Cross posted on Daily Kos

Thu Dec 08, 2005 at 12:30:31 PM PDT
Some of you know that among other things, I sell real estate in Manhattan.  Some of you even hold that against me undoubtedly.

I’d like to tell you the real estate story of one American. Perhaps this might illustrate why you should read what bonddad has been saying and recognize why this debt financed expansion is going to inflict tremendous pain on Americans of every socioeconomic level. This should give you a bad case of indigestion, because it is going to impact, you, me, everybody.

This is the story of a middle class speculator who lives in Southern California. She could be you, your neighbor, your cousin. But her story is playing out across the country. And most interesting, until I told her she was a speculator she didn’t even realize this.
This young woman (a home health care aide with three children) owns two houses. Her income is around $75,000 or so.

She has an adjustable rate mortgage on the house she lives in. She has zero equity in this home. She bought it a few years ago for around $300,000 and it is now worth in the neighborhood of $550-$600,000. She has both a mortgage and a home equity loan on this,her primary residence. She used all the cash she removed from the home to . . .purchase a second home.

Now let’s take a look at her investment property.  She supplements her income by renting out her second home, she has a tenant who is paying $1600 a month. She also has an adjustable rate loan on this property. This loan is also adjusting in 8 months. She thinks (fears) that when the loan adjusts the income her tenant is paying will no longer cover the monthly mortgage payment.  I think (fear) she is correct.

I asked her how and why did she get into this pickle?  She said well, to make money of course. Real estate prices can only go in one direction–right?  Wrong!

She is the classic speculator.  She didn’t even know she was a speculator until I told her.  I explained that if you sole motive in making a real estate purchase is to see the value of your investment increase, then you are a speculator.

This sort of situation is playing out around the country.  Even worse, since the real estate bubble has been fueled, almost in its entirety by abnormally low interest rates, as rates increase, housing prices will drop.

People like the young woman I described are going to face a situation called negative equity. This is when the value of the property is less than the outstanding mortgage. This is also the point at which people start to walk away from these homes and the foreclosures begin.  All in all, a very vicious cycle is underway.

As bonddad has been describing, this economy is riding a massive wave of debt. Homes have been turned into money machines. These money machines which we used to call homes, have been fueling consumer spending which accounts for 2/3rds of GDP. So, if you understand only one point, it is that the Federal Reserve and Mr. Bushspan have done all that they could to keep the hapless American consumer spending. Without consumer spending, we would be knee deep into a major recession.

When these loans start to adjust (upward) in the coming months, many Americans are going to be in a world of financial hurt. This is going to impact all of us, even those not saddled with astronomical levels of debt.

So, returning to the young woman in Southern California–she is nervous, very nervous. She is actually scared. The dream she thought she could buy her way into seems to be on the verge of collapse.

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