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OLIO 39 many books, including and is the author of the newserfdom An illustrated guide to the coming real estate collapse Even men who were engaged in organizing debt-serf cultivation and debt-serf in-dustrialism in the American cotton districts, in the old rubber plantations, and inthe factories of India, China, and South Italy, appeared as generous supportersof and subscribers to the sacred cause of individual liberty. ever before have so many Americans gone so deeply into debt sowillingly. Housing prices have swollen to the point that weÕve taken to calling a mortgageÑby far the largest debt most of us willever incurÑan Òinvestment.Ó Sure, the thinking goes, $100,000 borrowed today will cost more than $200,000 to pay back over the next thirty years, but land, which they are not making any more of, will appreci-ate even faster. In the odd logic of the real estate bubble, debt has cometo equal wealth.And not only wealth but an even stranger paradox. After all,debt throughout most of history has been little more than a slight variationon slavery. Debtors were medieval peons or Indians bonded to Spanishplantations or the sharecropping children of slaves in the postbellum South.Few Americans today would volunteer for such an arrangement, and there-fore would-be lords and barons have been forced to develop more sophisticated enticements.The solution they found is brilliant, and although it is complex, it canbe reduced to a single wordÑ Not the rent that apartment dwellers HARPERÕS MAGAZINE / MAY2006 landlord will soon �nd that what they really signed up for was the hard es account for mostdebt since 2000 $1,000 monthly payment can carry different levels of debt As it happens, banks are increasingly un-hurried about repayment. Nearly half thepeople buying their Þrst homes last year were al-lowed to do so with no money down, and manyfthem took out so-called interest-only loans,or which payment of the actual debtÑamortiza-tionÑwas delayed by several years. A few eventook on Ònegative amortizationÓ loans, which dis-pense entirely with payments on the principaland require only partial payment of the interest it-self. (The extra interest owed is simply added tothe total debt, which can grow indeÞnitely.) TheFederal Reserve, meanwhile, has been pushinginterest rates down for more than two decades.The IRS has helped create demand fordebt as well by allowing tax breaksÑthewell-known home-mortgage deduction, for in-stanceÑthat can transform a loan into an at-tractive tax shelter. Indeed, commercial realestate investors hide most of their economicrent in ÒdepreciationÓ write-offs for their build-ings, even as those buildings most OLIO 41 interest rates have been falling since 1981 corporations hide their real estate profits behind depreciationrden has shito labor and consumption illionsbillions It is also worth noting that capital gainsÑeconomic rent ÒearnedÓ without any actu-al labor or industrial investmentÑare increas-ingly untaxed.All of these factors have combined to lurerecord numbers of buyers into the real es-tate market, and home prices are climbing ac-cordingly. The median price of a home hasmore than doubled in the last decade, from$109,000 in 1995 to a peak of more than$206,000 in 2005. That growth far outpaces theconsumer price index, and yet housing afford-abilityÑthe measure of those month-to-monthhousing costsÑhas remained about the same.That sounds like good news. But thoserising prices also mean that more peopleowe more money to banks than at any othertime in history. And thatÕs not just in terms ofdollarsÑ$11.8 trillion in outstanding mort-gagesÑbut also as a proportion of the nationaleconomy. This debt is now on track to surpassthe size of AmericaÕs entire gross domesticproduct by the end of the decade.Even that huge debt might not seem sobad, what with those huge capital gainsbeckoning from out there in the future. But theboom, alas, cannot last forever. And when thegrowth ceases, the market will collapse. Under-standing why, though, requires a quick detourinto economic theory. We often think of ÒtheeconomyÓ as no more than a closed loop be-tween producers and consumers. Employershire workers, the workers create goods and ser-vices, the employers pay them, and the workersuse that money to buy the goods and servicesthey created. HARPERÕS MAGAZINE / MAY2006 capital gains are taxed at a lower rate than ever oprate housing prices have far outpaced consumer prices,even as monthlpayments remain affordablemortgage debt is rising as a proportion of gdpthe production/consumpti fortune. Economists call it the FIRE sec-is credit. The FIRE sector pumps credit into OLIO 43 the keynesian economyIR The FIRE sectorÕs other advantage is that dream is that the FIRE sector will expand to over the last twodecades, even as the real estate pie as a wholehas expanded. Everyone got a little richer, butrich people got much, much richer.We will be hard-pressed to maintaineven this semi-blissful state. Like any liv-ing organism, real economies donÕt grow expo-nentially, or even in a straight line. They taperoff into an S-curve, the victim of their ownsuccesses. When business is good, the demandfor labor, raw materials, and credit increases,which leads to large jumps in wages, prices, andinterest rates, which in turn act to depress theeconomy. That is where the miracle of compound interest founders. Although many peo-ple did save money at interest two thousandyears ago, nobody has yet obtained even a sin-gle Earth-volume of gold. The reason is thatwhen a business cycle turns down, debtors can-not pay, and so their debts are wiped out in awave of bankruptcy along with all the savingsinvested in these bad loans. HARPERÕS MAGAZINE / MAY2006 the rentier economy Japan learned this lesson in the Nineties.As the price of land went up, banks lentmore money than people could afford to pay in-terest on. Eventually, no one could afford touy any more land, demand fell off, and pricesropped accordingly. But the debt remained inplace. People owed billions of yen on homesworth half thatÑhomes they could not sell.Many commercial owners simply went intoforeclosure, leaving the banks not only withÒnon-performing loansÓ that were in fact deadlosses but also with houses no one wantedÑorcould affordÑto buy. And that lack of incom-ing interest also meant that banks had no morereserves to lend, which furthered the downwardspiral. BritainÕs similarly debt-burdened econo-my inspired a dry witticism: ÒSorry you lost yourjob. I hope you made a killing on your house.Ó We have already reached our own peak.As of last fall, even Alan Greenspan haddetected Òsigns of frothÓ in the housing market.Home prices had Òrisen to unsustainable levelsÓin some places, he said, and would have ex-ceeded the reach of many Americans long agoif not for Òthe dramatic increase in the preva-lence of interest-only loansÓ and Òother, moreexotic forms of adjustable-rate mortgagesÓ thatÒenable marginally qualiÞed, highly leveragedborrowers to purchase homes at inflatedprices.Ó If the trend continues, homeownersand banks alike Òcould be exposed to signiÞ-cant losses.Ó Interest rates, meanwhile, havebegun to creep up. So: America holds record mortgage debtin a declining housing market. Even at Þrst might seem okayÑwe can just weatherthe storm in our nice new houses. And in factthings be okay for homeowners who boughtlong ago and have seen the price of theirhomes double and then double again. But formore recent homebuyers, who bought at thetop and who now face decades of payments onhouses that soon will be worth less than theypaid for them, serious trouble is brewing. Andthey are not an insigniÞcant bunch. OLIO 45 in japan, real estate prices fell as quickly as they rose 1989 illionsofhomes HARPERÕS MAGAZINE / MAY2006 The problem for recent homebuyers isnot just that prices are falling; itÕs thatprices are falling even as the buyersÕ total mort-gage remains the same or even increases. Even-ually the price of the house will fall elow hat homeowners owe, a state that economistscall negative equity. Homeowners with nega-tive equity are trapped. They canÕt sellÑthedeclining market price wonÕt cover what theyowe the bankÑbut they still have to makeoften growingoften growingTheir only ÒchoiceÓ is to cut back spending inother areas or lose the houseÑand everythingthey paid for itÑin foreclosure. negative equity traps debtors ree markets are based on choice. But more and more homeowners arediscovering that what they got for their money is fewer and fewerchoices. A real estate boom that began with the promise of Òeconom-ic freedomÓ almost certainly will end with a growing number of workerslocked in to a lifetime of debt service that absorbs every spare penny. Indeed,study by The Conference Board found that the proportion of householdswith any discretionary income whatsoever had already declined between 1997and declining wages will only tighten the squeeze on debtors.But homeowners are not the only ones who will pay. The overall econo-my likely will shrink as well. That $200 billion that ßowed into the ÒrealÓeconomy in 2004 is already spent, with no future capital gains in the worksto fuel more such easy money. Rising debt-servicepayments will further divert income from new consumer spending. Taken together, these factors willfurther shrink the ÒrealÓ economy, drive down thosealready declining real wages, and push our debt-ridden economy into Japan-style stagnation or worse.Then only the debt itself will remain, a bittermonument to our love of easy freedom. Chart Sources Federal Reserve; Lendingtree.com mortgage calculator; Freddie Mac; 4,5 Bureau of Economic Analysis; ic Analysis; U.S. Treasury Department; MoodyÕs Economy.com and Bureau of Labor Statistics; Federal Reserve and Bureau of Economic Analysis; 15 Center on Budget and Policy Priorities; 17 Japan Real Estate Institute; 18 Federal Housing Finance Board; 19 National Association of Realtors.