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dwot (99.50)

Debt Slaves and the Slug Economy

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December 04, 2007 – Comments (13)

In university I was required to take any first year economic course as a pre-requisite for second year economics.  At the time I took the course I went on and on questioning the use of studying serf and slave economies in the economic history course I had chosen.

As I've aged I've come to find that was one of the most useful courses I ever took.  For example, I had a belief that people had always started families young until my generation, yet in the course I found that there have been many swings and in general when the economy is good people have children young and when it is hard they don't.

Another thing that was interesting was the degree to which people accepted their lot in life by comparison to "today's" standards.  When I took the course, around 1987, I had no idea how incredibly good standards were, or the degree to which they could decline.

In slave societies the slaves had little control over their lot in life, but they effectively protested for better treatment.  In serf societies people were tied to the land, always just barely able to grow enough to be able to eat and pay their "taxes."  They were as much slaves to the land as the "real" slaves in the slave economies.

Today we have debt slaves, and a debt slave couple was featured in a news story.  They have two mortgages, a car loan, student loans, and credit cards.  One morgage is $352,000 at 4.97% and the other is $85,750 at 8%.  With $40,000 in student loans, that's about $478k in debt without the care.  They have two kids living on a single income family.

At 5.25% interest debt servicing is about $25k per year without including the car loan.  For this family's home to be "affordable," he has to earn at least $150k per year, but affordable usually includes saving for a down payment so your debts are about 75% of your home,  not 120%+ of the value of your home.  For this home to be affordable with that expectation he has to make about $200k per year.

With $478k of debt paying an extra $880/month towards debt is not a lot in terms of trying to get out of debt.  By my calculations if they had the 4.97% rate throughout the mortgage that much extra payment would change a 25-year mortgage to a 16-year mortgage.  But they couldn't afford the mortgage rates reseting so they certainly will not be able to afford to save for their children's college or for their retirement.  They are not able to meet the debt obligations they agreed to and they want to give away a $5k annual tithe?

He is 39 and she is 38.  They been content to pay only interest on their first mortgage for the past 3-4 years.  At the rate they are going, and their current plan, he will be 66 and she will be 65 when they finally pay off their mortgage.  Their current $2900/month is not paying any principal on the first mortgage, so they will eventually have to pay more if they ever intend to get out of debt.

In "Instilled Truths" I mention my own home owning experiences, having paid $300k for a home in 1995, in a city with relatively flat wages. OK, so I felt it was actually important to work towards paying back debt, which cost lifestyle, but I know from the experience that buying a home in a city that is not affordable, ie the median home price is more than 3 times the median wage (it was between 4 and 5 when we bought), that all you seem to do is pay mortgage.  We shared a vehicle for 12 years.  We had a higher than average household income, but we were not higher than average in terms of spending in the economy due to paying debt.

For 2006, San Diego had an affordability index of 10.5.  This family will not have disposible income for much at all and will be hard pressed to provide for their retirement. 

I can not see how a economy over-wrought debt slaves can expect much economic growth so I doubt higher wages will help this couple out.  High debt in a slug economy, it is going to more than rough. 

13 Comments – Post Your Own

#1) On December 04, 2007 at 2:13 AM, FleaBagger (32.74) wrote:

Unlike the slaves and serfs of yore, these people brought this situation on themselves through their own carelessness.

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#2) On December 04, 2007 at 9:39 AM, Zanibel17 (98.36) wrote:

Flea-

We are taught at an early age that we should pursue home ownership, that it's the 'American Dream' no matter how expensive.

We're told to pursue higher education at the 'best' schools so that we can have a prestigious job even if we must borrow thousands of dollars for that privelege.

We are brought up in public schools that fail to teach us to think critically or question authority, and to always trust our leaders.

So when you say these people were 'careless' and 'brought this on themselves,'  I say that the system is DESIGNED for people to become indebted.  These people have been victimized, but they will never realize it, because they will believe those who say it is all their own fault. 

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#3) On December 04, 2007 at 10:09 AM, dwot (99.50) wrote:

I am not so sure FleaBagger.  Yes I think people who find themselves in the situation in the story brought it on themselves, but if I look at the bigger picture of the messages out there...

Here's what I mean.  I have an 80-year-old neighbour.  For me, I know that by going to university I lost the "I won the home equity lottery."  While I was studying 60-70 hours per week, there was an extreme change in the economy here in Vancouver.  Our home prices were close to triple what they had been when I did an estimate of what a home would cost me and what kind of wage I might make.  If you took a snap shot of Vancouver in 1985 and what the costs were, with a university degree and a job with the 1978 wages that a friend of mine had made when she worked in the area I had chosen to study, well, I could have bought a 3-bedroom townhome, a new car and had an annual vacation and been comfortable.  That was what I was looking at when I decided to go back to school.  I was 23 or 24 at the time.  When I got out in 91 wages were 10-15% less than what this friend had earned in 78 and housing was 2.5 to 3 times the price, well, by the time I had a down payment that's what it was.  There was NO chance of home ownership on my own, and even today the car I drive is 18 years old.  Yes, at this point I could afford a new car, but finances are only now getting comfortable so why would I want to take on more debt?  The car works.

There isn't much room for lifestyle when the economics change that much.  I talk about the economic changes and I constantly get this "you are young and have lots of time" and "things always work out" retoric from people in this age group.  I get the same talking with the blinders on from lots of people from around mid 50s on. 

It is stupid really, sometimes they will say they don't know how young people do it, but then they hang onto this retoric that things always work out.  They have memories of when things were tight and it did work out.  But they fail to look at the difference between short term hard times and no way out economics many young people face today.

I think young people get huge mixed messages and we are taught that we should strive for home ownership and there are tons of messages that things always work out.

So, yeah, these people were foolish in not truly assessing the economic difference they face compared to the totally moronic messages out there, but if you look at the serf societies, earlier they had a better lifestyle only to see it decline over time.  So would you blame the later serfs because the earlier serfs had it better?

The "rules" and "truths" change, and I believe they've change in far more ways than people realize.

Here's one that I'd like to come back and discuss in 10-20 years, "over the long term the stock market always goes up."  

I think the market has been highly artificially pushed up due to the aging population and a bulge of people looking for places to invest.  If not investing directly, their pension plans are doing the investing on their behalf.  As the aging population becomes net spenders and is no longer saving for their retirement but are instead are drawing on their retirement funds, the market will correct downwards.  And, as they pass on, their debt slave children will for sure cash out in order to pay off debt.

This is NEW and it is coming.  Up until now there has NOT been a net draw on investments due to an aging population.  People over about 40 and especially over 50 generally do try and put something aside for retirement.  There is a huge bulge in the population doing this because of demographics. 

The debt slaves below them are not going to have the same economic power to invest, so far, far fewer will be involved in saving beyond what they must pay for pension for their future.  Pension plans will be paying out more than they collect over all.

Yeah, they brought this on themselves, but I also think it has been driven by message about what society was without reassessing what it is today and doing what you were taught was the best, right, wise, responsible (fill in as many blanks as you want) thing to do. 

I have always been an advocate of responsible and strong lending laws.  The nature of humanity is that self-serving interests will always prevail over responsibility for enough people to make an enormous mess for the rest of us.  The nature of people is that they tend to want things before they can afford them. 

A capitalist society without controls is highly predatory and allows fraudulent practices to be legal. 

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#4) On December 04, 2007 at 2:01 PM, Imperial1964 (97.92) wrote:

It's a combination of both.  People's greed and carelessness, and the materialism that has been impressed upon them.

They're always told to buy it now and pay later and nobody explains to them that when they buy a depriciating asset (e.g. a car) on credit, they are getting screwed twice.

I agree with Zanibel (as usual), except for one point.  Every debt slave I know blames the situation on somebody else.  A layoff, confusing fine print, the system being rigged against them, etc.  That is true to some extent, but such thinking simply gives them an excuse for their behavior and prevents them from making any real changes in their life.

A friend of mine and his wife together make about half what I do and they own a bigger house (bought no-money-down) and 15-year newer vehicles than I do.  And they are both part-time students.  What makes them think they can afford that???  And when the house gets foreclosed and the car that still runs gets reposessed, they'll blame it on his unemployment.  He worked construction and it is wintertime.  For those who don't live in the north, construction workers in Illinois often spend about 3 months out of the year layed-off.

How much intelligence does it take to see that their situation wasn't going to work?  Both of them and thier lender should've seen that it wouldn't work!  They were in court for not paying their credit cards and on the verge of bankruptcy the month before they bought the house!

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#5) On December 04, 2007 at 2:39 PM, GS751 (28.08) wrote:

"and even today the car I drive is 18 years old.  Yes, at this point I could afford a new car, but finances are only now getting comfortable so why would I want to take on more debt?  The car works."  Being in the middle between high school student and college student I see people loaded with debt left and right.  At my job I make more than the mean income but there is a reason that I make my own lunch and not go to starbucks, subway etc. 24/7 and ride my bike, (don't own a car).  Through my low cost budgeting I have accumlated a decent amount of Berkshire B shares, If I keep this up through college, live a low cost lifestyle and let my Berkshire compound in my Roth IRA I will have a nice retirement.

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#6) On December 04, 2007 at 8:12 PM, dwot (99.50) wrote:

Well said Zenibel, except for the education part.  Perhaps what you say there is true, but I would prefer it to be said that we don't provide funding to enable schools to teach us to think critically.   "Inclusive" education means we put students with kindergarten or primary school abilities in high school classes...  We have also taken power away from teachers to teach kids responsibility by not having a requirement that if they aren't working they must attend summer school or repeat a years.  There are few consequence for kids who choose not to work as they are pushed forward whether they are ready for it or not.  I do wonder if part of the reason we don't make kids repeat when they are behind is because of funding.  It is saving pennies for dollars as these kids are disruptive simply because they can't keep up, so they in turn disrupt the quality of education for the rest.

Imperial, the example you give is incredible.  

GS751, being frugal will always work more in your favor and will provide for a better future, but I wouldn't trust Berkshire's past to be predictive of its future. 

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#7) On December 06, 2007 at 10:55 PM, infoLust (99.43) wrote:

that's my brother in a nutshell.  only he make far less than that.  I tell him free up your cash flow and default.

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#8) On December 06, 2007 at 11:19 PM, infoLust (99.43) wrote:

the other debt is tax and we get nothing in return for it except  road.  The richest country in the world and all we get is road.  I'm taxed about 40% of my income in total and when hard times knock I get less than 15% of it back.  Actually I've never tapped into it in hard times.  So I've actually received zero and road.  My salary got garnished finally for some student loan that I need to pay back but actually, they've received in tax multiples more than my student loan.  In demark you get paid to go to college. Actually I'd rather get taxed 25% more and get somethign for it.  We let corporations deteriorate our life ever so gradually in the name of free markets which has become synonymous with freedom of speech.  We don't understand quality of life.  We get only two weeks vacation a year.  Some strange virus on my computer forwarded your blog page to a porn site.  My commute to work I feel like a grain of sand flowing through an hour glass.

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#9) On December 06, 2007 at 11:57 PM, infoLust (99.43) wrote:

the link is wrong on the caps home page. just checked with my iphone.  It forwarded to some weird search page with ladies in bikinis.  i guess the unknown domain search page.  maybe some one got let go at moptely fool.  hehehe.

 

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#10) On December 07, 2007 at 7:22 PM, dwot (99.50) wrote:

My blog got forwarded to a porn site?

 

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#11) On December 10, 2007 at 6:34 PM, TMFCHarris (99.66) wrote:

dwot,

It looks like the link was showing the server name in the URL, which would lead to a file not found screen when the server was not on rotation. It should have been a 404 screen - I have no idea why InfoLust saw bikini babes.

 Info - you may want to check for malware, because that page was one your browser sent you to, not the Fool.

Hope that helps,

Chris 

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#12) On December 12, 2007 at 1:27 PM, Bimmer325 (< 20) wrote:

dwot,

Nice reflection of your introduction to economics and it's applications. Interesting that the folks in "debt slaves"  - as you  observed - have a different application philosphy than yourself that appears to make little or no sense at all.  In fact, it makes perfect sense.

One day a number of years ago, I was marveling at my busniess partners' extraordinary sales volume. As we talked the conversation transformed from sales to human behavior.  It was at this point that he made this statement:  "Quite frequently people do what they know rather than what they should."

The obvious question becomes, "how can they not know that their spending is unwise?"  And the answer is simple:  In an economic environment driven by the continuous barrage of fear-focused, immediate gratification oriented advertising and foolishly supported by political leadership, we find a public education system that fails to address at an early age the fundamentals of finance.

People do what do because it's what they've been taught.  The input takes many forms including but not limited to familial observation, advertising and the history with which they grew up.  Interestingly enough - and in my own experience - we find that depression-era children have spending habits far more conservative than their free-spending boomer counterparts. Not surprising given the harsh lessons of economic scarity between 1935 and 1950.  They do what they know.

I would ask that we all go easier on each other and appreciate the reality of what shapes our behaviors. Few are stupid, most are simply undereducated.  Support those initiatives that make financial education a fundamental part of the public school system beginning at the elementary level while you continue to provide a positive example for your children at home.

Just my .02

Bimmer

 

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#13) On December 12, 2007 at 6:12 PM, dwot (99.50) wrote:

Good position Bimmer.  I teach and don't think people appreciate the challenges of the fact that we have a mass education system, yet children with individual needs and the support and funding for education has been declining.

I have broken down the many ways debt at low interest rates is actually much worse than debt at high rates in "Six Degrees of Leverage," a six part write-up.  They are all in December and the link takes you to my December posts.

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