The Debt Bomb: Only housing is keeping the fuse on America's borrowing habit from burning down

Barron's On Line ^ | 20 January 2003 | JONATHAN R. LAING

[shrinkermd]

BUBBLES HAVE LONG BEEN part of the financial firmament. The tulipmania in 17th-century Holland and the notorious South Sea Company stock bubble a century later in England are lowlights of economic lore.

History is replete with numerous other examples of financial manias followed almost ineluctably by huge price busts, down to our own era. Japan is still paying the price of deflation and economic narcolepsy a decade after bubbles in its stock and real-estate markets popped. Debt collapses in Asia and South America punctuated much of the 'Nineties. The bursting of the U.S. tech-stock bubble in early 2000 led to the vanishing of more than $5 trillion in wealth, at least on paper.Now, many worry that a U.S. housing bubble, lofted by four-decade lows in mortgage rates, could explode, eviscerating consumer spending and economic growth.

[shrinkermd]

FYI. Sorry about no tables. This is one of the gloomiest articles I have ever read in Barron's. In forty years, I can recall some pessimism from time to time, but no outright suggestion that a classic, deflationary, debt repudiation depression is in the wings.

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[Fury]

Thanks for posting an informative article.

[First Amendment]

Some of us (or at least one) are not financial-savvy and business articles like this make me brain-sore - would someone mind translating this into simple layman's language for a simple mind? TIA -

[Alberta's Child]

As soon as I see comparisons between the U.S. and Japan in an article like this, I tend to question the author's credibility.

Japan offers a good lesson for the U.S., but not for the reasons the author uses. There are really only two ways for an economy to grow in real terms -- increases in population and increases in productivity. Japan's real problem is that the stagnating population growth has resulted in a deflationary situation where the agin population simply cannot be supported by their younger demographic groups, not only in terms of the cost of social services but in terms of reduced consumer consumption.

[Dec31,1999]

In essence, then, the American home is a bulwark for the economy. As long as housing values stay high, the nation is sheltered from a detonation of the debt bomb.

As long as immigration keeps rising, the housing market will sustain home values. It's a matter of supply and demand.

[dtel]

I am sure there are not too many illegal aliens buying 200K homes.
They tend to settle in the older run down sections of town.
Unless you own real estate in these areas, I wouldn't look for too many illegal alien buyers.

[Dec31,1999]

Here's a part of it: When the ecomony slows down, the gov't restimulates it by lowering interest rates, which encourages consumers and businesses to borrow and purchase more goods, but the gov't can't do that now because interest rates are near zero. You can't pay people to borrow money, so some other technique must be implemented.

When C's and B's are already highly in debt when the economy slows down, but can't borrow more money easily, because banks tighten up loan requirements, it exacerbates the problem. Higher unemployment and less C spending makes banks tighten up because they are less likely to be paid back during slowdowns. Round and round it goes.

The main point of the article is that there is too much debt already for the economy to be reflated, or restimulated by usual means, i.e. lowering interest rates, which may or may not be true. Nobody knows for sure, but it doesn't look good.

[proxy_user]

Who said illegal? I know of many legal aliens who have bought houses in the $250-400K range. This is holding up the housing market in many places. Some of them even buy a house before they get their green card.

[Dec31,1999]

They tend to settle in the older run down sections of town.

Actually, they pool their money and purchase homes even more expensive. You'd be surprised. And even if they don't,they support high prices by paying rent to investors, who get a rate of return on those houses in those less than desireable neighborhoods, which supports prices in nicer neighborhoods that more affluent folks want to live in.

[FITZ]

As long as immigration keeps rising, the housing market will sustain home values. It's a matter of supply and demand.

Not necessarily. In this border region, we've got extremely high immigration, no jobs, many immigrants live 3-4 families in one run-down house or housing project apartment. Over a third of the families here are on some kind of welfare program and many houses in the city are sitting empty. If you look at the statistics of the Texas and New Mexico border counties, you'll see alarming poverty rates and the only way most will buy houses if whent he government gives them the money to do so.

[4Freedom]

Excellent article. A must read for all conservatives observing the continued massive spending and growth of our 'national debt' by a Republican led government.

[dtel]

I'll give it a whirl.
First let me say, he did leave out over-taxation as part of the equation.
We went on a binge during the '90's, "Irrational overexuberance" I believe it was coined.
Wages were rising and instead of saving it, we 'invested' it.
Our 'investments' are down about 5 trillion according to article.
While wages were rising, home values were skyrocketing, as were taxes as percentage of income.
Now a 100K home costs 200K. This is where everybody gets screwed, OK you finance at 5%, BFD. You are paying 5% on a 100K paper profit for the bank. And paying RE taxes on a 200K value. (I'll get horse whipped for this paragraph, watch and see)
But I digress.
As more and more money is pulled from your pocket, you reach the tipping point he referenced, where your debt load exceeds your ability to repay it.
Throw in a foundering job market and the potential for real havoc exists.
Who knows what happens from here, hang on and enjoy the ride.

[Dec31,1999]

Good point. Japan doesn't allow immigration to any great degree, so they are not increasing their numbers as much as is necessary to sustain real estate prices. There is a certain wisdom to their approach, however. Compared to European and American standards nearly all neighborhoods are desireable in Japan.

[Kay]

Economics is not my forte, however, it has always appeared to me that the 1929 Crash was caused by people borrowing money to invest (margin?). President Hoover warned the banks about lending money for this purpose but they mocked him, telling him that he was old-fashioned.

Thus, it seems that we have repeated the same scenario. People have borrowed from their real estate this time to invest in stocks or just plain "things". Is this a set up for a major crash? No idea.

[LouD]

Interesting (and sobering) article.

Some good points about inflation versus deflation. I've always thought it was economic hubris to assume that we could achieve equilibrium at the razor's edge of zero inflation or deflation.

Moreover, for every argument against inflation (old people eating cat food because their the purchasing power of their passbook savings account has eroded) there was a countrbalancing argument for inflation (the student who borrows heavily to finance his education, and then pays back the loans with dollars worth less than those he borrowed).

It is probably better, not to mention easier, to have low, but consistent and predictable inflation, rather than attempting to achieve zero inflation. That is, assuming we could preclude the inflation driven expansion of the public sector that was fueled by bracket creep and capital gains that in the past consisted largely of inflated prices, not value appreciation.

[Dec31,1999]

Interesting. I wonder how much of that is because there is dirt-cheap property right next door in Mexico. I offer Tucson and San Diego as counter examples. Prices there are higher than many places much further inland. Here in the NYC suburbs, there is NOTHING for sale under 150K. And NOTHING under 200-225K in anything like a "good" neighborhood. I expect prices to level off or go down this year, though.

[dtel]

Inflation can only really work if all thing are inflated equally.
The tendency is for wages to stagnate or deflate and "stuff" to inflate.
Thus you make the same or less and things cost more, it can't go like that forever.
A carpenter still amkes $15 an hour, now instead of paying for a 100K home he is paying for a 200K home.
Thus the wife or live in must also work to make the bills.
The gov loves this, double the taxes, double the fun.

[uncbob]

My biggest fear for the economy has always been the instant gratification generation with 5 credit cards maxed out
I want it so I buy it with no thoughts to the future
It can blow sky high The speculative market that was going to those crazy highs was just another example of get rich quick pie in the sky etc etc mind set of modern day Americans

[dtel]

I fail to see the inflation is good argument.
All it is, is self-induced taxation.
As your wages inflate, if they do, you also rise in tax bracket, effectiively sucking out any profit from your increased wages.
We should all fight RE inflation, but we are all too greedy to realize it.(Myself included, buy low, sell high)
While we celebrate our new found wealth in our rising home value, once again we are creeping up in taxable value, thus slowly and steadily sucking the profits out through ever-increasing RE taxes.