then, that it’s so rare for managers to be able to consistently outperform for sustained periods of time?

Similarly, what does all this seem to indicate about the prospects of a fund manager who has just beaten the market for the past few years in a row?

About the Author: Mike writes at The Oblivious Investor, where he regularly reminds readers to ignore the noise of the market. If you like this post, subscribe to his blog to read more. I’m a regular reader.