Unless you’ve been living in a tent

Unless you’ve been on the street

Unless you’ve been secluding yourself voluntarily from the news this past week, you have probably heard about the current tent protests.  Students have taken to the streets in an effort to demonstrate to the government the urgent need for affordable housing.  While the macro-economist in me has a myriad of solutions to offer, the skeptic in me knows that the government will not do anything (after all, they caused the problem) and the responsibility to find affordable housing will ultimately fall onto the student.

This does not in any way excuse the government from its responsibility.  The government could and should offer affordable housing to students by building dorms, building public housing, or even recognizing more universities in Israel, increasing choice and allowing students to attend schools in cheaper areas.  In a true exercise of justice, the government could have the exporters subsidize student housing; after all, it was government practices in favor of exporters that caused the rise in housing prices in the first place.

But this post will not deal with what should be; rather it will deal with practical advice for students looking for affordable housing in the current economic environment.  Here goes:

#1 – Consider housing further away from the University.  There are many cheaper housing options that are a single bus ride from the University.  Consider a student from Tel Aviv University.  This student could look for housing in Tel Aviv, or could look for one next to the central bus station in Petah Tikvah – where a single bus can take the student straight to and from the University.  Similarly, a student at Hebrew U could look for housing in Efrat and a student at Ben Gurion could look for something in Omer.  There are obvious difficulties with living further away such as the time and cost of transportation, the impact on social etc, but a simple cost benefit analysis should be done to see if such a solution is feasible.

#2 – Get more roommates, even if it means getting a bigger place.  Like the last idea, you need to check the math before applying this one to your particular case, but in many instances, getting an additional roommate can save a lot of money.

#3 – Save money on food.  Do you buy food at the cafeteria?  Well, whether you save the money on rent or on lunch, it is the same ₪ 300 a month.  Consider packing a lunch for yourself.  Choose one night where and your friends cook the food you will eat for the next week (a bowl of chili and some pasta can go a long way).  And if you’re the type to use the snack machine at school, begin buying your snacks in bulk at the grocery store.  Why spend ₪ 10 for a candy bar when you can spend just ₪ 4?  Bring a water bottle around with you and fill it at one of the schools’ Tami4 machines instead of dishing out ₪ 6 for bottled water.  This money adds up in a big way.

#4 – Cut down on luxuries.  Do you go out drinking with your friends?  Do you go to restaurants on more than a weekly basis?  Try to find cheaper alternatives – buy a bottle of alcohol and drink with your friends in someone’s apartment or on the beach.  Eat lunch with your friends in the park instead of going to another fancy restaurant.  If you smoke, stop. And for God’s sake – make your own damn coffee.

#5 – Get a part time job.  Nothing will help you learn the true value of money and how to use it responsibly like having a part time job.

#6 – Don’t buy textbooks.  With few exceptions, you will never use them.  And when you do need them, you can usually borrow them from the library (or at least use it in the library and either do your work there or photocopy the few pages you need).

#7 – Live on a budget.  There is no solution that I can think of that does not hinge on the simple fact that a planned shekel goes further.  Budgets are not just for families; they are for anyone who needs to be in control of his or her finances.

The housing crisis is just one of many financial crises that students will face in their adult life.  In the real world, it doesn’t matter if someone can write a research paper; what matters is his or her ability to juggle responsibility, family, a social life, commuting, luxuries, and expenses.  During one’s college years, learning to live on a budget may actually the most important step he or she takes towards adulthood.

Speaking of adults, in my next post, I plant to deal with housing solutions for young couples and families. 

Students:  What do you think is the most feasible change you can make in your financial life in order to accommodate housing?

Welcome back.  It’s been a very long time since I’ve posted.  I hope to go back to posting once or twice a week, learning and discussing new financial and economic topics in Israel and all over the world.  So, without further ado…

Perhaps the biggest ongoing economic saga in Israel this year is the housing crisis.  The Israeli housing crisis, more than any other economic story this year, epitomizes the showdown between market forces and the practical needs of the people.  It echoes what governments all over the world (specifically America and Europe) have been telling us for the past four years: the market is broken (even if they broke it…) and an alternative solution is necessary in order to ensure a proper way of life.

The Israeli government has tried to address this problem, but to no avail.  Even with government stipulations demanding that affordable apartments be built and that committees find new solutions still, the overwhelming majority of Israelis cannot afford to buy an apartment.  This should be no shock to anyone who has taken economics 101. Building a couple of hundred affordable apartments will only make clear that there is a tremendous shortage, and government committees have a long and proven track record of solving nothing.

Let’s get down to the details: According to this article in Ha’aretz, any mortgage payment that equals more than 30% of a workers pay is considered too expensive.  Unfortunately, the article does not mention the length of the mortgages in question (you get more for a 30 year mortgage than a 10 year mortgage), nor the specific locations that are too expensive (hint: housing in the Galil is cheap!).  Most importantly, the article doesn’t answer the most obvious question:  If no one can afford a home, who’s buying them?  It seems like the restaurant about which Yogie Berra remarked “no one goes there anymore, it’s always too crowded.”

According to my observation (read: I don’t have the money nor time to do an academic study, but this is what I think is right), in addition to the regular market of buyers who can afford houses at the current prices, the Israeli housing market is receiving buyers from an additional three groups:

(1) People who put themselves in financial jeopardy to buy a home

Many Israelis spend 40% or more of their paychecks to pay the mortgage.  A number of Israelis home-buyers with whom I recently spoke used the same phrase “my wife works for the mortgage,” implying that all the money the wife brings home covers the a mortgage payment.  Of course, economically speaking, where the money comes from is not linked to the item on which it is spent.  If a father and mother both make money and one of them gives their child ₪ 30 for candy, the money doesn’t come from either the father or mother specifically, but from the income of the household.  So too here, the couple has established an arrangement where they will be spending an extraordinarily large percentage of their household income on their mortgage.  But less you think this is entirely crazy, most rentals are also much more than 30% of take home pay; these people are merely choosing Scylla over Charybdis. 

But the danger is immense.  If either spouse looses his or her job or has a financial surprise, the couple will immediately face a financial nightmare.  While those who rent can’t just pick up and leave the second they wish, they are much more free to adjust when the need arises.  And while rent may be high, renters do not have to bear the tremendous burden of home ownership (fixing things that break etc.) so a flat comparison between rent and a mortgage payment isn’t entirely accurate.  Unfortunately, these Israelis risk following in the footsteps of so many Americans, facing foreclosure and possibly financial ruin when the slightest gust of wind pushes them off track.

(2) People who live on windfalls

Have you ever wondered how so many Israelis who just get by suddenly have money for a new car or an exotic trip aboard?  The answer is that Israelis live on windfalls.  Not merely inheritance, but pitzyuim, keren hishtalmut, even dmei havra’ah are structured to make sure that Israelis receive money in windfalls and spend it as quickly as they can.  More recently, many Israelis are simply waiting for windfalls to pay off their mortgage or give them a cushion as they pay it off monthly.  While this method has its advantages, it should be stated clearly that more and more Israeli companies are cutting back on giving a keren hishtalmut and even paying legal benefits like dmei havra’ah.  So while spending a windfall is a great idea, relying on one can be downright dangerous.

(3) Investors

When the interest rate was low, investors saw real estate as a safe investment with a 4% – 5% rate of return.  So now that the interest rate is up again, investors are leaving the housing market and prices are beginning to fall.  Yes, you read correctly; housing prices are falling.  While only a year ago Moshe Gindi assured us that prices would never fall, he has gone back on his word, giving ₪ 150,000 – 235,000 discounts to Shufersal credit card holders who buy his properties.  In other words, Gindi realized that his properties fell ₪ 150,000 – 235,000 in value and is trying to find a round-about way to say he was wrong.

In the coming weeks, I plan to explore some short term alternatives for those of us who cannot wait several years for the possibility of the market to become realistic again. 

Are you looking for a home?  What has your experience been?

A couple of weeks ago that the media exaggerated some statements by the Ministry of Finance and the Bank of Israel to make it look like a full blown brawl was about to erupt.  In summary, the Bank of Israel raised interest rates and the Ministry of Finance wanted to make sure that foreign currency was still being bought on a regular basis.  No one even threw a chair.  So why all the hullabaloo?

Right now we are in the middle of a double edged crisis – on one side we have a housing bubble and on the other side a looming export crisis.  According to many economists, the Bank of Israel and the Ministry of Finance were disagreeing about which problem to tackle and which to ignore, assuming both are mutually exclusive.

Before passing judgment, it is worth taking a closer look at these two problems and how they impact our lives.

Let’s begin with the housing bubble, or as I call it, “The Jon Degani will never be able to afford an apartment crisis.”  Prices are rising for a couple of reasons:

(a) Investors – two types of people generally buy property, people looking for a home in which to live and investors.  When we have a bad market (and low interest rates abound), then investing in an apartment is a pretty good deal.  If an apartment costs ₪ 800,000 and it receives rent of ₪ 3,000 per month, then investing in an apartment is a solid investment with a return of 4.5%.  I know it doesn’t look like much, but it makes for a nice piece in the portfolio, especially when other investments perform so poorly.

(b)  Everyone else – when money is cheap to borrow, people tend to borrow more of it.  So when interest rates stay low, soon-to-be homeowners are able to borrow larger sums and pay more for housing, driving up prices.

(c) People leaving the periphery –As more people migrate toward the center of Israel, the demand for housing increases and the prices rise.

It would seem that the simple solution here would be to just raise the interest rate.  When the interest rate is higher, less money is borrowed, less money is put into the economy and inflation is curbed.  Also, with higher interest rates, investors will leave the real estate market and move toward government securities.  Unfortunately, not every solution is so simple.  Increasing the rate of interest would worsen our looming export crisis.

Our export crisis: 

Israel is an exporting country.  Correction, Israel is a country that imports a lot of goods, fixes them up and exports them for a profit (if you look at Israel’s major imports and exports in the CIA factbook, you’ll notice that our imports and exports are mostly the same).  In fact, over 40% of our economic activity comes from exporting (source) and if the shekel were to be too strong, exporters would loose a tremendous amount of money.  How so?

Let’s say that $1 = ₪4 and diamonds are $1 a kilo raw, $1.50 per kilo polished.  Israel imports one kilo for $1 worth of diamonds for ₪4, polishes them and resells them for $1.5 = ₪6.  This would earn Israel a ₪2 profit.

Now let’s say the shekel gets stronger and $1 is worth ₪3.  Israel imports one kilo worth of diamonds for $1 (₪3), polishes them and sells them for $1.50 = ₪4.50.  This would only earn Israel a profit of only ₪1.50

When the shekel gets stronger, imports and consumer prices drop causing customers to pay less and sellers to profit less.  Since Israel is the seller, Israel prefers for the cost to be higher so that it can profit more.

As the dollar plummets, Israel risks the shekel getting too strong, hurting not only exports, but all businesses tied to them (for example, the diamond polishers mentioned above).

So how can Israel solve this problem?

1 – Israel’s central bank can lower interest rates, driving down the value of the currency.  But of course, this would worsen the housing crisis so the Israel’s central bank chooses to…

2 –Buy dollars every day.  By buying dollars, Israel adds more to the supply of shekels, driving down the value of the shekel compared to the dollar.

“Hold on a second” you may ask.  “If we artificially inflate the exchange rate, then exporters profit at the expense of private citizens who have to pay higher prices for consumer goods.  Why should the producers be allowed to profit at the expense of the consumers?  If the prices have legitimately dropped, then let them get used to the new economic reality!”

Good question (thank you).  The truth is that if the dollar were to permanently fall, then the Bank of Israel would be stupid to try to maintain an artificial exchange rate; it would only end in another bubble bursting eventually.  But the Bank of Israel does not think the dollar will fall, at least not permanently.  The Bank of Israel is afraid of what will happen when the exchange rate, whatever it is, becomes too volatile.

Austrian Economist Eugen von Böhm-Bawerk explained this problem in his capital theory.  He explained that one of the problems with capital is its inability to be easily transferred.  This inability can spell disaster to a business in a volatile economic environment. 

Now in English:

Let’s say I decide to invest in building boats.  I invest thousands in machinery, raw materials, and manpower hoping to get a profit.  Now, after I spent millions trying to build boats, someone invents tiny hovercrafts that hover above water.  No one wants to get wet anymore and my boats become completely useless.  So I default on my loans, file for bankruptcy and end up penniless looking for a new business venture.  Maybe I’ll make tiny hovering plains.  But then the next year I find out that using small hovercrafts causes cancer.  The hovering system used a terrible chemical and the entire system becomes illegal.  Now boats are in high demand.  Unfortunately for me, I had to break all the ones I made into scrap to try to repay my debt.  Now I’m broke again.

Imagine that we decide to tell the exporters to go fly a kite and let the market work it out for them.  They become less profitable and investors move their money to other businesses such as pharmaceuticals where they can get a better return on investment.  The import / export companies fire thousands of workers and the pharmaceutical company begins hiring and training.  Now, a year later, the dollar gets stronger and investors move their money back.  The pharmaceutical companies have to fire thousands of workers and the import / export businesses begin rehiring and training.  Both firms wasted millions, if not billions, due to the turnover they suffered because of the fluctuation in the dollar.  In a few years, both of these industries will be considered too unstable and no one will want to invest in either of them.

And so, our government is doing what it can to try to make these businesses a bit more stable.  They cannot stop all fluctuation, but by using a couple of monetary tricks, they can help the import / export companies ride out the boom – bust – boom they expect to see in the American economy and the dollar.

So that’s our financial crisis in a nutshell.  In some of the coming posts I plan to discuss some of the repercussions of this crisis and how it affects our everyday lives.

What do you think?

PS – If you’re wondering, Eugen von Böhm-Bawerk is pronounced Oygen Bom Boverk

Haaretz has a fantastic article explaining the real issues behind the current housing crisis in Israel.  The piece, written by the CEO of Psagot Compass Investments, explains the rarely heard economic side of the issue

“Five years ago, in the summer of 2005, an investor bought an apartment for rental purposes: a small studio apartment in a new building but in an unattractive, congested area of south Tel Aviv. He paid NIS 430,000, using his own savings rather than taking a mortgage. At the time he could expect to rent it out for from NIS 2,400 to NIS 2,500 a month. Rental income of NIS 30,000 rent a year on an investment of NIS 430,000 translates into returns of about 6.5% a year. Israeli government fixed-income Shahar bonds would have yielded roughly the same return, in nominal terms.

Investing in property isn’t like investing in government bonds. Like every instrument of investment, it has both benefits and drawbacks. On the minus side are the headaches of being a landlord, the risk of getting stuck with a bad tenant and occasional expenses.

Unlike nominal bonds, however, rents and home prices tend to keep pace with inflation, and up to a certain threshold rental income is not taxable. Capital gains from bonds are taxed. In any event our man went for the property, not the bonds.

Five years later, where are we? The monthly rent rose to NIS 3,000 a month, representing an annual increase of around 4.5%, or between 20% and 25% over the five-year period. That wasn’t a meteoric pace, it was roughly the same as inflation.

But the purchase price is another story altogether. Similar apartments sell for NIS 800,000 today, meaning it rose by by 80% in five years, far outstripping the increase in rent.

In 2005 the return on investment was the same as nominal government bonds. Now the equation is NIS 800,000 (apartment value ) divided by NIS 36,000 a year (rental income ), which works out to 4.5% – the same as the return on Shahar bonds. In other words, that didn’t change in the five years.

That, dear reader, obeys the laws of economics and financing. When long-term interest rates drop, the price of income-generating properties rises. The longer the lifetime of the assets, the more their prices increase. Those are the laws of mathematics. Since property has a long lifetime, its price rises significantly when long-term interest rates drop.”

Some points of interest:

 1 – As one commenter pointed out, if this is true, then investors should buy properties when long term interest rates rise and sell when they are low.  The opposite would be true for private individuals buying a home in which to live.

2 – As long as the US keeps interest rates low and we match it (in order not to drive up the shekel and hurt exports), then the housing bubble will likely continue.

3 – Regulations aimed at keeping people from buying homes (more money down, stricter requirements, higher interest rates) will likely remove the buyers that are buying to live in the homes (and are paying via mortgage) but not those who investing (and often have the money up front via a mutually fund of some sort).  As a result, there will be a small dip in price, and then a rush for more investors to push into the market, probably inflating the bubble more before it bursts harder.

Do you think the government can do anything to fix the solution or just make it worse?