Your fallacious example proves once again why handing control over to the government is wrong. If we outlawed mortgages, instead of allowing the capitalist concept of borrowing to continue, the government would be forced to buy all the unaffordable houses (because your example seems to think that houses are cheap to build and only cost a lot because of mortgages) and provide free or cheap housing for all the newly created serfs– on the back of the “rich” people.

1. Mortgages that don’t take into account unstable income- in our new economy, workers are more likely to work in spurts- perhaps earning a lot on a book deal one year, not much the next- as opposed to the old days of working for one employer;

2. Mortgages that are initially priced as taking, say, 35% of income, and then due purely to Federal Reserve policy, increase to 50% of income;

3. Mortgages that are provided based on false information, and then the consequences of providing that false information (i.e., upholding the rule of law) are unjustly withheld, either by market incompetence or government fiat;

4. Mortgages that are made in fixed dollar amounts against a depreciating dollar- because the supply of dollars is not growing as fast as the supply of goods and services.

Homebuilding is one of the many services now outsourced to people who make significant capital investments. Mortgages (credit) allows others to more fully utilize these assets and allow the investors to reap a larger return (by more fully utilizing these assets). And we can all agree that more fully utilizing construction assets is a good thing in pretty much any economy, can’t we?

Another assumption must be that there is a division of labor and different skill sets and productivity of the market participants. It isa monetary economy, so something has become the defacto money, whether it be coins, shells pieces of paper or accounting entries.

If someone is going to sell their house and all others are occupied, that person must have a use for that money that he gets for the house that is greater than the value he believes he gets from the house. If the seller holds the mortgage on the house for 30 years, that means it will take that long to get paid for it. During that time, he will have to go without something that he would have had if he had not held the mortgage.

If the price of houses increased, as you assume they would, given that the supply of money is constant, there would be less money left over in the economy for other goods. There would be a deflation in the prices of other goods to offset the inflation in the price of houses. The lower cost of other goods would increase the demand for those goods. The higher cost of houses would decrease the demand for houses.

If, however, there was a central banker who was in charge of making money, and could increase the money supply out of thin air, the price of houses could rise as you say without the decrease in the price of the other goods. That would cause a bubble market in the housing portion of the market, as easy money flowed into it. As people noticed the increasing prices, more and more people would try to borrow money to buy. The price of houses would be bid up.

Eventually, people on the island would realize that the price of housing was out of whack wth the rest of the economy. It would take too much of a sacrifice of real goods and wages to buy a home. The housing market would stagnate, and eventually collapse as people start defaulting on their loans because they over extended.

In the real world, we have a central banker called the Federal Reserve, who’s manufacture of money out of thin air is multiplied many times by the fractional reserve banking system. The run up in housing prices in the real world happened like it did on your island with the central banker making money from nothing.

The problem is not borrowing. That is just a rational trade off for people. For every mortgagee who gets money to buy a house, there is a mortgagor who forgoes his money in order to get a future return.

The problem is with inflationary money creation and an ustable banking system based on fractional reserves.

Changing the method of payment from a cash basis to monthly increments is not what will cause the rise in price.

If the money stock in circulation is $10,000 then the most that can be paid for all 50 houses is still $10,000

The 100 residents can only bid prices up to equal the total amount of money in circulation.

Consider todays world to explain what I’m saying—-

If we are all paying $2.00 more per gallon of gasoline
then that’s $2.00 less that we have to bid up prices for other goods.

Back to your scenario.

If one of the residents printed up an extra $10,000 then the most that can now be paid for the same 50 houses just doubled to $20,000