The Wall Street Journal ought to know better than to write a big article about why “There Has Never Been A Better Time For Disciplined Investors to Take on Debt to Boost Their Portfolios.”
Yeah, it really said that. Semi-sheepishly, I might add.
The piece is riddled with caveats, which makes it better than those personal-finance pieces extolling the glories of cheap mortgage debt during the bubble. But somehow it makes it worse, since you know the Journal knows deep down that what it’s recommending is probably not a good idea at all. But it sure does make for eye-catching, contrarian copy!
And yet—and yet!—the cold clarity of financial analysis points to an inescapable conclusion: There has never been a better time for people to borrow money, whether to buy financial assets or boost cash reserves.
For sophisticated, disciplined investors who have lived and invested within their means—and perhaps decried the bailouts being lavished on those who haven’t—this is your time to take advantage. Not only are interest rates just about as low as they can get, but future inflation could erode the paper value of loans, making debt even cheaper over the long run.
Problem is, there are very few “sophisticated, disciplined investors”—even among Wall Street Journal readers, but many who think, incorrectly, that everybody else is dumb, but they themselves aren’t. And a little bit of knowledge can be a dangerous thing.
A good bit of the basis for the WSJ’s argument is that rates are so low that there’s basically free money out there, since future inflation will “likely” match most of that, and any positive return at all will be gravy. But, of course, deflation is a threat right now, as the paper acknowledges, which leads to this on-the-one-hand/on-the-other hand stuff:
It isn’t an easy concept to embrace. While the inflation scenario seems likely over the long term, there is a small but growing chance that the global economy could suffer from the opposite problem, deflation. Japan could be the template for the kinds of problems facing the U.S. and other advanced economies: years of tepid growth and falling asset values and prices.
That would make new debt more expensive over time, not less so. It would also mean that the job market is headed for a longer slump than even the direst estimates now suggest.
Then again, the moments that seem the bleakest often turn out to be inflection points.
Right. That last sentence is the classic contrarian-investor advice, and it’s not wrong. You know, you can’t buy low if everybody else is trying to buy low, nor can you sell high.
But leverage is different because it magnifies volatility and risk. Sometimes investors want more volatility. But now? Borrowing to goose returns is not the same as buying BP at half off.
As for deflation, interest rates aren’t this low by accident. They’re low because investors have nowhere else to go, but also because they don’t expect serious inflation or are worried about falling prices. Here’s The Wall Street Journal itself, from a report on Friday warning about deflation:
In one sign of rising alertness to the threat, yields on 10-year Treasury bonds—which fall when inflation worries recede and rise when inflation worries increase—have dropped from nearly 4% in early April to about 3.3%.
If deflation does indeed take hold (not unlikely), you have a nightmare scenario for your “Leverage, Baby!” enthusiasts: The money you’ve borrowed becomes more expensive to pay off while your investment is more likely to have tanked. Have fun meeting that margin call.
Again, the paper has plenty of “to be sures,” which is better than ignoring them, though it’s also a sign that you probably shouldn’t be writing the story in the first place. It’s too clever by half.
Wealthier investors who already have built up considerable equity in their homes might even consider—gasp—a cash-out refinance. Yes, this sort of behavior is what got so many people in trouble during the housing bubble. And, yes, leveraging a home to the hilt can be dangerous because if home prices continue to slide, you could owe more on the house than it is worth.
But people who have a potentially profitable use for that money—preferably an investment—could come out ahead using this strategy.
Yes, I’ve got a “potentially profitable” tip down at the dog tracks. I “could come out ahead” by borrowing money to double down. Or I could get a metal bat to the kneecaps.
Anyone likely to be able to use leverage half-wisely (and as we’ve seen in the last few years, that’s almost nobody) doesn’t need Wall Street Journal reporters to tell them now is a good time to borrow cheaply to goose returns. The audience here is people who don’t know what they’re doing.
Then there’s this gem:
Most important, “there’s nothing inherently wrong with leverage,” or borrowed money, says Christopher Jones, a New York financial planner working with high-net-worth clients. For people with the capacity to take on debt, who understand it and can tolerate the risk, “now is an ideal time to leverage cheap dollars to buy into areas that can produce much higher returns over the longer term,” he says.
Spoken like a true High Bubble snake-oil salesman. The inherently bad thing about leverage is that it reduces the investor’s (or company’s) ability to withstand a downturn.
And the same guy says this is in the following graph:
Mr. Jones is advising clients who can afford to pay cash for a home to take out a mortgage instead and invest the funds in a diversified portfolio. “If you look at where the market is now and where it could be five to 10 years from now, the return potential is significant,” he says. Ideally, investors would want to borrow at rates below 5% and invest the money in a well-diversified portfolio aiming to return 8% a year over 10 to 15 years.
Shoot me now. The market “could be” down 50 percent five to ten years from now. Ask the Japanese.
But forget all the particulars and step out of the weeds. The bigger point: What is a financial newspaper doing promoting loading up on debt in the middle of a debt crisis?
Wouldn’t the smarter, more responsible story be about how market conditions (and market advisors like Jones) are lining up to tempt investors into the same old traps that crashed the financial system two short years ago?Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at email@example.com. Follow him on Twitter at @ryanchittum.