The weird thing about the tumbling of the latest financial house of cards is that the cornerstone, such as it was, was confidence in the increasing ability of the bottom half of society to pay back unprecedentedly large debts.
Underlying these vast pyramids of debt was, all too often, a promise by a single mother who works at the DMV or a drywaller from Chiapas to (following a brief teaser period) make mortgage payments of, say, $3750 per month for the next several decades.
In recent times, investors have typically gotten rich in our society by betting on the rich to get richer. And most of the time, that's what happens: the rich get richer. Every so often, however, we have a meltdown because, during the bubble, investors temporarily overestimated the rate at which the rich will get richer—e.g., Silicon Valley in 2000, the Texas oil patch in 1982, commercial real estate developers around 1990, and so forth.
But, most of the time, you can get richer betting on the rich to get richer.
For example, Southern California is full of people who used to be movie, TV, or pop music stars but aren't anymore. Yet, with the exception of addicts who blew all their money on drugs, you almost never hear of ex-stars having to undergo the humiliation of having to get real, boring, non-glamorous jobs to pay the rent. Among ex-stars who stay off drugs, you find a lot of them during the longer and longer periods "between projects" coaching their kids' soccer teams, taking yoga classes, noodling on screenplays they never finish, walking their dogs, and just generally enjoying pleasant lives without bosses or jobs.
A big reason for them not running out of rent money: back when they were making lots of money, they didn't rent, they bought—and in very expensive neighborhoods.
One of the things everybody does when he becomes a star is to buy a house in Beverly Hills. And then when you aren't a star anymore and finally run out of money, rather than get a job, you sell your Beverly Hills house, which has appreciated dramatically, to somebody who is currently a star, and you buy a cheaper house in Santa Monica and live off the difference while you pretend you still have a career in the industry.
Then, after a decade or two of going out to lunch at nice restaurants you are running out of money again. So you sell your Santa Monica house to a newly rich person for a lot more than you paid for it and buy a cheaper house in Encino. Lather, rinse, and repeat.
This strategy works because the rich have been getting richer.
What's totally strange about the mortgage meltdown, however, is that the bet, at its base, was on the more marginal members of society to be able to pay off their inflated debts—a bet on the pretty-close-to-poor to get pretty-close-to-rich.
And that made no sense at all.
The homeownership rate had been stuck at about 64% since the late 1960s. The Clinton and Bush administrations pushed hard to get it up to 68-69%.
What in the world made anybody think that the second quartile up from the bottom was developing more earning capacity?
They'd sent their wives out to work a couple of decades before. What could they do now to pay bigger mortgage payments in the future?
The second quartile folks weren't getting better educated, weren't getting more unionized, weren't facing less competition from China, weren't facing less competition from immigrants, weren't getting married at higher rates so they could better pool their earning capacity.
So what trend suggested they were now developing more capacity to pay back huge debts than before?
Let me try to vaguely quantify how weird this is. The LA Times regularly reports on real estate dealings of celebrities. We regularly read that somebody whom you sort-of remember from some sit-com in 1978 has sold his home for $2 million. Bigger stars frequently sell homes in the $5 to $10 million dollar range. The real superstars' showpiece mansion estates go for maybe $12 to $25 million.
So, let's say that big stars' homes in the Hollywood Hills go for a median of $11 or 12 million. In the spring of 2006, the median sales price of all homes (houses and condos) in the Los Angeles region, an urban area of about 5 million people that includes vast tracts of Nowheresville in South Central and the San Fernando Valley, was $580,000. (It's now just under $400,000). So the ratio of home prices for stars to nobodies was about 20 to 1.
Now, 20 to 1 sounds like a big difference. But most measures of ability to pay would favor stars over nobodies by much more than 20 to 1.
Consider net worth outside of home equity. I would guess that most people who take out a $10 million mortgage might have, say, $10 million in stocks, bonds, CDs, art, vintage cars, and other assets, for a 1 to 1 ratio. What was the net worth of the median buyer of a $580,000 home with almost zero down payment in LA in 2006? $58,000? Maybe not that much when you subtract the car loans and outstanding credit card debt.
If the median net worth was $58,000, that's a ten to 1 ratio between mortgage and net worth (heck, there were buyers in 2006 and 2007 who had a net worth consisting of a monthly bus pass and some lottery tickets, so their ratio was close to infinite) vs. 1 to 1 for the rich folks.
Obviously, I just made most of these numbers up. But I know that I at least got the sign right. So how did people not notice that financial institutions were making huge bets on something that just wasn't happening—the lower middle of society getting much better off economically?
That level of stupidity requires a bipartisan consensus on what you aren't allowed to talk about in public.
Are you some kind of Communist who is saying that America''s free enterprise system can't generate enough high-paying jobs to pay for all this debt?
Oh, wait—it just didn't.
And they just haven't.