Tuesday, September 29, 2009
Posted by Jeff Lipshaw
Somebody had ripped my gym's Time, the one with Glenn Beck on the cover, to shreds, so I was reduced to reading the October 2009 edition of Money or this month's edition of Club Management. I went with the Money, and read an article (pp. 25-27) that made me wonder what kind of financial planners and economists they are hiring over there. Also, since I've been giving financial advice in the blogosphere anyway, why stop now?
The article says that lending to relatives could be a sweet deal. Son can only get a 9% interest on a $100,000 home equity loan (for you finance rookies, that's one secured by a second mortgage on your house). Dad has some money just sitting there earning 1% or 2% in a money market account or savings account. So he lends $100,000 to Son at 6% and everybody is happy.
Wait a minute. Now, in fairness, the author lists several cautions, but misses the most important ones. I often criticize welfare economics consequentialism that goes to one extreme in assuming that every perception or value or duty held by an individual is ultimately a matter of utility (read some of the early Posner on rational actor sex and love), even if the measure is somewhat difficult. That is, in that view, people don't engage in charity out of altruism; they do it because they get some kind of material, psychic, or other benefit from it. This odd financial advice from Money (of all people!) goes to the other extreme, and fails to put ANY cost into the equation for the effect of love, harmony, conflict avoidance, divorce, mental anguish, public embarrassment, or the like when you lend a lot of money to a relative, and it's not getting paid back.
For example, nowhere does it discuss getting security for the loan. The bank was willing to lend at 9% AND TOSS SONNY OUT OF HIS HOUSE IF HE DIDN'T REPAY! Dad is lending at 6% on an unsecured basis? Or even if he takes a second mortgage, is he really going to foreclose and evict his grandkids? And we haven't done anything yet to put a cost on the tension you can cut with a ham carving knife (unless it's Honey Baked Spiral Sliced) at Christmas or the matzoh kugel ladle at Passover when Son and the spouse and kids went to Disneyworld the week before and said, "oh, we'll pay you at the end of the summer."
The point is that there are costs that are hard to measure, and so Dad's real cost here isn't $100,000 and his real return isn't 6%. It's something a lot more than $100,000, and that reduces his effective yield on the money substantially. It's NOT a sweet economic deal for Dad unless none of that peace, love, and family harmony stuff means anything to him. I say this as a child who borrowed from parents, and as a parent who stands prepared to help out his children: if you think of that loan as anything other than a contingent gift, you are smoking the drapes.
You know what? I don't think the truth about whether those intangible can be reduced to money lies at either extreme - it's probably somewhere in the middle. Aristotle* would be proud of me, I think.