Investment Overview

Understanding the value of residential real estate investing is important to see when, why and how to grow your wealth.

Assets & Liabilities

The world financial system is strung together by the concepts of revenue and debt. A significant portion of the entire banking system survives due to the ability to receive payments from homeowners. The cornerstone is the residential mortgage, an instrument of debt that allows homeowners to borrow money to purchase a home.

In 2007 and 2008, we saw just how important mortgage-backed securities were (and still are) to the overall financial system. While this opened the eyes of many to the questionable activity of banks, many forgot to examine the real issues.

The problem is there’s a big difference between assets and liabilities.

What’s worse is that the average American has no clue what they are and how to use them. Even individuals who have at least heard of the terms assets and liabilities most likely don’t understand their meaning or how to utilize them in the real world.

The average American believes that an asset is a “thing” of value, such as their family home, which they have mortgaged for a 30-year time span.

That’s not necessarily true.

Not all homes are assets. In many cases, a home can be a liability and cost you more money than you will ever make. So how can we differentiate these terms and make them easy to understand?

It begins with an overview of assets and liabilities, including what they are and how to use each to your advantage. Understanding the differences between these two concepts is key to a person’s financial abundance.

In modern times, author and investor Robert Kiyosaki has been a sobering voice in the world of financial literacy.

“Just because something is listed under the asset column does not make it an asset,” said Kiyosaki. “The reason people suffer financially is that they purchase liabilities and list them under the asset column.”

This statement is characteristically true for most American families. Those with a formal education learn the basics of assets and liabilities from their college accounting courses. In general, this provides an overview of how to manage an income statement and measure their assets and liabilities with a balance sheet. The core tools, the income statement, and balance sheet are used to give an overview of a person’s financial status.

The problem I found with my classes on the topics, as I’m sure many can relate, are that they teach you how to “count” your income and expenses, but not how to understand the relationship between the two.

We live in a debt-based system, and, with the proper knowledge, you can leverage debt and liabilities to increase your assets. The issue with this basic understanding is that it doesn’t teach you how to utilize each in relation to the other properly. While there may be many societal aspects I could blame — formal education institutions, parents not passing on the knowledge to their kids, the growing complexity of the financial system can scare people off — it’s best if I just take the plunge and help further your basic understanding in relation to the real estate market.

The current symptom of this knowledge deficit has produced a generation of Americans who rely solely on their job as their primary form of income. You see, Americans are brought up in an environment where they go to work each day and exchange their time and effort for a paycheck. This paycheck is reported on a W2 tax form at the end of the year and serves as the only income stream for the majority of Americans.

This has caused most Americans to believe that income statements and balance sheets are primarily connected to the yearly income earned through employment, and then compared to expenses like rent, food, cell phones and vacations (if any.) Most tend to give the responsibility of financial accounting to a tax professional at the end of the year and don’t think much about it.
The job paradigm is the primary reason most of us have a backward understanding of assets and liabilities. As an individual grows in their career, generally through a promotion with higher pay, they begin to “invest” their money for retirement in the forms of IRA accounts, 401Ks and other institutional investments, in hopes of saving for the long-term.

The graph above illustrates the real relationship between assets and liabilities and, consequently, is the simplest way to understand how they affect your financial well-being.

It’s a straightforward concept. Assets are real property creating an income stream. The emphasis here is on the word “real” within the term “real property.” Meanwhile, liabilities are “things” that create an expense.

Assets

If you want to be financially successful in the Western world, you must understand what an asset is, and how it’s different from a liability.

An asset is real property that is acquired and then produces a rate of return. This means it’s a product, such as real estate, bonds or even a business that provides a positive cash-flow over a long period. The rates of return can vary drastically depending on the type of asset.

Examples of assets:

• A profitable business
• Dividend-paying stocks
• Interest-paying bonds
• Profitable intellectual property
• Cash-flow positive real estate

These all have at least one thing in common: they produce positiv cash-flow (meaning a flow of cash, or revenue). Although assets come in many forms, for this lesson we’ll continue to discuss real estate as an asset or liability. Many people in today’s economy don’t understand that cash-flow is the basis of wealth. More importantly, your monthly cash-flow dictates your lifestyle and your wealth. Certainly, income is a part of the revenue, or positive cash-flow concept. However, it is only one part of the larger equation found within an income statement.

Income statements are a diagnosis of a family’s profits and losses. If your expenses are greater than your income, then your family is losing money each month. If your income is higher than your expenses, you are saving money, and will be able to grow your wealth. Unfortunately, this idea gets lost in our modern financial world. The bottom line is if something is making you money over a period of time, it’s an asset.

Liabilities

Most of us have heard the term liability. We’ve seen it used in movies, described by tax experts and preached about by financial advisors. But what is a liability?

According to Merriam-Webster’s dictionary, “A liability is a thing for which someone is responsible, especially a debt or financial obligation.”

They also describe it as “A person or thing whose presence or behavior is likely to cause embarrassment or put one at a disadvantage.” Basically a liability is a negative responsibility. It is the opposite of an asset.

In plain English, a liability is an obligation that creates an expense, usually on a monthly basis. Instead of putting money in your pocket, it takes money out of your pocket.

Examples of liabilities:

• Personal home mortgage
• Credit card debt
• Student loan debt
• Car loans and leases
• Monthly payments and fees
• Taxes

The key to financial abundance is to either eliminate — or drastically reduce — your liabilities. Or, alternatively, balance them with income from assets. A recent study shows that the average U.S. household has now passed the $90,000 mark, which includes households that are debt free.

This shows us that there is a large problem with the pocket books of most American families. Liabilities are out weighing assets and these families are losing money month after month.

The “2015 American Household Credit Card Debt Study” also showed that the average household with debt owes $130,000.

As of the fourth quarter of 2015, these debts included:

• Mortgage debt, with each household having an average mortgage of $168,614.
• Credit cards, which average out to $15,762 per household.
• Auto loans, which average out to $27,141 per household.
• Student loans, which average out to $48,172 per household.

These figures don’t even include the debt of local and federal governments, who also are leveraging your financial life in order to outspend their balance sheet.

It is no wonder we are having a difficult time digging ourselves out of the financial meltdown aftermath. Americans are wallowing in debt and continue the cycle by taking on more debt. Is there a way out? How can Americans re-balance their asset-liability equation?

Is Your House an Asset?

A home with a mortgage is not an asset at all. Actually, that home, in most cases, is technically not owned by the family paying for the mortgage each month. It’s owned by the bank or lender until the entire note is repaid according to the terms of the loan.

If you live in a home that costs you money every month, even if it’s paid off, is that an asset or a liability?

Talk to almost any financial advisor and they will say, “Your house is the best investment you have.” Listen to Suze Orman on TV and she will tell you to save and invest in your own home even if it makes you cash broke because one day it will pay-off.

Your friends, relatives and mentors will call your house an asset but how could it be if a family is financially upside down with exceedingly high mortgage payments?

The truth is your home may or may not be your best investment. People tend to forget this fact, and the concepts of economic markets when it comes to their house. After all, for a majority of homebuyers, a residence is an emotional investment more than financial.

On the contrary, all of the talking heads could be correct. I’ve worked with tons of people that were initially terrified when they first purchased a home for less than $20,000 and now, over thirty years later, it’s worth millions.

There are a few simple questions to determine whether your home is an asset…

• What is the monthly cash flow?
• What is the average yearly appreciation?
• What are the monthly expenses?

In the current market, most families have a mortgage payment on their property. This payment is usually their largest monthly expense. Families pay more money for upkeep on their home than they spend on food, education or entertainment.

Look at it this way: an asset is only something that puts money in your pocket. If you have a house that you rent out to tenants, then it’s an asset.

If you purchased at a time and location that appreciates in value every year, that would be an asset. But relying on appreciation is not a consistently positive long-term strategy.

When the real estate market is doing well, it’s easy to assume that your house is an asset because it is increasing in value. This increase in value leaves many homeowners with the impression that their wealth is increasing.

Yet, without selling the asset for a profit, you are tied to the rising and falling tides of the market. This issue became clear during the 2008 real estate market collapse. In the years before the collapse, homeowners were flying high. Most owners saw a quick rise in their real estate values as the market rapidly increased due to many factors.

This sudden increase in value led many owners to borrow against their new-found equity in their properties. Families would take out home equity loans to buy cars, boats, vacations and more.

When the market began to get into trouble, those same people found themselves “underwater” as the value of their homes was now worth less than the mortgages owed against them. This caused many families to default on their loan payments and thousands of houses foreclosed.

After losing a home that a family made monthly payments on for years, it became evident that a home isn’t always an asset. Rather than investing in the hope of appreciation, invest for cash-flow and know when to cash out for a profit.

This may leave you with questions regarding whether or not a home purchase is a wise decision.

As previously mentioned, you’ve repeatedly heard of the positives regarding home ownership and trying to stuff it with equity thus supporting a perpetual rise—if not stability—in real estate values. A little understanding of the financial system is fundamental in balancing the risks associated with home ownership as a liability (meaning you’ll need to rely on the extension of a mortgage to kick off your home ownership.)

Real Money v. Currency

“Money” is likely the most controversial word in the whole English language. Millions of people loath it with a passion, claiming that money is the root of all evil. Meanwhile, opposing views say that it is the lack of money that causes harm.

We are called greedy if we hoard it, yet foolish if we spend it all. In our world, money is the difference between living and dying every day. It can buy you diamonds, gold, and cars, fill your stomach with caviar, lobster and coffee, or leave you starving on the side of the road.

Our entire life revolves around the man-made concept of money.

Take a second to think about nature. Deer don’t survive off of their Visa cards. Lions have no mortgage bill due at the first of the month. Yet, the average American household is in over $90,000 worth of debt. Even financial planners, bankers, attorneys and your accountant don’t completely understand the difference between currency and money.

Let’s take a step back and ask a very simple question first:

What is Money?

That dollar in your pocket is considered a medium of exchange. It allows you to purchase goods and services in many areas of the world, because the other party will accept it as payment. The dollar in my pocket will buy the same amount as the dollar in your pocket, but is that really money?

The money concept is based on a fundamental human activity: exchange.

For thousands of years human beings have worked to specify a common system of exchange. Prior to money, we bartered with whatever we could create (or capture) with our hands. How much is this necklace worth? Five cows? Ten chickens?

As silly as it sounds from our 21^st Century perspective, this was reality prior to the abstraction of exchanging a mutually agreed upon “thing” that represents the value of what we are exchanging.

From coins, to obsidian pieces, to shells, there has been a constant evolution of money subsequent to our bartering system. During the 11^th Century, China introduced paper money, after which Europe followed suit in the 13^th Century. However, these weren’t necessarily uniform. There were “larger” notes issued by different institutions (and smaller notes as well). As such, currency has, technically, been around for a great deal of human history.

What has changed in recent history is the tangible valuation the note is tied to. For example, the U.S.—and many other countries across the globe—had connected the value of the dollar to the gold standard. Much of this had to do to with the importance of gold valuation throughout human history.

Why was gold used? First, it’s rare. Second, it possesses additional production properties making it a highly desired precious metal—i.e. corrosion resistance, easy handling process. Furthermore, gold is a tangible “thing” that includes time intensive human labor (extraction and processing) as part of its valuation. These components combined to make gold the standard valuation for the “I owe you” which underlies the banknotes.

However, the gold standard has been abandoned by many, if not all, countries. The U.S. dropped the gold standard in 1971. Unfortunately, once banknotes were disconnected from that tangible asset, printing more currency became more attractive—after all, the banknote valuations were set free from “real” constrictions.

This printing of currency dilutes the currency supply, which in turn continually transfers wealth out of your pocket to the government and banking system. This happens without you even noticing until it’s too late and prices have risen beyond your control. Real money, on the other hand, has all of these characteristics and is a store of value over time.

Though the valuation of gold does fluctuate depending on many factors, it’s not as unstable as currencies that are not backed by gold, silver or another asset.

Dollars, gold, and real estate are all assets with different uses. Commodities, like gold and silver, are portable and easily exchanged, which is why they are widely used in trade.

Real estate, on the other hand, is a store of value, similar to gold and silver, since it generally increases in value as currencies dilute. Yet, it’s not easily exchanged but can be used for trade in certain circumstances. The significant difference with real estate compared to money and currency is that it can be used to generate real revenue due to it being a tangible asset.

As you can tell from this chart, each of these has value in a unique way. In the long run, only gold and real estate will keep up with inflation and demand over time.

Yet, only real estate gives you, the individual, an opportunity to add value. This means you not only store your wealth but grow it as well.

Let’s take a closer look at each aspect of these asset classes:

Accountable

Money allows for a record of debit and credit entries to cover transactions involving a particular item or a particular person.

Divisible

The medium of exchange (money) is capable of being divided to pay a portion of goods and services. This can be easily seen in the dollar system.

Examples of divisibility:

• • A dollar can be divided into one hundred pennies.
  • A twenty-dollar bill can be split into four five-dollar bills.
  • An ounce of gold can be divided into grams.

Portable

Currency is easy to carry or move around.

This is true with smaller assets like gold, dollars, and euros. It’s also becoming true with many currencies and assets in the digital space.

Units of exchange like your credit cards and bitcoin are used for the digital storage and exchange of dollars or gold (i.e. goldmoney.com). This makes it incredibly portable as long as the technology continues to permeate the market.

Durable

Money must be able to exist for an extended period of time without deterioration. A dollar bill can stay in your home for years. You can carry it, get it wet, crumple it up and in most cases it survives.

Gold is even more durable, lasting indefinitely.

There’s a reason we use these assets and it includes long-term security. Real estate is also quite durable but in a unique way.

Tradable

Others in the marketplace have made the conscious decision to accept the currency and/or money as a unit of value. Merchants are willing to trade goods and services in exchange for money.

Fungible

This is a property of currency or money whose individual units are capable of mutual substitution. Each unit is the same as the next, which makes the currency or money easily exchangeable. The money in my pocket has the same value as the money in yours.

Examples of Fungibility:

• • • One ounce of pure gold is equivalent to another ounce of pure gold.
    • A dollar bill is equivalent to another dollar bill.
    • One Bitcoin is equal to another Bitcoin.

Fungibility only refers to the equivalence of one unit of money with another unit of the same type of money.

Store of Value Overtime

The major difference between currency and money is the purchasing power of that asset. This is generally referred to as the amount of inflation per year.

An asset that stores value over time, like gold, increases in value in relation to an inflating currency. There’s a reason that it maintains its purchasing power: governments and private banks cannot print it.

Rate of Return

The gain or loss on an investment during a specified time period, usually a year, as a percentage of the original capital investment. Gains are defined as profits received, plus any capital gains realized from the sale of the investment.

Calculate the Rate of Return:

Rate of Return = Initial Capital Investment/Yearly Profit

This is the most simplistic formula for calculating the rate of return on an investment. The key aspect of this measurement is to see if your investment is growing in value and how that growth compares to other investment options.

The Economy

Right now, over 60% of Americans have less than a thousand dollars in their bank accounts. They live paycheck to paycheck every week to make their rent payments, and if they’re lucky, that might be a mortgage payment.

According to the U.S. Federal Government’s Census Bureau about 45.4 million Americans, which is roughly one-seventh of the population, received nutritional aid (food stamps) in 2015, the most recent month of data.

Humans have a tendency to think in the short-term. For the 40% of the population that has some form of savings, they are playing a dangerous game against time due to the increasing cost of goods.

The Keynesian form of economics, which dictates most of the western world, says that a 2-3% inflation rate of a currency is ideal. This directly means that the currency, your dollars, loses 2-3% of it’s purchasing power each year.

Assets are a hedge against inflation. The value of the asset rises as currencies dilute. Think of the value of your house over a 20-year period. It most likely has risen tremendously. This is also seen in the value of gold and silver. In terms of Real Estate, this is directly seen in a statistic called the gold to housing ratio, which measures the value of a home in terms of gold instead of dollars.

I firmly believe that passive income entities, like real estate, are the ultimate investment vehicle over time. The ultimate goal of a family is to acquire cash-flow real estate assets and maximize your returns.

Let’s start by looking at the U.S. Census Bureau figures for housing prices over the decades. In 1950, the median home price, adjusted for inflation, was just $7,354. Fast-forward 50 years and the median home price was $119,600. That is a price increase of over 16x in dollar value.

When I began to notice to tremendous returns real estate can accomplish I wanted to understand why this asset increases in value so well compared to other things like job wages. After exhaustive research and education, I came to realize our economic system is horribly upside down.

Though the economy might seem complex, it works in a simple, mechanical way. It’s made up of a few simple parts and a lot of simple transactions that are repeated over and over again a zillion times.

You make transactions all the time. Every time you buy something you create a transaction. Each transaction consists of a buyer exchanging money or credit with a seller for goods, services or assets.

These transactions are fundamentally driven by human nature, and they create three main forces that drive the economy.

• • 1. Productivity growth.
    2. The short-term debt cycle
    3. The long-term debt cycle

These concepts work together to measure and predict market changes. Above all else, spending drives the economy.

A free market is made up of buyers and sellers making voluntary transactions for the same goods. This could represent the car market, dairy market, oil market and the real estate market.

There are millions of large and small markets for everything of value. The macro-economy consists of the sum of all these transactions. By measuring the markets, you can have a better understanding of the current economic conditions.

At the time I’m writing this course, The United States of America is still considered the economic powerhouse of the world. If you were to turn on your television and listen to the mainstream media, you would hear that the official unemployment rate is below five percent, that over 60,000 jobs were added last month and that federal tax revenue is at an all-time high.

But if you peel back the official government data and look at the financial system as a whole you begin to realize that the economy is based on a dangerous system of fiat currency and debt.

At this time, the total debt of the Federal Government is about $19.2 trillion.

This amounts to:

• • • $154,344 for every household in the U.S.
    • $59,409 for every man, woman, and child living in the U.S.

Let’s take a moment to really look at this debt number. As we explained earlier, debt is generally considered to be a liability.

So how can we be so concerned about liabilities with our own company or family yet not give the same importance to the Federal, State or Local Governments?

People, businesses, banks and governments all engage in transactions within the economy. Exchanging money and/or credit for goods, services and assets. This debt based fiat currency system affects you as a homebuyer, seller and owner.

This is because the biggest buyers and sellers of all transactions on the planet are the governments. Our U.S. government, when involved in financial transactions, consists of two important parts:

• • 1. A central government that collects taxes and spends money
    2. A private central bank.

The Banks

In the United States, the public-private hybrid organization, known as the Federal Reserve, is the central bank. This was established by the passing of the Federal Reserve Act on December 23^rd in 1913, a night where the majority of congress was back home for the holidays.

Months before the passing of the Federal Reserve act, during that same year, the I.R.S. was created. This Act gave the power to control our money supply over to a private corporation. It was an intelligent system that fooled the public into believing it was “their” bank, when in actuality, the United States only controlled 20% of the Federal Reserve’s shares.

Understanding that the Federal Reserve Note’s in our pocket were not always what was used to buy and sell is important. This has to do with how our money is created in the first place, and it’s a story of our history. At the present time, every dollar generated is made out of debt. That’s right, each dollar bill in your pocket right now is actually a debt note for the Federal Reserve Bank.

It’s not just the ability to create Federal Reserve notes that give the banks so much influence in the market. Just as buyers and sellers go to the market to make transactions, so do lenders and borrowers.

The Federal Reserve became the leading lender to large private banks and the U.S. Treasury, allowing the major banks access to an endless supply of cheap money and then turning around and giving it back to worthy borrowers at a significant profit.

Lenders usually want to make a rate of return with their money and borrowers often want to buy something that they can’t afford to pay for in all cash, like a house or car, or they want to invest in something like growing a business but don’t have the needed capital on hand.

Credit can help both lenders and borrowers get what they want.

Borrowers promise to repay the amount they borrow called the principal

plus an additional amount called interest.

When interest rates are high, there is less borrowing because it’s expensive. When interest rates are low, borrowing increases because it’s cheaper. When borrowers promise to repay and lenders believe them, credit is created.

A credit-worthy borrower has two things:

• • • The ability to repay
    • Assets for collateral

Banks look at a borrower and notice their history of income and expenses. A family with a high income relative to their expenses (debts) tells the bank that they have a high probability that they will repay a loan.

If the borrower can’t repay on time, they look at any valuable assets that can be used as collateral and sold to repay the loan. This makes banks feel comfortable lending money.

Let’s relate this credit process back to real estate. Once approved a family can now go out and spend more money than they actually have at that point and time. This allows them to spend more money than they can afford on a house and pay it back over time.

From a seller’s point of view, this is great. The easy access to credit for buyers allows more families to compete for a property at a higher price point. If the market didn’t have this credit system available, the buyers in the market would have to pay entirely with cash or the voluntary trading of other assets.

For the overall economy, this easy access to credit is harmful. Not only does it contribute to the massive inflation of real estate prices – but the total amount of credit in the United States is also about $50 trillion and the total sum of money in circulation is less than $3 trillion.

In an economy without credit, the only way to increase spending is to produce more. But in an economy with credit, you can also increase your spending by borrowing. As a result, an economy with credit has more spending and allows incomes and prices to rise faster than productivity over the short run but not over the long-term.

While at first glance this may seem like a huge positive, after all, increasing income is a good thing, isn’t it? Yes, and no.

If that income is based on debt, then it’s only artificially “rising” and will eventually be pulled abruptly back down during the usual crests and troughs of the economic cycle. Remember, that debt based “income”—borrowing money or debt– isn’t based on something that has already been produced. It’s based on a promise of something happening in the future. Many of us have no verifiable proof of what will happen tomorrow. Imagine basing an entire economy on “maybes.”

To understand this in more detail, here is a brief overview of how a debt based economy can have drastic results:

Before the 2008 economic crash, millions of people were taking out secondary mortgages on their homes. While some were doing so to pay off serious medical bills or make home improvements on their primary residence, many other debtors decided to go on spending sprees. Financial institutions were handing out loans like candy. Certainly, this borrowing allowed more money into circulation. Bankers made money. Their employees made money. The economy was bustling as people ran out and bought cars, vacations, boats and any other device of instant gratification.

Let’s ask a simple questions, why were the banks on their own kind of spending spree? Aren’t they usually conservative institutions that demand your first born just to lend you $1,000?

Without getting too far into the mind-bending complexity of how they packaged the loans and sold them to other financial institutions (not to mention the financial traders who “trade” debt and make millions—if not billions—from the risk) essentially financial institutions that shouldered the risk were also raking in the cash. Each institution would pass the risk around and each would take a percentage based on the level of risk.

You may be asking, what risk? The source of this increased risk is predicated on predatory lending. A common term for this is sub-prime loans. The loans are made to borrowers with less than ideal income and credit history. In a normal free market, a bank would not risk lending their money with less than normal mortgage terms. What allowed these banks to break their normal risk tolerance was supported through government actions.

The “American Dream” should be equally available to everyone, right? In an attempt to accomplish this idea over the last 20 to 30 years the government created a scenario that basically demanded banks to assume riskier loans.

However, a glaring problem surfaced through the loosening of reliance on the reliable metrics for determining if someone had a high probability of paying off their debt. These measurements have been particularly robust for predicting the debtors’ reliability for something as substantial as a 30-year mortgage. Yet, the government was taking steps to supersede these lending requirements.

In the decades leading up to the infamous 2007/2008 financial collapse the government formed Fannie Mae and Freddie Mac. This didn’t happen all at once. Fannie Mae was established in 1938, and Freddie Mac originated in 1970. In short, what these institutions helped to do is create a secondary mortgage market. On the surface, the U.S. saw an increase in home ownership. Yet, there was something less honorable lurking in the “American Dream” underbelly.

Under presidential pressure, specifically in the 1990’s, Fannie Mae was encouraged to extend mortgage loans to low and middle-income borrowers. The credit sharks smelled blood and predatory lending also began to increase. Lenders hit the below average debtors with giant interest rates, early repayment penalties and a labyrinth of hidden fees within complex contracts.

Further adding fuel to the fire was the creation of a secondary market of mortgage-backed securities via Freddie Mac. In fact, mortgage backed securities were the bread and butter of Freddie Mac’s earnings.

A mortgage-backed security is the packaging of mortgages, which are then sold as “securities” to investors. In turn, the investors’ profit from the debt as they are repaid from the monies received on the principal and/or interest of the underlying loan debt. Because of the mortgage boom, combined with the expansion of credit to riskier debtors, less and less investors were adequately analyzing the enlarging risk in the underlying debt. Furthermore, the alluring promise of a huge payoff because of the increased risk encouraged the willing blindness of the public and investors.

Everyone is well aware of the result.

The point here isn’t to present debt as entirely negative. In many instances, borrowing money is needed. Yet, the need versus want delineation had disintegrated.

If you’ve got cancer, you’ll need medical treatment and consequently, you may need to borrow money for those medical bills, but no one needs a brand new car every year. Even fewer need a yacht or piles of designer clothes cluttering up their closet. Don’t get me wrong; nice things are wonderful to have! But just because something is tangible, doesn’t mean it’s valuable in terms of producing further income for you. The 2007/2008 economic collapse also proved that drastic increases in real estate valuation should be viewed and acted on with caution.

A debt based economy is shaky at best. It gives a false sense of ease and security, but all it takes is a tipping point of people to default on the debt and the walls of Babylon will quickly crumble.

What is the Federal Reserve?

Anyone who is interested in American History understands the 2008 meltdown experience is not the first time a systemic threat has either occurred or caused panic. Indeed, the Federal Reserve System was established as a response to dire concern over banking practices and the ensuing banking panics that occurred.

Why is this an issue? To freshen your memory a bit, a bank panic happens after a financial crisis destabilizes the fundamental psychology of “safety.” It’s natural for humans to want to feel “safe” in any system. When you place your money in the hands of a bank, you have a fundamental need for assurance that you’re placing your trust, your livelihood, in the hands of a reliable authority.

Consequently, when financial bubbles burst (such as the housing bubble did in the mid 2000’s) people panic. The behavioral result is that they want to run to the bank and pull out all of their assets. Since banks rely on the assets as their foundation, when a tsunami of people remove their assets from the banking system, this threatens the entire financial network (both public and private). For better or for worse, banks are the behemoths that oversee the trillions of dollars that flow through the various financial avenues on a daily basis.

As such, the Federal Reserve is the central bank of the United States. The congressional objective in creating “the Fed” was to maintain financial security within the banking system. As per the Federal Reserve website, over the years, it’s responsibilities have been expanded due to additional threats and changing economic factors since 1913, including:

• • • Conducting the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices.
    • Supervising and regulating banks and other important financial institutions to ensure the safety and soundness of the nation’s banking and financial system and to protect the credit rights of consumers.
    • Maintaining the stability of the financial system and containing systemic risk that may arise in financial markets.
    • Providing certain financial services to the U.S. government, U.S. financial institutions, foreign official institutions and playing a major role in operating and overseeing the nation’s payments systems.

You will find mixed information regarding the question as to whether the Federal Reserve is a privately owned entity. Suffice to say it is an organization that shares both governmental (technically considered to be non-profit) and private features. Regardless of anyone’s personal opinion about the institution its meant to keep the banking system, and as a result the entire economy, in equilibrium. The facts prove that it actually causes the exact opposite. Since the creation of the Federal Reserve in 1913, the United States Dollar has lost over 98% of its purchasing power. You can see this silent inflation in a range of commodities such as food, oil, gold and real estate.

The interest rates, or “Fed Rates,” set by the Federal Reserve have an impact on the stock market and its pool of investors. When interest rates are lower, it makes it less expensive to finance debt.

As a consequence, this makes debt more attractive. Businesses can expand through the extension of credit, including purchasing more equipment and hiring more employees. During the “Great Recession” (the reference many use for the 2007/2008 fiasco), the Federal Reserve raised and lowered rates in a counterbalance effort to avoid going deeper into a financial depression.

A general rule in terms of mortgages, for every one percent increase in the interest rate of a 30 year mortgage, it translates into about 10% of purchasing power. Meaning that a buyer that is qualified for a mortgage up to $1 million with 4% interest rate will likely only qualify for about a $900,000 purchase with a 5% interest rate.

While the Fed doesn’t set mortgage rates, its decisions regarding monetary policy do influence these rates indirectly. In turn, these rates also encourage or discourage the extension of mortgage loans. As a result, this has an impact on home values since demand increases value, whereby an over supply of available real estate at one time can decrease home values.

Conclusively, the government maintains a definitive dominion over the economic system at all levels. Such is the reason it’s a wise idea to keep an eye on the Federal Reserve interest rate activities as well as government policies regarding home ownership.