Littletown is a pleasant rural community in Heartland County, U.S.A.
One day the giant international conglomerate Widgit, Inc. decides to build a widget factory and set up some corporate offices in Littletown. A young but ambitious local developer takes advantage of the promising situation, buys some land, and builds 20 small houses. These are pleasantly spaced along tree-lined streets with land set aside for a park and a mall. These houses sell readily to incoming Widget employees for $150,000 each. The Littletown Savings and Loan is happy to lend each buyer (all of whom have good-paying, stable Widget jobs) 80% ($120,000) at 5% per year interest.
Over the next few years as Widget employees move on and new Widget employees come to town, there is a brisk but reasonable turnover of the houses; there are never more than one or two up for sale at any one time, and the buyers are anxious to settle in. So the prices gradually rise.
After a few years, one of the original buyers, Johny Homeowner, discovers that his house is worth quite a bit more than he paid for it, so he pays off his old loan and takes out a new, higher one. Notice that at 10% per year, the price of the house doubles in just under eight years; at 15%, in about five years. So Johny can take out $50,000 to $75,000 every few years--not bad!
Then one year, corporate exigencies being what they are, Widget, Inc. decides to close up shop in Littletown and move to Mediumtown. Uh oh! There is no one to buy the houses. The price drops. One of the owners who can't find a buyer and needs to go, walks away from the loan and when the bank forecloses and puts the house up for sale, it can get only $25,000 (from a speculator). Johny finds that he owes $250,000 on a house that is now worth only $25,000. And the bank, which now has loans on its books that are far in excess of the value of the collateral it holds for them, is itself threatened with bankruptcy; it tells Johny that he has to come up with $200,000 cash or else get out of his house so the bank can sell it, take the loss, and restabalize its books.
Meanwhile the municipality of Littletown has come to rely more and more on rising property taxes (which are typically the largest single source of municipal revenue, often making up more than 50% of a town's income). When these revenues are drastically reduced, Littletown has to fire teachers, firemen, and policemen; it has to reduce city services (like garbage pickup and road repair); and generally tighten its belt.
Poor Johny! Poor Littletown! Poor teachers (and other Littletown employees)! Poor banks! Even, "poor developer" who has just completed his third project--400 houses on another track of land on the other side of Littletown. And the poor speculator, too, who is stuck with a worthless house for which he paid $25,000.
Bun Gladieux, president of the Presssure Positive Company, has a blog with an interesting series of topics.
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