If you read finance related discussion boards and blogs, you must have read discussion on a confession in New York Times by a financial planner about how he lost his home in the real estate bubble in Las Vegas.
How a Financial Pro Lost His House – New York Times
Long story short, the financial planner bought a home with 100% financing for $575,000, refinanced it with a negative amortization loan when the home’s value went up and took $200,000 cash out to fund his business. He finally sold it for $531,000 in a short-sale when he moved out of Las Vegas.
There are many negative comments on this story. Many said it shows financial planners aren’t any smarter or more savvy about financial matters than the average Joe Six-pack. Some said this planner isn’t qualified to give financial advice. These comments miss the point entirely.
Financial planners are humans. Humans make mistakes. It’s important to learn from our own and others’ mistakes.
In addition, this planner actually handled the bubble very well. He didn’t know it was a bubble. Even if he knew, he didn’t know when it was going to burst. Just like today we don’t know whether bonds or gold are in a bubble. People who said bonds or gold are in a bubble have been proven wrong so far. They either lost money or lost opportunities to make money.
Shorting on suspicion of a bubble would be a mistake. The market can stay irrational longer than you can stay solvent. Not participating in a suspected bubble would also be a mistake. Bill Gross is a prime example. People accuse Bill Gross as an incompetent money manager for not staying in Treasuries.
The best way to profit from a bubble would be exactly as this planner did: maximize leverage for the upside and protect yourself from the downside. I’m not saying this planner planned this way but I don’t think he’s as foolish as people think. Given the options put in front of him, he made very good choices.
When a bank offers 100% financing on a house you think will go up in value but you are never sure, putting 20% down would be foolish no matter which way the market goes. If the price goes up, you make more money with 100% financing because you have more leverage. If the price crashes, you lose your down payment if you put 20% down. Of course you should do 100% financing.
After the home price went up and the bank offered you a cash-out refinance with negative amortization (pay less than the interest on the loan), not doing the cash-out refinance or paying down the mortgage would be a mistake for the same reason. If the price keeps going up, you increase your return on investment with an increased leverage from cash-out and negative amortization. If the price crashes, you already locked in a profit at the high watermark from the cash-out.
Our financial planner could’ve done better if he sold the home at the top of the market, but that’s asking for too much. Nobody can time the market perfectly except for being extremely lucky. That’ll be like demanding that Bill Gross times the exit from Treasuries at the exact top. I don’t expect Bill Gross to be able to do that.
The end result was almost exactly as planned, whether the financial planner planned it or not. The planner sold the home in a short-sale and ended up with a thriving business, partly thanks to the $200k seed capital from the banks. Now the planner is writing for New York Times and going on public radio. His book will come out in January. I heard William Bernstein said something nice about it.
Short of timing the market top, I can’t think of any better way to “lose” your home. Think how many financial planners are in this country. How many of them get $200,000 free capital from the banks? How many of them get publicity in New York Times? How many of them appear regularly on public radio? How many of them will have a book published by a major publisher, which will help bring in more business?
To top it off, now he should repay the bank for the loss from the short-sale, with interest. This way he’ll be able to claim complete redemption with a clear conscience for taking responsibilities for his mistakes. With a gross revenue of $840,000 a year ($56 million under management at 1.5% fee), he can afford it. Just think of it as marketing expense.
Our financial planner is smarter than you think. 100% financing, cash-out refi, and negative amortization loan aren’t really mistakes. They are exactly the right moves in a bubble. A drop in the credit score as the consequence, you say? The capital, the publicity, the book deal, and the business make it so worth it. The credit score will come back up over time. Who cares about credit score anyway when your business brings in $800k a year?
His clients are really lucky to have him as their advisor. The planning skills are worth at least twice the 1.5% asset management fee. All the negative comments just don’t get it.
Refinance Your Mortgage
Mortgage rates hit new lows. I saw rates as low as 3.25% for 30-year fixed, 2.625% for 15-year fixed, with no points and low closing cost. Let banks compete for your loan. Get up to 5 offers at LendingTree.com.