All right, everybody, here it is. This is, in the words of an old professor, “Da Biggie!”
We’re all about to go broke! How’s it gonna happen, you say? Well, we start with an economy that’s not sufficiently diversified to absorb a slowdown in any one big money area, and then you watch a big money area collapse.
It’s here, and it’s called Housing. Here’s how the game was played. Head of Family, A, wants a house and is shown several by real estate agent B. The prices are humongous, observes A. B says to A, hey, this is where you make money! B shows A a property appraisal from C that shows that the house is well worth the huge price. B further adds that, with prices of homes climbing at, say, a ten percent rate each year, your $500,000 house will be worth a little over $600,000. in two years. Then you can sell it and use the 100,000 to get an even bigger house, if you want to, or just refinance the house, get a new mortgage, and use the $100,000 to buy a nice car and a boat. Not only that, but you can get the first house with no money down and an interest rate so low for the first two years that it’s cheaper than renting. And, if that’s not enough to knock your socks off, all of the mortgage payments you make are tax deductible because it’s what’s called an interest only mortgage.
A says, “Where do I sign?”
Now here’s some old Wall Street humor that’s been around for years.
I asked my broker what stock I should buy. Broker “The XYZ company at $1/share.” I bought 2,000 shares. The next day I called and asked him what looked good. Broker “The XYZ company - they are at $2/share.” I bought another 2,000 shares. The next day my broker called… told me XYZ was at $4/share and asked if I wanted another 2,000 shares. “No, I’ve made enough on this stock. Sell my 4,000 shares.” Broker “To who?”
Well, between outsourcing, downsizing, an aging population, higher prices for gas and for home heating, etc. there are just not enough people willing or able to keep buying those high-priced houses. The real estate game is grinding to a halt. So buyer A can’t get the $600,000 he had hoped for after the two years flew by. Then his mortgage adjusts to the new, higher rate, and suddenly A is in big trouble. People who were paying $3,500 a month are being told they now had to pay $5,000 a month. So A, if he has not already done so, is not going to buy a new SUV. And A’s family won’t be going to Disney World for a while.
The problem now spreads, because most of the SUVs that were being sold were being bought by people like A. So salesman D is now in trouble. And because so many houses are for sale and just not selling, there really is no need to build many more homes. So electricians, and plumbers, and most all the other folks that participate in the home building process are now making significantly less money.
And it spreads in another less obvious but just as important way. When A took out his mortgage, he promised to pay Mr. Banker specific amounts of money at specific points in time. Mr. Banker could sell that promise to Mr. Investor for cash. Mr. Investor looks forward to the income from the mortgage he bought, and Mr. Banker now has cash to lend out to more people who want to buy houses, or open businesses etc. But if people like A are having trouble paying their mortgages, then Mr. Investor isn’t as interested in buying those mortgages. After all, there are other things Mr. Investor can do with his money. This means that Mr. Banker hasn’t got as much money to lend out. It also means that he’s going to be more careful when it comes to deciding whom to lend it to. Now the entire economy has a problem because being able to borrow is a big part of what keeps the economy moving along.
Again, if the housing industry were only a small part of the economy, this wouldn’t be too much of a problem. But the housing industry is so big that the impact of these circumstances is going to be enormous. Our government has to take this problem very seriously. Because one possible result of this mess is that other governments won’t want to lend us money. Recently, a congressman observed in a news interview that the government was spending money like a drunken sailor. One reader wrote in that as a former drunken sailor, he resented the comparison! But it’s true that we don’t pay as we go. We depend on other governments to lend us money, and that gives them an advantage when negotiating with us. This can get too complicated to fit in a blog post. So let’s just go back to buyer A. Say he owes $500,000 on a house and he can’t make the payments. If he were to sell his house for $450,000 he would still owe Mr. Banker, or whoever is holding the mortgage $50,000. Same if the house sold through foreclosure. If A doesn’t have the $50,000, then he has to borrow it or face bankruptcy procedings. Either way, it’s likely to be some time before A will find a banker willing to give him another mortgage.
Now let us imagine that the above description of the housing industry is roughly accurate.
Then we are facing an economic problem so great that, in the normal course of affairs, it will not correct itself. Business will stagnate. The dollar will become worthless. Jobs will be lost, careers will be ruined. What is outrageous is that congress is doing absolutely nothing. It is not surprising. It is part of the endless cycle of campaign promises followed by post-election inaction. The only prompt reaction we see from either party is a pointing of fingers. However, we had better not let them ignore this problem, and that bombing Iran won’t really make us feel that much better.
-Author’s note: When I first wrote the above, I considered that the executive branch would in fact bomb Iran to some limited extent in response to the housing crisis. I am pleased to say that instead, the government is going to give every family enough money for a nice day at the local amusement park, followed by dinner out. This makes no sense either, but I’d rather see my children ride a roller coaster than read of yet another military fiasco.