I keep hearing about “underwater” homes being the main cause of our economic plight.   I find this absurd since using this logic one could argue that our autos are the cause of our economic distress since almost all autos are “underwater,” i.e. worth less than the loan on the car.  No matter how you look at it a home that has “equity” or that is “underwater,” the two sides of the calculation, is a paper “gain” or “loss” not realized until it is sold.  So a home being “underwater” is merely a calculated problem that does not affect your everyday welfare.

That being said it is perhaps useful to focus once more on credit and the role it plays in our economy.  I have written before that the main consideration in taking on a loan is your ability to service the debt, i.e. repay it.  But when looking at credit as a useful tool we should also look at two other considerations, guarantee and leverage. 

The guarantee on a home loan is a mortgage which is a claim on the home and other assests in case of non-payment.  This is a bit more than an auto loan in which the car is usually the only guarantee.  Perhaps student loans have the least attractive guarantee now since so many college grads cannot find jobs.

On the country level the nation stands behind its bonds, thus the bonds are rated and priced according to perceptions of the nation that backs it, e.g. Germany pays 1% interest while Spain pays near 7%.  The whole point of the EuroBond is that it would be guaranteed by the entire European Union which allows a rating and interest rate based on all member states.

And now to the greatest advantage of credit and loans, leverage.  It is leverage that allows one to buy a house for three or four times his annual income.  A ten percent down payment puts you into the home of your dreams since that ten percent is leveraged to buy the home.  Ditto ten percent down on a new car.  And leverage based on zero down payment yields a college degree.

It is this leverage that fuels today’s economy.  Without it one is grounded in lower consumption levels that yield a less robust economy with lower employment.  And this is why I contend we will not regain our economy of  5% unemployment, 65% home ownership, an auto in every garage, and college education for all until we recreate that massive credit level we had until 2007.