The Way We View Debt

What do you mean by liquidity, and why is it so important?

Let’s say you have a $500,000 house and a $400,000 mortgage. I give you a $100,000 bonus and you use it to pay down your mortgage. You feel like you’re doing the right thing. You’re paying down your debt.
And then, bam, you lose your job. How much money do you have in the bank right now? Zero, because you just put it all in the house. Also, you have to keep making that mortgage payment. After a short period of time, you can end up going bankrupt — even though you did the right thing by paying down your debt.
If instead you put that $100,000 in a globally diversified portfolio, you could have kept making those debt payments, you could keep your house, you could look for a job. People don’t understand the flexibility that you have when you have money in the bank rather than rushing in to pay down debt. Especially debt that has a low cost of capital associated with it, like mortgage debt.

Via our pal Matt Levine, Bloomberg has an interview with Thomas Anderson, the author of a new book out called The Value of Debt. During the financial crisis, many households were overleveraged, which later resulted in a focus on de-leveraging and becoming debt-adverse (we got better at paying down our credit cards, for example, though that kind revolving debt is beginning to rise again). As you can see from his response above, Anderson argues that being too debt-averse is a mistake. He argues that it’s all about balance — pay off that high-interest, non tax-deductible debt first, but also hold on to some of your money in case you need it. Do what you need to do to remain secure, essentially.

Photo: Simon Gibbs

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