Monday, February 02, 2009

No Bail-out for the Prudent Investor

This morning I saw my friend, the bank manager, on the People Mover. He is my window to the front-lines of the credit crisis. As you may know, the banks with their government subsidies are simply writing off many, many loans. They are "forgiving" the debts of the people who borrowed money from them to invest in the real estate bubble. An interesting aspect of such debt forgiveness is that the borrower realizes taxable income on the debt forgiveness. Thus, my banker friend these days is taking calls from borrowers who cannot comprehend why the government should tax them on the forgiven debt.

These borrowers are the people who "flipped" real estate purchases, using borrowed money for their initial purchase and then being bought out by the subsequent speculator who himself borrowed money from a bank to purchase the subject property. At those flip sales, then, the seller walked away with cash, because his buyer was mostly if not completely financed by the next bank. The flip cycle for a given property typically would happen several times, and each time the seller would walk away with the cash provided by the bank in respect to debt that is now being forgiven as a result of government bank bail-outs. If this sounds like a sort of Ponzi scheme, then you are listening well. Except here no one gets indicted. The government picks up the tab.

But at least our speculators must pay taxes on the profit that they have made from their flip sales. I hope the tax enforcement is vigorous.

The banker contrasted all this with the story of a friend of his who bought a lot near Baptist Hospital with his own money. Then, with his own money again, he built a $600,000 house on the lot. The house did not sell and sits there shuttered. There is no government bail-out for him, the banker observed.

The banker also observed that there is no bail-out for the banker himself in respect of his retirement investments in the stock market. He will defer his retirement for several years, he said, because he believes that it will take at least 10 years for his stocks to get back where they were. None of his stock purchases were on borrowed money. (Prudently, he wasn't all invested in stocks.) No bail-out for him either.

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