A debtors tale: analysis of 5 families I know
A massive amount of commentary is made about debt in the world today. So many charts and graphs and statistics, some of which are certainly accurate and some of which are certainly hype.
I think it is often helpful to try to sit back and get a realistic view of a situation when investing. The first time I did this kind of excercise, it was 1999/2000, I didn't have any money aside from a trashbag full of table waiting tips that my longtime biz partner and I had saved to start our first biz's. But it was the dot com bubble, and everybody was talking about stocks. We'd log onto excite.com and marvel at the soaring p/e ratios, and the soaring share prices, and ... we had a friend who had inherited some money and was all about tech stocks.
We argued that at a p/e of 100 or whatever it was, CSCO was destined to come down, way down (we had read Dreman's book from the mid 90's advocating value stocks, low p/es etc.). He argued that this was different, this was a new economy. I argued that the market cap of CSCO was so high ($600B+ at its peak, I believe) that there was no way. It would have to get bigger than health care as a whole to have big growth for the company from here, bigger than all of cars, probably bigger than food or housing. To grow 10-12%/year for 10 years it would have had a market cap in the trillions, or 20% of GDP. No way a company making routers has a cap that is 20% of GDP. And so that was it, in my mind it was settled, it was coming way down. It had to come way down. The scale of the market cap had simply gotten too preposterously huge.
I was thinking about debt in these kind of terms the other day. What does it really mean? What is the debt situation of an average couple? What about the people I know? Are they desperate-debtor statistics? If so, are they broke/screwed, or are they ok? Lets take a look at a few couple and people that I know.
As with every blog of mine, all names are changed to cause confusion and protect the innocent, and the guilty.
Jason Monrow. Ole Jason is semi-famous in these parts. He owns a local business that has been aroudn for 15 years, does about a million dollars a year, has 4 modestly paid employees and one well paid manager plus himself. He keeps about 30 grand of cash in the bank, spending when it gets over that, and saving when it goes udner that, his debt would be related to a large number of cars (all with payments) so I'd estimate his debt (all in depreciating assets) at perhaps $100,000-150,000. He doesn't own a house (rents) and if this was a company that would wind up as "debt" on the balance sheet even though such a classification is debatable in my view. We'll forget the lease debt. He probably has income of around $100k/year. So his debt/income is about 1:1, probably. All in all thats not that bad of a situation, I don't imagine. The US is certainly in a worse situation (its debt exceeds tax revenues). Assuming inventory at his biz is worth $70k, his debt/net asset worth is 1:1, which isn't stellar and his net worth is probably close to zero.
So where does Mr. Monrow rank in the world of debt statistics? Debt:income of 1:1... is that considered dramatically bad? If his biz was shut down he'd default on all those payments in weeks, but it getting shut down seems to me as a customer highly unlikely.
Kory and Callie. Married w/3 kids, have the stereotypical split-level suburban house that cost $210k, they owe $180kish. She's a stay at home mom, he works for a Dow Jones company & makes I'll guess $100k. He has a company car, she has a brand new chevy crossover thingie (probably about $30k), lets guess they have $10k of net savings, which seems overall reasonable, as Kory told me once that he was saving money, albeit at a modest pace. So their debt:income is probably 2:1, which must be horrible. Their debt to asset value is probably around 1:1 also, and their net worth would probably be fairly minimal at around $25k.
So thats a pretty bad set of statistics... But they are above water and saving money. They'd be screwed if he lost his job and couldn't find another one, of course.
Bill and Jennifer. She works as sort of an independent jewelry sales consultant, he has a start up used car business and residuals from time as an insurance salesman, their total intake is probably around $90k. They owe $130k on their condo, no kids, he drives his inventory and she drives a Toyota, i don't know if they have a payment on it or not. So their debt:income is pretty bad 1.5:1 or so. Debt/net worth is a little better, perhaps a little better, and their net worth is probably around half a years salar or so. He recently took a job that wlil pay him six figures, and their household income will rise to perhaps $150k. So their debt:income will be 1:1 or better.
So debt:income of 1:1, debt:asset worth of around 1:1.2, and debt:net worth of perhaps 4:1 will be their situation when he gets the new job. The debt:net worth of the others above is probably far higher, as their overall net worth is fairly small.
Each of the 3 cases above, frankly, I think represent people who are in good financial shape. In each case they do or could save money, in each case they have a clear handle on their financial situation and its getting better over time, not worse (except in Monrow's case, as he blows every singlecent he gets over $30k in his account immediately because, frankly, money means nothing to him as far as I can tell).
Now, if they lost a job, businesses went under, etc., they would be in tough shape. No denying that. Moving on.
Big Bobby. Bobby is famous in these parts for being rich. In fact, he is the most famous guy for "beingn rich" anywhere remotely near these parts thats anywhere remotely near my age (we are the same age). So well known for being rich that I would wager if you took a poll in a local pub, probably 50% of people would tell you he owns the local shopping mall (he owns 0.5% of it, but is fond of telling people he is "an owner" of it, technically true I guess) and is a mega multi millionaire. Bobby drives brand new Cadillacs and Porsches all the time, getting at least 1 new car every year, if not two, and he has a million dollar house. When I show up at one of his restaurants in one of my cars, everybody runs around asking if it is Bobby's or you will even hear the staff telling each other to call bobby and ask if he got a new car.
But the thing is, and its hard to discern this exactly, because ole' Bobby is really, really all about everybody believing that he is rich, but... I am old college buddies with the bookkeeper at one of his biz's and I guess the financial situation isn't pretty. The house has no equity, him having taken out a home equity loan on it after a few years of ownership. The cars are rolled forward, with negative equity adding up, and he owes more on them now when new than he paid. I didn't know you could do that. And the company credit cards are maxed out to pay for lavish vegas vacations. Now, I am not judging silly spending in vegas, as I happen to hold (or so I've been told) the record for biggest bar tab at one of the clubs there, but at least I have the money.
I have seen the books for the restaurants and they are doing well. No equity in them, but they service their debt, pay all salaries, and kick off $100k or so each year. His 0.5% of the mall is probably worth a hundred grand, and he generates significant cash flow from his business, without question.
I guess Bobby is the poster boy for the debt bubble, eh? Any and all credit anybody will give him he takes and spends at once, on superficial "look at me" stuff. He should live in California or Vegas, I guess.
So here we probably have 3 or 4 million dollars worth of debt, probably negative net worth, a significant amount of cash flow, and at least most of the debt is being serviced (the restaurants). The hosue is unsellable as he lives between two old college buddies (who now work for him) an a neighborhood where there is no way anybody spends $1 mill fora house. Maybe he gets $600k.
How bad is his situation? I honestly don't know. It isn't good, and I've no doubt that a significant downturn in business would leave him bankrupt. I also have no doubt that a significant upturn in business would see him just spend more and more.
I guess thats the poster-child for all of this, eh? But for every one Bobby there must be a hundred, if not hundreds, of Bills, Kory's, or Jasons.
Old man Joe. Joe's a farmer near the end of his life. Farm is paid for, owes $80k for operating expenses for the year, which he will pay after selling this years harvest. His normalized income is probably $100k now that he doesn't have payments on the farm. So his debt:income is better than 1:1. But he is probalby worth $1.2 million (the farmland), so his debt:net worth is extremely low.
Grown man Joe. Same guy, but 20-30 years ago. Normalized income is proably $50k in todays dollars, probablyowed $400k on the farm. So his debt/income was appalling. Debt/net worth was still decent (once the farmland had appreciated slightly and been paid down slightly).
Young man Joe. Same guy, new farmer. Owed probably $600k on the farm (guessing),normalized income of $50k. Debt/income was horrific. Net worth was $0.
Bartender Barry: makes $35k has $15k left on his car payment. income greatly exceeds debt. His net worth is probably about zero (probably underwater on the car). Does having a debt/income ratio of 1:2 (way better than most of the above) make him better off financially?
So there you have a cross section of people I know. In most of these cases, their debt:income is horrific. In fact, by that measure, ANY NON HOME OWNER is doing "well". I would note that if all of the above just rented, their debt:income ratios would be vastly better. But, over the course of a decade or two, they would wind up worse off financially. Farmer Joe would have never paid off a house, the couples above wouldn't be paying off houses, and so forth.
I don't dispute that we have a debt problem in this country. Obviously the country itself does. The countries debt problem stems from years of malinvestment: handouts given, so as to ivnest in nothing, in exchange for votes.
Big Bobby's debt problem is also a function of malinvestment. Gigantic blackjack table tabs and money lost on cars and underwater on an ill advised house purchase.
But, as in the case of Kory or Billy, often debt (as in a mortgage you can manage on a hosue you bought at a reasoanble price) is a GOOD investment that will leave him better off down the road. So, sometimes, scary debt ratios (2x his income) isn't so bad.
And sometimes impressive debt ratios (less than half his income), represents no investment, and not necessarily a good financial situation at all (barry), albeit not a dangerous one.
I would love other peoples thoughts on the debt situation, with a focus on a realistic, and not hyberbolic, view of it. Clearly, if we were all perfect pictures of suburban life, nice job, house we can afford, which we have a mortgage on, maybe a car payment, and a little bit of savings... we wouldn't be in bad shape. But we would have frightening debt statistics. I think a thorough dig into what the actual debt situation is (as in, what % of the debt is "malinvested" debt) would be alot more helpful than simply lumping every debt into one scary stat (as in good business debt or reasonable mortgage debt).