In the US and Britain, ordinary people are suffering in their prosperity. They have enjoyed more apparent wealth – bigger houses, more vacations, more dinners out – but this is wealth consumed, not wealth created. In order to afford to spend so much more money, they had to borrow. So their real net wealth actually went down.
“Lost your pay slip? Call us…” say signs along the highways in Britain. We had no idea what this meant. Why wouldn’t people just ask their employer for a copy?
“Oh no…it’s a big scam,” MoneyWeek editor Merryn Somerset Webb enlightened us. “There’s a whole industry of people who provide fraudulent pay slips so that you can get a mortgage to buy a house.”
And now many of these people are living in bigger houses, but sending in higher mortgage payments and more property taxes, and these larger houses cost more in utilities. When the going was good, it looked as though it would be no trouble to keep up this level of extra wealth consumption. But now that the going is not so good, many of these people are in real trouble. Some are trapped between two mortgages and need to sell a house fast. Others simply have mortgage payments that are too large.
Mortgage rates are rising in the United States. And in Britain, last week, the Bank of England raised rates. “Now it REALLY hurts,” shouts a headline in The Daily Mail.
Freddie Mac predicts that house sales this year will drop 7% – to their lowest level since 2001. And an article in Barron’s explains why. The REAL mortgage rate is the difference between what a person pays for a mortgage loan and how much the property goes up. If mortgage money costs 6%, and a house goes up 6%, in effect, the real cost of the mortgage is zero.
A couple years ago, people might have paid only 5% for mortgage money…while their houses went up 15%. It was as if the mortgage rate was really MINUS 10%. But now, house prices aren’t going up…they’re going down – at least in America.
Barron’s put the real cost of a mortgage at about 6%. But in an area such as Orlando, Florida where house prices could be falling fast, the real cost of a mortgage could be 10%…or 15%. No wonder sales are sluggish. Who wants to buy a house under those conditions?
Not only is the marginal homeowner subjected to some real pain, so are the rich professionals who lent him money. Credit Suisse estimates that real total losses from CDOs (collateralised debt obligations – derivatives backed by mortgages) will top US$52 billion. Of course, that assumes that no one panics…and nothing else goes wrong.
Markets and Money