Dream Homes and Mortgage-Debt Nightmares

by Eric Englund

On September 13, 2006, the Senate Committee on Banking, Housing, and Urban Affairs invited a panel of experts to testify on the topic of "The Housing Bubble and Its Implications for the Economy." With the housing market dramatically slowing down, there is angst amongst the plutocrats in Washington D.C. that a nightmare scenario will unfold in which millions of over-leveraged homeowners struggle to avoid foreclosure; with many eventually losing the battle. Accordingly, the bursting of the housing bubble may cause a financial calamity that will make the S&L crisis, of the early 1990s, pale in comparison. Not surprisingly, as the Washington Post reported, the aforementioned experts have concluded that the housing "…sector is just returning to normal and is not poised to crash…" Nothing could be further from the truth.

In reading over the testimony, prepared by each expert, it is clear that there is concern that some regions of the U.S. have experienced unsustainable real estate price escalations. As a result, there is a danger that homebuyers in such regions may have overpaid for houses and condos. Should a significant pullback occur, in these once-hot housing markets, homeowners will suffer the consequences of owing more money than their houses are worth (i.e. being upside down).

To compound this problem, mortgage lending has been reckless, with homebuyers commonly purchasing homes using exotic mortgages such as adjustable rate mortgages (ARM), interest only mortgages, and option ARMs. With over $3 trillion in ARMs set to adjust in the next 12 months, there is a degree of nervousness amongst these experts as to how well homeowners will weather the storm of higher monthly mortgage payments. The consensus, nonetheless, is that the slowdown in the housing market will not stop the juggernaut that is the United States’ economy – even if a higher rate of mortgage defaults materializes. Such a conclusion demonstrates that dream-interpretation is a key component of today’s mainstream economic analysis.

A glaring problem, with this expert-testimony, pertains to a complete lack of understanding as to how the housing boom emerged in the first place. A healthy boom must be engendered by an accumulation of savings. Considering that there is a negative savings rate in the U.S., America’s housing boom has been driven by easy credit as engineered by the Federal Reserve’s monetary central planning – this is why the housing boom is more properly deemed a bubble. And, of course, a credit-induced boom invariably leads to a bust. For true enlightenment, I would suggest that these panelists read The Austrian Theory of the Trade Cycle.

It is also interesting that the panelists focused on the matter of house-price appreciation and how certain states saw more of this phenomenon than others. Hence, it is commonly asserted that all housing booms are strictly "local." Panelists, predictably, expressed worries about the "overheated" housing markets in Arizona, California, Florida, Maryland, Nevada, and Virginia. Real estate speculators, indeed, did enter these markets looking to "flip" houses and condos in order to make a quick buck. This denotes, sure enough, that lenders were shoveling money out the door to all comers looking for a mortgage loan – be it speculators, permanent residents, or buyers of second homes.

It is ultra-easy credit that has driven home prices, in many locales, to stratospheric levels. And the national media reported breathlessly, ad nauseum, as to how so many people have made a financial killing in the housing market. Even if frothy housing markets were local, real estate captured imaginations from coast to coast. Accordingly, a "bubble-mentality" emerged, on a national scale, in which Americans sought to cash in on housing – one way or another. Using this perspective, and considering that mortgage lending standards dropped to near zero countrywide, I would argue that the housing bubble truly became a national phenomenon.

So how did Americans, not living in a rapidly-appreciating housing market, cash in on the craze? First of all, regardless of where one lived, the common mantra was "you’d better buy a home today before they become too expensive." Additionally, the talking heads on CNBC, and elsewhere, were cackling such nonsense as "housing is a can’t-miss investment for the long-run." Is it any wonder that homeownership hit a record in the United States? To be sure, this record homeownership is a manifestation of the housing-bubble mentality. Secondly, with the assistance of banks and other lending institutions, Americans became conditioned to believe that houses were really ATMs standing at the ready to disburse funds on command. Thus, nationwide, Americans have borrowed against home equity to pay for new cars, boats, flat-screen TVs, vacations, home remodels, you name it. Houses are not only homes, but appeared to be self-filling piggy banks.

Using these two points, I disagree with the assertion that all housing bubbles are strictly local. Most assuredly, there are cities in Florida and California where house-price appreciation was surreal. Where this assertion falls apart is that the housing boom was driven by easy credit and not accumulated savings – and easy credit has been available in all 50 states. Even if real estate speculators weren’t heading to Butte, MT or Detroit, MI looking to flip houses and condos, mortgage loans were still incredibly easy to come by for even the most unqualified of borrowers. Therefore, a low-wage first-time homeowner in Detroit (with a 0%-down adjustable rate mortgage) can incur a financially ruinous level of mortgage debt just as easily as a high-wage professional in Tampa can do so by going overboard when extravagantly remodeling a home – 100% funded by an adjustable rate home equity line of credit (HELOC).

Both Michigan and Florida, as a matter of fact, are in the top-ten list of states with the highest foreclosure rates in the United States. Interestingly enough, Florida ranked 2^nd in the U.S. for house-price appreciation while Michigan ranked 51^st – this information was compiled, for the one-year period ending June 30, 2006, by the Office of Federal Housing Enterprise Oversight and includes the District of Columbia.

Let’s juxtapose the top-ten foreclosure states with each one’s latest ranking in house-price appreciation – both rankings use figures compiled as of June 30, 2006:

In examining this table, it is evident that there is not (yet) a correlation between a high rate of foreclosures and a high rate of house-price appreciation. At the moment, the above-mentioned experts and the U.S. Senators seem obsessed with the danger that "bubbly" real estate markets are populated with homeowners who are over-leveraged and may be likely candidates for mortgage defaults and, correspondingly, foreclosure proceedings. Yet, what about the rest of the country?

Perhaps a better way to look at this table is to understand that trillions of dollars of mortgage loans have been originated during the past five years and that there is a national housing and mortgage-debt bubble. Consequently, even without living in a hot real estate market, people everywhere could mortgage themselves into financial trouble. With seven of the top-ten foreclosure rankings attached to states with house-price-appreciation rates in the bottom half of the rankings, it seems obvious that these households would become financially tapped out earlier in this housing/borrowing craze.

Had Colorado experienced California-like house-price appreciation, it most likely would not rank 1^st in the foreclosure ranking. In such a scenario, Coloradoans would have had the "luxury" of being able to continue strip-mining ever-growing home equity and borrow more money to make ends meet – such as borrowing a large lump-sum in order to make future house payments, car payments, and grocery purchases while still having funds left over for an extravagant vacation. Alas, the borrowing binge ended all too soon, for many Coloradoans, and the debt hangovers have proven to be ruinous.

Be assured that there will be a rotation in the state-by-state foreclosure rankings. As the mortgage-debt binges come to an end in California, Hawaii, Maryland, and Oregon, count on Colorado being knocked from the top of foreclosure-ranking list. Soon, over-leveraged homeowners, in these once-hot states, will experience the pain of rising mortgage payments, declining home values, and no more home equity against which to borrow. It makes sense that most of the frothiest states will rise to the top of this shameful list later in the borrowing cycle – which was set in motion by Alan Greenspan’s panicky interest rate policy culminating in a 1% Fed Funds rate in June of 2003.

If members of the Senate Committee on Banking, Housing, and Urban Affairs had any clue, they would be investigating the criminal enterprise known as the Federal Reserve – a privately owned bank legally sanctioned to counterfeit money. Since the founding of the inflation-happy Federal Reserve, in 1913, the U.S. dollar has lost over 95% of its purchasing power. Heck, during the reign of Alan Greenspan, the dollar’s value depreciated by over 40%. In the context of the housing/borrowing bubble, the Senate Committee would deduce the following:

• Fiat inflation encourages consumption and debt accumulation while discouraging savings.
• In order to stave off a post-9/11 recession, the Federal Reserve targeted housing as a monetary transmission mechanism – generation-low interest rates saw to that.
• By targeting housing, the Federal Reserve succeeded in seeing to it that trillions of dollars were loaned into existence (via mortgage debt) and, not surprisingly, stimulating the "animal spirits" of Americans to borrow and consume as if there were no tomorrow.
• With trillions of dollars of mortgage debt coming into existence in a compressed time-frame (about 5 years), some housing markets became hotter than others while Americans, from coast to coast, found ways to tap into the mortgage-lending frenzy in order to participate in the real estate party.

After deducing these important points, one would hope that our Senators would seek out information in order to paint a financial picture of the average American household. Martin Weiss, of the Safe Money Report, has done so and discovered the following: "According to Federal Reserve data, the typical American family today has a balance of only $3,800 in cash in the bank, has no retirement account whatsoever, owes $90,000 on their mortgage, and owes $2,200 in credit card debt." In other words, due to the Federal Reserve’s harebrained monetary central planning, typical Americans have virtually no savings and are heavily mortgaged. Intelligent Senators – if any exist – would then conclude that the present-day American economy is a debt-laden house of cards built upon the sands of fiat inflation.

Ultimately, the panel of experts completely missed the point in that the housing bubble is most certainly all about debt. Whether or not a local real estate market was hot, a record number of Americans took the real-estate-debt plunge. Houses supplanted dot.com and telecom stocks as the next surefire wealth-building "investment." Americans, now, are more deeply in debt than ever. With so little savings to fall back upon, countless American families are one paycheck away from foreclosure and financial ruin. Once again, just look at the horrifying financial profile of the typical American family.

Using the intellectual tools of Austrian economics, there is little doubt that the debt-fueled housing bubble will turn into an economic bust of epoch proportions. Perhaps when the bust becomes painful enough, a superior panel of experts will be summoned by the Senate advocating the abolition of the Federal Reserve…one can always dream…as we are on the cusp of an economic nightmare.

October 9, 2006