Living the High Life
15 December 2003

By O. Max Gardner III

Modern day home mortgages are bundled by the thousands into financial
instruments that are then traded all over the world like stocks and bonds. This system of Asset Backed Securities has made it easier for capital to flow into the system which in turn has made it easier for more people to get more mortgages and indeed more money on these mortgages.  The Trustees of these large mortgage funds then retain Mortgage Servicers to collect the mortgage payments from the homeowners.  And they change Servicers on a regular basis.  Most homeowners think that their mortgages are being sold and assigned time and time again when in fact the actual holder of the debt is simply changing Servicers time and time again.

Generations of Americans used to buy homes by making a down payment of 20% of the purchase price, financing the remaining 80% on a 30 year fixed rate mortgage, paying off the mortgage, and then having a party to "burn the canceled mortgage debt."  The American Dream was to eventually own your own home "free and clear" of all debt.  Burning the mortgage used to be a rite of passage to financial independence.  This is no longer the case.  Now, the American home is just one more credit line to be tapped to buy the second or third car, the boat or the plasma screen home entertainment center.   The problem therefore is not that we have been assuming larger mortgages in order to live in larger houses that we can afford because of larger incomes.  The problem is that Americans have had roughly the same incomes and the same houses but have been mortgaging a larger percentage of those values.  In stead of paying of the first mortgage, we are frantically seeking the best rate on the second or third mortgage or looking into some new type of hybrid home equity loan.  Americans can now order these second and third mortgages over the internet much like ordering a pizza with "all the works" from Papa John.

An old saying goes something like liars like to figure but figures never lie.  Well the figures of the reckless assault on the equity in American homes are sobering to say the least.  As a percentage of personal income, mortgage debt in America has risen from 51 percent 25 years ago to over 100% today.  In the last 5 years alone, mortgage debt has increased by 60 percent, or $2.2 trillion dollars, an amount roughly the same as the profits of very American corporation for the last five years and twice the amount of China's annual exports to the entire world.

One problem with borrowing all of this money is that people might no be able to pay it back.  Another disturbing fact is that for the foreseeable future Americans will be spending a large portion of their income on mortgage debt service.  This in and of itself will constrain consumer spending, which accounts for two-thirds of our gross economy.  This retraction in consumer spending will also retard economic growth for the remainder of this decade.  Slow economic growth will inhibit income growth, preventing us from earning our way out of the financial black hole created by massive federal deficit spending and reckless tax cuts.  This hole is deep and dark and is getting deeper and darker every day.

At some point we will simply exhaust the supply of money available using homes as collateral for the loans.  For example, in 2001 and 2002 Americans extracted approximately $300 billion dollars in cash from their existing homes through refinancing and home equity loans.  This massive infusion of cash in the American economy has provided the fuel for rising consumer spending in the face of a severe economic recession.  The stock market has not lost 40% of its value because the economy is healthy.  And, the Enron's, WorldCom's, and dotcom failures are not a sign of a progressive and growing economy.

Why have the mortgage companies loaned Americans all of this money?  And, why have Americans elected to borrow more money on their homes than they should have?  The primary reason is that the federal government subsidizes mortgages through the Federal Housing Administration and such government sponsored enterprises as Ginnie Mae, Fannie Mae, and Freddie Mac.  These institutions raise money in the capital markets and they recycle the money into the home mortgage market.  These enterprises are subsidized because the Federal Government guarantees their debts.  These federal guarantees encourage people to overextend by making borrowing cheaper that it otherwise would be. 

American capitalism was never structured to deliver absolute economic freedom.  The American system once focused on the accumulation of wealth.  This is no longer the case.  Today, the dynamic of value-free modern finance has twisted capitalism from the accumulation of wealth to the consumption of wealth.  As Americans have increased their mortgage debt to finance the greatest consumer spending spree in the history of the word, we have become one of the most indebted people on the planet.  We are a Nation of Debtors.

As the NCAA annual tournament approaches, there are many basketball teams that are "sitting on the bubble" as to whether or not they will be invited to play.  Some will make the tournament but for many more the bubble will burst.  Everyone seems to know about this bubble.  Fewer recognize that they are in fact living in the bubble.  The mortgage bubble.  And it is about to burst.