The Financial Destruction of America’s Middle Class

You will not find the above headline anywhere today. Why? Because it isn't
there. It is a headline from the future.

Instead, if you look through today's papers, the headlines you get are
reassuring:

"Job growth is strong, surprising economists," says the New York Times.

"Fears of U.S. Slowdown Recede," adds the Financial Times.

David Lereah, Chief Economist for the National Association of Realtors,
says the worst of the housing slump is over:

"As the housing market recovers from its correction, existing home sales
should be rising gradually during 2007 - it looks like we may have reached
the low point for the current cycle in September. We've entered a more
sustainable period of home sales now, and we expect greater support for
prices over time as inventory levels are eventually drawn down."

A man who likes his women fat and his investment margins thin must find
America, 2007, an agreeable place. According to official statistics, the
average voter is bigger than ever. But they are balancing on the tightest
of tight wires. According to the financial news, never before have
citizens had so little margin for error.

They read the headlines and are happy to believe them. "The bad news is
behind us," they say. "We don't need any margin...because there will be no
errors."

Yet, this is not the first cycle in the housing industry. It is just the
biggest and wickedest. Typically, says Max Fraad Wolff in the Asia Times,
housing prices fall 30% in a downturn, over a period of about four years.
If that is so, this one has a long, long way to go down.

Edward Learner, director of the UCLA Anderson Forecast, makes a more
modest guess; he expects new house prices to go down 5%-10% in the year
ahead. The average house in Los Angeles is now valued at $510,000. That's
about 50% too high, says Learner. It could take five to ten years to get
prices back to normal.

Meanwhile, UBS says default rates on sub-prime loans have doubled...to 8%
of the total. Since 2002, more than $1 trillion in such loans have been
written. And now, many of them are going sour. In October, for example,
foreclosure rates in the sub-prime market were running 42% greater than
the year before. And in November came news that some of the packaged
securities backed by sub-prime mortgage loans were being downgraded by
Moody's - barely six months after origination. Downgrades are common -
mortgages go bad as people die, get divorced or go broke. But it usually
takes longer than six months.

Behind this news is a story that won't go away:

The Financial Destruction of the American Middle Class - this is the story
we've been talking about for the last three years. The plot is very
simple. Most people do not work for the finance industry. Most people do
not get huge bonuses. Most do not own Picassos, nor do they have houses in
Aspen. Most people earn ordinary wages. And they have not had a real raise
in the last 30 years.

"If we use 2005 dollars and the CPI-U (consumer price index for urban
consumers), average weekly earnings decreased by about $1 per week over
the 30-year interval 1975-2005," writes Wolff. "The folks have thus
stopped saving and have taken on massive amounts of housing and consumer
debt."

Wolff continues:

"In 1999, total outstanding household debt was $6.4 trillion. As of the
end of the second quarter of 2006 total outstanding household debt was
$12.3 trillion.

"Household debt has increased by almost as much since 1999 as the sum
total of all debt accumulated by all households across the preceding
220-year history of the [United States]. In 1999, household mortgage debt
stood at $4.4 trillion. At the close of the second quarter of 2006 it had
more than doubled to $9.33 trillion. In 1999, consumer credit outstanding
was measured at $1.6 trillion.

"Today, this stands at approximately $2.4 trillion dollars, signaling a
50% increase in less than seven years. This is usually soft peddled and
talked down by comparison to skyrocketing housing values. Household assets
held as real estate increased by $9 trillion from 2000-2006. This might be
called the mother of all modern bubbles. Yet household net worth struggled
up by a mere $1.2 trillion. Net worth badly lags housing values because of
waves of cashing out. When these waves crash ashore it will be with
massive destructive force."

The middle class still thinks it is the middle class. It owns one or two
or three automobiles. It has children in college...a house with
air-conditioning...maybe some mutual funds. But it is living on borrowed
time and borrowed money...in a borrowed house.

Even though house prices were rising, owners' equity as a percentage of
household real estate actually fell from 58% to 54%. In other words,
people 'took out' so much wealth from their houses that they ended up with
a lower percentage of ownership than they had had before - even at today's
high prices. As prices go down, their 'equity' will fall even further. For
many homeowners, it will disappear altogether.

"Americans keep refinancing and re-mortgaging. Why?" asks Wolff. "There
really is only one answer: desperation. Freddie Mac informs all those who
dare to look that 90% of its refinanced loans resulted in new balances at
least 5% higher than the previous loan."

Someday, perhaps soon, many middle class Americans are going to begin to
realize that something has gone wrong. Their houses will be falling in
price...while their debts are greater than ever. They will realize that
they have been bamboozled.

And someday, a politician will begin to speak for these people. He will
not tell them that they have been fools. Instead, he'll explain that they
have been betrayed by their leaders...swindled by Wall Street...conned by
corporate CEO's and flim-flammed by Republicans and Democrats.

He will be partly right.

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