“My Two Cents”
By Andy Sutton

8/4/2006

I saw an interesting headline this morning on an Internet news site. It mentioned the Second Amendment to the Constitution, and that it ought to be renamed the Right to Keep and Bear ARMs. I had to laugh. The golden slippered darling of the financial world has been taking quite a beating lately, and deservedly so. What was once an instrument to give the prudent potential homeowner some flexibility has turned into a masochistic torture device used to lure the unsuspecting into a life of servitude to their mortgage company.

The adjustable rate mortgage, and the even more perversely named "home equity loan" may well be the two biggest causes of the upcoming financial collapse once we begin the postmortem on the US economy. We could certainly find other causes as well, but that would require looking in a mirror, and chances are that once this mess comes to fruition, many may not be able to afford one. If the Federal Reserve is the pump in this liquidity game, then ARMs are the pipes and equity loans are the spigot.

ARMs are the carrot that lenders dangled in front of sub-prime borrowers as a means to get them into a house or to get qualified buyers into a BIGGER house. I've read stories of people who make minimum wage qualifying for outrageous mortgages. For the longest time, banks didn't care if the poor dimwits defaulted; the bank knew it could turn around and make 20% selling the house on its own. If the poor dimwits didn't default, the bank then came back 6 months into the game and offered an equity loan.

Home value is a funny thing. A realtor once told me a house is only worth what you think it is until you try to sell it. Why a bank would be willing to loan you money based on unproven value is still a mystery to me, yet each week, I get at least a half dozen letters offering exactly that. They tell me I'm missing out on a huge opportunity if I don't take advantage. An opportunity for what? Monetizing intangible 'value' and leveraging my family's future against the silly notion that home prices will rise ad infinitum sure doesn't seem like an opportunity to me.

Sadly, this engine named foolishness and its caboose called insanity is the train that drives the US economy to the tune of trillions of dollars per year. Consumer spending is nearly 3/4 of GDP, and much of this spending over the past few years has been a direct result of the excess liquidity pumped into the system by the Fed and spent by homeowners through home equity loans. ARMs got them hooked, the equity loans buried them. To make matters worse, much of the rest of the spending, at least lately, has been done on high interest credit cards or from savings. With the savings rate at -1.5%, the spending will have to end. Contrary to Central Bank lore and political doublethink, there is a critical mass where people will no longer be able to service their debts, let alone rack up any more. At that point, the game, indeed, will be over.

What's that gasping sound you hear? I'll tell you. Its 230 years of American superiority running out of air on the ocean floor.

Andy Sutton holds an MBA in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics.

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