Sunday, June 28, 2009

Two "New" Posts

Mike at Rortybomb was kind enough to alert me that my RSS feed was not updating. It turns out that the service I use, FeedBurner, has a limit on the total size of the feed (all of the blog posts in the feed file) that is not that hard to reach for a blog.

Once this limit was reached, rather than dropping the oldest blog posts from the feed file, they just stopped adding the new ones. I've addressed this by limiting the feed file to only the newest 10 posts, so there shouldn't be a problem in the future, but in the meantime those subscribing to my blog have missed the last two posts.

I encourage you to still read them, especially, "What we do to our kids: 19% and it can never be discharged in bankruptcy". This is a very important issue that's little known and discussed. The other post, "It's far better for China to increase demand and net-imports through investment spending than consumption spending", is on a far larger and more covered issue, but I think it contributes some important points that are widely misunderstood, and is well explained.

Saturday, June 20, 2009

It's far better for China to increase demand and net-imports through investment spending than consumption spending

Oliver Blanchard writes:

China has embarked on a major fiscal expansion, with a focus on investment rather than on consumption. This was the right policy given the need to increase spending quickly, but this increase in investment can only last for a while. The question is whether, as time passes, China will allow an increase in consumption.
Why is it constantly the case that we see calls for increases in consumption to stimulate demand and/or net-imports, even over longer run periods, when demand and net-imports can be increased with investment spending instead, which will create far more growth in wealth, science, technology, and medicine over the long run. Why are people constantly calling for China and other countries to spend more on big screen TVs, fashions, and eating out, when demand could be stimulated and net-imports could be increased just as much through investment in schools, universities (and student aid so a much greater percentage of young Chinese could go), infrastructure, health (mentioned briefly by Blanchard, but his focus was predominantly on increasing consumption) and safety, relatively clean power generation and conservation, provision of computers and internet access to the rural poor, etc., etc.
These things would make the people of China far wealthier over the long run, and advance science, technology, and medicine for the whole world far more than if instead demand and net-imports were stimulated through the purchase of big screen TVs, Nikes, Burger King, and SUVs.

Blanchard does give this reasoning:
China has embarked on a major fiscal expansion, with a focus on investment rather than on consumption. This was the right policy given the need to increase spending quickly, but this increase in investment can only last for a while.
and
...there will be heavy pressure on the US government to maintain a strong fiscal stimulus for as long as private demand is weak, and this may lead to larger and longer deficits than would be wise. While strong fiscal stimulus was and still is needed to fight the crisis, it cannot go on forever; at some stage, debt dynamics become unsustainable, markets react and fiscal deficits become counterproductive.
But a shift in the mix of a nation's spending away from consumption and towards investment can be maintained indefinitely without "at some stage, debt dynamics become unsustainable, markets react and fiscal deficits become counterproductive.", through the use of something called "increased taxes" to eliminate the deficit.
If a country, or the world, is in a demand-crunch, increased government spending of X on investment will stimulate demand more than increased taxes of X will decrease it. You can read the many excellent posts of Nobel Prize winning economist Paul Krugman explaining how increased government spending creates more stimulus per dollar than tax cuts, but the main idea is that a tax increase of X will cause a decrease in consumption of less than X. But all of the increased taxes of X will be spent by the government -- on high-return investments in this case.

As Krugman wrote:
Other things equal, public investment is a much better way to provide economic stimulus than tax cuts, for two reasons. First, if the government spends money, that money is spent, helping support demand, whereas tax cuts may be largely saved. So public investment offers more bang for the buck. Second, public investment leaves something of value behind when the stimulus is over.
To elaborate, some of the tax increase on consumers will result in them consuming less, but a large amount of it will result in them saving less. Essentially, when taxes are increased to pay for more government investment projects you are making consumers save less and spend more, but not on Nikes and TGI Fridays, instead on infrastructure, education, alternative energy, conservation, basic scientific and medical research, etc.

Moreover, increased government spending on high enough return investments (and there are plenty) can be maintained indefinitely even without tax increases (in rate) because the high enough returns over the long run allow the payoff of the government debt and much more (if that debt can be reasonably financed in the shorter run until the investments pay off. Nonetheless, tax increases, once the demand crunch recession ends, are desirable to eliminate deficits, and the public debt, much faster). As Berkeley Public Policy Professor Robert Reich recently wrote:
...That growth path, by the way, will be faster and stronger if the nation invests in our infrastructure, our schools, and our environment -- which is exactly what Obama aims to do. In this respect, national budgets are like family budgets. It’s dumb for an indebted family to borrow more money to take a world cruise. But it’s smart even for an indebted family to borrow money to send their kids to college. So too with the Obama budget. Public investments, just like family investments, build future wealth. They allow faster growth. They make the debt/GDP ratio even lower and more manageable over time.

Thursday, June 4, 2009

What we do to our kids: 19% and it can never be discharged in bankruptcy

New York Times columnist Gail Collins writes:

Citigroup sent a call to arms to its student borrowers, which is currently posted on Talking Points Memo. It warns darkly that if the Obama Armageddon comes to pass, “students and their families will not enjoy the benefits that competition has made possible for more than 40 years.”

There is, indeed, currently an army of different providers vying to supply students with financing for their higher education. I’m not entirely sure if the borrowing-money choices are as numerous as the body-hydrating ones, but they’re right up there.

This brings us to the critical question of whether endless options actually do any good. “We don’t hear students clamoring for choice in lenders. If anything, students and families need simplicity to understand the process and know how to navigate it,” said Edie Irons, communications director for the Project on Student Debt, a nonprofit dedicated to making college more affordable...

Some students receive financial counseling, but it’s usually cursory, and it is only mandatory for government-backed loans. “It’s not required for private loans, and a lot of students in the worst situation have both,” said Robert Shireman of the Department of Education. Shireman was just back from a panel where he met an officer in the United States Student Association, who told him that some of her loans had an interest rate of 19 percent.

The real competition among the lenders is not to win over students so much as the school financial aid officers. This has led to unfortunate but deeply unsurprising instances of thinly disguised bribes and kickbacks.
The 19% loan is a fully private student loan. Government student loans, and government backed student loans, have interest rates capped at reasonable levels.

With the 2005 bankruptcy law, to our great shame, private student loans can never be discharged in bankruptcy with extremely rare exception. Lawyers.com writes:
Student loans are not dischargeable in bankruptcy unless you can show that your loan payment imposes an "undue hardship" on you, your family, and your dependents. Non-dischargeable debts are those debts that you cannot totally eliminate when you file for bankruptcy and will have to be paid by you.

It is almost impossible to show an undue hardship unless you are physically unable to work and the chances of your obtaining any type of gainful employment in the future are non-existent.
So we have 19% loans for large sums of money sprung on unsuspecting 18 year olds that can essentially never be discharged in bankruptcy. With the immense exponential power of compound interest at 19%, this can quickly spiral to the point where it can never be paid off, with payments beyond a person's entire income This is shamefully close to a return to lifetime indentured servitude.

I once mentioned this to Al Melvin, Republican co-chair of the Arizona Senate Appropriations Committee. His reply was, "There's a thing called personal responsibility." But how can you be responsible for something you don't know about or understand? There are almost no 18 year olds who know that private student loans are not dischargeable in bankruptcy, or who could read the legalese in the contracts. There are few who understand the devastating power and implications of compound interest at 19%, which, with it's incredibly exponential growth, doubles debt in less than 4 years. Most don't realize that they should rely solely on government student loans as best they can because of the great protections of those loans and low rates (For example, federal government student loans allow for "Income Based Repayment" where payments are capped at 15% of disposable income (just 10% of total income for a family of four making $100,000/year), and any principle remaining after 25 years of payments is forgiven.)

We're not living in a freshwater economist's model. All 18 year olds don't hold all publicly available knowledge in their brains, and have advanced degrees in every area and specialty there is so they can always figure out what the perfect choice is, and instantaneously, with no time or money costs of analysis whatsoever.

Democratic Senator Dick Durbin wrote in a floor statement in 2007:
Mr. President, I would like to tell you about Connie Martin from Sycamore, IL. Connie's son decided to go to culinary school in Chicago 5 years ago at the age of 25. To pay for tuition, he borrowed $58,000 in private loans from Sallie Mae at 18 percent interest. His first payment was $1,100 a month--his entire monthly salary at a downtown eatery where he worked after graduation. His loan balance, including government-backed loans, is now $100,000. Connie's son has been working hard, and she and her husband have been trying to help him make the payments. I worry for borrowers like Connie's son who can't start over and will have debt that will likely haunt him for the rest of his life.
Is this really the society we want to live in? Where predators can troll the TV stations all day long with dreamy pitchs about how young people can become executive chefs, medical technicians, and fashion designers at exorbitantly priced for-profit schools (especially compared to community colleges), financed with private student loans at 18%, or more, that can never be escaped in bankruptcy. If you want to live in a country where predators are free to prey on our unsuspecting young, destroying their adult lives before they can even get started, then vote Republican. But if you want to fix the great harm that they have done over the last generation, oppose them in every election. The less Republicans there are in opposition, the more likely we can pass laws to protect our young from inescapable rapacious debt.

Tuesday, June 2, 2009

Let's cut the ammunition to the housing arms race permanently

Part 2 of 2 (Part 1)

...The largest roots of the problem [today's epidemic of foreclosure, and more generally personal financial stress and distress] are the great increase in economic risk over the last generation (see Hacker, 2006) and the great increase in the percentage of individual and family budgets spent on large fixed expenses, what Harvard bankruptcy expert Elizabeth Warren calls "Must-Haves" (Warren and Warren-Tyagi, 2005) .

Must-Haves are expenses that cannot be cut back on, at least not in the short run, without very serious consequences. While a family facing a layoff, illness, a suddenly doubling of their credit card interest rate, increase in their medical insurance, and/or other troubles, can immediately cut back on eating out and lattes, they cannot do the same for the mortgage, the car note, and the insurance payments, thus the name, "Must-Haves".

The typical family in 1972, even with just one earner, spent only 54% of its income on Must-Haves, but by 2005 this was up to 75%, even with both spouses working (Warren, 2007). And many families today spend over 80% of their income on Must-Haves. Thus, if something goes wrong, today's families have relatively little that they can cut back on to avoid an immediate disaster, or the start of a debt spiral that inevitably leads to ruin.

And it's far more likely today that something will go wrong. The economic environment has become much less secure. For example, the probability of an average American experiencing a 50% or greater drop in income over a year increased from 7% in 1970 to 17% in 2002, about 1/3 of Americans over the last two years risked illness without health insurance, and even with health insurance, the cost of illness is far higher today than a generation ago. At the same time, instead of cushioning this great rise in insecurity, government has actually been exacerbating it by following a philosophy of cutting back extensively on public risk pooling, social insurance, consumer protection regulation, and other public protections, culminating with the recent attempt to end guaranteed old age social security payments.

Why in this environment have Must-Haves increased so much? The primary reason is increased spending on housing. The inflation adjusted price of the median home increased by 80% between 1970 and 2008 (National Association of Realtors data) , and this is a huge reason for today's economic insecurity. Any real solution to the housing and personal financial crises must bring down housing prices. Despite the unfortunate and misleading somber tone we see in the press about declining home prices, over the long run, this does far more good than bad.

To bring housing prices down to levels where they don't impose undue financial stress on Americans, we need to consider what drove them to such unprecedented and lofty heights in the first place. Essentially, it is the result of a bidding war fueled by a combination of three key factors; women entering the workforce, a positional/prestige arms race, and a great loosening of credit regulations and standards.

The first factor developed primarily in the 1970s. As women entered the workforce, families had substantially more money to bid on homes in the desirable suburbs. This contributed to a 40% increase in real home prices between 1970 and 1979, which largely negated any increase in the family's standard of living from the wife's working. And, it made it so that typical families needed two earners to achieve what their parents basically achieved with just one.

The second and third factors really hit between 1995 and 2005, although they began two decades earlier. The modern era of credit deregulation began with the 1978 Supreme Court ruling in Marquette National Bank v. First of Omaha Service Corporation (439 U.S. 299), which essentially negated all usury limits on credit card interest rates. The Depository Institutions Deregulations and Monetary Control Act followed in 1980, which pre-empted state usury laws for first lien home mortgages.

The free market began seizing on this deregulation in earnest, eventually resulting in a family's ability to borrow amounts that were unthinkable a generation ago. With the ability to charge mortgage interest rates over 20%, financial institutions were more than willing in return to take on the high default risks that went with saddling consumers with unprecedented levels of debt. By 2004 it had gotten to the point where the average home price to income ratio in California was over 8, as opposed to the traditional level of about 2.

The mid 90s is when debt fever really took off, with the popularization of subprime mortgage securitization. This is the packaging of a large number of sub-prime mortgages into a single standardized security and selling it to investors. Subprime mortgage securitization increased 8.5 fold between 1994 and 1998. The result was that consumers could take out far larger and riskier mortgages, and thus bring far more money to the bidding wars for homes in the safe suburbs with good schools.

The third key factor in the great rise in home prices involves the prestige fever which has climbed to an unprecedented level over the last generation. This is explained in detail in Cornell Economist Robert Frank's book Luxury Fever. Homes, and their neighborhoods, are the strongest conveyers of prestige, so certainly the prestige fever has fueled the bidding war. In addition, there is the compelling positional issue of wanting to live in a safe middle class neighborhood with good schools. The ability to borrow far more added a great deal of fuel to bidding wars to live in such neighborhoods.

Why has the prestige fever reached such unprecedented heights over the last generation? A leading explanation is that the great increase in income inequality has resulted in what Frank has termed an Expenditure Cascade.

In 1978 the top 1% received 8 times the average income; by 2006, this soared to 23 times. For the top .01% the increase was from 86 times the average income to 546 times, and the trend has been accelerating. Between 2002 and 2006, the top 1% captured almost three-quarters of income growth. Greatly exacerbating the situation, simultaneously Republican tax cuts starting in the Reagan administration and continuing through Bush II have made taxes far less progressive. The top federal income tax rate was cut by 35 points between 1979 and 2006. Average tax rates on the richest 0.01% were cut in half between 1970 and 2006, while taxes on the middle class were increased.

To illustrate the Expenditure Cascade phenomena, suppose that initially the top of 1% drove $100,000 cars, and the top 5% drove $70,000 cars. Then, income inequality increased substantially. In response to their new wealth, the top-one-percenters start driving around in $200,000 Bentleys, super-high end Mercedes and Porsches, and entry level Ferraris. This then makes the top-five-percenters feel a lot less special than they had grown accustomed to; they feel a lot poorer and lower prestige. Their $70,000 loaded Mercedes 300Es start seeming like part of a lower group, kind of every day, so they really want to move up so that their cars aren't that much poorer than the Bentleys and Mercedes 600s's they're now starting to see all over the mall parking lot. So they start buying $130,000 Mercedes 500s's and new super Lexi to keep up.

But then the top-ten-percenters see them driving these cars, and they start buying more expensive ones to try to keep up, and not lose their relative position. And it just keeps going, cascading right on down the line, until everyone is buying more expensive cars, all pulled in a chain by the great increases in wealth we have seen among the super wealthy over the last generation.

Conclusion

Due to changes in government policy, economic structure, and social attitudes, we have had a great increase in family financial risk, and a housing bidding war that has lead to an explosion in home prices. And these things, for the most part, account for today's epidemic of foreclosure and financial distress.

As I hope I've convinced you, one of the most important things we could do for American families, especially over the long run, is to bring home prices back down to sane and affordable levels. This would help tremendously to return Americans to the safe and solid tradition of only spending about 50% of their incomes on Must-Haves.

Only 50% (or less) of monthly family income spent on Must-Haves, as opposed to the current average of 74%, leaves room to save 20% of income each month. This gives us Harvard Professor Elizabeth Warren's "Balanced Money Plan" – No more than 50% spent on Must-Haves. At least 20% to savings, and the rest is for "Wants", discretionary spending on anything you'd like. I believe this is the best plan for families today, and teach it to over 500 students per year at the University of Arizona and, over 100,000 per year in my personal finance education company (See Professor Warren's "All Your Worth: The Ultimate Lifetime Money Plan").

With Must-Haves at no more than 50%, families are much better able to deal with today's far riskier world. For example, if a spouse loses his or her job, the family has 50% of its expenses that aren't fixed and can be immediately cut back on to weather the storm without descending into a ruinous debt spiral. In this example, with unemployment compensation, the typical family should have no problem cutting back and avoiding taking on debt until a new job is found.

As I've shown, however, unfortunately, the tradition of spending only about 50% of income on Must-Haves got blown out of the water by the three key changes that lead to the home bidding war. I therefore propose a massive draining of ammunition from this devastating war – strong limits on mortgage interest rates.

Legal mortgage interest rate limits could simply be made low enough that the median family would not be able to get a large enough mortgage to buy a home that would consume more than 25% of its income in monthly payments. With all other families limited in the same way, a family would still be able to buy a home in just as good a suburb. They would not be outbid, because competing families would face the same constraint. It would be like placing a severe arms limitation on all sides of a mutually self-destructive arms race.

So, families would end up in the same communities, but paying much lower prices. And this is just as it was a generation ago when we did, in fact, have severe legal limits on mortgage interest rates. The safety of a family's community and the quality of its schools would be the same (With regard to school quality, property taxes for schools would be lower, but progressive income taxes could rise to compensate. Total tax rates would then not decrease, but parents' mortgage payments would – a lot).

With all families limited – essentially by law through mortgage interest rate ceilings – to spending, say, half as much on housing, no family would lose its relative position. No family would end up in a lower ranked community, but the typical family would be far more financially secure. This is just as with countries in an arms race. They would all be far better off if they were all limited to spending half as much on arms. No country would lose its relative position. All would be just as militarily secure, but they would have far more money to spend on their economic security and quality of life.

Severely limiting mortgage interest rates, then, would really get at the real root of the problem, and have an immensely more positive long run effect than minor tinkering.

To those who object saying the complete free market is always most efficient, please let me note that in spite of what screaming talk radio hosts and ideologues may say, it has been well proven in (scientific, academic) economics that there are many and severe inefficiencies that can result from a completely unfettered free market, and a government role can greatly alleviate these (see any university intermediate microeconomics text, especially under the headings market failure and externalities). Even Adam Smith realized that the Invisible Hand would not always work efficiently, and since "The Wealth of Nations" was published in 1776, the field of economics has advanced greatly, and shown very strongly that a substantial government role can greatly increase efficiency.

So for the sake of our families, let's permanently cut the ammunition to the housing arms race.

REFERENCES AND FURTHER READING

Chomsisengphet, S. and A. Pennington-Cross (2006) "The Evolution of the Subprime Mortgage Market", Federal Reserve Bank of St. Louis Review, January/February, 88(1), pp. 31-56. Available at:
https://www.research.stlouisfed.org/publications/review/06/01/ChomPennCross.pdf .

Frank, R. (2000) "Luxury Fever: Money and Happiness in an Era of Excess", Princeton University Press.

Frank, R. (2005) "Positional Externalities Cause Large and Preventable Welfare Losses", American Economic Review, May 2005: 137-41.

Frank, R. (2007) "Falling Behind: How Rising Inequality Harms the Middle Class", University of California Press.

Hacker, J. (2006) "The Great Risk Shift: The Assault on American Jobs, Families, Health Care, and Retirement and How You Can Fight Back", Oxford University Press, USA.

Lesser-Mansfield, C. (2000) "The Road to SubprimeHel” was Paved with Good Congressional Intentions: Usury Deregulation and the Subprime Home Equity Market", 51 S.C.L. Rev. 473.

Saez, E (2008) "Striking it Richer: The Evolution of Top Incomes in the United States", the University of California, Berkely, Department of Economics, Available at:
http://elsa.berkeley.edu/~saez/saez-UStopincomes-2006prel.pdf .

Smith, A. (1776) "An Inquiry into the Nature and Causes of the Wealth of Nations", London, England.

Warren, E. (2007) "The New Economics of the Middle Class: Why Making Ends Meet Has Gotten Harder", Testimony Before Senate Finance Committee, May 10, 2007, Available at:
http://www.senate.gov/~finance/hearings/testimony/2007test/051007testew.pdf .

Warren, E. and Warren-Tyagi, A. (2003) "The Two Income Trap: Why Middle Class Parents are Going Broke", Basic Books.

Warren, E. and Warren-Tyagi, A. (2005) "All Your Worth: The Ultimate Lifetime Money Plan", The Free Press.

Monday, June 1, 2009

It's deregulation AND positional/context/prestige externalities

There have been two very important articles in recent days about key parts of what has devastated the financial security of the middle class over the last generation:

– Nobel Prize winning economist Paul Krugman's current New York Times Column, "Reagan Did It":

But there was also a longer-term effect. Reagan-era legislative changes essentially ended New Deal restrictions on mortgage lending — restrictions that, in particular, limited the ability of families to buy homes without putting a significant amount of money down.

These restrictions were put in place in the 1930s by political leaders who had just experienced a terrible financial crisis, and were trying to prevent another. But by 1980 the memory of the Depression had faded. Government, declared Reagan, is the problem, not the solution; the magic of the marketplace must be set free. And so the precautionary rules were scrapped.

Together with looser lending standards for other kinds of consumer credit, this led to a radical change in American behavior.

We weren’t always a nation of big debts and low savings: in the 1970s Americans saved almost 10 percent of their income, slightly more than in the 1960s. It was only after the Reagan deregulation that thrift gradually disappeared from the American way of life, culminating in the near-zero savings rate that prevailed on the eve of the great crisis. Household debt was only 60 percent of income when Reagan took office, about the same as it was during the Kennedy administration. By 2007 it was up to 119 percent.

– Cornell Economist Robert Frank's Guardian article, "Alpha Markets":

Sometimes individual and group interests coincide. But interests at the two levels often conflict.

Male body mass is a case in point. Most vertebrate species are polygynous, meaning that males take more than one mate if they can. The qualifier is important, because when some take multiple mates, others get none. The latter don't pass their genes along, making them the ultimate losers in Darwinian terms. So it is no surprise that males often battle furiously for access to mates. Size matters in those battles. And hence the evolutionary arms races that produce larger males.

Bull elephant seals often weigh more than five times as much as females. But their size is a handicap, making them far more vulnerable to sharks and other predators. Given an opportunity to vote on a proposal to reduce their weight by half, bulls would have every reason to favour it. But they have no such opportunity. And any bull that weighed much less than others would never find a mate...

The financial meltdown that caught Adam Smith's disciples off guard would not have surprised Darwin. One of his central themes was that because much of life is graded on the curve, wasteful arms races create conflict between individual and social interests. The good news is that unlike other animal species, humans can often resolve such conflicts through intelligent regulation.

The factors, or phenomena, discussed in these two articles are very interrelated. They have really worked together to do tremendous harm to the financial security and quality of life of the middle class over the last generation.

How so?

Positional/Context/Prestige externalities are extremely powerful. Before deregulation, when relatively responsible, law abiding middle class families entered bidding wars for homes in the safe suburbs with good schools, and with the community populated predominantly by other relatively responsible law abiding middle class families, the government limited their arms (borrowing) greatly.

Families were simply not allowed to enter these bidding wars with enormous amounts of borrowed funds at high interest rates and fees. Government regulation prevented it. Families could only get mortgages that were a small multiple of their annual income, not 10 times, or more. So devastating bidding wars for homes in middle class suburbs were not possible.

With Republican deregulation, however, financial firms could now offer low down or no down mortgages on homes 10 times the annual income of a family, and they could charge interest rates well into the double digits, with fees over 10% of the loan amount.

The result was that home prices exploded, devastating middle class budgets and financial security.

What else?

As Harvard Professor and Chairwoman of the Congressional Oversight Panel for Economic Stabilization Elizabeth Warren wrote in her book, "All Your Worth: The Ultimate Lifetime Money Plan" (which I think is by far the best personal finance book today):

If your dad wanted to buy a car he couldn't really afford, he couldn't get the car loan. If your mom wanted to rent an apartment that was out of balance with your family's income, the landlord wouldn't rent it to her. If your parents tried to take out a loan – say, for an addition on the house or just to make ends meet for a while – they had to meet with a banker, face-to-face, to explain why they wanted the money. The banker would have asked for pay stubs, tax returns, and all kinds of financial records, so he could evaluate the prospects for repayment. And if things looked out of balance, the banker would have rejected the loan.

As a result, in those days it was really really rare to spend too much on the basic monthly bills. Why? It's not because your parent's generation was smarter or thriftier or "more in touch with what matters" No, things were different in your parent's day because the rules were different. Your parents lived at a time when the government strictly regulated the banking industry...As a result, in your parents' generation there were no zero down mortgages. Almost no one was "house poor", spending too much on a home or apartment. There were no offers on TV to "cash-out" your home equity. No one had a car payment the size of Texas, and car leases hadn't even been invented...

In today's world, you can get a mortgage that is too big for you – and the banks will help you do it. You can get a car lease that chews up half your income. You can wind up with a student loan bigger than some mortgages. And as sure as the sky is blue, you can rack up credit card debt without blinking an eye, even if you don't have 50 cents to make the payments.

So, how does this tie in to what I've been talking about? It all added tremendous borrowed money, debt, ammunition to positional/context/prestige arms races and externalities. With deregulation, your neighbor can now get a loan for a $40,000 car instead of a $20,000 one if he wants to get something "special", where what seems special is extremely positional, and/or if he wants to really look prestigious. Another neighbor finds he can now get a home equity loan to put in granite countertops, that he could never have gotten before. A friend gets a home equity loan to put in wood floors and tile, instead of nice carpet and linoleum. A co-worker gets a new credit card and charges a $300 watch, when before he would have only been able to purchase a $150 one (but it would have looked just as prestigious, and given him just as much satisfaction, because his peers would have been similarly limited to wearing $150 watches).

All of this sets off what Professor Frank calls expenditure cascades (or positional/context/prestige cascades).

What's an expenditure, or positional/context/prestige, cascade? Hold that thought.

I wrote an article at about the peak of the recent housing bubble which explains this, and I think discusses these issues well. It's called, "Let's Cut the Ammunition to the Housing Arms Race Permanently". I've reprinted most of it in my next post...