When my parents bought a house in south-east England, in 1940,
they paid all cash. It was the world of Foyle’s War, the
British TV program seen on PBS. I’m not even sure that home
mortgages existed at the time. Perhaps they did, but I don’t recall
hearing about them until I came to America.
When I bought a condominium myself, in Washington, D.C., in
1983, my down payment was 50 percent of the purchase price. I could
have paid less, but I didn’t have a 9-5 job (still don’t). So I
brought with me to the money-lenders a letter from Ronald Reagan
(written before he became president) saying how much he enjoyed my
articles. And another from Jack Kemp. That impressed them, but the
50 percent down payment probably impressed them more.
For years, the assumption has been that if you need money you
can always borrow it. You need more? Borrow more. Then things went
totally out of control. You could borrow the full value of a house
without showing that you had any means of repayment. Sometimes you
could borrow more than the full value. Then the housing bubble
burst.
A key error of postwar finance, still uncorrected, was the
persistent encouragement of debt. It was assumed on Keynesian
grounds that savings are actually harmful. They vanish into an
unproductive “sump” and reduce consumption. Saving was duly
discouraged—both taxed and inflated away. Meanwhile the interest we
pay (on a home mortgage) became tax deductible.
The old Keynesian joke—”In the long run we are all dead”—became
unofficial policy. Enjoy now, pay later. Borrow like there’s no
tomorrow. Time horizons were extended to infinity. The virtue of
prudence, built up over the ages, was cast aside. Debtors, for whom
there were once prisons, became winners. Economic theory and
traditional virtue became antagonists.
We talk today about rewriting the tax code. That is needed, but
in our climate of deliberately aroused class resentment, changes
that will encourage saving are unlikely. That would only help “the
rich.” Home builders can be relied upon to preserve the mortgage
interest deduction.
Governments had already learned that if they increase cash
benefits without charging anyone, no one complains. Deficit finance
was normalized. Making matters worse, ideologues in Europe thought
they could “unify” the continent with a single currency. They
promptly ignored their own deficit-limit rules (not to exceed 3
percent of GDP), and southern-tier countries like Greece assumed
that EU membership meant that the good times would never end. The
euro’s fixed exchange rates prevented local adjustments.
In the U.S., debt was further encouraged by Fannie Mae and
Freddie Mac. They would buy loans from banks that had lent
irresponsibly, and before you knew it the federal government was
guaranteeing those loans. Non-obliging banks were threatened with
lawsuits and penalties if their refusal to make new loans was
deemed discriminatory. Barney Frank and Chris Dodd reminded us that
we’re all entitled to buy a house. Claiming that an applicant
didn’t have enough money to qualify was probably disguised
racism.
Many of these bad loans are now insured by taxpayers and we are
on the hook for more than $150 billion. If the “Occupy” people
think that those responsible for this fiasco should be jailed, I am
with them.
We now imagine that buying a house must be encouraged. But that,
too, is recent. My father bought a house, but his father didn’t,
although he could have afforded one. Before World War II there was
very little inflation—perhaps none. Property rights were secure.
Owners could “let” property without the fear that tenants would
become immovable squatters.
The rise of inflation from (say) the 1960s to the end of the
century then made owning a house a wise decision. The value of the
house rose to protect the buyer against inflation. But that is no
longer true—except in privileged enclaves like the nation’s capital
(where house prices have fallen very little).
MEANWHILE, DEFICIT FINANCE prevails across the board. Payroll
taxes are spent by Congress the minute the money arrives. The
Social Security system is already paying out more than it takes in.
“Revenues cannot keep up with the flood of baby boomers who are
retiring at a rate of about 10,000 a day,” said a former
administrator of Social Security.
The so-called “trust fund” now consists of about $2.6 trillion
in non-marketable Treasury IOUs, kept in a filing cabinet in a
government office in West Virginia. Social Security is “currently
redeeming those securities to cover its cash shortfall,” wrote
Allan Sloan of Fortune. But the Treasury “has to borrow
money from investors to get cash to pay the trust fund so the trust
fund can pay Social Security beneficiaries.” In other words, Sloan
added, the financial position of the government as a whole “is no
better than it would be if there were no Social Security trust
fund.”
Which means there is no trust fund.
All this will be hard to reform. Recipients of government
benefits have one vote each and they may already outnumber the
taxpayers (also with one vote each). In 2009, Senator Cornyn of
Texas said, 51 percent of households either paid no income tax or
got money back from the government through the Earned Income Tax
Credit. About 46 million Americans receive food stamps.
The Democrats, representing the recipient classes, have the
power to prevent spending cuts. The debt ceiling showdown last
summer was an all-out effort by the combined forces of the media
and Washington to get Republicans to raise taxes. The GOP mustered
the will not to do so—for the time being.
But the present path of government finance is unsustainable, and
those in power don’t know what to do (except raise taxes). The
chess expert Garry Kasparov said recently that some economists
(such as Nobel Prize winner Paul Krugman) think “we haven’t
borrowed enough to get out of a crisis brought on by too much
borrowing.” But Krugman has also said some good things—for example
that austerity will not get us out of the present mess and will
stymie economic growth. Without that growth, something has to
give—and soon.
In Europe, it’s austerity across the board. Tax increases are
being imposed on everyone and we have even seen a few spending cuts
here and there. The ruling class in Europe is trying to get the
European Central Bank to solve its continent-wide debt crisis by
inflation: devaluing the euro by printing trillions more of
them.
So far, however, inflation has shown little tendency to
reappear, here or in Europe. In fact governments’ hands may be
tied, not by legal restrictions but by bond markets. In a
free-market order dominated by debt, bond markets may be more
powerful than governments. That’s what infuriates the ruling class
today—its subservience to market forces.
Inflation allows governments to repudiate their own debts (as
Germany did after World War I). But to do this successfully, the
monetary authorities must fool creditors into lending money at low
interest rates. That way, capital melts away and governments regain
power at the expense of the people. On the other hand, if inflation
is seen to be returning and lenders immediately demand compensatory
interest rates, the government’s own debt payments soar and
inflation is self-defeating.
The “bond vigilantes” are watching, but the remarkable fact is
that the interest rate on 10-year Treasury bonds has been dropping
this year. It is now down to 2 percent. On a 30-year fixed-rate
mortgage, the interest rate is 3.5 percent—lower than it was in the
Eisenhower years. The gold price, a closely watched proxy for
inflation, peaked at $1,900 an ounce in August, and is at $1,592 as
I write. (Its low for the year was $1,314 in January.)
Where are we headed? I’d be rich if I knew. But our time
horizons are rapidly closing in and the long run is short.
