Frugal Friday Feb. 20

It’s that time again! Here is this week’s highlights from the Frugalosphere.

Lots of questions, sublime and mundane, were asked and mostly answered this week. Lazy Man and Money asked if wine tasting was a frugal hobby. Why, yes, it is. Wine drinking, on the other hand, could set you back a few dollars. Free Money Finance asked Should Christians Have Life Insurance? Again the answer is yes, provided you do not buy more than you need, which apparently raises thorny theological issues. (Possible follow-up posts: Should Muslims Drive Volvos? Should Jews Own a Tivo?)

House Prices: The Long View

There was an interesting post at Debit vs. Credit two days ago suggesting that now may not be the time to buy a house. The gist of the argument was that house prices still have a way to go before they return to normal. This was illustrated with a chart of median new home prices as a ratio to median income since 1963. That’s not the most ideal set of data to use, for reasons that I will spare you.

The most useful measure of house prices are the S&P/Case-Shiller Home Price Indices. They only go back to 1987, but one of the co-inventors of the index, Robert Shiller, has chained together other useful house indexes to patch up a composite going back to 1890. (This is the third post that has mentioned Prof. Shiller in the past month. Just coincidence, I swear.)

I downloaded the data from his site, updated and cleaned up a few things, and produced the following chart, showing the inflation-adjusted sale price index for existing homes since 1890.

If you’ve never seen something like this before, you may be experiencing some shock and confusion. This is normal. Just keep breathing deeply. You thought house prices went up over time, didn’t you? Well, they do, but mostly because of inflation. Recent experience excepted, house prices are generally flat over long periods of time once inflation is factored out.

A few other observations worth making:

1) The last index value in this chart (which is for November 2008) is 144.0, still 13% higher than the 1989 peak of 127.4. That does suggest that we have a little more to go, or at least did as of November. On the other hand, it’s already down 40% from the 2005 peak of 202.5, so the worst may be behind us.

2) The recent run-up in house prices actually began in 1996. (From 1996 to 2005 real prices went up 86%.) It may not have gotten weird enough to be noticed in the media until the last years of the boom, but the index began hitting all-time highs as early as 2000. I mention this because it’s currently fashionable to blame the low interest rates of 2003-04 for the housing bubble. They sure didn’t help, but the worst you can say is that they were gasoline thrown on an already blazing fire.

3) As impressive as the 1996-2005 run up is, it is not entirely out of the ordinary. From 1942 to 1947, real house prices went up 60%, which is the best five year run in history. Further, prices pretty much stabilized after that and did not give back very much of the gain. This needs to be pointed out to those who say, in hindsight, that of course house prices had to fall after 2005, because the rapid gains made in years before were just unsustainable.

So is this a good time to buy a house? That depends. Do you need one to live in? There are many factors to consider, including interest rates, tax breaks and other incentives from the government, and local market conditions. (It is worth stating the possibly obvious that the chart above is a national average. Specifics of a particular area may differ both in the short and long run.)

But if you are looking at a house as a possibly shrewd investment, something you can buy cheap now and sell dear later on, you are likely to be disappointed. Even if the crisis were over today, and house prices returned to their pre-bubble habits, the normal state of things is that they don’t go up very much.

Suze Orman’s 2009 Action Plan, Part 2

[This is the second part of a two part review of Suze Orman's 2009 Action Plan. If you haven't already, you might want to read Part 1 first.]

In general, Suze Orman’s lack of candor can only be inferred from the advice she gives. For example, at several points in 2009 Action Plan she brings up the idea of taking out loans from a 401(k) plan and using the proceeds to, for example, pay down other debt. (For the uninitiated, a loan from a 401(k) plan is just what it sounds like. You allocate some of your 401(k) account to a loan to yourself, which you pay back with interest.) In every case she is firm in her rejection of the idea, even to pay off credit card debt charging 32% interest (p. 59.)

On its face this advice is nuts. Taking out a loan from your 401(k) frivolously, to go on a cruise perhaps, is clearly a poor idea. But within the realm of debt a 401(k) loan is almost certainly the best deal going and using it to pay off a loan with a Tony Soprano interest rate is just about as clear a no-brainer as you can find in personal finance.

So why does Suze Orman wave you off this strategy? Is she nuts? She gives the feeble explanation that in these uncertain times the risk of losing your job, which might mean the loan would be due in 60 days, is too great. That would be a lot more convincing if she did not, in the two ”situations” that immediately follow, discuss withdrawing funds from your retirement accounts for living expenses if you become unemployed.

Reading between the lines, the real reason Orman thinks this is a bad idea becomes clear. She thinks that if you take out the loan and pay off the credit card it will only be a matter of time before you run up the credit card balance again, leaving you with both a large credit card debt and a loan from your 401(k) to pay off. She’s not nuts. She thinks you are. But she can’t say that. So she tells a little white lie and moves on.

Very similarly, she calls using a HELOC (Home Equity Line of Credit, or a second mortgage) to pay off credit card debt “a dangerous mistake. You are putting your house at risk.” (p. 30.) That’s a common bit of folk wisdom, but it’s wrong. Short of bankruptcy, you are going to have to pay back all the money you owe sooner or later, and it would be helpful if the debt had a lower interest rate in the meantime. If you do go bankrupt, you may or may not be able to keep your house (and if you do it will be without much equity) but whether the debt in question was a second mortgage or unsecured loan will not change the outcome. Again, Orman gives the advice she does because she assumes you have a serious willpower problem. If you refinance your credit card with cheaper debt you will only start spending even more and dig the hole deeper.

Do all of Orman’s millions of readers have that sort of psychological dysfunction? For all I know, they do. She certainly has a devoted following who apparently find her advice useful. Even so, I would be a lot happier if somewhere near the beginning of her books she said something like “this book isn’t for everybody” and explained the sort of self-destructive behaviors her work was meant to address. Like they say, the first step is admitting you have problem. But Suze Orman admits nothing. She is like the wife of the compulsive gambler who tells her husband she doesn’t want to visit Las Vegas because she doesn’t like the desert climate. While preaching the importance of honesty and being realistic about your finances, she gives advice that is, in fact, an elaborate and disguised work-around to compensate for her readers’ presumed shortcomings.

Suze Orman’s 2009 Action Plan ends with the platitude that you should “always choose to do what is right, not what is easy.” Sometimes what is right is hard and uncomfortable. It might be hard to hear that your favorite money guru occasionally gives bad advice or that you are acting irrationally, but if it is the truth, it needs to be said. Like the lady says “The lies need to stop.”

Oh Those Wacky Rich People

For those of you who do not spend your waking hours prowling the blogs and newspapers (e.g. those of you with jobs) I thought I would summarize what I have learned lately.

1) The rich people who (used to) work on Wall Street are morons. Completely incompetent. All of them. “These people are idiots.” says Claire McCaskill, and she’s a senator, so she knows about groups of idiots.

2) Until recently, the idiots who worked on Wall Street, who most Americans associated only with making great piles of money without apparently doing anything useful, were nevertheless loved and trusted by all. There was never any envy or animosity. All that has changed now. “America doesn’t trust you anymore.” said Rep. Mike Capuano (D – MA) to a panel of Wall Street CEOs. And members of congress know a thing or two about not being trusted by America.

3) The really rich people who (used to) run Wall Street are particularly clueless. For years, they paid thousands of somewhat less rich people more than a million dollars a year because it amused them. Sorta like how some babies like watching mobiles. Obviously (see #1) there was nothing special about these workers, so they could have paid them a lot less. Now that the government is in charge, these banks will be run to maximize profit, so they will no longer pay anybody more than $500K a year. That’s not a bad salary for an idiot. Believe me, I know. It’s not like these people could just walk out and spin money for another employer or start a hedge fund or something. They’re idiots.

4) In these stressful times, comic relief is important for all of us, and what could be funnier than laughing at idiots? The New York Times has been making the most of this, with articles and opinion pieces that maximize the Wall Street idiot hilarity. Two weeks ago it was a side-splitting piece about how hard it is to live on $500K in NYC. Today we get one on what happens when the “Rituals of the Rich Meet the Realities of the Economy.” It turns out that those idiots indulge in such obscure rites as having their so-called “suits” put through a process called “dry cleaning.” Apparently, they still practice this behavior, but less often, much to the relief of the staff at Manhattan dry cleaners, who now have more time for reading and other hobbies.

5) Meanwhile, rich people outside Manhattan continue to reaffirm our faith in their judgement. A British bank, Barclays (not one cent of TARP money!) has introduced a Visa Black Card. For a modest $495 a year a person carrying this card will not only be able to buy all those things that a Visa card can buy, but will also get “24-Hour Concierge Service.” And the card itself is made of a carbon graphite substance, meaning it’s not mere plastic but really expensive plastic.

Suze Orman’s 2009 Action Plan, Part 1

I have only respect and contempt for Suze Orman.

On the positive side, it would be hard not to admire Orman’s talent and achievements. She is undoubtedly the most effective and popular personal finance guru in America today. Suze Orman’s 2009 Action Plan is her seventh consecutive New York Times bestseller. She has won two Emmys. Last year Time named her one of the 100 most influential people in the world. To put that last achievement in perspective, consider that the Pope did not make the cut.

Alas, this highly tuned and powerful machine is used to bring her vast audience fairly mediocre and amateurish advice. At best, what Orman tells her readers and viewers is pedestrian and obvious. At other times it is dangerously specific, assuming unstated facts about the reader’s situation. And once in a while it is just plain wrong. But wasting her abilities with weak content is not the chief reason I have contempt for her. She also has a righteous new-age shtick about courage and honesty which is not only grating, it is hypocritical.

Suze Orman’s 2009 Action Plan is her reaction to the current economic crisis. (Of course, given its success, I would expect an Action Plan to appear annually every January from now on, crisis or no.) It is one of many quickie books on similar themes that have appeared in the last few months. Orman’s was finished on November 19, 2008 and on bookshelves as a paperback by mid-January 2009. As would be expected, it is not very long and lacks much in the way of a coherent organization. The great majority of the book is in the form of an extended FAQ, with “situations” that could have easily been phrased as readers’ questions followed by short answers or “actions.”

The slim volume does contain a few longish bits of advice and explanation. One of these is the second chapter of the book, entitled “A Brief History of How We Got Here.” It is not merely brief (11 pages) but shallow as well, what you might expect from a bright high school student asked to summarize the economic situation based on accounts taken from one of our nation’s lesser tabloids. Admittedly, Wall Street and the economy are not Suze Orman’s fields of expertise, but this section betrays a remarkable lack of knowledge about how indeed we got here.

For example, Orman explains that in reaction to the low interest rates of the middle of this decade, the “too-smart-for-their-own-good minds of the financial sector” “bundled the prime and sub-prime mortgages into one investment, called a Credit Default Obligation (CDO).” Actually, CDO stands for Collateralized Debt Obligation, prime and sub-prime mortgages are generally segregated (not that that helped) and CDOs became the standard method for structuring mortgage bonds twenty five years ago. How CDOs were invented is described entertainingly in Michael Lewis’ bestseller Liar’s Poker (1989) which until recently I had thought everybody involved in finance and over the age of 40 had read.

The Orman view on what went wrong in the global economy begins and ends with American house prices and mortgages. That is like blaming a warehouse fire on faulty wiring without mentioning that the building was full of fireworks and that the sprinkler system failed. But no matter. 2009 Action Plan is for consumers, so limiting the explanation of what went wrong to consumer-oriented factors is not the worst thing imaginable. Orman ends the chapter by summing up that “the mortgage crisis is the most vivid example of how dishonesty and greed leads to financial destruction” and exhorts her readers to become honest with themselves about their own finances.

That’s a sentiment with which it is certainly hard to disagree. Truth and candor is a recurring theme of Suze Orman’s, both in this book and elsewhere. It would be much more convincing if Orman was herself more honest about how her advice about houses has changed over the past few years.

2009 Action Plan tepidly endorses buying a house, saying that “over time a home can be one of the most satisfying investments you can make” (p. 147) and clarifies that your house “will, on average, rise in value at a pace that is only one percentage point above inflation.” (p. 154.) I have no objection to either of those points, but isn’t this the same Suze Orman who called home buying “one of the best known investments” (The Laws of Money, 2003 & 2004, p.131) just a few years ago? In 2009 Action Plan Orman is repeatedly strident about not taking out a loan from your 401(k) or tapping your IRA for any reason short of dire emergency, and yet in The Courage to Be Rich (1999 & 2002) she suggests doing both to raise money for a house down payment (p. 223.) In 2009 Action Plan Orman condemns adjustable rate mortgages and says that a 30 year fixed is a “requirement” for home buyers (p. 148.) In The Courage to Be Rich she discusses both flavors of mortgage favorably and lists reasons you might be better off with an ARM. (p. 254.)

There is no shame in having been much more enthusiastic about houses a few years ago. As far as I can tell, all personal finance writers urged their readers to buy houses in the Good Old Days, and Suze Orman was actually more cautionary than most. And circumstances have indeed changed in the meantime. But for a person who lectures continually about the importance of honesty and speaking the truth about money, would it be too much to expect a modest mea culpa? Wouldn’t her criticism of the “dishonesty” of those who borrowed too much to buy more house than they could afford be more persuasive if she conceded that the chorus of personal finance advisers, Suze Orman included, egged them on?

[Click to the second half of this review here.]