Hidden leverage 2: we need a forensic accounting
Hi, friends, welcome back. We took last week off for the Memorial Day holiday and I hope this finds you well. In my last post, Hidden leverage and wealth in america, I discussed the mystery of unknown leverage and its potential impacts on our economy. I got a lot of interest after that post, so this week, I’d like to dig deeper (as promised in the last post) to take another look at what it is and why we should pay more attention to it. First, a quick roundup of market news and governmental actions.
Market updates
As I write this, bitcoin is hovering just over $37,000. That’s a pretty big hit since it’s all-time high near $65,000:
Coindesk.com, June 17, 2021 around 5:45pm PT
I know, I know, what goes down will go up. But it seems that some of the frenzy has cooled. For early investors, it’s still been a remarkable ride and it’s likely not done yet. For those who bought in high, well, time will tell about this one.
The other big story is, of course, inflation. In a word, Ouch! Headlining Marketwatch this morning was an article titled, “U.S. Consumer Prices Soar Again and Push CPI Inflation Rate to 13-Year High.”
As is typically the case, it’ll hit lower-income and middle-income households the hardest, including people who are still struggling to gain financial footing now that we’re at (we hope) the tail-end of the brunt of the pandemic. Issues like inflation and low wages exacerbate widening opportunity disparities and the resulting wealth gaps.
I believe that America achieves its full potential when we are both capitalists and humanists. For example, infusing more liquidity into the economy at this point (as was necessary for the last year or so) may not be our best long-term strategy. However, investments in our country’s future that lead to innovation, creativity, empowerment, financial growth and key technological and competitive advantages are commendable:
These have real, defined and measurable impact. Here’s one example, As reported by DegreePlanet.com:
“According to the Center on Education and the Workforce, associate degree holders earn on average around $1.7 million during their careers. That’s over $400,000 more than those who just hold a high school diploma! Plus, there are more job opportunities for those with associate degrees as compared to high school graduates.”
If that’s true, then the return on investment and long-term positive impact over generations is astronomical.
Covid/pandemic:
While media outlets report that we won’t quite hit the goal of 70% of Americans fully vaccinated by July, as of the time that I write this, more than half of us are there.
Even if the number of vaccinations given each day continues to decline across the U.S., as long as someone somewhere gets one, that gets us closer to near-herd immunity -- which is good news for those who can’t get vaccinated. (Some experts say that with many holdouts, we may never achieve actual herd immunity.) And so it goes around the world: If we’re not using all the doses we have, good for the Biden administration for ensuring that they get to people who need and want them elsewhere.
Hidden leverage: wealth in america doesn’t add up
From what I can find, America’s “balance sheet” doesn’t add up. For example, there are too many homes selling for $5 million and more if (as this article using statistics from data from the Federal Reserve’s 2019 Survey of Consumer Finances shows and which are likely higher now), in the U.S., there are:
15,298,070 millionaire households
Around 1,456,336 households with $10 million or more in net worth (about 1.13% of American households, so to be in the ‘top 1%’ takes about $11 million)
8,046,080 with $2 million
5,671,005 with $3 million
97,287 with $50 million or more
34,507 with $100 million or more
89,510 people with assets of at least $50 million
788 billionaires
To afford a $10 million home, your household income would have to be around $1.2 million annually. As pointed out on the blog, Financial Samurai, only about 0.3% of Americans make that much per year, out of the 107,000,000 or so adults (16 years old and up) who are eligible to work full time.
To actually afford these multi-million-dollar homes, then, as well as the cars and boats and other lifestyle amenities that go with them, people have to be using a lot of leverage, because it just doesn’t add up otherwise.
Here’s another example. Millennials are generally presented in the media as a savvy bunch of influencers making gobs of money on the interwebs. But a recent Bloomberg article presents a different story, summed up in this graphic:
Another look at leverage
As Investopedia defines it, “Leverage is an investment strategy of using borrowed money—specifically, the use of various financial instruments or borrowed capital—to increase the potential return of an investment.”
At its core, then, leverage is debt -- but it’s debt taken on specifically with the aim of achieving profits or growth. Leverage, in and of itself, is neither good nor bad: It’s how leverage is used and the results it gets that make it either good or bad.
For individuals, for example, this may be homeowners who leverage home equity to invest in things that they hope/believe will create wealth. They may use the funds to invest in stocks or other properties, for example, or to buy art or classic cars or to pay for college or graduate degrees, whereas the potential long-term earnings can offset the cost of the home-equity loan.
Businesses do it all the time, too, to fund expansion, upgrades and growth.
Used wisely and well, leverage has powered our country’s phenomenal economic growth, particularly over the last 150 years or so. But another challenge is this: You can usually only get leverage if you already have some sort of wealth or assets, because you have to have something to leverage.
Leveraged to the hilt
“Of course he’s broke, he was leveraged to the hilt!” As in, the debt hole got too deep. As in, completely. As in the idiom that it refers to, “...the handle (hilt) of a sword, the only portion that remains out when the weapon is plunged all the way in.”
The hilt itself won’t kill: It’s the rest of the sword, the part that we can’t see, that might.
I think we need to do a forensic accounting of sorts -- a reckoning, at least -- to get a more realistic picture of America’s balance sheet.
As I said in my preceding blog post, “It’s the amount of leverage -- put another way, borrowed money or credit -- that’s ‘hidden,’ with no real data and no way to account for it, and its potential impacts on our economy. This hidden leverage fuels growth in good times, but it also hides the financial risks taken by more and more Americans.”
Let’s say you bought a house several years ago and between its increased valuation and equity from payments, you could comfortably take out a home-equity loan to buy an investment property. And when that property accumulated enough equity, you cashed in to buy another property.
Now, you have a property portfolio which is worth, say, $3 million. In reality, you have access to properties that are worth millions, but your actual ownership of them is much less. Still, you’ll continue to build equity and have tangible assets to sell.
You've leveraged well and this is debt that economists and lenders can largely track.
It’s the leverage that we can’t accurately track that concerns me, because it’s likely significant and growing.
Let’s say, for example, that instead of buying real estate, you used that money to buy bitcoin and when the good times rolled, you used that bitcoin to invest in more bitcoin which, by its very nature, is difficult to track.
The art market is another area rife with hidden leverage. As this CNBC report indicates, the estimated value of private art holdings is around $2 trillion, noting these key points:
“While the big banks dominate art lending because of lower rates, more and more art finance firms and auction houses are expanding their loan business to attract more clients.”
“The value of privately held art is estimated at more than $2 trillion, and the potential market for art loans could easily top $400 billion, one expert said.”
“Lenders say the big opportunity—and the new risk—is in the business of reselling art loans to investors.”
I think part of the problem is that instead of leveraging assets to build wealth over time, leverage has become one more giant pawn in the gamification of every asset class in the hope of quick-and-big returns. This has likely created wealth; it has probably also created the illusion of wealth.
The fact is, we’re missing boatloads of economic data and if we’re missing data, then we have a bad model. We’re also sticking our heads in the sand.
This is hidden leverage and it’s everywhere—and while we can’t put our fingers on it and can’t assign a dollar amount to it, it’s there and looming large.
