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Friday, March 25, 2005

The Sharecropper Society

If you owe the bank 100 pounds, you're the one with the problem. But if you owe a million pounds, the bank's the one with the problem.
- Lord John Maynard First Baron Keynes of Tilton.

From the NY Times: The average house in San Jose, Calif., costs 35 times what it would cost to rent for a year. In Naples, Fla., some houses have been bought twice in a single day, an early-21st-century version of day trading. Buying stocks on margin has morphed into buying homes with no money down. The over-the-top parties of Internet start-ups have been replaced by flashy gatherings where developers pitch condos to eager buyers. The can't-miss aura of real estate has also helped nudge many families to invest more of their personal wealth in real estate by buying more expensive homes and taking on riskier mortgages...

On that note: Theres been a lot of lip service given to the "Ownership Society" these days. At every chance the Fed and administration officials boast about the unprecedented level of home ownership. Calculated Risk's
Free Money and Barry Ritholtz's The Big Picture - Household Debt at Historical high observations validate something I've been saying for the last year.

The reality is that a large percentage of homes "purchased" in the last three years are actually being LEASED with an option on potential profits. 100% financing, low rate ARM's or interest only loans make this possible.

Take the auto purchase as an analogy. You don't need a new car, but the allure of easy money and the terms are so attractive. You can't really afford to buy the Chevy, but under a lease you can get the Mercedes, and the dealer financing arm will look the other way, just so they can move the inventory and make some fees.

In the case of a home purchase, the monthly payment is just an overhead cost for you. A first time buyer was paying rent anyway. Why pay rent when you could own and maybe make a profit with no risk? Whats another $1000 or less a month? Roll those dice and you get the tax benefit and the potential profit on a sale.

In the case of a move-up, you had a mortgage at a higher rate anyway. You can cash out your existing equity and pocket it, lower your payments with a lower rate, go 100% loan to value and pay interest only!!! And best of all, first time buyer or move up, you have zero exposure and nothing to lose. Worst case scenario , you just walk, go rent for less and the bank eats it.

One final note, refering back to Keynes quote, when you owe the bank, you don't really own it, they own it. You pay interest for the right to be a sharecropper. And in the end, if enough people walk, its going to be the banks problem. And ultimately, like the S&L crisis, it will be the publics problem.

NY Times: Real Estate Instead Of Dot Coms


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