Monday, March 4, 2013

The US Mortgage

This is the Deed to the State of Rhode Island

Like our government budget, it is in tatters. Yesterday a commenter posited:

Pretty soon we will be borrowing more than GDP. But when you apply the "household" standard to this, it doesn't fit. People routinely buy a house, for example, that is worth far more than their annual income, or a car that is half of it. 

Let's apply the Mortgage Standard to it then.

Lender's use what is known as a debt to income ratio to qualify buyers for the issuance of a mortgage.  At first it appears to be a Prima Facie case.

US Government debt is  $16,657,000,000,000. So let's knock some zeroes off it so it looks more like a mortgage, eight should do it (and I'll knock eight digits off all the other numbers too).

Consider the US mortgage to be $166,570.  

This house is in Jersey
 So, the GDP is $156,320 but that's not what we make a year, that's what the 7-11 we work at makes a year, in reality we only make $24,933 a year (The GDP is not the US Government's income).

Our Mortgage

 While we owe the bank $166,570 we got one sweetheart of a deal from the bank, it is an interest only loan at 2.16% so all we have to pay a month is $299.83 The US debt service payment for 2012 was  $359,796,008,919, knocking eight digits off that gives you $3597.96, which works out to roughly $300 a month, pretty sweet deal huh?

Front Rate/Back Rate

 Lenders use what is known as a front/back debt to income ratio in evaluating applicants.  What they look for is a 33/38 ratio, some look for more, some look for less, but 33/38 is good rule of thumb.

 Front Rate:  The front rate is your mortgage payment evaluated against your pre-tax income.  An income of $24,933 yields a monthly income of   $2077.75, and that my friends yields a front debt to income ratio of 14.43%... Looking Good!

 Back Rate:  This is where our fantasy comparison starts to fall apart.  Back rate is the ratio of your mortgage payment to your actual income less consumer expenses (car, utilities, credit cards, groceries, etc.).  So Mr. Government may make $2077.75 a month but that doesn't pay his bills,  you see... Mr. Government is up to his neck in debt, while he made $24,933 in 2012 he spent $37960.  Worked out monthly that is $2077.75 IN and $3163.33 OUT.  His Back Rate Debt to Income Ratio is 152% or four times higher than the allowable 38%.  LOAN DENIED!

Negative Income?

So jolly Mr. Government lives high on the hog, spending more than he makes by charging everything on his credit cards.  Where is Mr. Government headed?  You guessed it...


 A False Analogy

While the mortgage analogy in defense of government spending is false, it is also false if used as an analogy against government spending.  The US National Debt is not a mortgage, however it is also not an infinite supply of money.  There are and will be consequences if it is allowed to continue to grow at the present rate.

The US is currently borrowing money at a negative real interest rate,  that is the interest on the debt is at a rate lower than inflation. The only reason this is happening is investors see no other alternative of sufficiently low risk.  If Europe were booming we'd be screwed!  The US is perceived as a safe investment and will remain so until other viable alternatives emerge, at that point borrowing rates will go up.

According to the CBO the US debt to GDP ratio is forecast to be 200% by 2040  if things remain unchanged.  The Bank of International Settlements, a conglomeration of central banks of which the US is a member, predicted the US will hit 400% by 2040.  Historically the break-point for debt-to-GDP ratio would seem to be somewhere in the neighborhood of 120-130%, the US may be able to sustain a ratio of upwards of 150% without significant consequences, it is after all currently the biggest game in town,  it is unlikely to be able to sustain a ratio of 200%.

We don't need to eliminate the debt, we need to control the debt and the debt needs to be discussed in terms of revenue, not in terms of GDP.



No comments: