November 16, 2006

Are you a Debt Slave?

This month, California has voted and approved $37 billion in bond packages that will improve the infrastructure of the state. The mantra goes, we will not raise taxes and be able to improve the state. Yet we will (and our children) will be paying for these bonds with interest for decades to come. Now how is this not a tax? Welcome to 2006 – where debt is credit and up is down and monkeys fly out of rear ends. Simply by changing the title of something people are mystified of the actual core of what is being pushed. The logic goes as follows: I want a plasma TV but it will cost me $3,000, money I do not have. But wait! I can have it for $100 a month over a five-year period. What has occurred with housing today is this “monthly nut” phenomena. People are happy that they can swing a payment no matter what the economic value of the item is. Financing has become the drug of choice for many recent home buyers and they are realizing that they need more drugs simply to maintain their previous high. This will be the undoing of the market.

As many recent articles have demonstrated, Americans are horrible savers. For the last year, Americans have gone into negative savings rates. Take a look at the chart below:

Not that Americans were ever good savers, unlike our Japanese brothers and sisters who save nearly 30 percent of their income, but we are now running a personal deficit each month. Anyone that has read any history book or economic book realizes that any country that runs trade deficits for a prolonged time is doomed to failure. This is tantamount to spending more than you make. What this does is that it creates a society where each month many Americans are simply paying debt service (ala the bonds) to fund their current spending habits. Take a look at the below data:

As you can see from the above chart, debt service has steadily increased for the past decade while housing affordability has fallen to a 20 year low. No surprise here. The financing machine that we are operating in will only stop when the mentality of those benefiting from it realize that they are slaves to their own personal consumption. People are literally mortgaging their lives away to debt. In no other time in history are middle-income folks able to purchase a large home, top of the line automobiles, furnish their homes with all the modern gadgets, and pay for it later in the future. The problem with this model as is being demonstrated by strains in our economy is that debt takes away from productive assets in an economy. So what is the median income in the top metropolitan areas in the country? Take a look at the chart below:

As you can see from the above, the median salary for someone in Los Angeles County is $60,000 per year. But this is based on gross numbers. What is the actual take home number for these people? Let us run the numbers:

Gross: $60,000
Monthly Gross: $5,000

FICA Medicare - $72.50
Federal Tax - $717.58
State & local Tax - $252.00
Salary deferral (401k/403b) - $250

Monthly Net Paycheck = $3,397.92

Now looking at the above, how much home could this person afford? If we follow the typical old school bankers rule of using 1/3 of your gross income for housing, we see that this person can afford a monthly payment of $1,666; aside from the fact that it is odd that the number of the beast appears in this formula (hmmm) it is absolutely impossible to find a home in Los Angeles County with a monthly payment of $1,666. The median home in Los Angeles County is $514,000 (DQ News). Let us run the numbers if this person were to buy a starter home:

Median LA County home: $514,000
Down payment 10% - $51,400
Mortgage - $472,857
Rate Set at 6.25% fixed for 30 years
Property Tax - $5,140
Loan Origination - $4,728
Misc. Closing Cost - $800
Home Insurance = $2,500
Points Paid = $4,728

Total Monthly Payment - $3,750

In all fairness, this house will provide monthly tax savings of $716 a month. So the total real monthly payment rounds out to $3,035. Again, going back to the median HOUSEHOLD INCOME, meaning 50 percent of all families fall below this point (and conversely 50 percent above) we see that our median family by no means can afford this home. They take home $3,397 and their payment (conservatively) is $3,035 leaving them with $362 of disposable income. Again, is there any doubt why ARMS, interest only loans, negative amortization loans, and any bogus debt slave™ product has grown through the roof? Keep in mind that this does not include the average American household having $10,000 in credit card debt, car payments, food, utilities, and all the other necessities of being human in an urban area.

The question I leave you is, are you a debt slave™?


Anonymous said...

On the salary chart, is the median salary per person or per household?

Dr Housing Bubble said...

On this chart it is per household. Data for median income ranges from $43,000 to $65,000 depending on the source - I tried to go high just to show the higher end of the scale. Below according to Wikipedia:

"The median income for a household in the county was $42,189, and the median income for a family was $46,452. Males had a median income of $36,299 versus $30,981 for females. The per capita income for the county was $20,683. There are 14.4% of families living below the poverty line and 17.9% of the population, including 24.2% of under eighteens and 10.5% of those over 64."

LA County Wikipedia

bubble_watcher said...

Just looking at the charts here, but it looks like housing affordability is going to revert back to the historic 90% level at some point in the near future while the Debt Service chart keeps on chomping higher and higher.

This month, California has voted and approved $37 billion in bond packages that will improve the infrastructure of the state.

Argh! And I voted every single one of these damnable bonds down.

Welcome to 2006 – where debt is credit and up is down and monkeys fly out of rear ends.

With $2 Trillion plus ARMs adjusting upward, I think its safe to say that we will be seeing a lot of monkeys flying out of rear ends in 2007..

Dr Housing Bubble said...


2007 will see the first major "shock" of the housing market. I think the major shock will occur in spring of 2007 for the following reasons (some which you already stated):

1. Inventory - many are wondering how could inventory be decreasing and at the same time sales are dropping. You would think inventory would drop when sales occur. But what is happening is many sellers are letting listing expire so they can relist in the spring 2007 selling season. Guess what will happen when many think this way?

2. Rates adjusting - As you stated, over 1 trillion in ARMS will adjust according to the MBA. Not only will this put a strain on would be sellers but it also makes buyers think twice about buying.

3. Zero to negative appreciation - Why would you want to buy when there is no rush? If anything, the trend is that housing values are going down. So the rush of the last few years of missing double-digit appreciation is now gone.

4. Market sentiment - Only a year ago you would be hard pressed to find negative information regarding the market. Now, major mainstream media outlets are releasing negative reports regarding housing daily.

2007 is up in the air in my eyes. 2008 will be a better gauge of what has transpired in the market for the last few years and the faint tune of the piper is becoming louder each and every day.

oc_fliptrack said...

I voted against those bonds as well, along with almost every bond measure to come down the pike since arriving in CA.

I'm convinced that people vote for these bond measures with the same mentality they apply to their own personal finances. Credit = wealth.

We [collectively] do not fear debt any longer. This will not be good when it breaks.