Wednesday, September 8, 2010

Bank capital ratios and standing on tippy-toes

Very thoughtful essay on bank leverage ratios, competition and who the real winners were in the credit bubble. I've long thought older people were the ones really making out on home sales. As a group, and especially in California, they were cashing out huge sums when someone my age bought their house.

Sure, buying a house in the bay area in the 70's & 80's was a smart investment decision, but was it worth a 5x -10x on your money? Returns like that are usually generated through extreme risk taking or because of a technical development that is ground breaking and actually is proved out as so. I see neither in the housing market. I only see Leverage.   

"The benefit for borrowers of competition however were dissipated in higher home prices and hence larger mortgages.  The real winners were people selling homes - not people buying them.  Even quite modest houses became valuable - and the elderly (the classic group moving to less expensive homes) did quite well.  I haven't heard the expression "old and poor" quite as much as I used to.  More generally you can see the relatively affluence of the elderly in the sell-the-home and go cruising set.  Carnival Cruises was - for a very long time - a better stock than you might ever have imagined.

The other supposed beneficiary was suffering an illusion.  Plenty of people - especially in their children's teenage years - had an-in-the-end-illusory wealth effect - where they thought their home was worth much more than it was - and felt confidence in spending some of that money - or in saving less for their retirement - because after all they could downsize and they might inherit part of Grandma's (housing) fortune.  

Net-net the losers out of excessive bank leverage were (a) the shareholders because they got lower spreads and took more risk, (b) taxpayers because they partly bore the risk and (c) younger home buyers because they got royally-rogered by the elderly people they bought from."