Betting the Ranch
By Daniel Kadlec
People have always wanted to be rich. It's no crime. Wealth as a goal is even noble when pursued honestly and patiently. Yet in these marry-a-millionaire times, the pursuit of instant and effortless fortune is being hammered home like never before: state lotteries, legalized gambling, day trading, Internet IPOs and, you guessed it, high-stakes game shows on every network. The message is clear: Patience is for losers; grab your share now. If you can't get past the qualifying round of Who Wants to Be a Millionaire, take out a loan and spend anyway--as though you never even needed a lifeline. Trouble is, many of us do need a lifeline desperately. Consumers are up to their eyeballs in debt, and the strain shows. Personal bankruptcies, credit-card debt in default and installment loans more than 60 days past due are all at record highs.
Mostly, burgeoning consumer debt is about living well: funding a car or vacation. But in some cases--a fast-growing share, I'd wager--it's about people leveraging bets in the stock market in pursuit of their million. No one knows how much has been borrowed to play the market, but this has been a hot issue since margin debt at brokerage firms soared in recent months to $244 billion, equal to a record 1.4% of the market value of U.S. public companies. Most firms will lend investors as much as 50% of the value of their securities. The interest on such margin loans is fully deductible as long as you have an equal amount of investment income. The loans tend to be used to buy more stocks.
That has Fed chief Alan Greenspan mildly concerned. When stocks fall, margined portfolios fall faster. What should make him lose sleep, though, is knowing that home-equity loans--now shooting beyond $500 billion--account for an unknown level of further market speculation. When home values and stocks rise together, "the gains from each help finance the other," he noted last November. If it turns out that rising home values are being mortgaged to prop up stocks, a crack in the stock market could hit home values hard.
No one seems to know the extent to which Americans are betting their houses on the stock market. Economists contend that people are more likely taking cash out of stocks and buying houses. Yet it would hardly be surprising if the reverse were true. Home-equity rates are comparable to margin rates at about 9.5%. They're easy to tap and fully tax deductible regardless of investment income. That last point is big because hot stocks today don't throw off dividend income. You may be better off in the short run tapping your home-equity line than margining your brokerage account. And consider: if you have tapped a home-equity line for any reason, and you also own stocks in a taxable account, you've effectively leveraged your house to be in the market. (Ditto credit cards: carrying a balance while holding stocks is like charging your investment.)
I'm against leveraged investing for most people. The risks generally aren't appreciated. For a long shot at instant riches, call Regis. But if it's guaranteed long-term financial health you seek, save your home equity for an addition and pay off the plastic.
See time.com/personal for more on debt. E-mail Dan at [email protected] See him on CNNfn Tuesdays at 12:45 p.m. E.T.