what does all of this really mean? From my perspective, what we’re seeing is a predictable outcome from the lending practices we saw starting in 2002 and 2003, whereby almost any U.S. consumer could get some kind of loan. We saw ‘exotic’ mortgages become all the rage, no-documentation loans where you just needed to “say” what you made and the bank believed you (also known as liar loans for obvious reasons). As consumers typically do, they bought things based on the monthly payment – not based on whether they could actually afford what they were buying. The lenders figured out creative ways to try and reduce the monthly payment as much as possible. Usually, this was accomplished by giving the borrower a low rate at the front end of the loan .. which would then later ratchet up significantly after a couple of years or so. If you look at almost ANY consumer-directed marketing, you’ll see that when the product or service being marketed is a bigger-ticket item, they almost always advertised based on “how much down, how much per month” rather than how much it will actually cost you. For example, the car manufacturers figured out years ago that what a consumer shops for isn’t the best price on the car, but on the lowest monthly payment, and the least amount out of their pocket up front. This is what caused leasing to become so popular. I recently decided it was time to replace my beloved Yukon Denali with a new vehicle, and looked around at my options with my in-house automotive expert, Kourosh (if you ever want to know anything about a vehicle, ask Kourosh). I decided that I wanted to get an SUV, since I’ve driven them for years and can’t see myself in a sedan. Add that to the fact that my wife Raylene and I are hoping to start a family over the next year or two .. and don’t forget we have 2 pooches to haul around .. and an SUV made the most sense for me. I found myself at the Land Rover dealership, looking at the Range Rover Sport Turbo. It fit all the criteria, is a beautiful vehicle, and all that was left was the negotiation with the sales guy. Since I was paying cash for the vehicle, I used that to my advantage in the negotiations, and came to what I thought was a pretty good deal. While I was waiting for the sales guy to write up the agreement, I heard someone calling my name across the lobby, and it turned out to be a young guy who had taken some of my programs. We chatted a bit, and then attention turned to what we were each looking to buy. Now, this guy is a pretty sharp young entrepreneur, but even when I first met him, I could see him getting caught in all the trappings of living the “entrepreneur’s life” — from what he thought it’s supposed to look like – fancy cars, cool clothes and all that. When I first met him, he was looking to raise investor capital for his fledging start-up business. What did he need the money for? Part of it was to pay himself back his own money invested in the company. In other words, he wanted someone else to invest in the company so he didn’t have to have his own invested. I told him at the time that was a bad reason to try and borrow money from an investor, and that would be a tough uphill battle. In any case, here we were, looking at luxury vehicles, and he’s trying to decide which model to get. I asked him what he was looking at, and he said “well I love the turbo, but I just can’t afford the payments. I told the guy I’d take whatever he could get for less than $800 per month.” I confirmed that in fact he was leasing the vehicle, and I asked whether that was for tax reasons — he said no, that it just made more sense because then he could afford a Range Rover. He couldn’t afford to actually buy one, but leasing would make it possible. Hmm. Well, that was one thing he said that was true – he couldn’t afford to buy one. And he really shouldn’t be there thinking about it. The problem is, leasing made him ‘feel’ like he could afford it, because it brought the payments down. The reality is, leasing is just renting a vehicle with a marketing spin on it. It’s a financing product designed by the financial industry to let consumers think they own a vehicle, when in reality they’re just borrowing it, and paying for use of it. Except for certain circumstances when leasing can make sense from a tax perspective (and in most cases, it doesn’t make sense), you are almost always better buying a vehicle outright — and then getting a vehicle loan to pay for it if need be. Why? Well for one thing, the leasing companies do their math in a way that makes you feel good about it. “You only pay for the part of the vehicle you use” is something they often say — which isn’t true because of the way they do their financing calculations. (one day, if I get inspired to do so, I’ll provide a detailed analysis of leasing calculations and why they’re NOT what they appear to be..) Not to mention the fact that the vehicle this guy was looking to buy far exceeded the maximum vehicle cost you’re allowed to write off in Canada — which means that he wouldn’t really get much tax benefit from leasing in this case. The bottom line — leasing is a good concept when applied to things like equiipment and fixtures for your business, or possible business vehicles like cargo vans and such, but in most cases, leasing doesn’t make sense for vehicles you plan to drive personally. The furniture stores have followed suit, offering “don’t pay for 17 years” marketing programs designed to get consumers to commit today, and worry about paying tomorrow. This strategy is also used creative real estate, in marketing lease-option and “wrap” homes for sale. What decision does someone make when looking to buy a house? How much down, how much per month. So the investor uses that thinking, and creates real estate deals that offer buyers the terms they can afford. In many cases, the buyer doesn’t even ASK what the total cost is, because they’re so focused on “how much down, how much per month”. So what does all of this have to do with what’s happening in the credit and financial markets in the U.S.? The fact is, U.S. lenders were far too flexible in lending money to people that simply didn’t deserve to borrow it. They went out of their way to provide loans, in many cases misleading consumers who didn’t know any better. Fortunately, Canada’s lenders are much more conservative than those in the U.S., which means we won’t see anywhere near the impact here in Canada like we will to the south. However, our financial industry will feel some draft from all the doors closing down in the U.S., and the thought that interest rates would go up in September is now gone. I now suggest that the Bank of Canada will not raise interest rates in September, as I suspected they would before. They’re going to wait to see what happens in the U.S., and if the Fed drops their rates (as they’re widely expected to) you can expect Canada to hold rates firm, or possibly even introduce a cut later this year. Our dollar is weathering the storm very well, still fluctuating in and around 95 cents U.S. If the Fed cuts rates and the U.S. sees more of a downturn, you’ll see the Canadian dollar continue to remain strong, and possibly even rise throughout the rest of the year. There’s no doubt, lenders in Canada will scrutinize deals more carefully as a result of all the mess in the U.S., but lending won’t stop. Our economy continues to be very strong, and I believe that the current credit fiasco will be primarily contained to the U.S. markets. I also believe that the stock market is just starting to see a period of major volatility. The growl of the bear can be heard in the distance, and I think we’re about to see him charge into the stock market as summer ends, and fear sets into the markets. The stock I bought a few days ago is already sold, with a 20% profit made. I’m certainly no day trader, but I recognize a good opportunity when I see one, and like to make a few thousand dollars in a few days when I can. The profits will come in handy when I stop to fill up my new Range Rover with gas this weekend! I’m back to holding one single stock in my portfolio, my Berkshire Hathaway stock. Aside from it being one way of paying tribute to my investing hero Warren Buffett, it’s actually been a very strong performer. And if the markets incur the storms I expect to see over the next several weeks and months, I bet it will continue to be a solid performer. So stay tuned to the markets at large, because I don’t think we’ve seen the worst of this credit debacle!]]>