Monday, November 3, 2008

The Great American Housing Nightmare: Next Phase

by Martin D. Weiss, Ph.D.

Sadly, it was not just the overwhelming quantity of debt that was so dangerous. Even more dangerous was the substandard quality of the debt. Consider the facts:

In all prior speculative bubbles in history, investors were required to put up at least some of their own money to buy into the boom. Even in the tech stock mania of the early 2000s, investors had to put up a minimum of 50% cash for their stock purchases.

But in the frenzy that preceded the Great American Housing Nightmare, millions of Americans bought homes with zero money down!

Lenders didn't merely look the other way while home owners borrowed the down payment; they actively encouraged it. Homebuyers without enough cash to buy a $500 TV set were declared the proud new owners of $500,000 luxury homes. Many took it one step further with serial purchases of homes, leapfrogging with glee from one free ride to the next.

In all prior speculative bubbles, borrowers were invariably required to make payments of interest and principal in full and without fail, with zero tolerance for any other arrangement.

In contrast, during the Great American Housing Nightmare, millions of homeowners were allowed to pay interest only or even less than full interest.

So it should come as no surprise that the majority opted to make the smallest payments allowed, while the lender added the unpaid amounts to the loan balance. As with credit cards, the more that time went by, the deeper into debt the borrowers fell.

In prior historical episodes of rampant speculation, loans were almost invariably held by the lenders, who, in turn, had a vested interest in making sure the borrower's finances were sound and their payments were kept current.

But in the Great American Housing Nightmare, the mortgages were mostly held by non-lenders — institutions and investors that were far removed from the borrowers.

In earlier manias, investors speculating with borrowed funds were required to document that they were worthy of the loans. They invariably had to present hard evidence of income, proof of assets, or both.

But in the Great American Housing Nightmare, even that was not the case. Millions were allowed to borrow huge sums without a scintilla of proof that they had the wherewithal to make the payments.

In earlier manias, the bubble was generally confined primarily to one debt sector.

Not this time around! Beyond the $14.8 trillion in residential and commercial mortgages in America, there are another $20.4 trillion in consumer and corporate debts. This meant that mortgages represent only 42% of the private-sector debt problem in the country.

Result: Americans are not only under tremendous pressure to sell their homes due to burdensome mortgages, they are also squeezed by huge credit card balances and by layoffs from employers equally addicted to debt.

By virtually every measure, the debts piled up prior to the Great American Housing Nightmare are far bigger and worse than any debt pile-up ever witnessed in history.
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