How to Become Wealthy: Redefining the Idea of Money in Hard Economic Times.
Learning to become wealthy is hard enough during good economic times. It may feel downright impossible when the economy hits a slump. It is a fascinating case study the past decade we have lived in. The concept of “money” and “wealth” and “debt” have all been used interchangeably. I think this is a common misconception by many because the way the economic system has been setup and how rewards were given out. When you think of money, what comes to mind? Luxury cars? Expensive yachts? $1,000 bottles of wine? Your psychological conditioning and association to money will normally bring up some of these visions in your mind. For the large part, they are all wrong.
Money is simply a method of purchasing items in our society. You get paid money from your work. If you go to the grocery store you pay with money. Money is a store of value. Yet the problem that occurred in this past decade is that people started to associate debt with money. You can purchase groceries with a credit card. You can also use a loan to purchase a luxury car. The function of debt and money was intermingled to the point that many people simply were unable to make the distinction between debt and actual money. The housing market was the perfect example of this and businesses capitalized on this psychological glitch. People given the opportunity want to be wealthy. This is something I sincerely believe. Yet when the idea of wealth is over priced homes, luxury cars, and expensive vacations why would you expect people given the chance to purchase these items to do otherwise?
Debt is not wealth. Debt is simply a way of purchasing things today with money you will earn tomorrow. That is an extremely important point. We have become so comfortable in our society with the idea that things will never change that buying large ticket items normally occurs without a second of hesitation. Yet as we are realizing with the current economic climate, things don’t always stay the same. Look at energy costs and how quickly they have thrown the automakers for a loop. The entire assumption was that fuel would rise in a patterned perfectly timed manner yet this did not occur. What happens? Entire lines of trucks are no longer viable consumer items.
You need to remember that the majority of people that carry the items of psychological wealth such as luxury cars and big homes usually have big debt as well. This is not to say that there are those who can afford these items with no problem but they are not betting with tomorrow’s income stream for those items. If you are paying for those items with years of future work, you are not wealthy. One of the main characteristics of wealth is freedom. If you have a large mortgage and a big auto payment, where is your freedom? If you lose your job or have your income reduced, you will no longer have your home and car. Want those items? You need to keep earning enough to support the monthly outflow. This logic is what created an environment where we are saddled with $12 trillion in mortgage debt and consumer debt is sky high.
You will never become wealthy by going into debt for the wrong reasons. Leasing a car will not make you wealthy. Buying a home with too much mortgage for your income will not make you wealthy. If you are set on becoming wealthy, there are a few things you can do to ensure you do not follow the herd:
(1) Define Wealth
What does wealth imply to you? Wealth should mean financial freedom. Wealth in economic terms should mean that you are able to do many things without the fear of losing your job or income. Wealth should never be contingent on the ability to purchase certain items. Most people do not become wealthy because they don’t define the goal. Let us say your bare essential cost of living is $30,000 per year. How much money do you really need? Well, if you are set to retire at 60 and expect to live 25 years, all you “need” is $500,000 earning 6% throwing off $30,000 a year. It is absolutely vital to have a target but more importantly, what does that target mean? Having $1 million is great but what is your plan once you have it?
(2) Break the Psychology of Debt
You may be surprised that many people in the big house with the fancy cars are only one paycheck away from financial insolvency. Do not become one of these people. If you are one of these people, cut up the debt and unload any financial albatross you many have. This is another reason people do not become wealthy. You do not buy the Mercedes before you reach your financial goal. You reach your financial goal, then you buy the Mercedes. It is important to understand what comes first in your mind otherwise you are bound to follow the herd. This housing implosion was brought on by a herd mentality and confusing debt with wealth.
If you think that being wealthy means being constantly in debt yet having the artifacts of the wealthy, you are simply living on borrowed time. You will become a prisoner to your possessions. If you want to become wealthy you have to learn to think this way. Instead of buying that McMansion why not buy a modest home and a rental that will throw off monthly income to you? Instead of buying that $80,000 BMW why not wait a few years and buy a used Mercedes for $20,000? Some people never get beyond this point and are destined to remain in the debt cycle.
(3) Diversify your Income Stream
You need to understand that having all your eggs in one basket will prove to have tragic results. Some acquaintances had all their asset base in housing equity and would talk about their $400,000 “equity” yet as the bubble crashed, all the equity was wiped out. Now, many lenders are closing off home equity lines and they no longer have that $400,000. They never really had it since it wasn’t liquid. The point of this is never ever keep all your money stored in one financial vehicle.
You need to first have an emergency fund that is liquid. You really need to have this before any stock investing. This is your life line and safety net. No point in saving for retirement if one financial mistake can set you on the street. Once this is met, make sure to start investing a portion of your income. I have written articles that are counter to typical market sentiment and there are many ways you can become wealthy but you have to go with something you understand and are comfortable with. Maybe you can do consulting on the weekends if you are good with computers. Maybe you are good with photography and can add that as an additional income stream. The point is, if you are one paycheck away from becoming financially insolvent you really need to get your balance sheet in order. As you look at income streams, you want to also take this perspective with your investments. Have it diversified to the point where you are protected no matter what happens in the market. Rule number one, never lose the money.
(4) Budget
Most people that become financially independent know where there money is going. What is the point that you bring in $20,000 a month when your outflow is $22,000? It is absolutely vital that you create a budget and preferably you invest some money into a computer finance program like Quicken or Microsoft Money. There are others out there but I am familiar with these two. They provide enough information that would make an accountant from 20 years ago blush. The most important thing they provide is a snapshot of your financial picture. It will also help track where the money is going.
When I wrote an article about a person living on $46,000 in California I was surprised how many people thought this was flat out impossible or that the budget would simply be unlivable. This is how half the people in our country live yet many of the comments reflected a baffled belief to the budget. If you know where the money is going, it can be done. Even with a hypothetical budget you can see why so few people ever become wealthy in this country.
Ultimately financial wealth is about having the right mindset. Things are tough. Anyone telling you that things are great right now is simply feeding you a line. Yet this doesn’t mean that you should resign yourself to the circumstances and give up. You can become wealthy if you choose to do so. This will not happen overnight but certainly nothing worth your wild is going to come easily. It is valuable life goal. Hopefully you can get into the right mindset and free yourself from the debt cycle and ultimately arrive at a point where you are financially free.
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Most Americans would probably agree that housing and the credit crisis is the number one issue. Even though many are seeing fuel as the major story of the day, ultimately the most expensive line item for most Americans is housing. Not only does it create the largest monthly outflow, it is also the single biggest asset for the majority of families. Most view their home as a safety net and not necessarily as a speculative commodity.
Given that housing is so important to the health of our economy, what can be done to improve the housing market? The recently signed housing bill does help in certain respects but also includes items that will only ensure a very large bill for the American taxpayer. Some of the good items include:
-Forcing lenders to writedown mortgage balances by 10% of their current appraised value if they would like to participate in the FHA refinance program
-An additional 3% one-time payment for insurance
-Shared appreciation
Those are some of the good items in the bill. The problem most people will see is what will occur with the bailout of Fannie Mae and Freddie Mac. This is the area where most problems will occur. It is important that Fannie Mae and Freddie Mac, which have practically become the only mortgage game in town, to ensure that what occurred in the past does not occur again in the future. With $5.3 trillion in mortgage debt between the two government sponsored entities, it is vitally important that things are done right from the beginning.
With that said, what can we do currently to improve the housing market? What are some viable solutions? I will offer 5 options of things that can be done today to start creating some movement and also confidence back into the market:
Solution #1 – Ensure Stronger Regulation over Lending
The first important solution is to bring back confidence in the lending apparatus. Wall Street firms no longer have a market to sell mortgage backed securities. Lenders now have to own their own mortgages or follow guidelines that the GSEs require. This has created liquidity problems. Yet given the nature of leniency with the GSEs, much of the loan guidelines only put us back to the pre-bubble days. It is simply the mindset of many has become dependent on credit being issued much too easily.
Regulation and enforcement of the rules is important. The overall feeling now is that the lending industry was misguided and people just do not have the confidence to go back in. Confidence takes time to earn and since we have yet to see any convictions of those who committed fraud be prosecuted, the public feels for the most part that many of these people got away with robbery. Given that it is an election year, we may have to wait another year before we see any large public trials.
On a more micro level, it is vital that those who have the power to make loans actually have the fiduciary responsibility of protecting their clients. Any fraud will be punished with legal consequences. For those that follow the book it will be business as usual. For those who don’t there will be stiff and swift consequences. The laws need to be changed and certain states are now requiring licensing for brokers and in the case of Indiana, a large number had their licenses revoked.
This is important because it lays the foundation of a market that once again is taking the legal importance of home ownership seriously.
Solution #2 – Legal Cram-downs
Another item that was overlooked during the housing bill is legal cram-downs. In a cram-down a court is allowed to look at secured debts and rework the actual payment amount based on the borrowers financial situaton. This happens through the bankruptcy process. Many homeowners that are severely underwater may have an incentive to walk away from their home. Through the cram-down process, at least the court would have legal jurisdiction over the entire balance sheet of a household to get a realistic picture of what they can afford.
This works because it interjects a third party into the negotiations. The current housing plan is voluntary and to think that the lenders will be unbiased is simply too hopeful. Each party will try to do what is best for their bottom line. Many lenders will have an incentive to unload the worst performing loans which brings into question the adverse selection process. That is, lenders will off load the worst performing loans to the government while keeping the best loans.
With the cram-down process, you can also go after speculators and flippers. Why should someone that purchased a $1 million home for flipping be able to walk away with no problems even though they may actually have the income to make the payment? In the end, it will be the taxpayers that foot this bill.
The cram-down process can be simply another tool to be used to get the market going again and at least it will help with some of the foreclosures out in the market.
Solution #3 – Legal Trust Fund
There has been blatant fraud. Some institutions up to the CEO level realized what was going on. They still have assets and still have funds and there is no reason that their cushion should not be used to setup a fund to protect the borrowers that they defrauded. Why ask the government for money when they have it right now? It is time to create a legal trust fund that each company will setup that will go directly to offsetting some of the problems with their own borrowers. Many can only support so much but we have yet to see anything happening even with the most blatant subprime operations.
The court needs to have the ability to go after bank statements of those that made hefty profits while pushing risky mortgages onto a public that is now ultimately going to fall on the U.S. taxpayer. There will be some high fees associated with this housing bust yet I am surprised that no politicians are going after this item.
Solution #4 – Down payment requirements for government loans
If we want homeowners to stay in their home, a down payment for government loans should be a must. We should require home owners to come up with a 10% down payment. It is surprising to see that the new housing plan still has the ability for borrowers to come in with 3 to 5 percent down. The reason for a down payment is that it creates a financial bond between the borrower and the home. There is something to lose if they do walk away.
The nothing down mentality will take years to eliminate but the quicker that happens, the faster people will see homes as places to live and will start coming back into the market. Government loans should be on the level of you lending your own money to someone. Would you give someone a $400,000 loan without a reasonable down payment? Of course not.
There is also something to be said about encouraging people to be savers. We are in this problem because of deficit spending. Having a down payment demonstrates that a person or family is able to save for a few years and has the discipline to be financially responsible.
Solution #5 – Eliminate Alt-A and Subprime Loans for Good
These loans clearly have no future in the market. In fact, they caused far more damage than any benefits that they brought. There is no need for these loans. There should be explicit legislation stating that any of these loans will not have any implicit or explicit guarantee from the government ever. If certain Wall Street firms want to back these loans, then it is their bottom line that will be on the hook, not the U.S. taxpayer.
The elimination of these products will ensure that once we work our way through the current mess, that future home buyers will be solvent and some balance will finally start to emerge into the market. Otherwise, we are simply setting ourselves up for a repeat of this housing bubble bust.
