Indebted Spendthrifts

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Writes a reader: "My daughter is only 25, but she just bought a house in Northern Virginia. Of course, she mortgaged most of it. But can you believe that they lent her $275,000? Is that crazy, or what? She works as a bartender, part time. She’s very responsible and is good for the money, I’m sure. But I can’t believe they would lend her that much money. How do they think she will pay it back?"

Are Americans really the heavily indebted spendthrifts the world’s press makes them out to be? On the evidence, yes!

The Bureau of Labor Statistics figures that the average hourly worker earned $521.73 per week in 2003, (the 12 months ending in June). During the same period a year later, he earned an average of $524.37. Immediately, we notice that there is not a lot of difference between the two numbers. In fact, BLS tells us that the latter is only 0.5% greater than the former. Which is too bad for the poor schlep who works by the hour. Because the cost of living — the CPI — rose by more than 3% during the same period; he actually has less spendable income this year than he did the last.

How then, is a consumer-led recovery possible? How can he spend more in 2004 than he did in 2003?

The answer, dear friend, is blowing in the wispy wind of America’s housing bubble.

"How much do places like these go for?"

We posed the question to our lawyer as we drove through a section of Baltimore known as Federal Hill — near where the British lobbed cannon balls in the War of 1812… and Francis Scott Key, looking on, composed the national anthem.

The houses are hardly fancy. Instead, they are neat, modest places… which would be more familiar in Britain as u2018mews’ houses. They were meant for factory workers in the 19th century — tiny, cheap, and simple.

Twenty-five years ago, so many of these houses had been abandoned that the mayor started giving them away for $1 each.

But the area has changed… and so has the nation. Twenty-five years ago, America was at the bottom of a confidence cycle. Nothing seemed to go right. Interest rates were high and stocks were low — selling for 6 to 8 times earnings. Gold was twice as high — even in nominal terms — as it is today. And Federal Hill was a derelict, abandoned, forgotten, trashy slum.

Today, America has never been more sure of herself. Everything seems to go her way. The Dow is more than 10 times higher than it was at the end of the ’70s; many sectors sell for 50 times earnings — and more. Interest rates, by contrast, are low — the Fed’s key lending rate is barely a tenth of what it was back then. Gold sells at a humble $400 per ounce. And Federal Hill is booming. There are bars, cafs, restaurants, even restaurants good enough to entertain a group of expensive Washington lawyers.

And the houses?

"Well, I just sold one," said our own consignee, "so I know what the market is doing. You can buy them for about $300,000. Two-fifty to three-fifty, I’d say."

We have pointed out on more than one occasion — often enough so you must be getting tired of hearing us say so — that rising house prices do not make people rich. A house can sell for $1 or for $300,000; it provides exactly the same yield either way: you can live in it.

But rising house prices are not neutral. A man buys a house for $1 and then sells it for $300,000. He then buys another house for $500,000 — with a $200,000 mortgage. He feels much richer. He is now consuming a house worth half a million dollars. But while he was previously debt-free… now he is $200,000 in debt.

And what about the first-time house buyer, like our colleague’s daughter? She puts down $25,000… and borrows $275,000 to buy the $300,000 house. The same place she could have gotten for a buck in the year she was born.

Are they richer? Not really. Instead, without realizing it, they have become speculators — leveraged ones — betting heavily that interest rates don’t rise and house prices don’t fall. Woe to them if they’re wrong.

Bill Bonner [send him mail] is the author, with Addison Wiggin, of Financial Reckoning Day: Surviving the Soft Depression of The 21st Century.

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