Saturday, May 16, 2009

N.Y. Times Financial Reporter Faces Financial Ruin

He should have known better. Edmund Andrews is a seasoned economics reporter for a major newspaper. He'd covered the Asian financial crisis of 1997, the Russian economic crisis of 1998, the dot-com crisis of 2000. He warned people about risky mortgages even as the current mortgage crisis developed.

So why did this middle-aged economic expert take out his own extravagant, risky mortgage in 2004, plunging him into the depressing world of unpaid bills, badgering debt-collectors, strained personal relationships and panic attacks? Today, his house awaits foreclosure and his once pristine credit score lies in shambles, making him a poster child for "Victims of the Mortgage Crisis."

His recent N.Y. Times article describing his personal woes deserves a slow, reflective read.

Here are some of my takeaways:

1) Rather than taking comfort in "what everyone else is doing" or "what many experts are saying," don't make big financial decisions without thinking them through dispassionately and rigorously.

Warren Buffett's mentor, Benjamin Graham, put it this way concerning investing:

"You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right." (The Intelligent Investor, revised edition, 2003, p. 524).

2) Get plenty of objective wise counsel, particularly on issue where emotions may hijack our reason.

Mr. Andrews had tons of information available to him. But emotions (e.g., "I'm in love and must find a decent place to live!") can bias information to serve its purposes. I recall, I believe it was a researcher, saying that if you torture the data enough, you can make it tell you whatever you want it to. When we want something badly enough, it's human nature to torture the figures to make them tell us, "It's okay to buy the house."

3) Before you flaunt the tried and true rules of thumb, make sure you're truly an exception.

So what are some tried and true rules of thumb for home buying? Unfortunately, when the mortgage crisis was brewing, the rules of thumb changed. From one blog a couple of years ago:

"Northwest Community Credit Union says 1.5 times your gross annual income:

If you and your spouse have a total income of $50,000 the general rule would be that you shouldn't borrow more than $75,000 for your home.

CNN Money says 2.5 times:

The rule of thumb here is to aim for a home that costs about two-and-a-half times your gross annual salary.

Washington Mutual Bank suggests anywhere from 3 to 5 times:

As a broad generalization, most people can afford to purchase a house worth about three times their total (gross) annual income, assuming a 20% down payment and a moderate amount of other long-term debts, such as car or student loan payments. With no other debts, you can probably afford a house worth up to four or even five times your annual income."

In retrospect, no wonder Washington Mutual went down.

When mom and dad bought their house 40 years ago, the rule of thumb given to them was that you could afford to purchase a house up to 2x your salary. That's if you put down 20% and don't have other significant debt. (They were neither making car payments nor repaying student loans.)

Crown Ministries suggests this rule of thumb: "Purchase/rent only if payments – mortgage, taxes, insurance, utilities, phone, and maintenance – don't exceed 38 percent of your net spendable income."

4) Don't assume "Best Case Scenarios." Always consider "Worst Case Scenarios."

Mr. Andrews knew that his salary would only cover the new house payments and his alimony payments. He assumed that his partner could land a good enough job to pay for everything else in their lives. What if she didn't land a job? What if she didn't land a good enough job? What if the job doesn't last? What if there's an economic downturn? What if emergencies happened?

Typically, Americans are overconfident about their investments, their abilities, and their future. Don't let your overconfidence lead you to over-borrow.

Other insights from this story?