Thursday, February 3, 2011

Did Congress Fuel the Mortgage Debt Crisis?

One of the main reasons that I worry that the U.S. is going to be in for a long period of sluggish economic growth is the huge hangover of debt that remains after the last couple of decades.

The numbers are staggering, from the $14 trillion federal government debt to the trillions owed by mortgage borrowers.

Many of my clients (as well as the Chinese government) believe that the Fed is trying to reignite inflation to get us out of our collective debt hole. Even if this is truly what the Fed is trying to accomplish (which I doubt), I remain skeptical that they will be successful.

If you go back over the last, say, 150 years, you will be hard-pressed to find a industrial country that was able to inflate its way out of its debts. Instead, the example of modern Japan seems more relevant, where low interest rates, disinflation, and sluggish economic growth are the norm.

In any event, Bethany McLean had a good piece in the on-line magazine Slate about all of this, and the overwhelming debt burden that needs to eventually be repaid.

She makes an interesting point. Much of the debt explosion started in 1986, when Congress eliminated the tax detectability of interest for any debt other than mortgages. Didn't take long for Americans to figure out that borrowing against the equity in their homes was the best way to go, especially in the last decade (I have added areas of emphasis):

The numbers in the commission's report chart the surge in housing-related debt: "By refinancing their homes, Americans extracted $2 trillion in home equity between 2000 and 2007, including $334 billion in 2006 alone, more than seven times the amount they took out in 1996." Of course, all of this came at a cost: "Overall mortgage indebtedness in the United States climbed from $5.3 trillion in 2001 to $10.5 trillion in 2007. The mortgage debt of American households rose almost as much in the six years from 2001 to 2007—more than 63%, or from $91,500 to $149,500—as it had over the course of the country's more than 200 year history." This was during a period when overall wages were stagnant. To cut the figures a different way, as the commission helpfully does: Household debt rose from 80 percent of disposable personal income in 1993 to almost 130 percent by mid-2006. More than three-quarters of this increase was mortgage debt. Did all this debt hurt economic growth? On the contrary, it supplied it: "[B]etween 1998 and 2005, increased consumer spending accounted for between 67% and 168% of GDP growth in any given year.
FCIC report: Wall Street's debt problem is different from yours. - By Bethany McLean - Slate Magazine

Ms. McLean goes on. Once Main Street figured out that mortgage debt was a great way to borrow and spend, it didn't take long for Wall Street to leverage up their balance sheets, buy and then package all of these mortgages and make boatloads of money for themselves.

Problem is, of course, is that too much of a good thing eventually comes back to bite you, and that's what seems to be happening now.