Debt-Serfdom Is Now the New American Norm   (October 18, 2011)

Trapped assets that generate no income streams in the present are not capital; the value of such non-productive assets is illusory. Strip away these trapped assets and the reality is revealed: most American households toil to service their debts.

The typical American household is insolvent: its debts exceed its assets. There is nothing fancy about calculating insolvency: if debts exceed assets, the enterprise is insolvent. By this measure, most American households are insolvent, if their real assets are marked to actual market.

For example:

Auto loan balance: $9,000
Actual market value of auto: $6,000

Credit card balance: $6,000
Street value of stuff purchased with credit card: $300

home mortgage: $250,000
Auction value of house: $200,000

Student loans: $60,000
Market value of education: Not applicable, as it cannot auctioned off or securitized

And so on.

The typical American household is thus in service to its debt, not to its assets, and to the holders of that debt. This is debt-serfdom: serfdom in service to the owners of debt, debt that may well always exceed the value of the household's assets. This is debt-serfdom for life.

If we look at the American household as an enterprise, then we have to differentiate between unproductive, trapped capital, assets held in a house or retirement account, and productive, free capital which can be moved in and out of productive assets to earn a return which increases free cashflow income in the present.

By this standard, most of the typical American household's assets are trapped and therefore unproductive. In this sense they do not even qualify as capital. Let's say a household owns a house with a real-world market value in today's depressed market of $250,000, and the house carries a mortgage of $150,000. On paper, the household holds a net asset value of $100,000.

But this asset is not actually productive; it produces no income and exposes the household to the risks of declining real estate valuations. The asset provides the value of shelter, but if similar shelter could be rented for less than the costs of servicing the mortgage debt and the many costs of ownership, then sinking the entire household's net worth/assets in a house does not "pencil out" as a productive investment of assets.

In a practical sense, this $100,000 is inaccessible and thus trapped; housing is highly illiquid and has transfer costs of up to 10% in realtor and escrow fees. In most cases, the sale proceeds are simply reburied into another mortgaged home. The asset is trapped and thus not deployable capital.

The same can be said of many retirement accounts that are routinely counted as assets on household balance sheets. the assets are trapped in the account until retirement, and their deployment is often restricted to a handful of risky options (investing in Wall Street, for example). The purchasing-power value of the assets might decline considerably by the time the funds can actually be withdrawn, and in this sense their present value is chimerical.

Since these funds are trapped, they also don't qualify as capital: they cannot be used to start or buy a business or other assets which return free cashflow in the present.

Trapped assets are not capital. They cannot be moved into more productive uses that yield income streams that add to current income, which is the definition of capital. Borrowed money that is sunk into trapped assets is not borrowed capital; it is simply debt that must be serviced.

If we set aside assets trapped in real estate and retirement accounts, a truer picture of the American household's actual productive capital emerges: most households have essentially no productive capital, and their debts far exceed whatever meager free capital they do own.

In a very real sense, the non-cash, non-small-business assets of the typical American household are invisible, unuseable, inaccessible and thus illusory; they exist as entries on the balance sheet but not as real-world productive capital.

Wealth and income do not flow from servicing debt incurred by trapped assets, it flows from productive free capital.

Thus the typical household toils not to increase productive capital that can be deployed to increase household income but to service their crushing debts. How else can we describe this situation other than debt-serfdom?

Tomorrow I will discuss the slow and largely misunderstood transmogrification from a free people with limited access to borrowed capital/debt to a nation of debt-serfs.

If this recession strikes you as different from previous downturns, you might be interested in my new book An Unconventional Guide to Investing in Troubled Times (print edition) or Kindle ebook format. You can read the ebook on any computer, smart phone, iPad, etc. Click here for links to Kindle apps and Chapter One. The solution in one word: Localism.

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