”What they really signed up for was the hard servitude of debt serfdom”

From ‘The New Road to Serfdom’ by Michael Hudson, 2006.  This was written at a time when sales were crumbling, listings rising, and home prices were just starting to show weakness.  Sound familiar?

”With the real estate boom, the great mass…can take on colossal debt today and realize colossal capital gains—and the concomitant rentier life of leisure—tomorrow. If you have the wherewithal to fill out a mortgage application, then you need never work again. What could be more inviting—or, for that matter, more egalitarian?”

”That’s the pitch, anyway. The reality is that, although home ownership may be a wise choice for many people, this particular real estate bubble has been carefully engineered to lure home buyers into circumstances detrimental to their own best interests. The bait is easy money. The trap is a modern equivalent to peonage, a lifetime spent working to pay off debt on an asset of rapidly dwindling value.”

Most everyone involved in the real estate bubble thus far has made at least a few dollars. But that is about to change. The bubble will burst, and when it does, the people who thought they would be living the easy life…will soon find that what they really signed up for was the hard servitude of debt serfdom.

Today we found out that almost half of potential first-time home buyers, that dwindling pool of real estate market lubricant, believe that the market has shifted into a buyer’s market.  The implication, according to RBC who conducted the poll, is that this will translate into higher home sales in the coming months as these newbies seize this momentous opportunity to snatch real estate at the bargain price of a few percentage points below their all-time highs.

I’m not so convinced that it will have a material impact in the face of the massive declines in sales we’ve seen in every large centre, but it does highlight how naive first-time buyers can be when they mindlessly perpetuate the unfounded idioms of society at large.  With the average downpayment for a first time home buyer now in the 7% range, it means that to buy the average home in Canada, it would require a mortgage of just shy of $310,000.  Amortized over the maximum 35 years at a consistent rate of just 5%, well below the long-term average, the home owner would still pay almost $350,000 just in interest charges for a grand total of over $650,000.  Do they get how much money that is?  Do they get that after 10 years they will have paid off a grand total of $40,000, still owing $270,000?

So for 10 years, they would be making mortgage payments of almost $1600, of which almost $1300 is interest, plus property taxes, insurance, and maintenance.  As I’ve always said, the vast majority of first-time home buyers are still renters.  They’ve just gone from renting space to renting money.  And it’s darn expensive rent at that!

So why do they do it?  ‘‘It’s got to the point that home ownership is now considered the only “proper way” to raise a family,” noted this article from the Post.  Mass psychology at work!

In a different article earlier this week, TD Chief Economist Craig Alexander noted that, “it’s become more common for children to go directly from their parents’ home to buying a home, skipping over the renting stage that had become common for previous generations.”

Of course, this is reflected in our rising home-ownership rate, now having eclipsed the high-water mark the US experienced during their bubble.  With home-ownership rates rising across all cohorts, it means a shrinking pool of first-time buyers out there.

As Hudson noted above, this extreme love affair with home ‘ownership’ and repudiation of renting can be rationalized IF home prices increase as they have in the past, providing the owner with tax free capital gains or if incomes are pushed higher via sustained inflation, making the debt burden less onerous.

But what if I’m right?  What if the perpetual expansion of debt has nearly reached its limit?  What if I’m right and a secular shift away from debt and towards frugality is virtually assured?  What if I’m right about the great feedback mechanism that real estate provides to the broader economy: increasing demand for loans, increasing consumer spending and consumer confidence, increasing employment, and in turn increasing real estate prices again?  What happens when this mechanism hits the reverse button?  The answer is deflation via falling demand for credit and recession due to the associated feedback mechanism.  It also means wages stagnate or more likely decline for years.  All assets relying on credit to be funded will be hammered, as the US, UK, Spain, Ireland, Greece, and many other countries are realizing.

But understand this:  The debt remains!

So think long and hard before you walk the road to serfdom.  Our societal attitudes towards debt are both very new and very unusual in the timeline of human history.  To be caught on the wrong side of a mean reversion can be a nasty affair.



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One Response to ”What they really signed up for was the hard servitude of debt serfdom”

  1. Vinny says:

    Thanks for an excellent article ben!

    Although I would point out the majority in the next generation of home buyers has been groomed up to be of the notion that income rises and inflation will reduce the burden of debts. Barring those across border who have had a first hand experience with the opposite, it does become very hard to drive the point across to a cohort who have concrete faith in their previous generations prosperity plan.

    They seem to think there is nothing wrong with sacrificing 30 years of purchasing power to put a roof over their head and commit to additional compromises to their lifestyles, as they compensatory trade-off in capital gains more than offsets it. As you have previously highlighted, rosenberg’s research indicates that values and price/income ratios are not normal. And it will mean revert, although speed and magnitude of the correction is hard to predict.

    But for the elite human class, 4 decades of data analysing is not enough to accept that they might be wrong!

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