Sunday, December 03, 2006

Economics 102 - the housing bubble

I found this chart on the internet, and wanted to pass it along to you. In addition, I found another chart to which I added a trendline. A trendline is an analysis that shows the way a market is (or should be) going in the absence of distortions. The trendline uses historical figures to project what present or future figures should be. The trendline in the chart below should cause everyone to be seriously concerned, because it shows that housing prices would need to fall about 1/3 of their current level in order to be in a sustainable and reasonable zone.

The savings rate in America has hovered around zero for some time now - some years even being negative as people incurred more debt than they have assets to cover it. Since most people aren't terminally stupid, we can presume that most people have done this because they believe the value of their homes protects them from being actuarily broke. This chart, however, shows that the "real" value of most people's home and property is 33%+ less than what they think it is, and a true market correction will more than wipe out any positive balance that they think they have. In other words, this error in financial planning has caused most people to be in debt far, far beyond any future ability to dig themselves out of the hole.

Now, I have already mentioned to you that if you don't already have a plan for paying off your credit cards, you need to get one. The problem with that is many people will say to themselves, "Well, we can do it with a home equity loan." In reality, you probably don't have any equity. If you think or know that you will need to move or sell your house anytime within the next, say, decade - then this is a terrible idea.

This is not to say that it's necessarily a bad move for everyone, though. After all, the terms of home equity loans are fixed and non-changeable (good loans, anyway. I hope you already know to avoid adjustable rate loans like the plague). The terms of your credit cards are that they can change the terms at any time they want - interest due, minimum payment due, length of loan, etc. - and you have no recourse whatsoever. If you go into this with your eyes open, realizing that the value of your house may (probably will) fall below what you will owe for your mortgage and equity loan, then you can still take advantage of the situation. You just have to realize that you will probably not be able to move or sell your house for quite a while.

This solution is still not perfect, however, because - as I have also mentioned before - God never intended you to be paying interest to your co-religionists and forbids usury loans. It is a far, far better solution to form or join a 0% interest loan society if you have no other options - but the vast majority of us do have some other options - we just don't like them.

First and foremost should be taking a hard look at your resources and 1) sell what you really don't need, regardless of how much great status it gives you (expensive cars, second or third cars, kid's cars, vacation homes, flashy jewelry, etc. - you know what you have), and 2)realizing that if you do have savings but are in debt, you are still likely experiencing a net loss every month because the interest paid to you by savings, money market accounts, CDs and whatever are way less than the interest you're paying for your credit cards and consumer loans. Although many "professional" financial planners will disagree, I urge you to get out of debt first, even using what you have saved now to do it. Only when you aren't bleeding red ink on your monthly budget sheet are you ready to re-direct funds toward long-term savings.

Here's why: Money you have saved loses value every year. Real estate isn't the only thing hopelessly overvalued - think about it: it now costs $10 or $20 dollars (depending on where you live) to buy now what you used to be able to buy for $1.00 in 1960. That means (splitting the difference) that paper dollar bills have lost 85% of their value during my lifetime - and I'm not exactly ready to push up daisies yet. To be really quick and dirty with the math, lets say that it lost 80% over 40 years, or 2% per year. (The real figure is more like 2.7ish.) That means you need to make at least 2-3% interest on your money every year just to have the same amount of purchasing power. The same amount! You haven't actually increased anything if your money is earning less than 3% annually, which means your real rate of return on your savings or investments is whatever your broker says, less 3%. For most of us, that means in reality we aren't earning anything. The only one making money off of our money is our broker, who gets his or her fees regardless.

So paying off debt is the smart thing to do, class. Just be aware of how you choose to do it - because presuming you have x-dollars in home equity is wildly unrealistic. If you do go there, go knowing the reality of the situation and how long it could take you to extricate yourself from it. If you're happy where you are - great! Use the system. If you aren't sure, then try and find some other way to pay your debts other than home equity loans or second mortgages - because being stuck with debt worth more than you can sell your home for may be a very bad place to be.

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