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Why We Borrow Until It Hurts

People bought houses with pick-your-payment mortgages and zero down payments, aided by low interest rates -- but then the rates went up and the mortgage market melted down.
People bought houses with pick-your-payment mortgages and zero down payments, aided by low interest rates -- but then the rates went up and the mortgage market melted down. (By Gary Gardiner -- Bloomberg News)

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What We Owe
By Michael S. Rosenwald
Washington Post Staff Writer
Sunday, March 23, 2008

If the subprime mortgage mess has taught us anything, it is that we are leverage addicts. Nearly all of us are -- from Northern Virginia, where we bought big houses with no money down, to Wall Street, where traders borrowed cash to make bigger bets on the housing market.

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Seeing Zero Percent Interest Until Next Year! on envelopes causes us to tear them open, find the Web address, enter some information and send new credit cards hurtling toward our mailboxes. Financing cars for three years is so passe; we finance them for six or seven. And now we buy -- or used to buy -- houses with pick-your-payment mortgages. We are leveraged from here to China. U.S. consumers spend more than 14 percent of their after-tax income just to stay current on household debt.

The question worth asking now is: Why do we love leverage so much that it hurts?

The simple answer, according to personal finance experts, is that we want more -- more money, more house, more car, just more, more, more. We often think we deserve more. Leverage gets us more. With historically low interest rates, leverage is the easiest and quickest tool to get more stuff.

The problem is that too much leverage has a downside that is easy to overlook. When everyone else is using leverage so successfully to get more, do we wonder what will happen if interest rates go up? Not so much.

This is where the simple answer breaks down. So we turn to the more complicated answer: Blame our brains.

That's what Jason Zweig thinks. He's an investing guru and journalist, and as many people wonder how we all could have been so dim-witted these past few years, he provides one possible answer in a book called "Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich."

Zweig has studied several experiments examining people's brains when they make personal finance decisions. The results, he said, are surprising.

"You would expect logically that the borrowing and spending of money would be emotionally painful to people because having money is intrinsically a good thing, and having less money would have to be worse," he said. "Going from more money to less would be painful."

If only that were true.

"When people borrow and spend money, it's really the reward centers of the brain that become activated," Zweig said. "When you borrow money, you are thinking not about the long-term consequences but the short-term result: You have more cash in your pocket. The pain you are going to experience down the road of having to pay -- that's in the future, it's remote, it's abstract."

Now think about the housing boom, particularly about people borrowing way more than they could afford.


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