I don’t understand a lot of things about Coronavirus and the disease it causes (COVID-19), but I understand a few. I can see that is spreads very quickly–and seemingly easily–and it does so because it is a new strain of a virus for which humans have no built-up immunity. I can also see the economic ramifications. They are so deep, in fact, that conservative members of the US legislature–the party for small government–is supporting the largest free money handout in US history. I’m not going to debate how socialist of a policy this is…I leave that to the socialists. Instead I focus on this part: the legislators want to borrow (using US government bonds) more than $1 trillion because they want to give the American people that money so they can buy food and, of course, pay their bills.
But this is something I don’t understand. Why are we still paying bills right now?
I understand that for utilities–water, gas, electricity, internet, etc–there is a cost involved in providing that service. Someone has to clean the water and pump it to your residence. Someone has to dig up the ground to get the gas and build the pipes to send it to your residence, etc…those are necessary costs at the moment.
But what about the biggest bill of all, the cost of your home? In America, there are a few main ways you can live:
- Free/subsidized housing
- Rental property, either through an owner/landlord or a management company/apartment building
- Ownership, generally through a home loan/mortgage
For the purpose of this post, I’ll focus on the second and third: renting and owning.
If you rent an apartment in an apartment building, for example, you pay monthly rent to the management company. But do you know where the money goes? It actually goes to a few places. It goes to pay the salaries of the management company employees, the upkeep of the building, the master insurance policies, the utilities for the common areas, etc. That number isn’t small, but I also don’t think it is the largest part of the pie. The larger piece of the pie, I think, goes towards loan payments from a bank that the management company used to fund the construction of the building. It also could go towards something called a Real Estate Investment Trust, a “company” that owns, operates, or finances income-producing properties (like apartment buildings). While I haven’t been able to find any information on the general breakdown of the overall income stream for apartment buildings, I can only imagine (from my experience as a financial advisor) that much of the income goes toward loan and REIT payments. The banks that helped fund the property sell those loans to investors, and those investors earn dividend payments each month, just like they do in REITs.
I wasn’t a financial advisor for very long, but I don’t know of anyone who was using income from a collateralized debt obligation (bank loans) or REITs to pay their bills. On the contrary, they were investments people had as part of a larger diversified investment strategy in a retirement plan or other nest egg.
In the end, that is a long way of saying that, to me, it seems like the majority of rental property payments are going toward investments and dividends paid to investors. If we can all agree that those payments are not needed at the moment, and investors in those investments say, “We understand there is a global crisis, so we’ll start collecting our dividends when this thing clears up, but don’t worry about it for now,” then there wouldn’t be a need to collect as much rent from renters. At that point, everyone’s cost of living would go down, and they would have more money for food and other necessities to keep themselves alive while this whole mess is going on.
The other form of rentals come from personally owned properties with landlords who rent their homes to other people. In most cases, these are used as investment properties because the owner lives somewhere else (probably owning the home they live in) and, in effect, has someone else paying the mortgage on the home they own but don’t live in. So what happens if that rental income stops? The owner would be forced to make the payments to the bank on their own…
And that brings us to how home owners are affected by this…
This is a simpler explanation that rental properties because the premise is the same but it involves less actors.
When you buy a home, you have a few options:
- Buy it cash and own it outright
- Veteran’s Affairs loan
- Federal Housing Administration loan
- Private financing (a mortgage through a commercial bank)
If you buy it outright, you don’t have a mortgage. If you buy it through the VA or FHA, your mortgage is “sold” to an organization called the Government National Mortgage Association (referred to as Ginnie Mae). For this purpose, we’ll focus on private financing through a commercial bank. When you do so, you agree to borrow a certain amount of money for a determined length of time and that you’ll pay a specific portion of that each month for the duration of the loan.
Then, as typically happens within your first month, you receive a letter from your bank saying something like, “We just wanted to let you know that we have sold your mortgage loan to the Federal National Mortgage Association,” (referred to as Fannie Mae). Fannie Mae, a company, then takes this loan and pools it with a bunch of other loans from what are supposed to be similar borrowers and creates an investment out of it. Fannie Mae then sells that investment on the stock market and investors can purchase it, receiving regular dividend payments, just like a REIT. At this point, your bank no longer “owns” the mortgage, because it sold the debt to Fannie Mae. Nevertheless, you still have to pay your mortgage payment because that was your agreement with the bank (yes, your agreement stipulated that your bank has the right to sell your loan).
So, we’re in the same place as we were with apartment rental income. The payments for mortgages go to investors in collatoralized debt obligations, and I think you would be hard-pressed to find someone who relied solely on these payments for their own livelihood. (Please let me know if you do…) If the investors, Fannie Mae, and the banks all got together and said, “Hey everyone, we know it sucks right now, so just pay us when you can,” and “Sorry, investors, there is a global pandemic going on, so you’re not going to get a few dividends for the next couple months,” then anyone with a mortgage wouldn’t have to choose between paying their home loan and buying food.
Then, we can extrapolate this to any sector of life. Businesses that can’t pay their office space, restaurants…really anything. It goes for credit card payments, too. All of those payments go to banks and other financiers. Let’s just forget about all of it until this passes.
Speaking of things I understand…
I understand that this is an over-simplified way of explaining the situation and my thoughts about it. I also understand that what I wrote could be (and possibly is) wrong.
Take this post for the underlying point I’m trying to make: this all sucks right now, and we all need to pitch in to make it easier on all of us. We can go back to our focus on stock market figures and mortgage rates and debt-to-income ratios after this is over. For now, let’s put our swords down and ensure people can survive.