Archive for the ‘Finance’ Category
Note: this is applicable to fixed rate mortgages.
Mortgage brokers typically use your gross monthly income to calculate the amount they're willing to lend you. Frankly, this is a very bad way of calculating what you can actually afford. It is more useful to know what you can reasonably afford each month before you go house shopping.
If you've got a monthly payment in mind that you're comfortable making, you can use a present value calculation to come up with the amount you can afford to finance. In Excel, this is very easy with the
=pv(interest rate, number of payments, payment, montly payment)
- Interest rate: If annual percentage rate (APR) is 3.5%, this number will be 3.5%/12 = (0.035/12).
- Number of payments: 12 months * 30 years = 360
- Payment: What you're comfortable paying on a mortgage each month.
- You're willing to spend $1,750 a month on a house
- APR: 3.5%
- Term: 30 years
=pv((0.035/12), 360, 1750)
You can afford to finance: $389,716.22
When determining what you can afford each month, don't forget the following:
- House insurance
- Mortgage insurance (PMI)
- House taxes, typically calculated as some amount per thousand dollars of assessed house value
- Homeowners' fees, if applicable
These are things that many renters don't need to pay, and thus forget to think about when buying their first home.
At the end of November, I mused about public sector's problem of attracting and retaining top-notch talent:
Ben Bernanke's salary as chairman of the Fed is just over $191,000. Henry Paulson as CEO of Goldman Sachs made $16.4 million according to Forbes. [...] I find it very hard to believe that compensation plays no role whatsoever in an individual's choice of employment.
This all seems terribly obvious to anyone who thinks about it, and Nate Silver has commented on the same phenomenon with a real-world example:
In retrospect, it is clear that regulators did not have the human capital to keep up with the financial industry, and to understand it well enough to be able to exert effective regulation. Given the wage premia that we document, it was impossible for regulators to attract and retain highly-skilled financial workers, because they could not compete with private sector wages. Our approach therefore provides an explanation for regulatory failures.
That is, the excessive wages paid by Wall Street not only lure talent away from other parts of the private sector, but also from the public sector, where employees are subject to government wage controls. The very people who might be the most capable of enforcing regulations on the banks instead wind up working for them.
This is a very real problem. Some of the work that I did in my first job after college at KPMG involved valuing intellectual property in conjunction with international tax disputes. We had our economists, and the IRS had theirs. The thing was, however, that our economists were better than the IRS's, because if someone at the IRS was any good, we'd hire them away and treble their salary. Part of a good regulatory reform plan, then, would be to increase the salaries paid to employees at institutions like the Fed, the Treasury, the IRS, and the FDIC.
So how do we solve the problem? Tripling an IRS economist's salary probably means they're making in excess of $400K/year, which is more than the President makes. Is it feasible to have regulators that make more than the President?
This might sound crazy, but…
With the absurdity of some of the tranching in the mortgage securitization process — some parts of a single mortgage rated AAA and others parts labeled something less despite the underlying risk being identical — I was curious if it were possible to de-securitize these collateralized debt obligations?
If there is a mechanism by which this can be done, it seems to me that a savvy investor with sufficient time and analytical resources could make a killing by de-securitizing and re-assembling or re-packaging the pieces of mortgages that are actually good investments. Particularly if significant percentages of good-risk mortgages are labeled as less than AAA or AA. You wouldn't even necessarily have to hold these new CDOs for the lifetime of the mortgage. If you could demonstrate how you assessed risk and bought up these mortgage bits, you could re-package and sell these to investors as new CDOs — once they're done being afraid of the CDO market, which could take a very long time indeed.
Not everyone that bought a home in the last 5-10 years was a deadbeat, and I have no doubt that there are some bargains hidden in the paper wreckage. Not being familiar with finance law, I don't know if a legal vehicle exists to de-securitize these CDOs. Any kind of illumination would be most welcome…
It's a sad day in the world of finance writing and blogging. I regularly pull out one of her Compleat UberNerd posts and read it. A gifted explainer and eminently talented writer. Peace to her memory and to her family.
I saw this a few days ago on delicious, and it's very good. It explains how collateralized debt obligations (CDOs) work, and how they caused a problem in the financial sector.
The only thing that I would add that Paddy doesn't really mention is that when mortgages were sliced up to be sold, pieces of a single mortgage could end up in any tranche from a legitimate, first-tier AAA rating to the lower, second-tier BBB rating. That indicates that the ratings were meaningless because it's logically impossible for one mortgage to be both low risk and high risk at the same time — yet this kind of thing happened regularly. Pension funds and other programs that are only allowed to invest in AAA-rated securities for stability reasons were severely hurt because it was impossible for them to know they were buying junk. The ratings agencies were not doing their job, possibly because they couldn't understand what they were evaluating, and possibly because it was in their short-term best interest to look the other way for political reasons. I suspect it was a bit of both.
The creation and sale of these investment vehicles was so complicated and obfuscated it was almost impossible to know which were truly AAA, and which were junk. Several hedge fund managers spent a whole lot of time digging into the soft underbelly of these investments, and shorted the hell out of the lower-tier BBB CDOs. Even they had a hard time figuring out which were which. This short-selling activity was the only information being added into the marketplace that was any indicator that these investments were bad. (Which is why banning short-selling is a terrible idea.) Literally everyone else thought they were great, with the exception of a handful of contrarian analysts like Meredith Whitney. While many people say they "saw it coming!" — few actually did. Hindsight is always 20-20; informational cascade tends to wash out an individual's own private misgivings which is why analysts like Whitney were castigated and short-sellers like Steve Eisman and Andrew Lahde were scorned during the subprime heyday.
You can read more about some of this in this superb Portfolio piece.