Locked Out/Locked In/Gridlocked

June 4, 2004

I watched “Sunday Morning” a few weeks ago.  They ran a segment on the Los Angeles residential real estate market, which is blisteringly hot.  Some couple was hoping to buy a home for $600,000.  They had been locked out by other buyers recently.  Their offer of $500,000 had not been sufficient.  The real estate sales lady commented that houses that were $600,000 last year are selling for $1.2 million this year.  Anyone who didn’t get in last year is locked out today.

I shuddered.  If they could have heard me, I would have yelled at that 30-something couple: “Run for your lives!  Rent.  Move to Wisconsin.  Anything.  Don’t sign that contract!”  Of course, I would have yelled to the sellers, “Way to go!  You’ve got ’em.  Take the money and run.  Move.”

Think of a couple that owe, say, $200,000 on a $1.2 million home.  If they moved out and rented for a few months, they would establish their house as an investment property.  Then they could sell it, pay off the $200,000, move to Northwest Arkansas, invest $1,000,000 by buying ten homes and renting them for $800 to $1,000 a month.  They would enjoy income of $8,000 to $10,000 a month, and they would see their investment double in the next ten years.

They could even hire a local rental agency to handle it for 10% of rent, and they could stay in L.A. and rent for $2,000 a month, pocketing maybe $4,000 after taxes.  Will they do this?  Of course not.  They will buy a $1.4 million home.

A housing mania makes fools of buyers and sellers.  Buyers don’t know how to say no and rent in peace (RIP).  Sellers never know when to quit.  Their ship has come in, and they’re at the bus station.


There are three areas of life in which we must lock ourselves in, in order to get in at all: religion, marriage, and citizenship.  We say “I do” to all three.  We take an oath, explicit or implicit.

Not many people ever change their religion, although in our day, there is a lot of church-shopping.  That was not true a century ago.  There are today a lot of divorces, however.  That was not true a century ago.  There are not many people who switch citizenship.  In these three areas, we say, “To get in, you must get locked in.  You will therefore be locked out.”  We worry when we see lots of people leaving their religion, leaving their spouses, and leaving the country.  We think, “Something is seriously wrong here.  We’re losing it.”

As Americans, everything else in our lives is up for grabs: neighborhoods, houses, jobs, careers, diets, fashions.  You name it; we’re ready to try something new.  In fact, we expect to change.  If we never get a better job offer, or buy a bigger house, or move to a nicer neighborhood, we’re considered losers, even by us.  The only exception is Warren Buffett, who lives in the same 3- bedroom home in Omaha — Omaha!!!! — to manage his $25 billion or whatever it is these days.  Sam Walton did the same.  Nobody called them losers.  But everyone else who doesn’t move every five years is considered locked out, i.e., a loser.

Those young couples who are signing contracts on homes for $600,000 or $1.2 million are locking themselves in.  They are fearful of being locked out.  “We’ve got to buy now!  It’s now or never!”  But what are they being locked out of?  A crackerbox house in a particular neighborhood in overcrowded Smog City, the murder capital of the United States.  For this, they will indebt themselves for 30 years?  For this, they will give up having more children?  For this, they will become two-income families until they retire at age 75, fearful of getting fired, desperate to remain locked in?

I say, “Run for your lives!”  But they won’t.

Why not?  Because if things ever get tight, they will walk away from the deal.  They will declare bankruptcy and wash their hands of the whole thing.

Problem: on the other side of piles of these mortgage contracts are a couple of government-created dolts named Fannie and Freddie.  Fannie and Freddie have attracted the savings of millions of investors who think that there will never be a doubling of mortgage rates and therefore a halving of the market value of mortgages.  They also don’t think there will be a halving of the dollar or a recession that forces a million couples to walk away from the deal.

There are lots of future losers standing in the wings.  Losers these days are people who make permanent commitments in the expectation that a man’s word is his bond, that contracts will not be broken.  Meanwhile, the divorce rate is at 50%.  Losers are people who think that there is respect for contracts in this society, and who then become dependent on income generated by contracts.  They forget what happened to Congress’s 1994 “Contract With America.”  It was broken before the 1996 election.

A contract today is more reliable than a political promise, but not by much.

If couples will walk out of a marriage that has become uncomfortable, they will walk out of a crackerbox home in southern California when the mortgage payments become uncomfortable.  And why not?  Nobody cares.  Radio ads tell them, “No matter what your credit is, we’ll get you into a home!”  They believe it.  “There’s always more where that came from.  There’s a mortgage-supplying sucker born every minute.”

Are they locked into a life of unbreakable debt?  Hardly.  Are they locked out of future mortgages if they walk away?  Not even after a bankruptcy, they believe.  They are signing contracts, making promises, and seemingly locking themselves in.  But they have their fingers crossed.

We live in a nation in which everyone has his fingers crossed, from the top of the political pyramid and the economic pyramids (think “Enron employees’ retirement fund”) to the couple next door, who are talking with $250 a hour, high-volume, no-fault divorce lawyers this week.

Nobody cares . . . until grandparents realize that they will never have another Christmas with their grandchildren because the wife got the kids and they’re the parents of the husband.  Nobody cares . . . until the Army volunteer whose enlistment is up is informed that he has just been drafted by the Army for another six months in Iraq . . . so far.

When you can’t trust the other guy in the deal, you are forced to rely on your own resources.  That is what is happening today.  The division of labor is at risk because we can’t trust each other.  If you think I’m wrong, take a look at your insurance premiums.  Are they going down?  Term life insurance, yes, because we’re living longer.  Nothing else.


The cost of buying a new car or a home is such that my children’s generation is locked out of the ownership markets unless they want to burden themselves with a great deal of debt.  If they want to buy new cars, they cannot afford to pay cash.  A home in some areas of the country is unobtainable.  This is not universal, of course.  But in markets like the California coastal cities, Boston, New York City, and other urban areas, those under age 30 are essentially confined to rentals.

This is not a matter of life and death.  There are other places to live.  There are bargains available if you look carefully and have cash.  This is the eBay generation.  Someone is always in a hurry to sell.  This makes for opportunities.  But for young people who were not taught the virtues of thrift and deferred gratification, the lure of debt begins early and entraps them.

The problem is, most Americans have all grown up in the shadow of debt.  Permanent debt is considered normal — a way of life.  This begins at the top.  There is no suggestion by any respectable economist that any government, anywhere, will ever repay its debt, or should.  Worse, it is now impossible to repay it without bankrupting the economy.  The reason is the monetization of debt.  The central bank in every modern nation owns piles of government debt.  If the central bank were to sell off this debt, it would have to buy some other asset to keep the money supply from shrinking; otherwise, there would be a deflationary depression.  The central banks have created a monster: a government debt structure that cannot be liquidated.

Yes, the FED could legally buy other assets besides debt.  It could sell T-bills and buy gold or silver or copper or apartment houses.  That would keep prices up.  But this would transfer real assets of value in the economy to the FED.  The official counterfeiter would become the real owner.  The FED would become the owner of last resort if ever decided to stop being the lender of last resort.

In effect, the existing inverted pyramid of debt has created a system in which the central bank has a permanent lock on assets, either debt assets or equity.  If it were to sell off T-bills without buying something else, the banking system would collapse, taking the division of labor with it.

This is why no one with influence ever suggests that the national debt will ever be paid off, or even should be.  We are like heroin addicts who cannot imagine like without the junk.  In the case of the division of labor which sustains our lives, this appears to be the case.  If the debt pyramid ever topples, the economy will shrink so far and so fast that millions of people would be threatened with extinction.

If the banking system ever does go into gridlock — “cascading cross defaults” — what would anyone use to buy necessities?  If the banks could not honor credit cards because other banks were not honoring them, the system would lock up.  There is not enough currency to sustain the enormous quantity of digital, fractionally reserved money.  My ability to pay you is dependent on someone else’s ability to pay me.  What happens to all of us if the payments system ever gridlocks?

With commodity money, this is not a problem.  If coins were the sole basis of trade, there would be nothing inherent in the system that would make impossible the exchange of goods and services for coins.  The coins would always be in someone’s vault or purse.  The coins would circulate.  Commodity money is not threatened by gridlock.  Debt-based money is.  Of course, exchanges would take longer.  We would have to carry coins with us.  We would go looking for substitute means of payments.  There’s the rub.

When the free market creates substitutes for coins, this makes rapid exchanges possible.  So long as these substitutes are the equivalent of warehouse receipts that are fully backed by a commodity, this is not inflationary.  But when there are more receipts issued than commodities to redeem them on demand, we see the money supply rise, with prices not far behind.

That is our world today.  Prices rise.  The alternative is a collapse of the payments system because of the leveraged, inverted pyramid nature of fractional reserve banking.  A revolution in Saudi Arabia that would shut off the flow of oil for six months would threaten the survival of the payments system.

That’s why the U.S. is building a dozen air bases in Iraq.  Saddam is no threat.  Osama’s disciples are.


Our credit card world did not exist 40 years ago.  Credit cards were for the elite.  Today, everyone uses them in the United States.  We have trusted the payments systems with our lives.

We have therefore trusted the debt structure that serves as the legal basis of money.  The ratchet is always upward: more credit, meaning more debt, producing more money, forcing prices ever higher, creating demand for more debt-secured credit.

When I was my children’s age, the credit cards were first making their way into the middle class.  The gold exchange standard kept the central bank from creating too much money by purchasing more government debt.  That world is not only gone, it could not be restored without a vast contraction of the money supply and the division of labor with it.

So, we have learned to adjust.  We have become inoculated to the threat of rising prices.  We have devised investment strategies to deal with rising quantities of money.  But the fact remains that the world of our youth is gone, and this includes a sense of foreboding about debt.  We do not fear foreclosure as much as we fear being shut out of a hot market.

The result of this mentality was the NASDAQ boom of 1996-2000, and the dot-com mania of the same period.  We are now seeing similar manias in some real estate markets.  People think of debt as a headache that everyone learns to live with by means of increasing the supply of money.  People expect to be able to pay off their debts with depreciating money.  They assume this, and for the past 70 years, they have been correct.

Those few people who can remember the Great Depression as adults are in their eighties, at the youngest.  The politics and policies of never-ending debt, credit, and monetary expansion have erased the social memory of the West.  The wisdom of the pre-World War II era has been bankrupted.  “Buy the best, pay cash, and take delivery” sounds quaint in our ears, even if we are over age 60.

The problem is, those of us who are over age 60 are about to hit the Social Security/Medicare system like a runaway train.  Workers who remain in the work force are going to be asked to dig deep into their wallets for the sake of a generation that has come to regard wealth transfers as our legitimate claim on the younger generation.

The younger generation, with almost no savings, is now going to be called upon to pony up cash.  They are going to be facing their monthly debt service payments, but on top of these will be new obligations for which neither they nor Congress has prepared.


We hear a lot about the national spending spree based on debt.  Well, it exists, but it is not so wild as we might think.  Something wild is out of control.  This spending spree is not out of control.  It is amazingly well controlled.  It has become a way of life.

Our problem is not the spending spree or out-of- control debt.  Our problem is consumer spending and consumer debt as a way of life.  It is not wildness that threatens us; convention does.

When in doubt about personal debt in America, go back to the tried and true statistic, “Household Debt Service and Financial Obligation Ratios.”  Well, it’s not so tried and true.  The FOR stats have been added to the table in the last few months.  But they are useful, mainly to demonstrate their stability over long periods of time.

Click on this link.  Be prepared to take a look at DSR: Debt Service Ratio.  This is the ratio between total debt payments and disposable personal income.  What is remarkable is how stable it is: from 11.14 in 1980 to 13.22 in the third quarter of 2003.


The Financial Obligations Ratio (FOR) adds some extra items, such as property taxes, homeowners’ insurance, and automobile lease payments.  It was 15.84 in 1980.  It was 18.41 in the third quarter of 2003.

Yes, there is an upward ratchet here.  The debt repayment burden is creeping upward.  But statistics this stable over time are not the stuff of doomsday scenarios.  To put it in medical terms, it’s not a heart attack that is more likely to kill us.  It’s cancer.

These statistics indicate that people are not irrational.  They are not spending like drunken sailors.  Their creditors won’t let them.  They are loading up on goods — mainly consumer goods — in a systematic fashion.   They are loading up on debt, a little at a time.

The household debt-repayment load is not the main problem.  There is no massive default on the immediate horizon.  The main problem is the steady decline of thrift that has accompanied the upward ratchet of household debt.  Americans are becoming present-oriented.  People have ceased to save for a rainy day.  People assume that the government will guarantee sunny days for all, with a few cloudy days for variation.  No need to save for a rainy day.

Personal savings as a percentage of disposable income is in the 3.5% range today, less than half of what it was a decade ago, and a third of what it was in the recession year of 1982.  (See Chart 1, p. 36.)


If you read the article, it’s mildly upbeat.  But the charts point to the problem: the increase in both debt and household wealth (housing prices, mainly) and the decline of thrift have been accompanied by an unprecedented fall in interest rates, from 1982 to today.  If interest rates go back up — Warren Buffett and I think they will — then the process will be reversed: reduced household wealth and presumably reduced household debt, as people are forced to cut back on new spending.  But rising debt has sustained the consumer-driven economy.  How will the boom be sustained?

Will thrift return?  That will take a true revolution in Americans’ thinking.  I don’t see it coming.  That is the #1 economic problem facing us.  We have lost our commitment to thrift as a people, meaning the top 20% have lost that commitment.  Those few who still retain it have put their money into bonds, mortgages and stocks — all looking increasingly dangerous.

The other looming economic problem is this: debt repayment is affected by interest rates.  The debtor is being subsidized by central banks.  The FED in 2001 started pumping in money.  Now the central bank of China is pumping money, buying dollars, and buying T-bills.  The central banks of America, Japan, and China have pushed down America’s interest rates by increasing the supply of funds used to purchase T-bills, a process that has lowered short- term rates.

This has persuaded consumers that there is plenty of wealth for all.  Why not borrow?  After all, rates are low.  And they really are low.  But they are not low because savers have made available lots of money, meaning that they have restricted personal consumption.  On the contrary, they have increased their personal consumption.  Today’s low rates are a product of a great deception by central bankers: the deception of increased thrift on the part of savers.  There is decreasing thrift.

Households have increased their purchases of consumer goods by adding to their total debt burden, but low rates have kept debt repayment schedules relatively low.  The question of questions today is this: When rates go back up, in response to tighter money or rising prices or both, what will happen to household budgets?  Second, what percentage of these debts are subject to interest rate revisions?  A fixed rate, 30-year mortgage is not at risk.  An ARM is.  An auto loan is not at risk.  A credit card loan is.

Most debts are fixed for a few years.  Then they are subject to revision.  Loans on consumer goods such as cars are fixed, but most people trade in their cars every four years.  By the time the loan is paid off, the car is not worth much.  (Come see me; I’ll make you an offer.)  The lender knows that the person who buys a new car this year will be back to do it again in four or five years.  The lender has a fish on the hook.  Both of them are content with the arrangement.

But when the guy comes back next year and in years thereafter, he will find that cars are more expensive and rates are higher.  His budget will not handle this double whammy.  So, he will cut back — on savings, probably, and on spending, surely.

At the margin — where new goods are at risk — the market will get bad very fast.  The level of debt has risen.  People will have to cut back.

This is not a prediction of financial cataclysm.  There will have to be other factors to create a cataclysm.  A crisis in oil due to terrorism is always possible.  But if we are talking about household debt, there is no strong evidence that I can see that indicates that business will not be usual.  It just will not be good.  Rising rates will undermine the boom — and there is not much of a boom.

This is the great threat of the present economic order.  The system is never allowed to clear itself of bad debts — not in Japanese commercial real estate, not in Chinese loans to state industries, and not in American residential housing.  The central banks keep the overall markets afloat with fiat money, which makes funds available for sectors that should be allowed to tank.


The belief that sunny days are forever has pushed housing prices up and younger buyers out.  Thrift has not disappeared, but it is surely enjoying longer and longer vacations.

The belief that a business is too big to fail, meaning too big for the government and the FED to let it fail, has a name: “moral hazard.”  Greenspan has been known to use the phrase.  The fact is, there are such businesses, and the FED and the government do intervene to bail them out.

It’s not this TBTF (too big to fail) moral hazard that is the main problem.  Such failures are fairly rare.  The moral hazard that is the great threat to our long-term prosperity is the widespread attitude that the system as a whole will not be allowed to fail — not this or that conglomerate.  It is the debt-based pyramid that is supposedly TBTF.  And this widespread confidence adds to it day by day.

So, those people who got in early — home buyers, Medicare recipients, and pension fund investors — are living well — not off the fat of the land, but off the thwarted expectations of younger employees who got in late.  This is the characteristic feature of every Ponzi scheme: newcomers subsidize the gains of the old-timers.

The outlook of those people who went through the Great Depression died away in the prosperity of the 1950s.  My generation had no recollection of the Great Depression.  It looked like sunny days ahead to us — and so they were, excluding Vietnam.  But Nixon got left holding Lyndon Johnson’s empty bag: the recession of 1970-71, the gold rush at the Treasury’s front door, and a war that would not go away.  Nixon closed the gold window, and the dollar declined rapidly after this.

For your amusement, go here, and see what it takes today, after taxes, to buy $1,000 worth of goods in whatever year you select.  Use the inflation calculator.


If I taught high school, I would force my students to spend an hour per term on this site.  Let them learn the truth of what the U.S. government and the FED have done to our money.


In mania periods, buyers fear getting locked out more than they fear getting locked in.  They fear not buying that 2,000 square foot home in Los Angeles for $600,000 more than they fear a 30-year debt obligation at 6%.  They lock in their geographical mobility, their dual incomes, and their two-child families for the sake of a 2,000 square foot crackerbox house.

They do not think of where they might live more cheaply, where they might try their hands at a new job.  They are narrowly focused on this county, this neighborhood, this crackerbox house.  They cannot see beyond a lifestyle based on lifelong debt.  They are unable to see debt as a tool of production — a business loan, for instance — because they see it only as a means of consumption.  Consumer debt is like inflated money: bad debt drives out good debt.  This is Gresham’s law of debt.

Why?  Because the debt markets, like the monetary markets, are directed by government monopolies.  In a free market where contracts are enforced, good money drives out bad money, and productive debt drives out consumer debt.  But where the State intrudes to take over the issuing of money, the moral hazard phenomenon appears.  Aggregate debt is never paid off; it is, at best, rolled over.  The money supply, at best, stays stable.  But usually debt and money grow together, a symbiotic locking in of opportunities.

We can no more imagine a world in which consumer debts are paid off and not renewed as people grow older and wiser and richer than we can imagine a world in which government debts are paid off as politicians grow older and wiser.

There is a time for debt: when we are young and starting out, whether we are families or businesses.  There is a time for extending credit: when we are older and wrapping up.  But the cycle of debt and credit has been destroyed by central bankers and politicians.  The cycle has become a one-way street.

The younger generation imagines that debt is forever.  We have taught them well.  For my generation, it has been.  Our only hope, we think, is to become net absorbers of wealth — not our own wealth which we have accumulated, because we haven’t, but our children’s wealth, i.e., their labor power.  We have put our faith in Social Security/Medicare and the government’s ERISA program, which supposedly guarantees our private pensions.

This faith will go down on the good ship Default.  This faith cannot be funded by a pay-as-you-go system.  As economist Herb Stein used to say, things that just can’t go on have a tendency to stop.

We will find that it is better to be locked out than locked in.  Let us hope that we will not be gridlocked.


Someday, some politician is going to issue an emancipation proclamation for the locked-out generation. You had better not be dependent on plantation income when that day arrives.