So what happens when you give poor people money? They spend it. The stories of people who won the lottery and managed to spend themselves into bankruptcy a few years later are classic examples of the pathology of the beliefs of spenders. A great many Californians are spenders. This is why California has a strong cultural pathology.



The main psychological reason house prices in California were bid up to such dizzying heights during the Great Housing Bubble was because there was a high percentage of the population in California that subscribed to the spending habits just described. They went out and borrowed as much money as they could with exotic loans, bought up all the real estate they could get their hands on, and in the process drove real estate prices into the stratosphere. In other areas of the country, reckless spending was not so trendy, and home prices were not bid up so high.

Pretentious displays of conspicuous consumption are less common in the Midwest, and consumerism is often viewed with contempt rather than envy. In short, there is a smaller percentage of the general population in the Midwest with the aforementioned pathologic beliefs. To substantiate this claim, observe the profile Minnetonka, Minnesota, a suburb of Minneapolis with very similar income and demographics to Irvine, California. The median income in Minnetonka, Minnesota in 2006 was $84,024, and the median income in Irvine, California in 2006 was $84,253. This is close enough to be a good comparison. The median home price in Minnetonka in 2006 was $305,600, and the median home price in Irvine in 2006 was $722,928. , If the thesis is correct, one would expect to find a much higher percentage of home loans utilizing exotic loan terms in Irvine as compared to Minnetonka. In 2006 the Minneapolis area had 8.7% of its loan originations were negative amortization, while Orange County had 32%. In all of California more than 80% of loan originations in 2006 were either Option ARM or interest-only.

Here are two groups of people with the same median income, and with the same access to credit making very different choices. Potential homebuyers in Minnetonka and Irvine faced the same decision on taking out an exotic loan and buying more house than they can afford or choosing to live within their means. Very few in Minnetonka chose to overextend themselves, so they did not bid up the values of their houses. Residents of Irvine (and the rest of California) chose to utilize exotic financing and thereby real estate prices were bid much, much higher. The high utilization of exotic financing was the cause of the price increase, not the result of it. Nobody was forced to buy.

Perhaps Californians were just more financially sophisticated than the rubes back on the farm in the Midwest? If many in California were spending freely, feeling rich, and enjoying life, where is the pathology? The beliefs and resulting behavior is pathological because it is not sustainable. There is an inevitable Day of Reckoning when all debts must be paid.

Charles Ponzi was the most excessive example of this pathology. So extreme was his activities, that the term Ponzi Scheme has become synonymous with the use of ever increasing amounts of investment or debt. This scheme is also encapsulated in the expression "robbing Peter to pay Paul." The twentieth century economist Hyman Minsky wrote about the "Minsky Moment" when borrowers must liquidate assets to pay off debts which in turn lowers asset prices and creates more margin calls and even more asset liquidation.

At some point, the debt becomes so large that no lender is willing to loan more money, no greater fool can be found to bail them out, and the whole system comes crashing down. However, while the debt was building, the debtor becomes accustomed to a certain lifestyle and level of spending. When the credit is cut off, the debtor can no longer spend, and a great deal of suffering ensues. This is Armageddon for debtors: the spending stops, they lose their homes and with it their illusion of wealth, and they definitely are not enjoying life. The cause of all the weeping and gnashing of teeth is not an exogenous event, but rather a direct result of the circumstances they themselves created.