With newsstands dominated by scary headlines, Hollywood break-ups and still more diet plans, Harper's magazine is typically somber and understated. However, for those with an interest in real estate the May issue offers a jarring cover story that's tough to ignore: "The New Road to Serfdom: An illustrated guide to the coming real estate collapse" by Michael Hudson.

Using 20 illustrated steps, Hudson explains some of the conditions which will lead many households into a lifetime of debt and too many others into an inevitable pit of foreclosure and bankruptcy. He acutely understands that "affordability" today is too often measured in terms of monthly payments rather than overall debt load.

"Why is the demand for mortgage debt so high?" he asks. "There are several reasons, but all of them have to do with the fact that banks encourage people to think of mortgage debt in terms of how much they can afford to pay in a given month -- how far they can stretch their paychecks -- rather than in terms of the total amount of the loan."

The problem, of course, is that for too many borrowers paychecks are essentially fixed while monthly mortgage costs are not. If interest rates rise -- or if loans automatically convert from low "start" rates to bigger payments in three -- five or seven years, then many owners will face one of three realities:

• They will not be able to sell at a profit or a break-even basis (because prices will have declined as more homes come on the market);

• They will not be able to rent at a profit or a break-even basis (because too many owners will try to rent unsold units at once); and

• They will not be able to hold (because monthly payments will be crushing).

At first it may seem as though the inability of someone to pay their loan is a problem just for those who bought and financed imprudently. However there are other parties who will be impacted, not a minor matter since one of those parties may be you.

Even if you've been financially cautious to the point of absolute boredom, the value of your property does not exist in a vacuum. If a few additional homes above the norm in your neighborhood are foreclosed, if they sell at distressed prices, guess what happens to the value of your home?

It's not just homeowners who will suffer if there are price declines. Lenders too will be walloped by the marketplace.

At the annual meeting of BerkshireHathaway which was held last week, billionaire investor Warren Buffett gave his usual clever and insightful performance before investors.

According to Money magazine, Buffett said with regard to lenders and their annual (10K) reports that "dumb lending always has its consequences. It's like a disease that doesn't manifest itself for a few weeks, like an epidemic that doesn't show up until it's too late to stop it. Any developer will build anything he can borrow against. If you look at the 10Ks that are getting filed and compare them just against last year's 10Ks, and look at their balances of 'interest accrued but not paid,' you'll see some very interesting statistics."

In other words, there's no value to a loan which potentially produces a lot of interest if the interest is not actually being paid.

The issue, of course, is that a nonperforming loan secured by a property which has lost value or cannot be quickly sold or rented is not an "asset" in the usual sense of the term. Instead, nonperforming loans are a financial albatross that when spotted can undermine balance sheets, valuation models and stock prices -- something that no doubt interests Buffett and other investors.

For more articles by Peter G. Miller, please press here.

Published: May 16, 2006

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