Easy credit drives up prices

Aug. 19, 2004
My wife and I are unusual in that we have lived in the same house for 41 years.
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We felt lucky when we bought our home because we got it at a good price, and it was located in an upscale neighborhood. Our neighbors were mostly corporate executives or other people with successful businesses and upwardly mobile careers.

We got the house at a bargain because the owner had been promoted to a position at another office 350 miles away. His company was pressuring him to relocate quickly, so he was willing to accept any reasonable price. I offered him what I thought was an insultingly low figure of $137,000 in today's dollars, but he accepted it.

That is chump change in today's market, but lending standards were different back then. Banks generally wanted down payments of one-third the selling price, and they preferred to limit mortgages to 20 years. Under these conditions, I wound up with a monthly payment of about $700 in today's dollars. My wife stayed home to raise the kids, so we were a single-income family, and my salary was nothing to brag about. Still, the mortgage left some wiggle room in our monthly budget.

At the time, the goal of everyone with a mortgage was to pay it off. There actually was a ceremony associated with your last mortgage payment. You invited friends over, built a fire in your fireplace or patio grill, and had a round of drinks while, with great fanfare, you literally burned the mortgage.

You could get a mortgage with easier terms through the FHA or GI bill. But people needing financial props to buy a house were often looked upon as spending more than they could afford. Nevertheless, the trend toward easy credit was gathering steam, and people increasingly were beginning to buy houses with low down payments and long-term mortgages.

I questioned my brother, a real-estate agent, about how people of modest incomes were able to buy expensive property seemingly well beyond their means. “How are they ever going to pay off their mortgages?” I asked.

“They never intend to pay off the mortgage,” he replied. “It's easy to get big mortgages today, so buyers pay ridiculous prices. That gives owners more incentive to sell. Everyone is in the market, buying and selling, while they keep paying higher and higher prices.”

So liberal mortgage terms didn't do much to make housing more affordable. Instead, the greatest effect has been to inflate the price of real estate. Today, 40 years later, easy credit for housing has created an enormous bubble in the real-estate market.

Meanwhile, the Federal Reserve, with its rock-bottom interest rates, has encouraged speculators to buy stocks with borrowed money. That is one reason the stock market is priced beyond its intrinsic worth, creating another worrisome bubble in the economy.

Why are medical costs rising at double-digit rates? The answer is that hardly anyone pays their own medical bills. Medical care is a desirable product, and economic theory says that when the price of a desirable commodity approaches zero, demand for it approaches infinity.

The same is true for higher education. College is something few people actually pay for, at least in the here and now. If you can't get a grant, college loans put off the day of reckoning. Moreover, the less someone can afford college, the more likely they are to get a college education. Clearly, higher education is a world of upside-down economics.

Almost every time there is an attempt to make something more affordable, we see an opposite effect. Unless prudent credit practices are put into effect, housing prices will continue to soar, the stock-market bubble will grow worse, the cost of medical care will continue upward, and there will be no constraints on college costs.

Getting back to that house we bought in an upscale neighborhood, it isn't a highprestige place anymore. Now it is in an enclave of starter homes.

-- Ronald Khol, Editor
Send feedback to MDeditor @ penton.com

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