The Surprising Borrowing Habits of the Rich

[f3lix]

From the Wall Street Journal:

"The Surprising Borrowing Habits of the Rich"

Most news about the "indebted consumer" focuses on the middle class. As the rich bask in record incomes, those in the anxious middle are borrowing heavily to bridge the gap between their incomes and rising costs of living.

Or so we're told. A closer look at the nation's personal borrowings shows that the rich are piling on debt faster than the middle class -- though for very different reasons.

According to the Federal Reserve Board's Surveys of Consumer Finance, the nation's richest 1% loaded up on $342 billion in new debt between 1998 and 2004, the latest year for which data are available. (The 1% represents households with net worths, including primary residence, of at least $6 million.) Economists say that debt number has probably continued to grow since 2004, because interest rates remain low by historical standards.

Disproportionate Shares

Just as the rich control a disproportionate share of national wealth, they also account for a disproportionate share of debt. The richest 1% now hold 7% of the nation's debt, with a total of $650 billion in borrowings, up from 5% in 1998.

Debt for this group grew faster than for any other group in the Fed survey. Total debt held by the top 1% increased 150% between 1998 and 2004, compared with growth of about 100% for those in the 50th-to-90th percentile wealth range. The rich, in short, have joined the great American borrowing binge. Call them the leveraged elite.

After buying up second (and third and fourth) homes and funding ever-more lavish lifestyles, today's risk-friendly rich are embracing debt as a way to expand fortunes and fund increasingly acquisitive lives.

There are, of course, some differences in how the rich use their borrowed funds. Unlike many lower-income Americans, who rely on credit cards and home-equity and other loans to meet living costs, the rich often use debt as a financial tool. Most of their debt is for mortgages on their primary or nonprimary residences, according to the Fed data. They may have plenty of cash to pay for that $20 million mansion, but they'd rather keep the money in higher-returning investments or businesses.

This "strategic debt" involves taking out a loan at, say 7%, and investing the money in the financial markets for a return of, say, 10%. Debt may be a necessity for the middle class, but the wealthy are "making a sophisticated economic decision," says Arthur Kennickell, an economist with the Federal Reserve.

And on the whole, their balance sheets remain healthy. According to the Fed, the debt held by the top 1% amounted to only 3.7% of their total wealth. That compares with 24% for Americans ranked in the 50%-to-90% groups.

Today's rich are more comfortable with risk. In a world awash in cash, many of today's wealthy made their fortunes by leveraging and making big bets with their businesses. They're applying the same principles to their personal wealth.

Eric Hadar, owner of a New York private real-estate investment firm, borrows from U.S. Trust for both his real-estate business and his personal finances. "Real estate is really about leverage," he says. "So I apply some of the same principles to my personal finances."

'There is a drive by the merely rich to keep up with the obscenely rich.'
Whether it's buying a house or other personal asset, Mr. Hadar first calculates whether a loan makes economic sense. "It's an arbitrage. I won't just go out and borrow money to buy a boat, because there's no economic justification for using debt for that," he says. "But if I can make more than my borrowing costs from a loan, I'll consider it."

For instance, he's thinking about buying a jet for business and personal use and says he may borrow up to 80% of the purchase price, since the jet saves him time and adds value to his business. He adds, "My litmus test is, if I can't pay it back in a worst-case scenario, I don't borrow."

Beyond Mortgages

With some measures showing prices for high-end goods outpacing the broader inflation rate, the wealthy are increasingly looking beyond mortgages to use debt for buying beachfront homes, yachts, cars and other collectibles. Private bankers say loans for jets are among the most popular.

In fact, some sociologists and economists say the rise in wealthy people's debt stems in large part from the growing pressure among the elite to keep up with richer peers. The biggest disparities in wealth today are among the rich, with mere millionaires getting shoved aside by decamillionaires, centimillionaires and billionaires.

So the haves are borrowing more to keep up with the have-mores. Those in the 95th percentile to 99th percentile of wealth have almost twice as much debt as the top 1%, as measured against assets. Economists and wealth managers say it's the single-digit millionaires who are becoming the most stretched, as they borrow to match the lifestyle of even-wealthier people.

The result, says Dalton Conley, a sociologist at New York University who studies status, is even more debt. "What we're seeing is the top 1% struggling to keep up with the top 1/10th of 1%," he adds. "And those people trying to keep up with the top 1/100th of 1%. There is a drive by the merely rich to keep up with the obscenely rich."

[Beebs]

Originally Posted by f3lix

From the Wall Street Journal:

The rich, in short, have joined the great American borrowing binge. Call them the leveraged elite.
...
After buying up second (and third and fourth) homes and funding ever-more lavish lifestyles, today's risk-friendly rich are embracing debt as a way to expand fortunes and fund increasingly acquisitive lives.
..
They may have plenty of cash to pay for that $20 million mansion, but they'd rather keep the money in higher-returning investments or businesses.
...
In a world awash in cash, many of today's wealthy made their fortunes by leveraging and making big bets with their businesses. They're applying the same principles to their personal wealth.
...
'There is a drive by the merely rich to keep up with the obscenely rich.'
...
the wealthy are increasingly looking beyond mortgages to use debt for buying beachfront homes, yachts, cars and other collectibles. Private bankers say loans for jets are among the most popular.
...
In fact, some sociologists and economists say the rise in wealthy people's debt stems in large part from the growing pressure among the elite to keep up with richer peers. The biggest disparities in wealth today are among the rich, with mere millionaires getting shoved aside by decamillionaires, centimillionaires and billionaires.
...
There is a drive by the merely rich to keep up with the obscenely rich."

Who was this written by, the communist party?

How dare these people be intelligent and use money in a productive way and enjoy the benefits of being smart? Disgusting.

[DJ FC]

Pretty Piss-poor article to be written in the Journal if you ask me, very imprecise and also written in an 'alarmist' type tone.

This "strategic debt" involves taking out a loan at, say 7%, and investing the money in the financial markets for a return of, say, 10%. Debt may be a necessity for the middle class, but the wealthy are "making a sophisticated economic decision," says Arthur Kennickell, an economist with the Federal Reserve.

...

Whether it's buying a house or other personal asset, Mr. Hadar first calculates whether a loan makes economic sense. "It's an arbitrage. I won't just go out and borrow money to buy a boat, because there's no economic justification for using debt for that," he says. "But if I can make more than my borrowing costs from a loan, I'll consider it."

It is most emphatically NOT arbitrage, you fucking morons. What happens when your investment goes bad, interest rates change, you get in a little financial funk? You lose everything, just because you wanted that 3% spread. The only possible arbitrage would be if you could borrow at a rate lower than the US Treasury can (hence borrowing cash and buying T-Bonds) and I'm sure as hell no banker is going to loan you money for less than the US Government.

No arbitrage exists in this market, and the people engaging in it in this way are upping their leverage perhaps quite dangerously for the amout of return.

But, as Beebs points out, leverage is important, and no self-made millionare ever became rich without putting his neck on the line and taking some debt, it's the way the world works. And if the rich do this in moderation, they can handle the swings in the markets and end up, on average, ahead 3%.

[Beebs]

Depends on usage, arbitrage in the way he ment it is just a difference in price, not a risk free situation. Yes I realize it isn't totally correct, but its used alot that way.

[DJ FC]

It's not even close to arbitrage.

It's borrowing to make an investment. It's anti-arbitrage... you can lose more than you started with.