Analysts tell us that the current volatility is largely driven by a contraction in the value of real estate in the United States of America (U.S.) and governments around the world are taking the usual steps to reassure the public that this is only a temporary situation—a healthy, over-due correction in the normal cycle of our global economy.
While governments try to calm people’s fears and the markets seek a sustainable level, it’s a good time to reflect on what has happened to the U.S. housing market and what each of us can do to protect ourselves and our families. After all, there is a cause for every effect. There are reasons why investors are skeptical. And there are timeless financial lessons found in the world’s best-selling and most authoritative Book that continue to help individuals make wise financial decisions no matter what the markets do.
In their newly released (2007) book Crash Proof: How to Profit from the Coming Economic Collapse, Wall Street prognosticator Peter Schiff and co-author John Downes describe the rapid rise of American real estate as “the worst speculative episode in American history.” According to these writers, “The real estate bubble…has been artificially propping up the entire national economy. The unwinding will cause havoc reaching well beyond the stakeholders directly involved” (p. 116).
Schiff and Downes contend that today’s real estate problem began shortly after the bursting of the dot.com bubble in 2000 when the U.S. Congress gave taxpayers a $1.35 trillion tax cut and increased government spending. At the same time the Federal Reserve dropped the interest rate to an unprecedented low level (p. 117). Taxpayers immediately had more money to spend and the low interest rates made it possible for people to buy homes who had never been able to do so before. Those who could afford homes could suddenly afford more expensive ones.
Coupled with the low interest rates, lenders began relaxing the traditional standards by which borrowers could qualify for loans. Instead of requiring a down payment of 20% as was the case a decade or so ago, lenders began offering loans without requiring any money down. ARMs (adjustable rate mortgages) with artificially low interest rates at the beginning of the loan enticed even more people to buy homes on the gamble that interest rates would remain low and that they would somehow be able to make the payments when the rates rose.
Given this scenario, real estate became one of the hottest investments around. Some naïve home owners assumed real estate would continue to rise indefinitely and they withdrew their escalating equity via refinancing or second mortgages whenever they needed more cash to continue their spending. Their homes became their personal cash machines.
It was a recipe for disaster and sadly, the disaster has begun for those unable to make the payments on their loans. As happens in all overly speculative areas, eventually the good times end. Now as the prices of homes decline, many builders and home owners alike are having a hard time selling their properties. Many are also losing their homes via foreclosure.
While the severity of the contraction in the housing market and its ultimate effect on world markets is yet to be determined, the Bible provides a wise observation. Twice it says “A prudent man sees danger and hides himself; but the simple go on, and suffer for it” (Proverbs 22:3 Proverbs 22:3A prudent man foresees the evil, and hides himself: but the simple pass on, and are punished.
American King James Version×; 27:12, Revised Standard Version). What did the prudent—the wise—see regarding U.S. real estate?
In addition to noting the potential problems in the housing market, the wise could have noted and applied an astute financial principle. This principle simply says that “the borrower is servant to the lender” (Proverbs 22:7 Proverbs 22:7The rich rules over the poor, and the borrower is servant to the lender.
American King James Version×). This means that the borrower is in the more precarious position, being responsible for repaying the money borrowed.
Keeping this principle in mind, each of us can carefully consider whether or not to borrow money. Good questions for us to ask include: What happens if interest rates go up—a pretty sure proposition if we receive an artificially low initial rate? Will we have sufficient funds to cover an unexpected emergency? Am I putting myself in an awkward position?