Who just wants to be a millionaire?

A popular article on CNN.com talks about modern-day millionaires. And to that, I say: Who just wants to be a millionaire? The term has lost all of its cachet. Not to say that millionaires are losers; obviously they're doing much better than most of us.But it certainly doesn't mean what it used to.

The Oxford English Dictionary lists the first documented usage of the word "Millionaire" coming in 1816 from George Gordon, Lord Byron: "He is still worth at least 50,000 pds being what is called here a 'Millionaire' that is in Francs and such Lilliputian coinage." It is interesting that even back then, there was a question over what might truly be considered a "worthy" millionaire. Obviously currency conversion rates can wreak havoc with the term. you can be a Yen millionaire for roughly $8500. That's a pretty low bar to pass.

So, what's your own definition of a millionaire? Personally, I look back to roughly 1900 to 1920. The age of Robber Barons and The Great Gatsby.... the age when the term "Millionaire" was extremely impressive. Using the Inflation Calculator we can see the following current values for previous millionaires:

• 1900 Millionaire: $23.3M 2006 dollars
• 1910 Millionaire: $21.6M 2006 dollars
• 1920 Millionaire: $11.3M 2006 dollars
• 1950 Millionaire: $ 8.2M 2006 dollars
• 1970 Millionaire: $ 5.3M 2006 dollars
• 1980 Millionaire: $ 2.7M 2006 dollars
• 1990 Millionaire: $ 1.6M 2006 dollars

Based on this, I'd have to go with the nice round figure of $10M to be what I would personally consider to be a "modern-day millionaire." That's the kind of money that you can't get by being an extremely frugal teacher or janitor like those described in The Millionaire Next Door (the very fact that there can be a "Millionaire Next Door" is an indication of how much the term has slipped). That kind of money almost requires that you be very successful in what you do. Of course, there will always be lucky people like heirs, lottery winners, and early employees (as opposed to founders) of startups who end up with $10M+ net worth. But it's still a very rarefied group, and it's my goal to end up there.

Re: JLP's Subprime Lender Mess Question

In QotD: Subprime Mortgage Mess - Who's to Blame?, JLP at All Financial Matters poses the question: "Who’s to blame for the subprime mortgage mess? The lenders or the borrowers? Or, should the blame be shared?"

He got a lot of interesting replies, and this was going to be one of them, but I started writing and it got very long, and then I got pulled away and ... blah blah blah. The point is, my answer is here now.

They're both to blame for their own part of the problem.

Anybody who defaults on a loan is obviously to blame for 1) overextending themselves and/or 2) not understanding what they were getting into. That is an individual problem, and each individual is responsible for their own problem.

Lenders are at fault for the bigger, aggregate problem. They made stupid loans, quite simply. They made loans that they couldn't cover. Millions of them. Millions of poor business decisions, pure and simple. They are totally at fault for that and therefore bear the majority of the responsibility for this whole thing. Loaning to subprime borrowers is inherently risky. You go into it knowing that some percentage of them will default. It is the job of the lender to figure out that percentage and set their rates accordingly to keep from going bankrupt.

Your average individual American cannot really tell you how much house they can afford and how much they will be able to afford 2, 5, or 10 years down the road. A bank, with lots of smart people working for it, using tons of actual data to make predictions, can. The credit game is one of "if you build it, they will come." If you decide to loan money to people with poor credit, people with poor credit WILL decide to borrow money. If they default (which some will, no matter what) then you have nobody to blame but yourself for lending them the money. If you create lending programs specifically for people with poor credit, and then advertise them in every newspaper and every other broadcast medium, guess what? People with poor credit will apply for that credit! And if the company is stupid, it will approve more than it should at lower rates than it should.

We are all familiar with the typical bad image of a company with more marketing acumen than actual good products. They come up with something stupid, and then, in order to sell it, they use marketing to "create the market." They generate demand to meet their supply of the product -- demand which, like the product, was nonexistent before. And then millions of people end up with Pet Rocks or Food Dehydrators feeling like idiots, while the marketers of the product are laughing all the way to the bank. This current situation is a case of the lending companies "creating a market" that shouldn't have been created.* And in this case, there are some "just desserts" being dished out in the form of crashed stock, some ethics investigations and maybe even some criminal prosecutions.

(*Note: I'm not saying that lending companies created the demand here. There is always a demand for free money or easy credit. Lenders created the supply, and thus created the market. You could set up a business to lend million-dollar unsecured loans with no credit checks, and I'll bet you'll find pent-up, currently-unsatisfied demand from several billion people -- but obviously it would be a bad business decision to enter that market. All of this comparison to Pet Rocks and the like is just to connect the two different shady kinds of business. In the Senate hearings on this fiasco, I bet we will hear time and time again from lending execs that they were just "trying to meet the market demand for this kind of loan product." And guess what? I just did a Google search for lender trying to meet market demand. The first result was (I admit, this amuses the hell out of me) a recent speech by Sen. Hillary Clinton:

According to most recent statistics, delinquent payments now affect more than 13 percent of subprime loans in our country. That's the highest level in four years. Now, many would attribute this rise to unsophisticated homebuyers, even irresponsible buyers, or the subprime market itself. But the foreclosure rate for all mortgages increased by more than 17 percent in the last quarter of 2006. That's the highest foreclosure rate in four decades.

So when somebody tells you this subprime market thing is no big deal, or maybe, you know what, let the buyer beware, these folks signed on the dotted line, it's their responsibility. Ask them why the rate for all homeowners is so high. Because the economy is not supporting homeownership the way we need it to. And after all, in the absence of an alternative, the subprime market has opened the doors to millions of families and responsible lenders and the market are rightfully casting out some of the worst actors in the subprime industry. But the market will not address the millions of families trapped in unworkable mortgages, hounded by delinquency and facing the grim possibility of foreclosure.

...

We need to expand the role of the FHA to issue more mortgages at better rates to these homeowners. We need to give consumers more counseling and information, prevent families from being trapped in high interest loans with pre-payment penalties and in some cases, allow more breathing room from foreclosure.

...

Now, I will soon be reintroducing my 21st Century Housing Act, which will take steps to modernize the agency by allowing the FHA to reinvest a portion of its revenues in new employees and information technology; to develop new mortgages to meet market demand and to position the FHA to work more efficiently with lenders and to serve more borrowers.

Guess what, JLP? It's neither the lenders' nor the borrowers' fault! It's the economy's fault, stupid! Ok, that was a bit longer diversion than I meant to take, but I was just so amused by that.)

Tech blogger and Yahoo Jeremy Zawodny blogged a couple of weeks ago about New Century Financial Corporation's website and the dangers of having a live stock quote on your company's homepage. I'm sure the slide from $30 to less than $2 in two months is something that NCFC really wants to promote on their front page! (And I'm really surprised that they haven't taken it down yet). That stock is no longer listed on the NYSE.

Are the individuals responsible for their own individual problems? Of course. But they're basically too stupid to keep themselves from getting into these problems. That's an assumption you can always bank on (pun intended). "Nobody ever went bankrupt underestimating the intelligence of the American public." This is pure statistics, and (as I have written before) it is the thing that has driven the success of Dave Ramsey's philosophy more than anything else: you simply can't trust the majority of people to make good decisions about money. People are short-sighted. The story of Faust is resonant for a reason.

I read stories like this one and I find it hard to place the blame in any particular place. First off, the people sound like idiots because they knew they were signing for a more expensive mortgage than they wanted. Secondly, the real estate agent sounds like a scumbag. Thirdly, the loan originators sound just as stupid as the borrowers for lending to people skating so close to the edge, without requiring enough equity to be able to withstand a hit if the local housing market dropped. The kind of loan that these people got (100% financing) sounds like the kind of loan I'd only give to somebody with A to A+ credit. And then there's Wall Street, which seems to gobble up mortgages like there's no tomorrow. I've actually read (and thought it was reasonable) several authors writing about investing in REITs (Real Estate Investment Trusts) because they produce a good rate of return and their loans are backed by actual assets. Well, New Century Financial Corp. was an REIT. There are undoubtedly some good (non-subprime) REITs out there, but this whole thing leaves a bad taste in my mouth. Also, the "backed by assets" promise doesn't seem so great any more.

There's also the matter of subprime loan recipients. Think about it: if you're applying for this kind of loan, you're already desperate. Your credit sucks. Do you really care that much about a foreclosure if you're already so badly off to begin with? At that point, taking on a mortgage is just a gamble, and you probably realize it. You think "Well, I know I probably won't be able to make my payments for the next 5 years, but I'll just enjoy the house while I have the chance." So you're sitting there, you found a house and this guy is telling you that you can qualify for a loan. The terms are ridiculous, but who cares? You'll be no worse off than you currently are if you default on the loan. And if you happen to keep a good job and pay off the loan eventually, hey, great. It's other people's money anyway, right? And there's never been a better opportunity for these people (in terms of interest rates and the housing market) than there was two years ago. Is it any wonder? Can you really blame these people for taking out these mortgages? They took a risk, sure, but it really wasn't terribly risky for them. They weren't even going to lose their down payment, because they didn't make one.

Anyway, I'm just rambling now. My main point: Everybody has their share of the blame. Individual borrowers: to blame for their individual loans, taking out too much in loans, not reading or understanding the loan documents properly. But we're talking about millions of individuals here. On the corporate side, we're talking what, maybe a hundred (order of magnitude) companies all originating these loans? Shouldn't these companies with billions of dollars at their disposal have been more prudent than the unwashed, credit-less masses? (I do realize that I'm probably giving too much credit to these corporations.) Moving on upward through the chain, I have a pretty hard time blaming the government at this point, although the government will be to blame if it bails out any of these bankrupt companies or encourages any more of this kind of loan. On principle, I'll rarely argue for more regulation, and if the further regulation goes the way that Senator Clinton is proposing, it will just make things worse.

A Question and an Example

First off, the example: golbguru has documented the effect of credit utilization (what I usually call debt (or balance) to credit ratio) on his FICO score. To sum up, his score went from 771 to 737 when his credit utilization went from 2% to 23%. He did this as part of a credit card arbitrage plan.

This is the kind of thing I love to see. I am just one person with one FICO score. I have tracked my score for about 3 years now, and I have seen the effects of various financial decisions on it. But I necessarily have a limited set of experience there. Seeing how other people's FICO scores change in certain situations is more data that helps up to confirm our model of the FICO score and how to properly game it. If any other readers have similar experiences (with before-and-after FICO scores) to share, I would love to have you leave a comment about it!

Now, on to the question part. A reader wrote in recently with a question about student loans for an MBA student. I am doing some research for the full answer, which I will post here soon; part of this research involves getting info from others. Namely, have you (or somebody you know) ever been turned down for a student loan? What kinds of student loans, e.g. Stafford, Perkins, etc.? For what purpose were the loans, e.g. undergrad, grad school, med schoool, law school, business school?

When I went to college, I got Stafford and Perkins loans. My parents also got PLUS loans for my education, even though their credit was in pretty bad shape at the time. I was (and still am) under the impression that it is very difficult if not impossible to be turned down for these loans; I'm not sure if your FICO score ever even enters the equation. Student loans are heavily regulated and sometimes even backed by the federal government. Plus, they seem like a pretty safe loan. Education is a proven good investment, and after graduation, one's income is almost guaranteed to go up. Plus, student loans can't be wiped out by bankruptcy.

But, my knowledge is once again limited to my own experience. I have no idea what the loans are like for graduate school or professional school. So I am asking you to please leave a comment so I can find out more. If you have ever had student loans, I want to know about them.

Risk, Freedom, Security, and the Majority

Over at All Financial Matters, JLP has made a couple of heavily-commented posts about paying off a mortgage early vs. letting it run for its full term. (If you haven't read these posts along with all the comments, please do so! A lot of what I'm going to say relies on the context from those comments.) This is another thing that Dave Ramsey harps upon, and his followers also feel strongly about it.

I have been reading a book by Robert Kiyosaki (hear me out here) called Rich Dad's Prophecy. I borrowed it from the library, and I am not yet done with it (actually I'm only about a quarter of the way through it). I guess I will get more into Kiyosaki on a later entry, although I'll note now that I generally "drink the Kiyosaki Kool-Aid." I can't yet comment too much on this particular book, as I'm not too far into it and he seems to be making more claims than he generally does.

At the point in the book where I stopped last night, RK spends a lot of time talking about freedom vs. security. A lot of time. He can be very repetitive, although I can't really begrudge him that. Some ideas just need to be hammered away. Anyway, most of the discussion is couched in terms of retirement accounts and how most people are counting on their retirement to be secure (like the old-style defined-benefit pension plans) while they are actually nowadays more free and hence less secure (401(k)s etc. are usually invested in the stock market, leaving more choice to the individual holder, but the stock market has its inherent risks). If the supposed Social Security Reform ever goes through, this trend will just continue.

It is very clear that the majority of people will opt for security over freedom, both in the political arena and in the realm of finances. Most people are not risk-takers. They want their money invested safely. That is why they want to do things like pay off their mortgages early. And this is where I am slowly coming around to Dave Ramsey's point of view on certain things. The majority of people cannot be trusted (and cannot trust themselves) with absolute freedom. It is all too easy to ruin your life and run your finances into the ground. So many people do it all the time. So I can see why DR needs to be dogmatic about it and basically force people into having security by locking themselves into a 15-year mortgage, even though they lose the flexibility to do something else with that money.

But, there are people who have self-restraint, live well below their means, and save a lot of money without being forced to do so. I believe myself to be one of them... we'll see in 10 years where it's gotten me.

Follow-up to earlier posts

I got the following questions from sm in response to Part V of the Intro to Credit Gaming series, which covered credit inquiries and new credit:

Do you know a general rule of thumb for how long one should wait between applying for credit cards? How many credit applications is OK per year? Also, does pulling your own FICO score show up as a credit inquiry?

Sorry it took so long to reply -- somehow this comment slipped through the cracks (I wish that Blogger had a "new comment" notification!). As a rule of thumb, I typically don't apply for new credit within 6 months of receiving other new credit. However, this rule was made to be broken. I would try to wait 6 months between credit cards. However, mortgage and auto loans are handled differently.

MyFICO.com (please use that link if you want to use MyFICO to buy credit scores) has a fairly comprehensive page on credit inquiries. In particular,

For many people, one additional credit inquiry (voluntary and initiated by an application for credit) may not affect their FICO score at all. For others, one additional inquiry would take less than 5 points off their FICO score.

Inquiries can have a greater impact, however, if you have few accounts or a short credit history. Large numbers of inquiries also mean greater risk: People with six inquiries or more on their credit reports are eight times more likely to declare bankruptcy than people with no inquiries on their reports.

So for most people, inquiries will have an extremely minimal effect on your credit score. As long as you have a good credit history and lots of credit to begin with, inquiries will barely affect your score. If you are just starting out and have no history or established credit, your score will be affected more. This also answers another question: try not to have more than 4 or 5 inquiries in a year if at all possible. Inquiries stay on your report for 2 years, but they only affect your score for 1 year. This is why I recommend that young people starting out with their credit limit their credit card applications to one every 6 months. Of course, if you don't have a mortgage application or other big credit need coming up within the next 12 months, you can choose to go wild with the credit apps and everything will disappear from your score when those 12 months are up.

This connects to a discussion between golbguru and me in the comments of an entry at The Tao of Making Money, which I also wanted to touch on in this post. A little further down on the MyFICO.com page is this:

Looking for a mortgage or an auto loan may cause multiple lenders to request your credit report, even though youre only looking for one loan. To compensate for this, the score ignores all mortgage and auto inquiries made in the 30 days prior to scoring. So if you find a loan within 30 days, the inquiries won't affect your score while you're rate shopping. In addition, the score looks on your credit report for auto or mortgage inquiries older than 30 days. If it finds some, it counts all those inquiries that fall in a typical shopping period as just one inquiry when determining your score. For FICO scores calculated from older versions of the scoring formula, this shopping period is any 14 day span. For FICO scores calculated from the newest versions of the scoring formula, this shopping period is any 45 day span. Each lender chooses which version of the FICO scoring formula it wants the credit reporting agency to use to calculate your FICO score.

Ok, that's a big chunk of text. Let's look at exactly what it says, because although it's all connected, there are two main points here.

1) While you're shopping for an auto loan or mortgage: None of your recent (within 30 days) auto loan or mortgage inquiries will show impact your credit score. You can go to 4 different lenders, each a week apart, and your inquiry with the first lender will not affect the score that the 4th lender sees. This is plenty of time to find a mortgage or auto loan. Note that this only pertains to these particular kinds of loans. Recent credit-card inquiries will still show up and affect your score.

2) After you're done shopping for an auto loan or mortgage: All auto-loan or mortgage inquiries within a 14- or 45-day span (depending on what scoring method the lender uses) will be consolidated into 1 inquiry for the purpose of your credit score. So you could shop around at 20 different lenders for your mortgage, and have all of them pull your credit score with a "hard" inquiry, and it will show up as 1 inquiry on your score after you're done shopping. Obviously you should try to limit your shopping periods to 14 days, because you have no way of knowing which method any future lender will use.

And finally, to answer sm's last question, no, checking your own credit score does not result in a "hard" inquiry that will show up on your credit score.

And finally-finally, I wanted to clarify about the Washington Mutual credit card that I use to keep track of my credit score. It is not an annual free trial or anything like that. As long as I have the card, I will be able to log in to the site and check my credit score. I assume that this is actually a near-costless benefit for WaMu because, as a lender with which I have an open account, they are checking my credit score for their internal purposes on a regular basis anyway. All that they have to do is take that score (which they're already pulling) and put it up on the website. It is accessed through the account management website, as just another part of the site. There's the typical "View Statement", "Pay Bill", etc. and then there's the "Credit Profile" page. If anybody wants me to create a post with screenshots, etc. then I will be happy to.

Why I Disagree with Dave Ramsey

The other day, I was driving a lot and happened to catch a couple hours of Dave Ramsey's show. I think I've got a bit better read on him, and I know now that I disagree with him on a super-fundamental point.

Some chick called in from Houston talking about how she had been in a lot of credit card debt, but she pulled herself out of it and was now using them responsibly, turning the tables on the credit card companies by putting them to use instead of the other way around (as I advocate). Well, Dave Ramsey would have none of it. He gave the oft-cited statistic that people spend 15% more when they have a credit card than they do when they pay cash. He cited a study by McDonald's that said that people spend more with credit cards than with cash.

(Brief aside: I couldn't find anything specific about the way these studies were conducted, but really quickly I can come up with a way that they might be flawed: Cash is obviously limited. People who carry both cash and credit cards might try to pay with cash but be forced to pay with the credit card when the transaction size gets too large. Also, I think that many people (like myself) are reluctant to use the credit card when it's just a small transaction amount. So you have to turn the question around: what if, instead of credit cards "making" people have larger transactions, having larger transactions "makes" people use credit cards? This is an easy way to get the same result. As everybody learns in Statistics 101, Correlation Does Not Imply Causation. And even if it does, the direction of the causation is often up in the air. If anybody's got a link or further info on any of these studies, please let me know! There's got to be a journal article somewhere.)

Dave said that he had an "emotional attachment to cash" (and implied that everyone else in the world does too). He said something to the effect of "when you pull out old Uncle Benjamin and lay him down on the table to pay for a meal, you have a little heart-to-heart." This is absolutely false for me. I have never been too good at holding on to cash. To me, cash is meant to be spent. If I didn't want to spend it, it wouldn't be in my wallet, or even in the form of cash at all. It'd be in the bank. Some people talk about credit cards as a contrast to "money in the bank" (e.g., when distinguishing between credit and debit cards and why they prefer the latter). In my case, cash is "money already out of the bank."

When I lay down the credit card, I know that I'm still going to have to pay for it when the statement comes. Using a credit card obliges me to carry out a future action. This adds certain weight on the mind. Cash has no such consequence, and carries no such weight. In fact, when I use cash, I get the opposite emotional effect from what Dave describes. I feel carefree. Sometimes (if the amount is large) I even feel powerful. Spending cash gives me a high, even if it's just $5 at the sandwich shop. Spending on credit gives me the opposite effect. It is literally a burden, and it is felt as such. This is one thing that helps me keep from over-spending on my credit cards.