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.