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Debt Addiction And The Tax Burden

The Fed's flood of cheap money during the housing boom fueled another mass economic malady: the "buffett effect." When any consumption item--whether it's food or money--is offered at one, low price, people tend to gorge on it. During the mortgage bonanza days, home buyers not only took out loans as if they were being given away, they took out second and third mortgages. They also tapped home equity by simply increasing the amount they were financing. Even down payments could be borrowed. By going deeper into debt, they felt as if they were "playing with the house's money," in Las Vegas patois. Homeowners were spending money that they thought was on the house; their loans were supposed to be covered by gains they bet would come in the future.

Homeowners were emulating their libertine Uncle Sam in their debt frenzy. The Bush administration and Congress were borrowing feverishly to finance income-tax cuts and the Iraq and Afghanistan wars. A national debt that was under $2 trillion in 1985 rose to more than $11 trillion in 2008. A budget surplus from the Clinton years evaporated. Much of the Treasury debt used to finance tax cuts and war materials was bought by the Chinese, who hold more than $1.6 trillion in U.S. debt securities. It hasn't been the greatest investment for them as the value of the dollar has sunk over the past five years, but it's bought them immeasurable good will.

The Fed was well aware of the debt excesses triggered by the bubble. Greenspan had documented the huge rise in home-equity debt during the bubble years. In a paper for the Fed Cowritten with economist James Kennedy, he concluded, "Since the mid-1980s, mortgage debt has grown more rapidly than home values, resulting in a decline in housing wealth as a share of the value of homes." By 2008, Americans actulally owed more on average than they owned in average home equity. While housing wealth had initially made Americans wealthier on paper, it also convinced them to save less and borrow more.

How could it be that homes were making people poorer? The answer was simple: Millions were going deeper and deeper into debt to finance their lifestyles and to keep up with bills. Not only did home equity provide a ready source of cash; for the bulk of Americans, it also was tax free. If they withdrew funds from their 401(k), as millions did and are still doing as they exhaust their home equity, the money was subject to federal and state income tax plus a 10 percent penalty if taken out before age fifty-nine and a half. But home equity was sacrosanct in the tax code. You weren't subject to capital gains if your profit was under $500,000 (for married couples filing jointly) and it was from a principal residence that you lived in for two years prior to sale. Interest on home-equity loans was tax-exempt for the most part. And if you itemized on your tax return, mortgage interest and property taxes were deductible. Aided by the tax breaks, homeowners borrowed as much as they could.

So called "equity taps" accounted for "four fifths in the rise in home mortgage debt since 1990," according to the Greenspan report. How was this money being spent? In his typical tortured economic jargon, Greenspan cited "bridge financing for personal consumption expenditures." Translation: People were often buying boats, cars, and other items that would not increase the value of their homes. Ironically, while they were vacuuming about half a trillion dollars out of their homes annually from 1991 to 2005, the real U.S. savings rate turned negative.

Meanwhile, debt addiction spread to credit cards. "Plastic" debt has risen 31 percent since 2000, and tripled between 1989 and 2008. Those in the deepest credit-card trouble--some 20 percent of homeowners--paid off their unsecured plastic debt with equity from refinancing. They were paying off debt with more debt. Few in the outside world discouraged homeowners from their insatiable debt fix. Wall Street certainly made money from this addiction. the manufacturing, repackaging, and securitization of private debt reached epic levels as the twenty-first century dawned. Total credit-market debt topped $40 trillion in 2006, quadrupling from $10 trillion in 1987, which was the total for all private and public debt that year.

Whey they exceeded their limits on home-equity-related borrowing, highly leveraged homeowners loaded up on their credit cards: The average homeowner seeking foreclosure counseling in 2008 had about $17,000 in credit-card debt, up from $13,000 in 2006. The underlying driver of the constant demand needed to sustain the American economy is a debt bubble that threatens the global financial system. If it weren't for the fact that the United States is deeply indebted to Asia and Europe and their "dumping" of American debt securities would trigger the economic version of mutually assured destruction., the financial health of the last remaining superpower would be even more imperiled. The dark storm on the global economic horizon is that America's creditors are starting to move away from dollar-denominated debt into Euros and other currencies. That doesn't bode well for the debt-crazed U.S. economy.

It was not surprising that when the housing boom came along it provided another seemingly painless opportunity to borrow. With home prices rising, a consumer would need more money to buy a home anyway, and credit was available on easy terms. But the practice has only swelled homeowner debt burdens.

Debt Addiction And The Tax Burden
By John F.Wasik, Author of The Cul-de-Sac Syndrome: Turning Around the Unsustainable American Dream

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