The American Decline III: The Middle-Class Con Game

In the last two essays we have examined the relations between the rich in this country (the upper 20% who own 83% of the total net worth of America), and the poor (the lower 40% who own less than 1% of the total net worth). This time we will examine the 40% in between them, the middle-classes.

Remember, we established in our first essay that jobs have been stagnant since 2000, and that real gains in mere wages from jobs have barely exceeded inflation since 1980. So “net worth”, and not wages earned, is now the key to upward mobility in America, because net worth is what you can invest, in one form or another, to make money beyond mere consumption. The middle 40% of the American spectrum holds only 16% of the country’s net worth.

What do they invest it in? Housing, largely--owning “a home of their own” and “acquiring home equity”. Never mind that they must borrow far in excess of their net worth in order to make this investment. Never mind that, for the life of the loan, the financial institution actually “owns” the bulk of the worth of the property through the legal lien. Never mind that they must service this debt with interest for decades. Never mind that the housing market is like any other, with risk of falling home values, while you are locked into paying off that mortgage no matter how much your home’s value declines. Home ownership is the American Dream.

Home ownership is the Middle Class Con Game.

Owning a home is not an “investment”. It is mere consumption, a very expensive hobby, fun for some, a burden for others, but profiting no one except the institutions making the loans. The only people who “invest” in housing are landlords.

Don’t believe me? Let’s do the math. The figures cited below are generally approximate mean or median figures extracted from the sources I will link to as we go along. They are rounded to the nearest $100.00 for convenience. Since inflation applies to all figures equally, we will not factor it in. We will assume $10,000 of net worth available for a down payment. This is the money we are “investing” in the property.

Cash For Down Payment $10,000
Average House Price $250,000
Amount of Loan $240,000
Length of Loan 30 years
Fixed Interest Rate (This is quite generous, 7-8% is current) 5% per year
Total Interest over 30 years $223,800
Total Payment over 30 years $463,800
Total Maintenance $400 yr @ 30 years $12,000
Sale Price to recoup $10K without profit $475,000
Percentage of appreciation to recoup $10K without profit 90%
Profit on investment of $10,000 $0.00
Percentage of profit on $10,000 0%
Net Loss on Home Ownership with no home value increase -$225,000
Percentage Loss on Home Ownership -90%


Now no one can reasonably assume that their home will appreciate 90%! It might happen, but it would be an obvious windfall. And it would have to do this just to break even—no profit at all on the initial $10,000.

No serious person, confronted with these reasonable figures would call owning a home an “investment”. Owning a home is a hobby, and a very expensive hobby at that. What about “equity”? Equity is merely the money used to pay off the loan principal plus any appreciation that might happen to occur. It pays no set rate of interest or average yield to the homeowner, and is not that much better for the homeowner than building up the same amount of money in a simple, no interest, checking account. The checking account would not require any major debt service in the bargain. And, as the figures above show, the equity you accumulate, without appreciation in home value, is only moderately more than the money you spend in debt service and maintenance. Appreciation in home value is not guaranteed. Housing is a market, with risk, like any other.

Now let’s look at what might happen if you took that same $10,000 of net worth and invested it in a very conservative buy-and-hold stock and bond portfolio for the same 30 years while paying average rent.

Cash For Investment $10,000
Stock to Bond Percentage in Portfolio 40%--60%
Length of Investment Time 30 years
Annual Average Yield 12%
Total Yield in Dollars $300,000
Profit on Investment $290,000
Median Gross Rent per Month $600
Total Gross Rent over 30 years $216,000
Net Profit on Investment and Rent together $74,000
Percentage Profit on Investment and Rent 30%

Now, THAT’S an “investment”! Seventy-four thousand dollars and 30% pure profit. To achieve the same profit with the home of our hypothetical buyer, he would have to sell it for $549,000, or approximately a 140% increase in home value!

The benefits of renting and investing become even more spectacular if you assume that the amount of money which is going to service the debt on, and maintain, a home is also invested in this same portfolio:

Total loan interest over 30 years $223,800
Rent Differential over 30 years $234,000
Maintenance Differential over 30 years $12,000
Total Invested Capital Available over 30 years $256,000
Capital available per annum from Differentials $8,200
Total Yield from Capital over 30 years $2,516,000
Total Profit on Investment $2,260,000
Total Gross Rent over 30 years $2l6,000
Net Profit on Investment and Rent $2,044,000
Percentage Profit on Investment and Rent 430%+

Wow.

Over 2 million dollars and 430% net profit on investment and renting! Owning a home is a very expensive hobby.

The con game--perpetuated everywhere from Better Homes and Gardens magazine to the prose introductions of the United States Census figures--is the lie that a home is an “investment”. Who profits from that lie? The financial institutions that lend the money, that’s who. They are part of that exact same equities market that rewards real investments, and clearly punishes borrowing to own real estate to live in.

But why does it matter to the decline of America as a whole?

Oil consumption.

Consider my city, Columbus, Ohio. In 1950 the economic reach of Columbus, what we now call the Metropolitan Statistical Area, was no larger than Franklin County. That country had a total population of 503,410 and a land area of 540 square miles. Like most Ohio counties, Franklin is nearly a perfect square in shape, and Columbus, the county seat, is approximately in the geographic center. So, for convenience, let’s assume an exact square and an exact midpoint.

This would give a distance of 12 miles, more or less, from the county boundary to its midpoint, and this would be the about the maximum distance anybody would have been driving to work in Columbus in 1950.

As of 2004, the Columbus MSA consisted of fully eight surrounding counties: Delaware, Fairfield, Franklin, Licking, Pickaway, Madison, Morrow, and Union counties. The MSA has a total population of 1,549,360 (2000 census) and a land area of 3983 square miles. So the maximum distance from the center to the edge of that perfect square is 31 miles, this is the reasonable maximum distance most people would travel to work in Columbus. Effectively, Greater Columbus is three times larger than it was in 1950. This growth has largely been a growth of middle-class home ownership with single-family units on lots of about 500 to 1000 square feet. The name for this is suburban and exurban sprawl.

Over the second half of the 20th century, transportation was the largest consuming sector of petroleum and the one showing the greatest expansion. In 2002, 13.1 million barrels per day of petroleum products were consumed for transportation purposes, accounting for 66% of all petroleum used. This is because of suburban and exurban sprawl and, ultimately, because of the middle-class con game of individual home ownership.

For perspective, let’s compare Franklin County with San Francisco County, which is contiguous with the city of San Francisco itself. San Francisco is surrounded on three sides by water, and that has restrained its capacity for exurban sprawl to the minimum possible.

San Francisco County 2000 census data:

Population 776,733
Land Area 47 sq. miles
Population Density 16,634 per sq. mile
Home Ownership Rate 35%
Poverty Rate (1999) 11.3%


Franklin County 2000 census data:

Population 1,068,978
Land Area 540 sq. miles
Population Density 1,980 per sq. mile
Home Ownership Rate 56.9%
Poverty Rate (1999) 11.6%


San Francisco is a clean, livable city, with a wonderful subway system to do the work that hundreds of thousands of cars do in Franklin County, at a far lower cost for, and rate of consumption of, crude oil. And, in the best of times, such as 1999, the percentage of people in poverty in each county is virtually equivalent. San Francisco is what every city in America could have been but for the con game of home ownership and the cheap energy prices which sustained it, with rising incomes for everybody in America, until 1979 and the dominance of the Republican Party in American politics, with its huge, stock-market boosting budget deficits.

Let’s consider the implications for oil consumption under contemporary conditions. China, India, and Indonesia are rapidly increasing their consumption of oil and this, along with our increasing consumption of oil, is pushing a sustained and continuous price rise of crude.

This is likely to continue unless there is a sharp downturn in the entire world economy. Such a downturn is now far less likely than ever before, because the world economy is rapidly becoming less and less dependent upon consumer activities in the United States. Just recently China, which has captured most of our old manufacturing, has also passed us as the world leader in consumption of many industrial consumer goods.

So oil prices will continue to rise for the foreseeable future, and the consequent increase in poverty in America that is tied to oil prices will also increase, widening the income and net worth gap between the upper 20% and the lower 40% of America.

However, unlike China, India, and Indonesia, where rising oil consumption is actually generating wealth through manufacturing, services, and marketing, our oil consumption is largely going toward simply being able to get around in our insanely sprawled exurbs, and to heating the homes in a few of them.

In other words, our oil demand is not only inelastic and tied to our poorly managed urban growth, it is also producing little or no wealth for the country as a whole. And, as exurban spread by the middle 40% of Americans continues, propped up by their borrowing, our oil consumption, and the consequent cost of living for all Americans will steadily rise. The percentage of that cost taken up by fuel consumption will rise even faster. And the real quality of life for all but the rich 20%, whose immense net worth is invested in equities rather than debt service, will steadily decline.

We have seen how excessive government borrowing has been crucial to the meteoric rise of the Stock Market since 1980 and the consequently huge capital gains to the upper 20% of this country. These capital gains have never “trickled down” to the lower 40% with virtually no net worth, and they have merely enabled the middle 40% to assume 30 years of debt service whose real cost will far outstrip the home they acquire for it.

This private borrowing for home ownership, home improvement, and home equity cash out also contributes to the expansion of the capital markets where that debt service cash of the borrowers would be more profitably invested. Who does this really benefit? Not most of the people buying the homes, and certainly not the people who can neither afford to invest in the markets nor buy a home.

So what of the future? In order to manage the slow recovery from the recession of 2000-2001, the Federal Reserve has kept interest rates at historically low levels for an extraordinarily long time, soliciting an incredible rush to borrow among the middle 40% of this country, and consumer debt levels have reached historic highs. Thus through 12 years of economic expansion, contraction, and relative stagnation, the housing market has steadily flourished.

However, interest rates are starting to rise, as are inflationary indicators, which force the Fed to keep interest rates rising. Also, the market for home borrowing has become saturated as more consumers reach debt levels where they can no longer receive favorable terms from lenders to borrow more.

This has put the burst of the housing bubble within sight. In my own town, for the first time in years, I am starting to see homes offered for sale with asking prices of under $100,000. And among the more cautious in the real estate business, the warning bells have already started ringing.

The middle-class, however, will have to eat its loans no matter how much the market hammers down their home values. Moreover, with stagnant real job growth, sharply rising interest rates to curb the inflation, steadily rising fuel prices from both inelastic and nonproductive American patterns of consumption, and a fast approaching fall in the business cycle from the rising interest rates, the American middle-class is very likely to see a horrible day of reckoning in the near future.

Sharp job losses--far more in all probability than we saw in 2000-2001 where over 2 million jobs went south--combined with falling home values and debt service which is ever harder to maintain in the face of steadily rising fuel prices, will very likely ripsaw the American middle-classes--and end their American Dream of upward mobility--for the foreseeable future. Bankruptcy rates will skyrocket and the ripple effect through America from downstream to upstream lenders will knock down a great many standing dominos.

Of course, anyone in the upper 20% who has diversified the investment of their net worth with investment abroad, or in petroleum stocks will do quite well, thank you; perhaps not quite as well as in a booming American economy, but still very comfortably enough.

So, if you are a member of the American middle-class yourself, think carefully about the real results of the policy changes proposed by a Republican President and a Republican Congress. They want to turn America into the “ownership society”, or so they say. I presume this means that they would love for you to borrow some money and buy a home. You just might ask yourself the real reason why.

You might also ask what does “privatizing” Social Security do for anything but the growth of the Stock Market, in which you are likely to have a very diminished share, even with a private SSI account, because of the debts you’ve assumed to buy a home and make ends meet.

What does a “flat income tax” of, say, 15%, or a national sales tax on the things you buy, mean for you, compared to what it means for someone in the upper 20% who has seen their real income rise 68% over the last 25 years through stock speculation?

What does “tort reform” and restrictions on “class action” lawsuits do for you, compared to what it does for those who own stock in insurance companies?

What does “bankruptcy reform”, making it harder to discharge debt at a discount, mean to someone such as you who is tied to debt service for 30 years, whether your job is finally outsourced abroad or not?

What does the refusal to let anything but “market forces” determine the price of gasoline mean to you, when you can’t get out of driving 150-300 miles a week in your old sedan, while your wife drives the equivalent amount in your new gas-guzzling SUV?

After all, you bought it at a premium price--on credit with finance charges--since your wife thought it “safer” for her and the kids. Can you cut any real corners and still make it to work, the grocery store, the home improvement warehouse, Wal-Mart, the soccer match, and the karate lessons?

What will the fact that health insurance costs are rising five times faster than inflation--with no address to this problem by Republican government even on the horizon--mean to you?

What are the implications for you of steadily rising deficits, with steadily diminishing domestic government services, such as cheap college loans for your children, by both state and federal governments?

Will the children you are raising really have a better life, or even as good a life as you have had in the America of the future?

If I were you, I’d start asking these questions real soon. As the latest ad campaign, by one of the largest insurance companies in the business, says, Life Comes At You Fast.