Zbigniew Piekarski takes the roof off the housing bubble

"Man is born free; and everywhere he is in chains. One thinks himself the master of others, and still remains a greater slave than they."

- Jean-Jacques Rousseau (1712-1778)

Those are the opening words of The Social Contract (1762), one of the most influential works in the philosophy of adolescents in each succeeding generation. They are words that inspired the slogan Liberté, Égalité, Fraternité - and the slaughter of millions. As our American cousins celebrate the few remaining years of their "independence," it is of particular relevance to explore the ideas of a bygone age that still provide a basis for present illusions.

Rousseau's ideal was that of the "Noble Savage," a creature innately good and moral who was corrupted by the social customs and institutions of the time. The solution was simple. Once he was "forced to be free," he would abandon the corrupting influences of custom and tradition, recognize his innate virtue and morality, and come together with his brethren for the "common good." This would enable the creation of another Garden of Eden. To facilitate this Nirvana, those who would not abandon the "corrupting influences" or who would not display the necessary "virtues" would either be ostracized or put to death.

The English Puritans, the French Huguenots, the Germans, the Swiss and the Dutch Reformed all abandoned the corrupting influence of the Church as an institution, with its hierarchical structure, grandiose schemes and lavish expenditures and made a virtue out of egalitarianism, hard work and thrift. Max Weber (1864-1920), in his book The Protestant Ethic and the Spirit Capitalism (1905), provides a vivid analysis of these forces, which he attributes to the development of the capitalist system.

At the heart of this spirit was "thrift." The economy could "breathe" naturally. The cycle of expansion lasted about 2.5 years followed by a contraction of 1.5 years (0.62 percent of the time, a Fibonacci ratio). One could get used to this within one lifetime and plan accordingly, as it was the mundane stuff of life.

But the representatives of the "common good" had grandiose schemes which inevitably led to wars and the indebtedness of nations. In order to pay off their debts, they created central banks.

The Bank of England, constituted in 1694, existed to pay off the debts of the Nine Years' War with France and then the excesses of the South Sea Bubble.

The second Bank of the United States was chartered in 1816 and disbanded once it had paid off the debts of the War of 1812. The Federal Reserve system was signed into law in 1913 and created the credit to finance World War I and the excesses of the Roaring Twenties. It was allowed to exist in order to right the wrongs that it perpetrated by financing the New Deal and then to continue expanding credit to historic extremes in the Great Asset Mania of the 1990s.

Initially the credit provided was of the self-liquidating variety, used to produce and manufacture and add value to the economy. Then it became easier to fuel non-self-liquidating debt for governments, for real estate and for purchasing consumer items that were produced in other countries.

The final outcome of a ballooning credit supply has always been speculative bubbles followed by general impoverishment. Thus we are still in the midst of an equity bubble, a bond bubble and a property bubble.

In the Land of the Free, most individuals have voluntarily placed themselves in chains. Between the years 1942 and 1966 the average citizen was indebted to the tune of 64 percent of his annual disposable income. Now it's about 112 percent.

Mortgage debt, in particular, has increased at a rate of $725 billion annually in the quarter ending March of this year. Given the recent drop in mortgage interest rates, the total for 2003 will more likely reach $800 billion-$850 billion. In 2002-2003, the total increase in mortgage debt is likely to be equal to the entire amount of consumer credit that has ever been extended.

The average debt of U.S. households has increased by 56 percent from 1995 to 2002, according to statistics from the Federal Reserve and the U.S. Department of Commerce. Household debt alone is now $8.4 trillion, $6 trillion of which is the principal on mortgages; "disposable personal income" only totals $7.8 trillion. And of the areas in which household debt grew in 2002, home mortgage debt led the way at 12.7 percent, the highest growth rate in any area of the U.S. economy since 1999. (By contrast, consumer credit grew by only 3.3 percent - they got their pound of flesh in the mid-90s.)

The Chinese, Japanese and Koreans are particularly thrilled. The Americans mortgage their homes, send their factories to Asia, and buy from them like crazy using the money released from their homes.

While the average housing price backing all of this mortgage lending increased by a rate of 6 percent in the first quarter of 2003 (compared to the first quarter of 2002), the percentage of equity held in homes actually dropped to an all-time record low of 55 percent - a 2-percent drop over the previous year.

The average American is now worrying about the negative equity on his two-year-old car while the foreign ownership of America is increasing: 11 percent of equities, 32 percent of Treasuries, 14 percent of agency debt and 21 percent of corporate debt is now in the hands of foreigners, with Asia increasing its purchases of American debt by 40 percent over the past few months.

As most discerning individuals in the financial world know, this is becoming a very unstable situation, as everything - literally everything - plays at the margin and a miscalculation of a very small percentage of delinquent loans could have dramatic consequences. Countless individuals may be "forced to be free" of the earthly possessions that define their identity. In order to survive and prosper, stay debt-free if you can.

On the WSE: The recent spike up can be easily explained. It is in celebration of Dr. Wiesław Rozłucki being interviewed by Shellie Karabell, the leather-clad grande dame of the Paris stock exchange, on CNBC. The first spike was on the rumor; the next on the statement by Dr. Rozłucki that improvements in corporate governance will lead the WSE indexes higher. I assume that the disappearing money will be returned to the balance sheet.