WHO IS TO BLAME?

"Many an optimist has become rich by buying out a pessimist." Robert Allen

Are You An Optimist? Robert Allen, author of the above quote made a fortune by being an optimist. He wrote a book entitled, Nothing Down in which he outlined how to buy real estate with no out-of-pocket cash. You certainly have to be an optimist to run up large amount of debt with no idea of how you might pay it back. Looking at some statistics I am about to share with you the only conclusion is that we have been a nation of optimists. While I strive to be optimistic, I don't want to carry it to the extreme of being stupid.

Not All Debt Is Bad. I have always believed that debt has a place in many financial strategies. You might say that one of my specialties has been one of helping my clients develop sensible debt strategies. Unfortunately, you can't say that all debt is good since one inevitable consequence of debt is that it adds risk to your life. Although you can utilize debt to create wealth, it can also destroy your wealth. When carried to an extreme, it almost always creates risk that is virtually impossible to manage. As a simple example, consider the purchase of a million dollar property with an operating income of $100,000 a year. If you buy this property with a million dollars worth of debt at 5%, your interest cost is $50,000 a year. If everything works right, you have just created $50,000 in income from thin air (since you have none of your money in the deal). You have also obligated yourself to pay $50,000 a year whether or not your tenant pays the rent. This situation can be managed, provided you have a secondary source to make those payments or liquid assets available to pay the loan. The trouble is that most people don't have a clue as to how they might make those payments without income from the property. The other problem we have is that too many of us used borrowed money to purchase assets that produce no income and lose value rapidly. When this happens we look around to determine who we can blame for our predicament.

We Have Converted The Blame Game To An Art Form. In the current environment, we blame greedy corporations, lax government regulators, the war in Iraq, and huge federal deficits for our situation. I know I sound like a broken record when I call your attention to irresponsible borrowing by consumers so I have found some statistics to illustrate what I mean. Morgan Housel, who writes for The Motley Fool Stock Advisor derived some statistics that show how we have consistently increased our debt levels relative to our income. In 1974, the average household had total debt equal to 63.5% of annual income. This meant that a family making $40,000 a year had total debt of $25,400. By 1988, this had increased to 81.2%. Ten years later in 1998 debt levels were 92.6% of family income. By 2008, we were at 130%. This means a family making $100,000 a year had an average debt level of $130,000. These high debt levels relative to income means that our lives become more risky all the time. Since consumer spending is 70% of our economy, if consumers decide to cut back on spending to lower debt levels, the effect can be highly detrimental to such factors as unemployment, price stability and the government's ability to sustain spending levels.

One Last Point. Our congress is dangerously close to passing something called "Cap and Trade" with the objective of decreasing our reliance on foreign oil and encouraging clean, renewable, energy. Most of us will support those objectives but the real question is the methods they will use to accomplish those goals. There are a number of things I dislike about this legislation but one of the worst is a provision that requires the seller of any piece of real estate to undergo an "energy audit." Those properties that do not meet government standards will have to bring the property up to standard before it can be sold. Many sellers can not afford these costs, especially in an environment where home values are often less than mortgage balances. I wonder how many of us would really support this level of government interference into our lives.