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MyGallons.com: Profiteering off the frenzied fear of the weekly fillup July 4, 2008

Posted by The Armchair Economist in Commentary.
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Recently, I’ve been reading countless stories about consumers making ridiculous financial decisions to trade their SUVs for something more fuel efficient, anything ranging from a Smart car to a motorcycle.  The sad part is that for many of these people, they are upside down on their SUV (ie: they owe more on the SUV than the car is worth) so they are paying HIGHLY inflated prices for the gas sipper they are trading into (I’ve heard loans of 39k for a 27k Prius!)  Insane, but this isn’t normally enough to get me to post, but today I came across an article by Kimberly Palmer, of the Alpha Consumer blog on a company called MyGallons.com.

The premise of this company is that you can buy gas at today’s price and use it later, when gas prices increase even more.  Sounds good right?  (if you have any kind of training in finance you probably already see the faults).  The fine print includes: Annual Fee of: $29.95, ($39.95 if you don’t want to give them permission to automatically deduct from your credit card), a $1.95 ‘fill up’ fee if you use a credit card (the only accepted payment method), in addition to other fees (ie: an overdraft fee).  I’ll leave it to you to do some back of the envelope math to see how much ‘savings’ you need to negate the transaction costs.

So what happens if the price of gas goes DOWN?  The FAQ helpfully states: Gas prices move up and down all the time. If prices drop you can wait for them to go back up in the days or weeks ahead. (more…)

Economics of trading in an SUV May 29, 2008

Posted by The Armchair Economist in Commentary.
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With oil futures at $130/barrel and gas prices topping $4.00 a gallon in many areas, SUV owners are feeling the pinch at the pump where fill ups often cost between $80-100. While it is easy to villify SUV owners for their largess and lack of forsight, the question remains: Is it worth it to trade the SUV in for a smaller, more efficient car?

Many consumer finance organizations (1,2) argue that it isn’t economic to trade in an SUV while the SUV market is depressed and trade in values are low. The argument is that since everyone else is trading in their SUVs and no one is looking to buy them, the market is flooded with these vehicles. The trade in value you will get is thousands of dollars less than what these vehicles ought to be worth, and the hit you will be taking on trade-in value is not justified from the savings recouped by $30 per fillup. You would need hundreds of fillups to make the trade-in worthwhile and the smarter strategy is just to wait until the market improves before trading in your SUV.

This argument is predicated on two facts: 1) Gas prices will improve.. or atleast not continue to get worse 2) Demand of SUVs will improve in the future. Without a crystal ball, there is no guarantee that gas prices will improve (infact, Ford predicts gas prices will remain in the 3.75-4.25 range through 2009). While I don’t know if gas prices will be 3.00 or 5.00 one year from now, I’m willing to bet that it won’t go to the price levels in the 90s-early 2000s ($1-2/gallon) that enabled consumers to waste gas without a second thought. (To put that into some perspective, oil prices need to drop from the current $130/barrel level down to the $30-50/barrel level!) Without a significant drop in oil prices, we will likely not see any increased demand for gas guzzling vehicles. The only way we’d work through the current backlog of SUVs is for people who actually NEED the carrying capacity of these vehicles…

A RATIONAL decision to purchase an SUV? Thats a new one..

Accountability and the Mortgage bailout May 17, 2008

Posted by The Armchair Economist in Commentary, Economics, Politics.
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Five years ago, I was three years out of college and had just written the check for the final payment of my college loans (hurray). My thrifty ways had led to a slowly growing pile of cash in my money market account. I considered purchasing a home since I was gainfully employed, had little expenses and had enough cash for a nice down payment. A little more research into the housing market showed that many of the newest mortgage loans were Adjustable Rate Mortgages, mortgages that had low teaser rates that were to reset in a few years (usually 3-5 years) at the prevailing interest rates. The historically low interest rates, coupled with the stratospheric (not yet ionospheric, as I was soon to see) housing market, and number of ARM mortgages was enough to put a slight pause into my own dreams of owning a home. I reckoned that by the time the interest rates rose in the next few years,  many people who bought in hoping for a quick buck will head towards the exit – all expecting to  cash out before their loans reset, leading a possible downturn in the housing market possibly creating some buying opportunities. By the way, this was before mortgage lenders found a way to mediate the perfect storm of less knowledgeable (subprime) borrowers , increasingly greedy banks willing to accept an amazing new form of seemingly low risk, high return mortgage products , and an increasing number mortgage brokers with surprisingly absent scruples that finally caused the housing market to crash and burn.

Last week, the House has passed a $300 billion in federal insurance to refinance troubled mortgages. While I feel some sympathy for some families that will lose their homes, I question the wisdom of not letting the market work out the kinks of the housing bubble. In the true American (read litigous) fashion, we’ll likely be arguing about who lied to who, who knew what when, and who is truly a victim for the next decade, the truth is that everyone involved in the entire chain of events is partially responsible and should be held financially and criminally (if warranted) liable. Why should bystanders and taxpayers be held financially responsible for other peoples actions? 

Subprime borrowers were giddy at the prospect of finally owning a home, but did they ever wonder WHY even though they didn’t have enough credit to buy a used car, people were now giving them hundreds of thousands of dollars without even checking their income (or even requiring a down payment!)? Did borrowers using ARM mortgages ever consider what would happen if the interest rates ever increased from historic lows (did they really think rates would stay there, or even go lower?!?). While I can see the excitement of owning your own home, as well as the prospect of watching it go up in value 100% every 3 years, did these borrowers ever consider that housing prices might not continue appreciating exponentially in perpetuity? Sure, I understand that that some of these folks might claim that mortgage brokers lied to them or misrepresented some aspects of the loans, but didn’t these borrowers have a duty to try to figure out ‘whats missing’ in this picture rather than blindly sign on the dotted line and hope that they wouldn’t need to consider the ‘what ifs’ should things go sour? In the end, sure, it sucks to lose your home, but should you have been able to purchase this home in the first place (ie: did you really lose it if it was never meant to be yours?). I won’t even get into borrowers who can afford to pay their loans but decided to walk away because their loans are now upside down (ie: they owe more on the house than the house is worth).

Mortgage brokers represent another one of the responsible parties. Enticed by hefty commissions on subprime mortgages, brokers did everything and anything to write loans to innappropriate borrowers.  Mortgage brokers first lowered the credit standard of the borrowers (ie; subprime borrowers, who never should have been able to borrow in the first place),  they lent money without even proof of the borrowers income via ‘Stated Income’ loans, they lent money with ‘No Money Down’ removing the borrowers stake in the gamble, and they underwrote loans for amounts greater than the collateral was worth (ie: money for your house AND renovations).  All of these tactics served to increase the pool of borrowers and ensure that the hefty commissions kept on rolling in.  Brokers may argue that their managers told them to lend money via these standards, while managers may argue that the brokers acted on their own but one cannot deny that as professionals, both parties should have enough understanding that basic mortgage underwriting principles were being violated. 

What enabled the mortgage companies to underwrite such risky loans?  Weren’t they concerned about the fact that they wouldn’t be able to collect on their mortgage payments when the borrowers hit upon hard times?  The beauty of this scam lies in their ability to sell these mortgages to other investors, thus absolving them of the riskiness of these loans and yet keep the fees and commissions from writing these mortgages. 

Banks and Investors, in blind pursuit of ever increasing returns,  was the likely party that enabled the house of cards framework of the mortgage crises.  Companies such as Fannie Mae existed that bought mortgages from the primary mortgage market and bundled these mortgages together to sell as a portfolio product that promised high returns with limited risk (with favorable ratings by credit rating agencies).   The basic rule of finance and investment is high returns come with high risk, and there are VERY little opportunity to get high returns with low risk (free market economics states that there are no free lunches).  Securitidized mortgage products (a portfolio of thousands of mortgages bundled together reduces the risk of individual defaults much like the protection you receive when you buy a mutual fund and one of these companies goes bankrupt) have always held a dear place in investors hearts due to their predictable (and relatively safe) income stream.  With the increasing number of subprime loans, loans offered to risky borrowers and thus had higher interest rates, the rate of return of these packaged mortgage products rose accordingly.  For some reason that I don’t understand, credit rating agencies failed to see the risk inherent in these loans and gave them credit worthy scores.  These credit ratings encouraged investment banks to blindly invest in these products creating a cycle of more demand for risky mortgages.  At some point, why didn’t someone at the investment banks question WHAT had fundamentally changed to enable the once modest mortgage market to offer such an increased rate of return in exchange for minimal change in risk? 

One can argue how borrowers were coerced to borrow money by mortgage brokers; Mortgage brokers are just writing the loans that ‘help people own homes’ and to fulfill the demand of the securitidized mortgage products, and Investors were misled about the riskiness of the mortgage products. However each party likes to play victim, each should be responsible for their actions and the resulting consequences without burdening the rest of the population. 

Disclosure: I still don’t own a home.. maybe in a few years. digg story