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A question of wealth...
blaisepascal
I've a question about how you define wealth.

Take Joe Hypothetical: He is well-paid, drawing a monthly salary of $1M. He has several very nice rented apartments in Manhattan, Tokyo, Westminster, etc, and also rents garage space for his fleet of leased supercars. He regularly eats out at 5-star restaurants, and regularly flys first-class around the world. His average bank balance of $100K just about matches his outstanding student loans, which is just about his only debt. His monthly expenses for all this is also about $1M. He doesn't own much other than his clothes and the personal items in his apartments (electronics/media devices, etc. Nothing of large resale value). His net worth is just about $0, but he has huge cash-flows and lives the high-life. He does not worry about money.

Is Joe Hypothetical wealthy?

Or take the minor aristocrat Lord Entail, who own vast tracts of familial land -- which means that, although he owns it and has full use of it, for practical purposes he can't sell it. The estimated market value of the land is in the $100M range, but he can't capitalize on it. It's currently forest, and by the terms of the deed it can't be clear-cut or logged, which means he effectively can't lease it to the developers who would build on it. His other incomes have deteriorated and his expenses are growing (including maintenance on the land he can't get rid of), and he is dealing with more bankers than he is comfortable with. His estimated net worth is $100M, but it's all illiquid. His cash-flows are small, and he lives a modest life. He worries about money every time the bills come in. Is he wealthy?

Sally Heiress owns outright a large apartment overlooking Central Park, as well as several mansions around the US. She has investments totaling over $1B in value, and growing regularly. Despite this, she has chosen to live in a Florida retirement community under an assumed name, living off her $2000/month social security check. None of her friends know about her enormous net worth. She hasn't opened a financial statement from her accountants in years. She worries about stretching her SSI payment to the end of the month. Is she wealthy?

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All I can tell you...

...is that Sally is an idiot.

Re: All I can tell you...

I recently heard a podcast about a (recently deceased) heiress who had lived out of public view since the 1920's and checked herself into a nursing home 20 years ago under an assumed name. The level of wealth, the apartments and mansions, etc are similar to Sally Heiress's. The example wasn't pulled completely out of my ass.

Re: All I can tell you...

I did not mean to imply that your scenario was half-baked. I can honestly imagine an heiress doing something like that... and I consider that person to be an idiot.

Now, I don't know the heiress' motivation for going into a nursing home under an assumed name, but think of all that wealth just churning in on itself. Walking away from it all seems to me to be incredibly self-serving. Why not liquidate everything and give it all to charity? Why not create your own charity?

I guess I just don't understand all the permutations of humanity... which is good, otherwise life would be incredibly dull.

Re: All I can tell you...

One question unanswered in the podcast was: what happened to her estate? She lived a recluse since her divorce in the 1920's, she has no family, no children, no close relatives. Who did she will it to? If (as is possible, in this case) she died intestate, who gets it then?

Re: All I can tell you...

If you die and have no family, spouse, or will, then it all goes to the state and *poof*

Is Joe Hypothetical wealthy?

Yes.

Is Lord Entail Wealthy?

Lord Entail is confused. That the land has been in his family since William the Conquerer doesn't mean he can't sell it. It just that he doesn't want to. So what? I didn't want to come to work yesterday.

Lord Entail will eventually have to find a way to make enough money off the land to cover his expenses (perhaps by selling hiking permits, or renting space for nature retreats,) or he'll have to realize part of that $100M by selling it to someone who can. That's how capitalism creates wealth.

Lord Entail makes an interesting comparison to Joe Hypothetical. Joe has taken his $12M/yr. and purchased nonappreciating assets (i.e. rented goods and consumable luxuries,) while Lord Entail has essentially taken his $100M and purchased a depreciating asset, i.e. land that requires maintenance. Joe's wealth will remain constant (if he doesn't get fired) and Lord E's wealth wil decrease.

Is Sally Heiress Wealthy?

Yes. Believing you have to survive on your social security check doesn't make it true, any more than believing you are a penguin makes it a good idea to move to the South Pole.

Would it make a difference if Lord Entail's deed was truely in fee tail? Let's also assume that the current laws and procedures to convert fee tail to fee simple did not exist, so Lord Entail was legally barred from selling the land and severely restricted in the sort of leases he can make or mortgages he can get.

Making those assumptions violates your previous assumption that the estate has a market value of $100 million. Something only has a market value if it can be brought to market.

The question you seem to want to be asking is "Is someone rich is all they have are highly illiquid assets?" I.e., if you find a brick of cocaine the size of a cinderblock, are you rich or not? The street value of that much fine Peruvian flake is immense, but converting it into cash requires setting yourself up as a some kind of local drug kingpin. Learning how to do that includes a non-zero chance of getting shot in the face, which is a darn high barrier to entry.

The answer to the question of how much these assets are worth is that it depends on how difficult it is to convert them into cash, and how much of a hurry you are to get rid of them. You seem to be hep to the economics jive; you've probably seen the formulas.

Let's look at real-life equivalents to Lord Entail: the folks who bought investment properties at the height of the boom. They can't sell them, not without taking a big loss. People who buy houses seem to have a big psychological block against selling for less than they paid. This isn't the same as being legally prevented from selling, but it's still a barrier. And they paid enough for those houses that they can't cover the mortgages by renting them out. (There's the equivalent for "maintenance on the land they can't get rid of.")

So what do they do? Some struggle to make payments until they get forclosed on. Others go for jingle mail. They default, the keys go back to the bank, and someone writes a snippy editorial in the WSJ about irresponsible borrowers.

Are these people rich? Nope.

Joe Hypothetical is what I have heard called "broke at any level of income" or "big hat, no cattle". His expenses equal his income. He lives paycheck to paycheck. He looks wealthy but he is broke. On the other hand all he has to do to stop being broke is stop spending so much on things he doesn't need.

Lord Entail is "land rich and cash poor". That is harder. As others have mentioned there are ways to develop a property other than clear-cutting or logging. Living modestly is not living wealthily but it's better than nothing. There is a difference between being wealthy and spending a lot of money.

Sally Heiress is wealthy by any standard. Just because she doesn't spend her money doesn't mean she doesn't have it.

My opinions have been influenced by Get rich slowly and The Millionaire Next Door: The Surprising Secrets of American's Wealthy

Depends where you live

Whether they are wealthy or not depends on where in the world you live and the culture there. In the US, an entity (company, person, whatever) is seen by assets, profit, and also revenues---

Based on that capitalist view of the world, Joe is not wealthy, but has the potential to be quite wealthy when his loans are paid off or if and when he cuts back on his spending to save $$. I think Joe's situation mirrors what most Americans do with their money---whether they make 20k a year or 100k a year - spend to the limit and act wealthy.

Lord Entail is wealthy from the standpoint of assets - and he could sell the land or take legal action to change it's status---but again, he has the potential to be wealthy, but no actual liquid wealth, which for most companies would mean bankruptcy. There's also the option of just selling, donating, or giving away the land to rid himself of the expense. He's a fool to sit on growing expenses without taking some action.

Sally is most certainly wealthy, but chooses willingly to lead a far less wealthy life. Public view doesn't change facts, and if she enjoys living the quiet life, then all the power to her.

Again, these assessments are based on our capitalist culture here in the US...in other countries around the world, wealth would be seen differently, though more and more the world view of wealth is coming more in line with capitalism and less with traditional culture.

Two of the three live in worry and want. I guess the answer to your question depends whether the definition of "wealthy" includes financial security and freedom from worry and want. Sally Heiress worries about stretching her ssi, Lord Entail worries about keeping his heritage intact and meeting his familial obligations. Their wealth is theoretical; in your scenario there are substantial legal and/or psychological barriers to their assets that they are unable to overcome. I don’t think they can be considered wealthy. Joe Hypothetical could be considered wealthy since he does not worry about money and lacks for nothing but only as long as he can generate an income. If security is part of wealthy then Joe isn’t wealthy either.

Edited at 2011-07-12 06:59 pm (UTC)

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