As American as Debt

            When you review some of the most important aspects of financial markets, allowing individuals the ability to borrow money is important. Having a large amount of funds available in your debt markets is important for pushing down the rate charged on debt. This is surely a good thing, because without it you would not be able to purchase a car or house unless you were quite independently wealthy. There is, however, some major concerns about where our society is moving in regards to debt and equity. You cannot escape hearing about the sub-prime mortgage mess or the collapse of the debt markets in general. It may be worth taking a look at why and how we are having issues with debt in America.

 

            In understanding current problems, it may first be helpful to ask the question, where does all this debt come from. The simple answer is that every dollar borrowed is a dollar lent, meaning that there is somehow an excess of dollars coming from some portions of society. While every person is in a sense lending each other money in our modern society through the banking system, those with the most money have the most free funds to offer, and they can lend it most freely. In our society today, unequal wealth distribution has become more and more noticeable, providing a liquidity glut that has increased the funds available for lending and decreasing the debt rates.

 

            Now with all this cheap debt available, it may be important to understand what this does to house or other asset values. I would like to use the example of the housing market to illustrate how debt can skew a houses value. Housing prices will almost always go upward as long as people can pay for them, the supply side of this would never have any reason to decrease the value of their house. Taxing authorities will also appraise housing values higher for tax purposes. Now the only way to bring houses down or to what might be thought of as a fundamental value is the demand side. As debt is cheap and easily accessible, individuals will have no problem putting up 5% of the houses value as an equity down payment and then borrow the rest at a low rate….. they often only think of the rate as it determines their monthly payment, they do not, however, think about how many times over they are paying for the house or what they have now just valued the house at. As individuals will do anything to get the house due to its skewed value for them, or the fact that it might be a good investment going forward, the price of the house is certainly above its fundamental value. These factors are further hurt by the availability of debt.

 

            As the wealth distribution becomes more skewed, and individuals on the lower end have less and less equity (lower paying jobs or no jobs at all), those poorer individuals will have to borrow to pay for items. Buying things on credit cards has become common and have kept the price of certain items higher than what they should be. As credit provides some magnification of a persons own income, and as people have no problems using credit to purchase items, the value of the item can be priced above what individuals can actually pay for it. Debt can often keeps prices unrealistically high and cause an inefficiency in the market as the true price either comes after a long period of time, or not at all.

 

            Who knows how the market will react to the current problems. Who knows if housing prices will consistently fall in some areas, or if purchasing of overvalued items will fall.  This issue of debt, however, is one that should be taken seriously. There is clearly a tendency for over-borrowing and over-pricing due to debt. Many individuals have no problem running up a large amount of personal debt and then declaring bankruptcy. Many people do not think twice about purchasing clothes or food with debt even though this is borrowing your future pay to purchase these consumable and deteriorating items today. Debt can be of great use, but it always comes at a price. Unfortunately, this price is often ignored.