Friday, October 10, 2008

Observation on the Financial Debacle 

Starting around 2003 our area around Carlsbad, CA experienced a housing boom. Lots and lots of "mcmansions" of 3,000 to 5,000 square feet and lots of luxurious upgrades in the kitchens and baths selling for prices in excess of $1 million.

My wife and I kept remarking to each other, "I wonder who's buying those places? How can they afford them?"

The answers to those questions have now become clear: average upper-middle class families; they can't.

Evidently many of those home buyers got into their homes by resorting to ARMs with teaser rates and maybe only interest only terms for the first several years.

Those mortgages are now adjusting and the hard reality of doubled (or more) payments is hitting home. The result is many, many realtor signs in front yards. And because of the ripple effect, turmoil in the world's financial markets.

But why did those average middle-class families decide on that kind of financing? Did they think that home values would continue to increase without bound? Did they plan on selling and moving before the ARMs adjusted? Did they think that their income would increase sufficiently (or their expenses drop sufficiently) that the payments after their ARMs adjusted would be within their means?

My guess is that they didn't think about it. They just wanted the house and scaled up their credit card experiences to take on obligations of gargantuan proportions. In other words, they did it because they could.

I have long believed that American schools should be teaching basic economics and real-life examples such as the time value of money, the power of compound interest and the law of supply and demand. People need to realize from an early age that credit card balances that aren't paid off promptly are extraordinarily costly, and that there is virtue in deferred gratification. When was the last time you saw a store touting its lay-away plan? I believe that better-educated and more informed home buyers might have paid more attention to the financial shock that awaited at the end of the 5-year ARM rainbow, instead of believing that there was another pot of gold in the form of a low-rate refinance. I won't even go into the issue of "home equity" loans of up to 110% of value, with the proceeds being used to buy cars and big screen TVs, and to pay for exotic vacations.

You remember the fable of the ant and the grasshopper? Well, we've turned into a nation of grasshoppers, and winter is upon us. Unfortunately those few ants who bought and saved wisely are being hurt along with all the grasshoppers.


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