A Lego model of financial capitalism | Hacker News Reader

A Lego model of financial capitalism

asomo.co

196 pointsDogwash2484 comments

A variation of this is why owning your house has (historically in the USA) been such a "deal".

Because you put 20% down (or less) in cash, borrow the rest, and the appreciation goes to you. At 20% down, if the house goes up 20% you've doubled your money. At 5% down, it's 4x (minus transactional costs).

As long as you ignore all the other aspects, like inflation, maintenance, etc, you have a pretty darn good return on paper.

It's actually safer than almost any other debt financing. Even in bankruptcy creditors can't take your house.

Yes - the benefits for single family home ownership are so insanely high it's hard to come up with situations where it is not the way to go (usually involving not being in an area for long enough to overcome transactional costs).

In California on a purchase loan you literally can't lose - the bank can only take the house, it's non-recourse.

I just don't think it makes sense from outside the system.

If the benefits are so great, why can't the benefits be shared and even increased if I live in a condo in a row of condos? Then we have fewer outside walls to insulate, we can all pitch in for a manager to handle exterior maintenance, we can pool parking, maybe get some solar panels using that nice big shared roof space...

I agree the benefits _as the system is set up now_ are obvious. I don't think those benefits _should_ exist because I don't think they make sense or fall out from first principles.

And this isn't a communist thing, I think that single-family homes just look like an inefficiency. As a capitalist, why am I paying to heat and cool extra walls?

Most of these benefits apply to condos too.

What sets condos apart (in the same general location) is the monthly HOA fees. Monthly condo fees could range from $200/month to $4,000 a month or more. When buying a place with a HOA you really need to do your due diligence. As part of the process you will receive a copy of the HOA's financial statements. You need to dig into those and look at common areas like the streets and the pool and look to see how much expected lifetime remains, the current estimated future costs, and the level of the reserves (do they have money in the bank or not).

This is the reason my elderly parents still live in an oversized home for their current needs. They've looked at downsizing to a townhome or condo, but comparing everything they would lose to sharing noise through walls, HOA fees despite still being responsible for mowing and shoveling snow, and everything else it just doesn't make sense for them.

> Monthly condo fees could range from $200/month to $4,000 a month or more.

Older high rise buildings have much higher fees, this is unfortunately true. (Soon as you have interior hallways and elevators...)

But as you alluded to, in general if you go through the finances of townhome complexes, the HOA dues are (often mandated by law) just creating a cash reserve to cover future expected maintenance.

Or to put it another way, realistically everyone who owns a home needs to set aside a few hundred a month to save up to buy a new roof, siding, paint fence, do pest removal, an so forth. The HOA in a townhome complex is a forcing function that requires people (again in some cities by law!) to calculate what the expected maintenance costs are going to be and to then save up accordingly for them using some low interest safe investment vehicle (or just cash, but IIRC my HOA has its money in some 2 or 3% interest bearing accounts).

> and the level of the reserves (do they have money in the bank or not).

This is the key part, a healthy HOA has reserves for the next n years of issues and has reasonable HOA dues to keep those reserves at a healthy level. Basically they know some large bill is, statistically likely, to come up, which will drop the reserves down, and the HOA dues are set at such a level as to refill the reserves before the next big bill comes around.

This is the math that all home owners should be doing.

Most people should pay themselves HOA++ so that they have a maintenance account when needed.

The problem is if you don’t you just hurt yourself a bit - but a badly managed HOA can hurt you surprisingly when it’s discovered that they have no money at all for major maintenance items and trigger a sudden assessment.

> As a capitalist, why am I paying to heat and cool extra walls?

Paying to heat and cool “extra walls” is worth it to me for privacy and noise reasons. I also use the space for my gardening hobby, storage, and as an extension of my garage for diy woodworking projects. Money well spent in my opinion.

When in doubt, math it out:

https://www.nytimes.com/interactive/2014/upshot/buy-rent-cal...

Paywalled

> it's hard to come up with situations where it is not the way to go

One mistake is buying excessive amounts of house (and not renting it).

Ownership is no-brainer inasmuch as it also replaces your rent (or provides income).

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EDIT: Another situation is short-term (< 12-18 month) rental.

If you were to invest the money, you might come out a little ahead, but the value of having somewhere to live outpaces that.

The fancy word for this is LBO

I think a rental property would be more like an LBO. The bank takes into consideration the income potential of what you're buying when underwriting the loan. Obviously your credit-worthiness still matters too.

It also why leveraged losses can be so devastating - the same works in reverse.

When your home depreciates, you lose the down payment and you are still on the hook for the debt.

That's what happened during 2008 GFC when home prices went down.

Are you still on the hook for the debt, though? I though that's what bankruptcy was for

Just because you go legally bankrupt doesn't mean the debt magically disappears.

In many states a home loan is “non recourse”, which means that in a default the bank gets the house and nothing else. The debt is completely discharged.

But your credit score will still take a hit.

They don't like it when you play by the rules.

You’re eligible for a new mortgage within ~3 years after foreclosure with an FHA mortgage, 7 for conventional. This is known as waiting periods wrt mortgage underwriting guidelines. Credit score might impact the rate, but on the property ladder might be than not, have to model both ways (appreciation, cost of debt service, reserves, rent, etc).

(Strategically defaulted on property after buying at the peak before 2008 GFC)

The following page provides a good overview for the US https://www.uscourts.gov/services-forms/bankruptcy/bankruptc...

>> you lose the down payment

This loss isn't recognized unless you sell. If your house loses value but nothing else in your life has changed then "Just keep swimming" and historically you will win in the long term.

The history of financial markets is about 3-4 lifetimes long. That’s not a lot of history to go on.

Maybe on aggregate but the devil here is in the details.

Plenty of people buy houses in "on the rise" areas and reap the benefits as desirability increases, it's true. Even market crashes like in the mid/late 00s don't impact their long term prospects. But there are also dilapidated cities and small towns in this country that have fallen from their heights never to recover.

It's easy to look back after owning your home for a decade and conclude it was all inevitable, but the "home ownership" bet is one that the house you're buying in will be in a desirable area in the future. This isn't always going to be true, and it's a real risk.

And yes there are protections from being on the hook for the full levaraged amount. You can walk away from an underwater mortgage, but if you put in a large down payment you're kissing that goodbye, and it's still a pretty big disruption in your life even if it's one you can recover from.

It can be quite a long time 10-15 years.

I was in that situation and probably on paper we should have walked from an underwater house. But we could afford the payment, so we stayed.

The only really annoying thing was waiting ten years until the value went back up enough that we could refinance from the relatively high rates we had been paying. Annoying to be paying 8% when you could get 3% but you can’t refinance because you don’t have the cash to become not underwater.

> This loss isn't recognized unless you sell.

True, up until the point you lose your job due to recession and then you have to sell.

All you have to do is wait instead of panic sell and you will have weathered any recession in history just fine.

True, up until the point you lose your job due to the recession and have to sell.

The house going up 20% is its own oddity. My living here doesn't attract more business or residents to the neighborhood, it doesn't really improve the value of the land except for my fractional contribution to keeping a nice grocery store open nearby.

I suspect in many cases home ownership is just subsidized. Might be Director's Law at work. https://en.wikipedia.org/wiki/Director%27s_law

It a lot of factors but the main drivers are inflation and desirability. In places where the desirability is basically neutral, houses do what you would expect and “used” ones sell at a moderate discount to new construction.

They aren’t making more land.

Aren’t they? Isn’t that what sprawl is? Obviously, not literally creating more physical land, but developing land into useable land.

They’re making more useable land.

Sprawl has its own cost growth function. Bigger roads, bigger water distribution, bigger sewers, bigger runoff, etc. And typically you develop the easiest and best land first then expand in the more and more difficult to develop. This inflates costs as time goes on.

You can't make more of unique locations. Dirt isn't the issue, it's location. Times Square doesn't use that much "land", but it's a unique, non-commodity location.

Sprawl in NYC wouldn't create more Times Squares, so in this sense, "they aren't making more land".

There's plenty of land in Siberia. There are very few locations that are in the middle of dense cities.

If not for suburban zoning laws from the 20th century there would likely be more midtown-style skyscrapers in NJ/LI/CT.

They are making more valuable/liveable land.

Land itself is cheap as dirt.

Level land in Wyoming for $350/acre (so $70/house at median lot size). [1]

(Does it lack transportation, utilities, stores, schools, and jobs? Yes. Because those make land valuable.)

[1] https://www.land.com/property/80-acres-in-Sweetwater-County-...

Land is cheap. Location is expensive.

Home prices have an inverse relationship with interest rates. Housing cost as a percent of income has been relatively stable in the U.S. lower interest rates mean you can borrow more for a given monthly payment. Interest rates had a 35+ year slide from 1980 to 2005. It's been really weird since then.

  My living here doesn't attract more business or residents to the neighborhood

On the contrary, try getting internet, sewer, water, electrical, or gas hookups in a rural area and let me know the cost.

In fact, if you have a rural undeveloped plot of land amongst other undeveloped plots, and you pay to bring in electricity and gas or whatever, the properties around you will go up in value because now it’s cheaper to connect them up.

You living there reduces supply.

To make matters stronger there are significant tax benefits (the public subsidizing private home ownership) and the US’s 30y fixed rate loan is startlingly good, especially since you have a refinancing option. The risk of these loans is again subsidized by the public.

> As long as you ignore all the other aspects, like inflation, maintenance, etc, you have a pretty darn good return on paper.

That's a pretty significant amount of things to ignore. When you include closing costs (10-15k in NY) and insurance, you're underwater on your house for a pretty long time.

Historically, conventional wisdom has been two years to recoup the overhead.

Obviously depends on market volatility, and I've no idea if there's a more accurate # now.

I've heard 5-7 years, but that may be with much lower than the 20% down.

7 years is the usual estimate in a “neutral/slow” market because it usually costs 10% to sell (realtor fees, etc).

Of course if appreciation is going up more than 10% you can profit much faster, or you have flipping techniques to avoid frictional costs (like being your own realtor).

Insurance and maintenance are costs of shelter, though. That's an exchange for the benefit of enjoying a roof over your head -- it shouldn't be considered a financial loss from an investment perspective. If you were renting out the property instead of living there, the renter would be paying those costs through their rent.

My apologies, I meant interest and maintenance.

And I would say that maintenance certainly counts as a financial loss when you're considering the property from an investment perspective. If it was a paper investment (stock/bond/whatever), it wouldn't exist. It's part of that specific investment.

My point is that unless you're living in the woods, you have to pay for maintenance. Maintenance has a cost, but not an opportunity cost. If you choose to invest in tech or gold or whatever instead of a home, then you're still paying indirectly for maintenance for whatever structure you're occupying.

At least as a homeowner you do have the freedom to advance or defer certain maintenance work according to your budget.

  If it was a paper investment

Those have "maintenance" fees too at most brokerages.

And even if they don’t, there’s still maintenance somewhere being paid by someone.

Some are lower maintenance than others (physical gold you have to secure, etc) but everything needs at least some work to keep from wasting away.

The point is that the simplistic “I made money selling my house” takes into account few if any of these costs (many which can be accounted as valid for the need of shelter).

I rent. I pay something like $15.00 a month for insurance. My basement flooded and my landlord had to pay for an emergency plumber. It’s “built into the rent” but I still don’t have to bear the cost. My landlord assumes the risk of being ready to cover an expensive maintenance item.

Yes but you compensate them for this risk via your rent.

The landlord gets equity in the property. The tenant get freedom, peace of mind, etc.

It's a question of priorities and personal values.

Yes, at about half the rate a mortgage on this place would cost.

I put those savings into investments that aren’t stored outside.

Appreciation is a good deal for speculators and flippers, but for normal homeowners it isn't worth much. If all house prices double including my own, the money I make selling my house just goes into buying a new one.

It still matters to normal homeowners who eventually intend to downsize before they die. Or if they borrow further against the rising value of their house to finance other investments at a lower rate than they otherwise could borrow at. But yes, it matters much more to speculators or investors who own rental properties.

Speculators are definitely gambling on appreciation but investors (while liking it) don’t want to depend on it.

They want appreciation that they can be causal on, like reducing or increasing vacancies, raising rents, etc.

I have paper appreciation but very real tax increase. My taxes almost 3 times higher now comparing to what I paid when I bought the house.

That is a symptom of your city's budget needs increasing, not rising home prices.

The presence of leverage means that appreciation still favors you. Assume you buy a $100k house, with a 30 year mortgage at a 6% interest rate and a 20% down payment. You then buy an equivalent house.

Over the course of those 5 years, you will spend $28.77k in principle and interest, reducing your loan balance from $80k to $74.44k

At 0% appreciation, you sell, giving you $25.56k in equity, then buy another $100k house at 20% down leaving you with $5.5k in cash.

At 2% appreciation, you sell, giving you $35.96k in equity, then buy another $110.4k house at 20% down leaving you with $13.88k in cash.

At 4% appreciation, you sell, giving you $47.22k in equity, then buy another $121.66k house at 20% down leaving you with $23.00k in cash.

At 6% interest, the difference between the 80k loan and 97.328k loan is $103.89 a month, or about $1.25k a year. Set asside $6.23k from your surplus to cover the marginal P&I cost for 5 years and you are left with $16.77k cash. Subtracting the $5.5k of equity you woupd have had at 0% appreciation, and a 4% appreciation rate netted you $11.27k over just 5 years.

Given your 20k initial investment, that is a net return of 56.35%. Which is an annualized return if 9.35%.

The appreciation presumably does not include all the money you spent just maintaining the house, or all the fees involved in both buying and selling. And the costs don't include remodeling the new house so that it's got the things you liked about the old one, or the cost of moving. I'm not arguing home ownership is a bad investment, it's been a good one for me. But every time I look into the actual cost of trading up houses, the calculation gets really complicated, and doesn't look as cut and dry as it did on the back of the envelope.

Those are all costs you would need to pay regardless of appreciation.

Not calculating/ adding in the additional feels from selling (and usually also buying) a house make your calculations flawed.

Thats a lot of work, and you have property taxes and maintenance.

An index fund gives me 8% without lifting a finger and is very liquid while a house isn't.

Your math may well be correct but I can't follow it without a spreadsheet, so let's do a simpler example with two different appreciation scenarios.

Scenario A: I buy a $100k house with $50k down and a $50k mortgage. House prices don't change. I sell the house, then buy another $100k house. I'm still at $50k in equity and I still owe the bank $50k.

Scenario B: same as scenario A, but this time, all home prices double, including mine. I sell for $200k and now have $150k, which I use to buy another $200k house. I now have $150k equity, but I still owe the bank $50k.

In Scenario B I'm better off than someone who didn't buy the house before prices went up -- a fact that should surprise no one -- but I'm not necessarily better off than I would have been if prices hadn't doubled at all. I still owe the bank $50k in both scenarios. The housing price appreciation hasn't actually helped my finances unless I sell the house or use it as collateral for loans, neither of which I am interested in doing. Because I own the house to live in it, not to use it for financial engineering or speculation.

There is an ugly reverse side of this that people don't like to notice (in a "difficult to get a man to understand something if his salary depends on him not understanding" way).

If this appreciation is a good deal, it suggests there is a wealth transfer happening between new residents in an area to old ones. In a vacuum house prices shouldn't reliably appreciate compared to the interest rate. For all the complaints about the very wealthy, this wealth transfer by real estate is likely one of the major effects that stops people improving their own living standards. Once people are forced to be long term renters they aren't going to be as wealthy as they otherwise could have been, due to the theoretical concept economists call rent seeking (distinct from the usual meaning of rent).

You seem to have forgotten repayment of the borrowed funds with interest, and the risk of your home losing value for a million of reasons.

Property taxes, time for maintenance, filling the house with shit you don't need simply cause you have the space, working a job you hate cause it pays well and pays the motgage (as opposed to waiting for your lease to end and moving to a new town).

Don't get me wrong, overall owning is better, maybe. However, the 25 yr and 30 yr mortgage (as opposed to say 15 yr) will someday be viewed as the start of the downfall of the middle-class. It's when housing prices shot up (as did total cost of paying off the mortgage) and life became the march for more $ (over peace of mind).

You are paying some other people mortgage or your own.

The problem for some occupation like uk “junior” doctor you do not stay and hence it is a kind of investment to offset this (buy to let vs your rental place).

For one mortgage …

For second or third or fourth, it is a pension. As long as it is rentable …

it's important to note that post financial crisis, interest rates were very low due in part to quantitative easing. With interest rates rising, asset prices will have to come down. Leverage cuts both ways, the equity in your house can easily be wiped out.

I went off to his https://www.asomo.co/p/the-war-on-informality essay, and found it a good read - the graphic illustrating the small monetary interaction then and now hits hard.

He's written loads of good stuff!

The Lego model has a scale problem. Some of those arrows are a LOT bigger than others. It's not a minor issue when discussing the economy, as a whole.

Really clear. Recommended.

I guess citizen's united & regulatory capture would be the KraGle.

https://web.archive.org/web/20240405111833/https://www.asomo...

You can tell this is fluff because it discusses commercial real estate without ever mentioning the many tax shelters that politicians have created for their real estate developer donors, e.g.

> "What are the most common tax benefits of investing in commercial real estate?

> "The most common tax benefits of investing in commercial real estate include accelerated depreciation, mortgage interest deductions, and tax advantages for an investor’s heirs. Accelerated depreciation allows investors to write off the cost of their investment over a shorter period of time than the asset’s useful life. Mortgage interest deductions allow investors to deduct any interest they pay on a commercial mortgage off of their federal income taxes. Lastly, tax advantages for an investor’s heirs can lead to a massive difference in returns, especially over an extended period of time."

https://www.commercialrealestate.loans/blog/the-top-10-tax-b...

If the market really goes belly-up, then the government will step in to bail out the 'fearless entrepreneurial capitalist investors' as with the subprime collapse, the covid collapse, the Silicon Valley Bank collapse, etc. Then the cheerleaders of capitalism stop complaining about socialism, at least for as long as it takes for them to deposit their government welfare checks.

> You can tell this is fluff

What does that even mean? It's not a marketing page, it's just a simplified, introductory lesson.

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