Have I been fooled about wealth distribution?

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Numbers can be pushed around all over the place. But it is vital to understand there is a vast difference between an asset that has been encumbered and one that has not. This is not well understood by a lot of people.

A house that has a mortgage on it is an example of an encumbered asset. Leases are encumbered assets. A futures contract is another example. Other examples include bonds, salary contracts and so on. Technically speaking, even certain forms of cash in the bank are encumbered. Think CD’s or savings accounts. Even demand deposits can be considered encumbered because they depend on the bank staying in business.

Examples of assets not encumbered would be a house that has been paid for (though it may still be encumbered by property taxes), precious metals, fine art and antiques, pretty much any hard asset that doesn’t have an IOU associated with it. Cash kept at home. Throw in corporate equity shares as well.

So … everyone knows there are enormous amounts of debts in our worldwide system, both public and private. Several years ago, I recall reading somewhere that some smart guys did a back of the napkin calculation of world wealth. They thought that world wealth amounted to approximately $200 trillion … of which about $150 trillion was debt. Remember debt is booked as an asset to the creditor and a liability to the borrower.

Finally, a slight aside: it’s interesting to read about this rich person or that who is worth $X billion dollars. But what is not as well understood is that is just the current paper valuation of that person’s net assets, nothing more and chances are very good he probably doesn’t have more than 5% to 10% of that amount in cash or in assets easily converted to cash. So saying Warren Buffet is worth $60b doesn’t mean that he has that kind of cash sitting around. Most of his wealth is tied up in Berkshire Hatheway stock.
 
No. I misunderstood him. That was my mistake.

He ran a circle around me so fast I might even look clever. I know I am only clever by accident. So I was able to see it after his last comment.
 
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Say I take a loan of 100k over 30 years and I will repay 200k. 100k is added to my balance minus 200k. That is according to the wiki. My net worth is negative 100k.

The bank counts the loan as an asset. Does it count as worth 0 at first and increase in value as I pay it off or do they just count it as worth 200k? If they count the whole thing then they add 200k to their net worth. That would happen immediately. In actuality it is only worth the full 200k in 30 years.

My net worth is negative 100k but only because I am deducting 30 years of payments all at once. So there is a huge disparity because I am adding 30 years of payments to the creditor’s current net worth and subtracting it from my current net worth. But it does not reflect the present distribution of wealth. It reflects the distribution in 30 years but without adjusting for inflation or market conditions that might change the value of the house.

I will have to look into the facts about how a loan is valued for the creditor to be sure of this.
 
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I think I understand by what encumbered means. What I want to know is how does it affect the appearance of disparity. I need to find out how creditor’s calculate their net worth.
 
The loan is an asset to the bank, it appears in the bank’s list of assets and the value of this asset is the current balance of the loan. As you pay down the loan, the principal portion of your payment goes to reduce the balance of the loan. Meaning that the dollar value will decrease over time until eventually the loan is completely paid off.

The loan is a liability to you. If you kept a list of assets and liabilities in your name, this loan would go on the liabilities side with dollar value being whatever the remaining balance is.

Your loan payments are not counted by the bank until they are actually received by the bank. There are two parts to your payment: the principal, which goes to reduce the loan balance; and the interest, which is your cost of borrowing the remaining balance for the next month.

The bank records the principal against your loan balance and the interest as income which is a separate line in their books. The interest income received is merged with the cash on hand from which the bank conducts its operations. This cash on hand is a separate asset on the bank’s books, totally separate from your loan.
 
Awesome, thank you. That saves me a lot of work.

So this might be an exercise because I have not looked up the model they use for determining wealth distribution yet. Yes, I know.

Determining net worth in regard to current wealth distribution would seem to be more accurate like this:

Equity in assets + cash. I would not include liabilities because that is a projection of expenditure. For a creditor I would not include loan assets because that is a projection of gains. Edit: I think the creditor has to include the value of the house as an asset minus what the debtor can claim as equity.

As for determining the rate at which wealth is being redistributed. The interest rate and fees is one way to determine the rate between creditor and debtor. All transactions can be assumed to be agreed to be more or less a fair trade. There are crooked deals but they are not the norm. People will spend money on an product or service only if they think it is a fair or better deal. All that is left is interest and fees. The lower the interest rate and fees, the slower the transference of wealth.

Since many transactions involve buying consumables and services, this type of wealth dissipates. Though it is still a fair trade because maintaining a certain standard of living is something we desire. Since these things are temporary, the wealth distribution favors the seller.

Edit I think equity is the wrong term to use. I am just getting confused about who to apply the value of a house to when it is under a mortgage.
 
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It can be said that on a long enough time frame, all material wealth will dissipate. Theologically.
 
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Eh, nevermind. I think that I have learned I don’t know what I am talking about.
 
You can get a car for less than $30,000 if you buy a very small car…not the big Suvs so many people like. It seems you could even get a used car but make sure it goes. Bring it to a mechanic before buying it.

I don’t know about a $4,000 house. Is there such an animal out there? If so, I may consider buying one as long as it doesn’t resemble a flavela in South America. There was a house in Gary, Indiana which was purchased for $35,000 (Still cheap these days.) The purchaser wanted to document this house because of demons. It turned into a nightmare and it was torn down.

In accounting you can make anything look good on paper.
 
Real estate prices reflect the economic stability of an area. So if an area is economically thriving, real estate prices are up, up, up. If an area has a very fragile economy, the real estate prices are down, down, down. We only ended up in our small, rural town because my husband and I got jobs in opposite directions, and it was kinda-sorta in the middle, giving him a 25-minute commute, and giving me a 45-minute commute. We bought a 3/2/2 for $40k. If we had gone the next town north, a similar 3/2/2 would have gone for $120k. If we had gone one town south, the same house would have sold for $75k.

So, areas like mine aren’t good areas to seek out just because they’re cheap— because their economies are unpredictable. A major employer can leave Los Angeles or New York or Miami or Dallas, and there will be loss to the local economy, but it probably won’t directly affect you unless you were employed by them. In a small town that only has two or three “big” employers, if one of them packs up and relocates— it will affect not just those who are directly employed, but every restaurant, dry cleaner, grocery store, gas station, yard guy, dog groomer, etc, in town who relies upon their spending to keep their own businesses afloat.
 
If you bought a car for $30k all with a loan, it should probably show you with a -5k net worth since the value of the car offsets most of the debt. Same with a house. As you pay off your debt over time, your net worth should go positive.

I would expect most people are close to zero net worth, when you take into account the value of the assets minus outstanding debt.
 
But, however, if you pay off the car loan as fast as humanly possible … and then keep the car for 20 years, then the net cost of the car is very low.

The “book value” of the old but very usable car doesn’t count for much … because there is no way of accounting for the “imputed value” of an old vehicle. The “books” are designed to provide guidance for tax purposes, and there are management accounting and tax accounting. But you can smile as you drive your paid-for vehicle for years of happy motoring.

Keep the car until the frame breaks.

[OR, buy a used car for cheap. And for cash.]

Great source of guidance and inspiration:
google youtube DaveRamsey

Even if you have a home loan or mortgage loan, pay it off as fast as humanly possible.
 
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A house is a place to live … it’s a roof over your head. A warm place to sleep in winter.

If someone gets a home loan or mortgage, then it’s not really his house; it belongs to the bank.

Google YouTube DaveRamsey

I have a friend who gets second mortgages because he insists on having new cars and he carries several car loans on his home mortgage.
 
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Buy a smallish house and pay it off fast. If possible choose a house on a LARGE plot of land. You don’t need to mow the grass all the time. But you could build on to the house. [Yeah, it depends on zoning and underground pipelines and easements and the airport approach lighting system and neighbors who hire in rock bands and the proximity of your local prison.]

He worries about the “metallurgy” of my car(s). We have only had the frame break a couple of times. [Three times?]
 
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Loans are assets to the banks. They buy and sell loans just like we can buy and sell other items. They can even sell just part of the loan, such as the servicing rights.

In cases of mortgages, the vast majority are backed or insured by the government sponsored entities like Fannie Mae and Freddie Mac or other programs like FHA, Rural Development or VA loans. Those mortgages feed the securities market which include all of our IRAs, 401ks, etc. So it is not just banks who are profiting from the loans.

There are other ways to make loans, and other investors to back the loans. Sometimes a bank has to repurchase the loan from the investor.

All this to say, you asked a very complicated question. How assets and liabilities are determined depends on a number of factors including who is asking the question. Is it the Bank? The IRS? The taxpayer? The homeowner?

Generally, speaking you don’t compare the assets of businesses to the assets of individuals. There are too many different variables. All businesses, eventually, are owned by individuals or the government (which arguably is own by us…)

So it would be better to compare the bank owner to the home owner.
 
Consider that if everyone was absolutely equal in wealth distribution, then in a few minutes a few would start to have more and some would start to have less.

There is a whole entire industry devoted to calculating how to add up wealth: the accounting profession. THOUSANDS or millions of people and that is all they do all day.
 
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And then there are those people who are interested in CREATING wealth … making more wealth for EVERYBODY.
 
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