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Thread: New Road to Serfdom ...

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    Default New Road to Serfdom ...

    excellent basic explanation of economic mechanisms and the coming negative equity trap ...



    (snip)"Free markets are based on choice. But more and more homeowners are discovering that what they got for their money is fewer and fewer choices. A real estate boom that began with the promise of “economic freedom” almost certainly will end with a growing number of workers locked in to a lifetime of debt service that absorbs every spare penny. Indeed, a study by The Conference Board found that the proportion of households with any discretionary income whatsoever had already declined between 1997 and 2002, from 53 percent to 52 percent. Rising interest rates, rising fuel costs, and declining wages will only tighten the squeeze on debtors.

    But homeowners are not the only ones who will pay. The overall economy likely will shrink as well. That $200 billion that flowed into the “real” economy in 2004 is already spent, with no future capital gains in the works to fuel more such easy money. Rising debt-service payments will further divert income from new consumer spending. Taken together, these factors will further shrink the “real” economy, drive down those already declining real wages, and push our debt-ridden economy into Japan-style stagnation or worse. Then only the debt itself will remain, a bitter monument to our love of easy freedom."(snip)

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    Default Re: New Road to Serfdom ...

    Okay, I'm lost now...

    If I cut the article and made it start from point 16 it would make some sense.

    Basically it's saying that residential real estate is more expensive than ever. As a result, people are servicing larger and larger loans with their same limited amount of expendable income - i.e. getting into loans that amortise slowly if at all.

    Residential property is also overvalued and must come down. Because the loan amortization is so slow there is no buffer for when the price of housing goes down. Then they are in negative equity and they cannot sell.

    But this assumes overvaluation. There's no convincing argument made that house prices are too high. In my mind I think they are. But that's because the actual rent is too low to justify current prices. Returns are running at like 2-4%... so either rent has to increase and/or prices come down. Now there's likely to be an equilibrium rent based on the supply and demand of housing... but that changes very slowly. So the only part of the equation that can move is the price of housing - it must come down.

    At the end of it all, I have no idea why anyone in the right mind would purchase residential property right now. When you can rent for so little in relation to the cost of residential property, why would you?

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    Banned Melonie's Avatar
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    Default Re: New Road to Serfdom ...

    ^^^ depending on the viewpoint you choose, you can draw the conclusion that real estate is overvalued, US workers are underpaid relative to real US dollar inflation rates, the US dollar interest rates are too low relative to real inflation rates, a confluence of economic conditions which allowed Americans to live beyond their means for the past 20 years have now come to an end etc.

    All of them translate into a conclusion that the debt service costs on a home mortgage for a median priced house now require a huge percentage of the average homeowner's after tax income.

    All of them translate into a prediction that real estate prices will drop in the future relative to their assessed values of the past few years in absolute US dollar terms, but that monthly mortgage payments will not drop (and some will definitely increase). When combined with rising costs of property taxes, homeowner's insurance, heating / cooling utility bills, etc. this will leave a large number of homeowners with zero disposable income after the mortgage and associated bills are paid (as opposed to the 48% of homeowners who actually had disposable income left over in 2002).

    Thus if it isn't true already, a large majority of US homeowners must soon spend every after-tax dollar they earn in the future on their mortgage plus associated property tax, insurance, and energy bills plus basic transportation costs to get to work etc. This will leave a large majority of US homeowners with NOTHING EXTRA to be spent on discretionary items, new cars, durable goods, lap dances, restaurant meals, or anything else, which the author contends will cause a major slowdown in the US economy.

    The reference to Serfdom apparently implies that, in the wake of real estate prices that will continue to fall for some time to come, the majority of US homeowners have effectively become wage slaves who will wind up turning over every dollar that they earn to lenders (and the US gov't) without ever seeing a single dollar of long term capital gains from the eventual paying off of their mortgage and subsequent sale of their property.

    In essence, the author's point seems to be that most US homeowners are more or less 'renting' their home from the bank that wrote their mortgage, since they cannot pay off the mortgage to become the actual owners of their home. Most will wind up taking whatever sort of longer term refi deal they can swing, at whatever interest rate, in order to lower their monthly mortgage payments enough to allow them to keep paying property taxes, homeowners insurance, utility bills etc. in an attempt to avoid bankruptcy and the total loss of whatever equity they have managed to build up in their house that hasn't been wiped out by falling prices. And even if they could pay off the mortgage, the home could not be sold for anywhere near the same price as it was recently purchased for.

    .
    ~
    Last edited by Melonie; 02-20-2007 at 11:07 AM.

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