At the end of last month I proffered three potential explanations for the continued fall in the US savings rate. The first explanation was that the economy was in a cyclical recovery predicated on asset price inflation and this gave enough troubled debtors breathing space to spend more freely. The second explanation was the opposite, that distress amongst those troubled debtors was leading them to spend a larger percentage of income. The third explanation was that strategic defaults were giving a lot of people money in their pockets that would have otherwise gone to servicing debt and this had increased consumption.
(Note: Because savings is not actually measured in the national income and product accounts as it is a residual calculated by subtracting consumption from output, I focus more on why consumption is increasing.)
Early this month, I wrote why the fall in the savings rate is not meaningless – because it gives us insight into the sustainability of this cyclical recovery. I said
Understanding why savings rates are dropping in the midst of a still severe economic shock, weak credit growth and sustained high levels of unemployment will tell you something about the durability of the policies used to goose GDP over the past three quarters.
And so I want to take another look at some of the anecdotal evidence here. I have talked a lot about the first explanation in the past. And because all measures of retail sales and consumption are increasing in the US, I don’t put a lot of stock in the second explanation. So I wanted to focus on the third explanation today, namely that people are defaulting and that is boosting spending.
Defining strategic default
Strategic default has been the subject of a lot of chatter in the media and in the blogosphere. I would define strategic default as a refusal by a debtor to make repayment of a debt obligation as contractually specified despite the means to make repayment, therefore triggering a different set of default terms as specified in the contract. The point is two-fold:
- a debtor has refused to pay according to the obligations specifically laid out in a legal contract
- the debtor could make the payment as specified, but has strategically opted to revert to the default language of the contract because it is in the debtor’s best financial interest.
As I see it, a contract sets out an agreement between counterparties on how obligations must be met. However, contracts generally contain a loophole specifying what remedies can be taken if either party does not fulfil her obligations. So, a debtor who strategically defaults is implicitly saying, "I don’t want to fulfil the repayment obligations in the contract. feel free to take the remedies designated in the contract for default on payment."
Why might someone do this? Basically, someone strategically defaults because one finds oneself in a situation in which repayment no longer makes financial sense. For example, you buy a house for $400,000, $40,000 in cash and $360,000 as a mortgage. The value drops to $300,000, so you are now 20% underwater and rentals are half the price of your mortgage payment. Meanwhile your repayments are 60% of income and you and your spouse have two children to take care of.
A person in this scenario who could continue paying the mortgage might opt to default, knowing that the bank might even delay in foreclosing on them, giving them rent free accommodation on top of defaulting. Remember banks are playing the pretend and extend game in order to avoid credit writedowns. The growing divide between delinquencies and foreclosures tells you that this is what is happening. I outlined a lot of this last month in the post "Strategic default: In come the waves again."
Now obviously, there is a certain morality that comes in to play here. I won’t go into that here but Interfluidity delved into this in December with three excellent posts:
- Strategic default and the duty to shareholders
- Strategic default: a soldier’s perspective
- Norms of credit
Evidence on defaults
What I do want to pick up on is the anecdotal evidence that strategic defaults are rising and leading to increased consumption. Here are some articles whose titles tell you defaults are indeed rising and that many of them them are strategic:
- Dec 2009: Serious U.S. mortgage delinquencies up 20 percent | Reuters
- Jan 2010: U.S. 2009 foreclosures shatter record despite aid | Reuters
- Jan 2010: The Way We Live Now – Walk Away From Your Mortgage! – NYTimes.com
- Jan 2010: ChumpChanger: Morally Conflicted About Walking Away? Don’t Be.
- Jan 2010: Alex Dalmady’s Blog: My Neighbors Mortgage
- Feb 2010: Walking away from negative equity | Dean Baker | Comment is free | guardian.co.uk
- Feb 2010: O.C. has 13 months of unlisted foreclosures – Lansner on Real Estate : The Orange County Register
- Mar 2010: ROI: When It’s OK to Walk Away From Your Home – WSJ.com
- Mar 2010: More homeowners are opting for ‘strategic defaults’ – latimes.com
- Mar 2010: Fannie Delinquencies Reach All-Time High at 5.52% – HousingWire
Evidence on strategic defaults
But what about the consumption link? After I wrote the first article in March (based on a reader tip), I started to see articles talking about strategic defaults increasing consumption popping up in the media.
Here’s one from Housing Wire last week:
Here’s a provocative thought: what if ‘extend and pretend’ within our nation’s troubled mortgage markets is actually providing a lift to consumer spending? It’s not as far-fetched as the idea might initially sound, and it might help explain some interesting data we’ve seen as of late — and it also might explain why the statistical recovery we’re seeing now doesn’t really feel like a recovery to most Americans.
And, if I’m right, it also explains why we may very well slip right back into the throes of recession all over again as we head into 2011.
Let’s start with what we know. We’ve got 7.4 million non-current loans in this country, according to data source Lender Processing Services, Inc. (LPS: 36.93 0.00%) — that’s an awful lot of households still living in a house, without a mortgage or rent payment draining their available disposable income. And the mortgage or rent borne by most households has historically been one of the most significant capital commitments any household makes, relative to other purchases.
In fact, as I’ve shown in previous columns, most Americans behind on their mortgage have gone more than a year without making any payments. The average age of a loan in foreclosure is now 410 days delinquent, after all, according to LPS; and that’s just the average. Many delinquent borrowers are able to stay in their homes for even longer than that.
Just yesterday, Diana Olick pointed to strategic defaults saying:
I opened up a big can of debate Monday, when I repeated some chatter around that consumer spending might be juiced by all those folks not paying their mortgages.
They have a little extra cash, so they’re spending it at the mall.
Some of you thought the premise had some validity, others, as is often the case, told me I was an idiot.
Well after the blog went up Erin Burnett put the question to Economist Robert Shiller, of the S&P/Case Shiller Home Price Index, during an interview on Street Signs.
He didn’t deny the possibility, and added:
"In some sense there might be a silver lining in that."
Then I decided to ask Mark Zandi, of Moody’s Economy.com, who will often shoot down my more ridiculous theories.
I asked him if this was a crazy idea:
No, not crazy. With some 6 million homeowners not making mortgage payments (some loans are in trial mod programs and paying something but still in delinquency or default status) , this is probably freeing up roughly $8 billion in cash each month. Assuming this cash is spent (not too bad an assumption), it amounts to nearly one percent of consumer spending. The saving rate is also much lower as a result. The impact on spending growth is less significant as that is a function of the change in the number of homeowners not making payments.
I’m not sure I would say this is juicing up spending, but resulting in more spending than would be the case otherwise.
Many of these stressed homeowners (due to unemployment) are reducing their spending, just not as much as they would have if they were still making their mortgage payment.
So, there you go.
My anecdotes on strategic defaults
Here’s what I have uncovered via two anecdotes a friend sent me.
This first one comes via Bill Fleckenstein from a retired hedge fund manager. Catch Fleck via his daily newsletter (subscription) or his MSN column, which is free. Bill says the reader told him the following five anecdotes:
- My 25 year old niece had $10,000 of outstanding credit card debt. Recently, she told the bank she couldn’t pay. She is not unemployed so the ‘hardship’ is all relative. Nevertheless, the bank offered her a concession which she refused. They offered another concession, she refused again. Finally, they told her if she paid $150/month for 2 years (total of only $3600 with no interest), they would call it paid in full! She accepted in a heartbeat. It is less than a month later, and she celebrated her good fortune by going on a cruise to Hawaii.
- A friend owns a small manufacturing co. He tells me of one of his female employees who was saddled with a $450,000 home she purchased almost five years ago with no down pmt. One year after her purchase she pulled $75,000 home equity and purchased ‘fun stuff’ including a boat. She recently walked away from the house (now saddled with $525K mortgage), purchased a new house for $200,000 (in her sister’s name) and kept all the goodies purchased from the home equity withdrawal. With the much lower mortgage payment she just bought a new car.
- Almost everyone in my "survey" is aware of, or knows someone living rent free in their home for an extended period of time, having stopped paying their mortgage. Many of these free boarders are spending lavishly on non-essentials. My hard-working part-time assistant knows two different 35+ yr olds who have enjoyed over 9 months (one is up to month eleven) of rent-free living in very nice homes they purchased in 2004/2005! Both are employed and both enjoy a non-frugal lifestyle. My assistant wonders if he should do the same or have me pay him more so that he too can enjoy the ‘good life’.
- My sister is a nurse with 25+ years on the job. She told me of a young couple that she is good friends with that both work at her hospital making a decent joint income. They didn’t like the fact that they grossly overpaid for their 3000 sq ft home in 2006. They stopped making hefty monthly payments six months ago and haven’t yet been contacted by the bank. They have decided to wait until contacted and then walk away. In the meantime, they just returned from NYC from a week vacation in the Big Apple.
- My brother-in-law wanted to know if he should stop making payments on everything. He lives in Virginia and his carpentry skills are not as marketable as they were in the height of the boom. He and his wife’s best friend have lived close-by for many years. For the past 13 months since they strategically decided to stop paying their mortgage, they had yet to be contacted by their bank. Not even one letter! My brother-in-law doesn’t understand how they get to pocket the mortgage and spend carefree, including a 10-day Caribbean vacation.
I can list numerous other, verified examples. And these are just from my tiny, tiny universe. I can’t help but assume if I know of this many instances, there must be millions of similar stories across the country. And I am sure many of your readers have first or second hand knowledge of similar situations.
Bill, for me, the weight of evidence is pretty powerful. I am convinced that it is a specific government policy to increase consumer spending by allowing massive debt repudiation. And, I think they are pulling it off, at least for now.
Another hedgie in San Francisco, responded with this after seeing these anecdotes:
From the West Coast I have at least that many stories. They come in clusters. One brave party takes the first step and "wins" then relatives or co-workers follow the successful example. The persons are still employed – default on debt – they rarely get contacted by lenders and then negotiate hard (the debtors that is). After some settlement they keep spending lavishly. In every case a vacation is part of the program. Every case!
In one example 5 employees at a local business that caters to wealthy clients have defaulted. The first guy and his ex were a classic accident waiting to happen – big lifestyle and all on borrowed $$. He’s still in his place 19 months later. Then a guy who got his hours cut back – same story. The last two are STILL making over $100k. No one is making his mortgage payment. No one is in foreclosure yet – only the first guy has even been contacted and he’s the most underwater. The last two (one guy I know well) are still religious about the credit card debt, however.
I have a place of the beach in Mexico. One of the newer buyers on our beach got the money from a refi in Oregon in 2006 (about $300k). He stopped paying last year on his Oregon place – still has the house, no proceedings – just some letters. He even rents it out during the winter to another couple who walked away and mailed in the keys on their home last year (foolish them!!).
Small business here are getting killed, however. There is very little new money and the terms to renew a line, or refi a CRE mortgage, are crazy. Almost all small business lines are also tied to assets – real estate in most cases – and it’s very hard to renew with a smaller bank.
I know this sounds like lunacy but these are stories I know personally.
Clearly this is not scientific data in the least. But I hope you see the evidence is pretty substantial that strategic defaults are indeed goosing retail sales. The question is what comes next?
Let’s call it “Souk 2.0:” you pay agree to a price at the point of sale, then renegotiate (successfully) when the collector comes for the money.
In the old world, the collector beats you up and takes back the stuff, then makes sure no one ever gives you easy credit terms again.
In the new world you keep the stuff and get your discount too.
I understand why ordinary folks will try to game the system, which has screwed them for years. Less clear is why creditors let it go on and government abets. It is creating a nation of liars and thieves.
Actually, the USA has been a nation predominately populated by liars, cheats and thieves… not to mention fools. Americans have been cheating themselves, each other and everyone else for more than a few decades and this behavior only seems to be more and more prevalent. Just think about the tens (hundreds?) of thousands of people aiding and abetting Goldman Sachs, JPM Chase, BoA, Citi, GE, Ford, GM, P&G and a plethora of other organizations steal from their “fellow Americans.” While the CEOs, COOs, CFOs, presidents and VPs make fortunes, their minions happily(?) carry on cheating their neighbors for a pittance. It is not just mortgages that are upside down, reason and rationality have become so topsy-turvy as to be nonexistent.
This really has been the decade for anyone who cheats, lies or is dishonest. Who games the system wherever opportunity presents itself no matter what it does to society or the economy at large. Ayn Rand on steroids.
Meanwhile savings are being gutted – interest rates are too low so the only option is the stock market casino – while consumer basics like food and gas are skyrocketing. If you were thrifty and good with money and lived within your means – forgoing the latest gadgets and a nice car and luxury vactions if you couldn’t afford them – you’re a sucker.
“Ayn Rand on steroids.” I assume you’re referring to the victory of her villains in Atlas Shrugged, not John Galt.
We are certainly far, far away from the kind of capitalism Rynd espoused. Even if you don’t agree with her moral and political views, there is no mistaking our current system for the one she espoused. To me our current system and our current situation do resemble the circumstances in Atlas Shrugged. However, the producers won’t go on strike – they’ll keep toiling and paying taxes for quite some time to come.
Living frugally and savings is its own reward. It’s become kind of old fashioned, but it’s true. I myself have no desire for the high life and find peace in living simply and watching my savings account grow.
These people who repudiate debt and spend like drunken sailors – well sure I have a little bit more sympathy for them than the big banks, but the truth is that they are living desperate, toxic lives. Count me out.
Count me out as well. Our goal is financial security, not the trappings of wealth (boats, luxury cars, vacation homes, etc.) We bought a fixer-upper house in 1998, renovated using cash or very short term borrowing from a HELOC, and refinanced to get a lower rate and shorter payoff in 2004.
I think one of the reasons these people live and spend as they do is that they know it could all end tomorrow – home gone, credit lines cut, etc., so the get while the getting is good, but they have no security. I have 70% home equity, a well funded retirement plan and plenty of cash in the bank. I’m secure. I’m not interested in trading that security for some extra spending money and nicer stuff.
A guy I know here in southeastern michigan premeditated default on his mortgage by buying a cheap home to live in temporarily, then moved into it and defaulted on his mortgage. He later bought back his original home at auction in cash for a fraction of what he originally paid.
“…I am convinced that it is a specific government policy to increase consumer spending by allowing massive debt repudiation.”
How does he make this leap? Perhaps he means *lack* of a policy.
Inaction is very much a policy here. For something this large and this important, this certainly has been thought through at a variety of levels. There’s no way that this is just a coincidental thing. Mortgage forbearance has been
Do they view this as a way to spread the bailouts around, and increase spending, and sentiment?
Do they view this as another stimulus to consumer spending, and somehow think that additional consumer expending is exactly what our 70%/30% economy needs? After all, isn’t this a shortfall in aggregate demand?
Any other logical explanation I can grok requires tinfoil hats. It blows my mind that they think this is a good plan, but to believe otherwise implies some very, very dark things, and that’s far less plausible than this numb-skulled scheme.
Sorry, that was meant to be, “Mortgage forbearance has been enacted by specific, targeted legislation, if you need proof of the deliberations that have certainly occurred.” My outrage is moving faster than my fingers. Kinda nice that after all these years and all these bailouts, I still got it in me.
I agree with that statement. I am in the mortgage industry. The HAMP program was specifically designed to extend and pretend, IMHO.
Left alone the “greedy banks” would have foreclosed by now. The government has been almost wholly responsible for dealying foreclosures.
Sorry but you are way off base, participation in HAMP is voluntary for lenders. There’s nothing stopping lenders from foreclosing.
I wonder are we skating on ‘ice thinner’ than in 2006-2007 with all the ‘extend and pretend’ policy but at the same time market keep zooming up! Any thoughts?
I guess that makes me a sucker. I live beneath my means and pay all my debt. I don’t own a bunch of consumer crap nor do I desire to. I am greatly concerned as to what comes next? Readers may want to watch the Zeitgeist movies on freedocumentaries.com for a little eye opening.
“Why might someone do this? Basically, someone strategically defaults because one finds oneself in a situation in which repayment no longer makes financial sense. For example, you buy a house for $400,000, $40,000 in cash and $360,000 as a mortgage. The value drops to $300,000, so you are now 20% underwater and rentals are half the price of your mortgage payment. Meanwhile your repayments are 60% of income and you and your spouse have two children to take care of.”
Although I have made the point a zillion times, I can’t help myself. We had a whole society, everyone from the president, Greenspan saying adjustable rate mortgages are good, to government policy explicity with Fannie and Freddie TO BUY A HOUSE, BUY A HOUSE DAMNIT!
Now, all the mortgage companies, real estate agents, developers, and everybody essentially who were making money by selling 714K homes to strawberry pickers, thought that overpricing and over selling were OK.
Gee, now some of the buyers are looking at their contracts and thinking why should I pay 500K for a 250K house?
And I say, “exactly.”
Finally, having people spending all their income on overpriced houses helps no one. Better to let assets and income adjust.
Agreed, if the housing and mortgage markets were truly “free markets”, I would blame the individuals. But they weren’t. Even during the bubble, Fannie and Freddie had “only” 45% market share.
Two government entities had 45% market share at their low point?
I wonder if anyone has done a study on the outcome of the last 5 years under a true price discovery real estate industry?
For example .. take buying an auto off of eBay. There are plenty of objective 3rd parties to give you a fair assessment of the vehicle as well as regulations to prevent bad info.
If a person wanted to sell their home they would call in an inspector who would have to assess the house based on some kind of government regulated 30 point system or something similar. For fraudulent assessments there would be penalties involved. Take some great photos or hire a marketing company to take great photos like the auto owners do and there you now have a free market. For an extra fee hire a lawyer or have eBay provide the service as part of the auction..
Apply this thought to the last 5 years and I see the elimination of the bubble as the outcome.
I live in the Bay area, and work for a very large database company(you can guess which one)…I have a colleague who purchased a nice big home in 2006/2007 time frame. His home was upside down in valuation, so since the past September, he has stopped paying his mortgage payment. It’s not like he has been laid off or anything like that. He just stopped paying because his house value was lower than what he bought it at. So since last Sep, he has been living in his house rent free.
I, on the other hand, thought that houses were still too overpriced then and even now, and continue to rent, paying my rent on time every month. Why the heck am I being punished for being prudent?
Now hearing about the stories you mentioned above and my colleague’s case, I wonder why I still pay my entire credit card bill in full every month, whereas other people can get to reduce their credit card debt and spend even more.
I think there is something wrong with people’s mentality too. For e.g., if I was in the place of that 25-year old who owed $10,000 in CC debt, I would be happy that they reduced my debt and start saving instead of spending even more. It’s like these guys are on drugs, they will keep spending, ask for their CC debt to be reduced, and continue spending, and the cycle repeats.
There is something really rotten about the whole thing…
The endgame is transfer of debts to the state, and ultimately sovereign debt default. In other words what is happening to Iceland, Greece, and California will happen to the U.S. government.
Save money, invest in metals and durable goods. Protect your assets, make good decisions, and bide your time.
It’s coming, the only question is when.
There is something rotten about the whole thing; when it finally falls to the ground the stench will be unbearable…
My wife’s friend is a paragon of virtue (or an idiot – depending on the way you think) compared with these stories. She stopped paying her mortgage on her deeply underwater Florida home and used the extra funds to payoff her HELOC, credit cards and make a bigger dent in her student loan balance.
I think it has more to do with the stock market. The wealthy are doing well and, in a country like the US, that drives a lot of consumer spending.
Rant following. Sorry.
The debtors are rescued; large firms with access to the securities markets are rescued; and the stupid lenders are rescued. This, all on the back of the taxpayer and/or the holder of assets denominated in USD.
I’m one of the prudent idiots. I can’t help it; it’s in my blood. That blood was boiling for much of the naughy noughties, as I watched others live it up and putz around on borrowed time and money. Now I have to watch them literally benefit — benefit!! — from their past profligacy.
How are these people in a position to bargain with their creditors? I know the old saw about owing a million versus a hundred million to your bank, but these are all small-time debtors that are only acting as a collective because the social norms are shattered. The creditors have no incentive to really pursue a just settlement, because they know they’re getting the cash back through the taxpayer back door somehow.
Again, the individuals responsible for this phenomenon — policy-makers and their machines — can’t be unaware of it. We have explicit tax breaks for those foreclosed or short sold. Good thing California has the money to spare; I’ll inform my furloughed colleagues at the CSU/UC systems.
I just don’t understand. This sort of activity is so poisonous, so ruinous to the social fabric of a country. It encourages all the wrong kinds of behavior. And regardless of what you think about maintaining systemic stability, the same behavior certainly could still be punished appropriately. Instead, we have NYC vacations and cruises being funded, alongside literally record bonus years.
Serious open question: why does the government — again, not full of dummies — let this behavior go unchecked?
“This sort of activity is so poisonous, so ruinous to the social fabric of a country. It encourages all the wrong kinds of behavior.”
Of course this is pushing the whole country to bankruptcy. A monetary one. In the end the behaviour is also in a sense a logical one in view of the future.
Yes America is clearly moving towards a Weimar-ish future.
Whatever people think and say. What they do is more important. The problem of the kind of loop they are definitely self-feeding and accelerating. Both economically and psychologically.
Wow…moral hazard on a national scale…another benefit of bailing out the bonuses of the financial class.
I have studied a little bit of history, and what I ascertain is that when a people of a nation believes itself to be great, but hides its head in the sand concerning the real problems that it faces (via lies, denial, obfuscation and (best-of-all) blaming others), and refuses to take painful action in order to correct the situation, the culture is rotting and the nation will steeply decline in prosperity. Rome went through it. China went through it. And now US.
Very sad. I think the US should change the anthem from the ‘Star Spangled Banner’ to ‘This is the End’ by Jim Morrison
I have a long time friend who is deeply in debt after trying to keep his business alive over the past two years, all the time hoping for a miracle. His credit card companies and he seems to have quite a few have all raised his rates to 30% on what I estimate to be close to $100K in card debt. I told him to stop losing sleep and file BK. At 30% they are forcing him into default.
And add as a reply to some, (ndk)
America, where we’ve equalized the right to do financial crime up and down the class spectrum.
channeling is a little like dreaming, but you’re wide awake and you just let the mind drift, prompted by an idea and see what images get thrown up on the mind screen. this is how the world thinks, not how people think conciously but this is what drives their conscious thoughts if they would tune in to it, like all the stars above the sun, and it’s the way the world as an entity thinks. there’s is no logic really. it’s like electromagnetism but without the wave form precision. so when the channeling goes around the mortgage situation there’s like a canyon or a declivity off to the upper right like a door where dream space opens onto a vista filled with an empty and sort of grey light, like some science fiction book cover and there’s a quietness and a lassitude there like a place you used to live in but that’s empty now or like a di Chirico painting without the colors. yeah, like after the party at 4 am., not real original I admit but it’s not always an Academy Award. what this means is the shit will hit the fan and people will have to confront their equations, which are all wrong, all wrong, even now they are still all wrong. but the frenzy still has a grip on things now it is so shallow it’s like looking at a river in the sun, you just don’t know how deep it is. IT may be inches, just inches of water over the rocks. This sort of inquiry is a lot easier to do than the roll up the sleeves analysis. ha ha ah ahahah. And it’s just as accurate. ho ho — you could even say it’s “efficient” in terms of energy vs. output. lOL
Original or not, I enjoyed reading your musings. Please more like that. Cuz I like it. :-)
Feeling woozy now … will sign off
Liars, cheats, and thieves run the country and set the example. We should not pretend to be surprised.
“I am convinced that it is a specific government policy to increase consumer spending by allowing massive debt repudiation.”
Congratulations! You get it!
This has been clear for at least a year. The various programs for the banks, including the mortgage modification schemes, are simply ways to pay off private parties to default and go on spending by issuing federal debt to be paid later by the rest of us.
Look, I don’t disagree with you, tew. But how can our government seriously have that as their motivation for policymaking?
We’ve known for many, many years that domestic consumer spending was way too high. Investment in non-productive assets was too high, and investment in productive assets was too low. Investment in productive assets in Asia has been almost preposterously high, and consumption is extremely low. We also “know” — through lip service, at least — that the authorities want to promote more savings in America, and more consumption in Asia. “Sustainable” is the new shibboleth for our desired financial model.
Our only policy step towards rectifying these imbalances has been to attempt to force China to revalue its RMB(and I’m delighted that China has resisted thus far). That’s it.
Many of our other policies, while perhaps being a boost to accounting identities of savings and income, in practice serve to discourage savings from personal income. Edward points out in his linked piece:
“In fact, the Federal Reserve’s low interest rates discourages household sector savings and promotes the accumulation of debt. The government may expand in order to induce an increase in net private sector savings, but fiscal expansion is a blunt instrument. The government cannot (in the short-term) determine where capital account or private sector surplus is directed or held. Right now, government deficit spending is increasing business savings and not household savings.”
This is also true regarding the bad incentives we’re setting up. People learn. Social mores are not static. We lecture China to set up a greater safety net so that people feel free to spend more and save less, but we assemble a massive array of safety nets here for everybody, not thinking it will also discourage savings.
Maybe you’re right, and this is all a manifestation of Krugman’s version of St. Augustine’s prayer. But it’s nigh on decades of this crap being piled higher and deeper. This is just the latest salvo, and we’ve made zilcho effort to unwind it.
I am losing my credulity, and seeking alternative explanations. It might be time for you to do so too.
“They2 are trying to destroy and re-create the social world we live in. They do this by destroying values most of us hold dear, like honouring commitments, telling the truth, helping people in need, etc, in short, everything that requires empathy is to be wiped out.
Lying, cheating and hurting people is furthered and postitioned as desirable qualities and is to become required behaviour to be successful.
The psychopath are trying to remake the world in their image.
To be able to rationalise his bad behaviour, a psychopath needs to be able to convince himself, that ‘all people are like this and I am only more successful then they are’.
Unfortunately, not all people are like that, so the psychopath, through his behaviour makes everyone around himself act as he does.
In other words, a psychopath recreateds the world around him in his image.
It all depends on what you mean by ‘contract’.
Lookie what the USA government did with General Motors’ investors as part of that company’s bankruptcy. What were their contracts worth?
What is ‘extend and pretend’? Isn’t accurate accounting a form of fiduciary duty, an agreement between a company and its investors/customers?
How many mainstream economists have been discussing ‘Debt Jubilee’ in the past few weeks? Hudson, Auerback … who else? We are sailing in uncharted waters, when the US establishment starts accepting default/repudiation as the ‘new normal’.
Moral hazard: business as usual. The money system is based on promises to repay. That $10 in your pocket is an IOU. How does the new normal fit in with a system of world exchange where repayment is optional? At the same time, how can all the redundant claims be met?
Very interesting article and timely, too:
Remember these examples the next time we hear about “greedy banksters” etc on this blog. Ordinary people have been every bit as much to blame for the financial crisis as bankers, but there are a lot more of them, so politicians and indeed any public figure who stands to lose by upsetting the public – eg central bankers – are going to emphasise the role of either a minority like bankers or outsiders like the Chinese.
I do think that it would be worthwhile punishing these individuals somehow. From a group – eg national – point of view, default is really just another way of postponing facing problems, because the market can be expected to recover its losses by extracting a risk premium on future borrowing, but it will be levied on all borrowers from that group.
Those examples are just child’s play. In my area of southern california I know personally of several people who have serial refied and cashed out over a million dollars over the last eight years….and have been living in their houses rent free 18 mos after an NOD has been filed. Their house was like having a job paying 200-300K per year tax free- except no work was involved.
For fun go onto foreclosure radar and look at the refi and second and third lien history of some of the houses in default in the higher end areas of socal. It will blow your mind. Then notice that the NOD was filed over a year ago and no auction ever takes place. This cannot end well.
So weird that everyone knows of all these cases, when my brother in law got the foreclosure hammer after being 60 days late on his mortgage.
Maybe this is only for jumbo loans that lost value in bubble areas? We’re in a long-term depressed area and his loan was on it’s 3rd refi with debt consolidation too.
One point I would like to make: what if it’s all a lie?
In 2004, Chris Swecker, Asst. Director of the FBI in charge of the Criminal Investigation Division, held a press conference warning of the new “epidemic” of mortgage fraud sweeping the nation. In one year, the amount of fraud reports went from a mere few hundred to nearly 3,000 and the following year, surged upwards of 30,000.
He attributed most of this fraud to the work of “affinity groups”. When questioned about affinity groups and what that meant, he responded that he meant affinity as in “ethnic”.
So the question that comes to mind is what ethnicity he was referring to. My guess ( a wild guess it is!) is that perhaps it was the Middle Eastern ethnicity, and this was deliberately done to bring the US (and the dollar?) to its knees.
Pj, I think you’re way off on that one on several counts. I feel awkward even responding to it, but I’m compelled to do so.
First, the amount of money to be siphoned off by mortgage fraud seems massive to us mere mortals, but in the grand scheme of things, it’s not nearly enough to trigger the systemic issues you allude to.
Second, if your goal really were to bring the US to its knees, the last thing you want to do is to bring the USD down too. Debt is your leverage; money is a proxy for control and power.
Third, if the Federal Government is in hock to you, well, there’s a million stories throughout history regarding governments and countries kneeling before creditors. Point being, you, the creditor, need the USD to be healthy. Inflation is redistribution from creditors to debtors. And if the Treasury is making you whole by indebting itself to you on the behalf of private entities, well, that’s not such a bad thing.
You can do a little homework to find examples of affinity scams in all ethnic or other groups. My neighbor was affinity scammed by a guy who claimed he was a Marine. Does that mean the US Marines are trying to bring the US to it’s knees?
You can add me to the list under #1. My outstanding was over 50,000..
Not going to say anymore..
I can’t get on the “I am convinced that it is a specific government policy to increase consumer spending by allowing massive debt repudiation. And, I think they are pulling it off, at least for now” train on this. But it is interesting that all these defaults could be responsible for savings rate not increasing and spending going up. I’ve thought for a while that very few lessons have been and will be learned from everything that has happened over the last few years. Now the question is “how long does it last and what will the consequences be if/when it ends?”
Interesting anecdotes. My personal observation within my ethnic and peer groups in Southern Cal, that many if not all of them lost their houses and being evicted. One particular person was trying to play the game “default” to get “Obama” deal, and end up losing his house (and becomes the talk of the town). Not to doubt any anecdotes presented here but you always find what you are looking for. Maybe we just don’t live in the same spectrum.
I suspect it depends on what housing
market you’re in. If there are buyers,
then the banks have more to gain by
foreclosing. But if the alternative is
that you leave and the house gets gutted,
burned out and abandoned
then there’s less incentive to call the
Here’s one thing that will solve all this – a sovereign debt crisis for the USA. When Uncle Sam can only borrow at 7% for 10 years this bullshit ends because there won’t be any more money left for Washington to bail out these idiots or the institutions that lent to them. Then we can either destroy the US dollar and end up using gold or get back to a system where borrowing money at low interest rates is not a “right”.
I hope as many people game the system as possible – that will precipitate a crisis sooner – the sooner the better.
Well let’s see…people called their politicians and said no bailouts….what did they get bailouts and bonues….they expected justice….what did they get no prosecutions…they called their politicians and said no Geithner who cheated on his taxes….what did they get Giether and Summers and Emanul….they contacted their politicians and said get rid of Bernankee….what did they get more of the same…..So they gave it their best and got the worst….when there is no representative government, no justice…..what happens anarchy…That is what we have….
I agree that the cumulative debt load outstanding is the biggest issue, and I have no problem with debt forgiveness undertaken by private entities. That’s their deal, that’s fine. If a private entity can’t repay their debts, whether corporate or citizen, we have an excellent system for dealing with the situation. It’s called bankruptcy, liquidation, and the Mellon approach. I have favored it from the beginning and I still do.
This path is, IMHO, far more dangerous than that sort of credit contraction. We have more credit expansion — not inflation, but credit expansion — as the government rescues banks from their bad loans. Some private individuals suffer a lot, some private individuals party a lot.
But every creditor is made basically completely whole, by the Feds. I have MAJOR issues with debt forgiveness that consists of backfilling banks by way of the Treasury. That’s not the banks forgiving debt; that’s not the government forgiving debt; that’s the prudent taxpayers being forced to rescue stupid lenders. Some spendthrifts get off, which is abhorrent, and the wealthy creditors are barely nicked, which is ghastly.
Regarding the “other” overtones in your commentary, and others here, I think we should be careful about defining the villains too broadly or too narrowly. I’m the first to admit that there are an awful lot of the wrong surnames showing up in the wrong places in the wrong ways, but it’s not everyone, nor is that entire ethnicity to blame. I think it detracts from a very important focus on the real crimes being committed here, and can make it a lot easier for some people to dismiss you entirely as a nutball.
Here Here, I 2nd just about everything “ndk” wrote in various posts on this thread, and heartily endorse the last paragraph above.
Vespasian, father of Titus.
Only one however, Helvidius Priscus, was put to death, and he had repeatedly affronted the Emperor by studied insults which Vespasian had initially tried to ignore, “I will not kill a dog that barks at me,” were his words on discovering Priscus’s public slander.
yep. The initial fact, back in 2008, was that savers would pay for the profligate. A natural outcome of a bubble.
There could have been seemingly fairer ways to balance the scales a little. I favored and wrote quite a bit that bank creditors (those lending to and investing in banks) should not get 100 cents on the dollar. The AIG payments for Goldman were only the extreme instance of gaming (robbing) the savers.
But there are further dimensions to this kind of consideration. For instance, the economy does indeed rely on personal spending…. We are are irreversibly in the same boat (the same economy), unless you want to chop wood and hunt, etc.
This will result an eventual run on the credit of the US. As credit dries up and contracts internationally, governments and politicians will get to confiscating savings and property. Even FDR got to that point.
If more colledge educated people are engaged in this scandal than non-college educated people, I think it would be time for congressional hearings into the failures of universities and colleges to recall their defective degrees.
This is just math — consumer spending (disposable income) boosted by deliquincies. And it is…the only way the economy can recover to reasonable strength anytime soon.
The only way.
Defaults and foreclosures are our friends.
I first thought on this a little over a year ago and worked out that such defaults are necessary and sufficient for a significant economic recovery.
To clarify, it’s a mistake to think that if defaulters had to pay partially (to their ability) that would make savers more whole…. The economy doesn’t work that way. Average savers can’t see returns that on average exceed the economy. We;re all in one boat.
Creditors should not have been made completely whole. That’s the entire point of the $100,000/$250,000 cap on FDIC insurance. That’s the whole point of too much debt: too many claims on future productive assets, and we just made more of them trying to evade these existing claims’ implosion.
Those claims are not going to annul themselves through inflation unless some veeeery large changes occur in the configuration of the real economy. Rather, we’re just likely to lurch into another asset bubble, this time starting with even lower interest rates, and to crash even harder next time. Edward has another excellent piece on this.
I agree bank creditors should have taken major losses, and even wrote blog posts about it suggesting precise mechanisms.
About how the federal debt (claims) will be serviced, all the actions by Treasury and the Fed have been in the expectation that real growth in the economy over time will make good. I agree with this idea: stopping the downward spiral of the real economy at some point (say at -10% or -15% for instance, instead of allowing a natural collapse to -35%) during a credit bubble collapse pays on net (vs servicing of the debt incurred to do so), as the economy begins to get real growth in time (due to innovations (e.g., new products and services) in the private sector).
It’s valid to speculate about new bubbles. We’d be much better off to encourage the real economy by replacing taxes on production with taxes on consumption (thus helping to level the playing field of domestic producers vs foreign).
See my other reply below also.
I certainly agree with your preference for transmutation of the tax code like that, Hal. It’s an excellent idea. Multinationals might not like it so much, though; as in, they’d fight tooth and nail against it. Right now, they benefit from no real taxation on either end of that exchange.
I’m much less convinced that our efforts here have helped to avoid deflation. I’d bet on — and am betting on, in fact — the opposite. I think it’s given us a very long, protracted period of steady deflation. We have an even more preposterously titanic debt burden now, and servicing it has become more expensive in real(and nominal) terms.
Unless you can show clearly how inflation results from this bailout and increased debt load(please see some of Koo’s balance sheet recession work), I prefer to think we’ve extended the process and made things worse.
I can certainly see and empathize with the other side of this particular argument. I just don’t find it nearly so compelling.
NDK, thanks for the Koo links. The graphics are fun. :-)
indeed we are to a point.
but it may be — as others here have noted — that the fury at seeing banksters and loan liars walk away with stolen money so discredits “the system” that fewer and fewer of us well-behaved sheep will cooperate with its ethical and legal codes.
As a result, the frictions and inefficiencies of ensuring one’s financial and physical security in an increasingly Hobbesian world will erode the growth potential of the economy as a whole, and eventually grind it to a halt, as society descends into anarchy and chaos.
So it’s not that everyone eventually benefits from condoning bankster and loan liar looting, it’s that everyone eventually loses, but the banksters and loan liars have the cash to hole up in their gated communities behind their armed guards, where they can drink themselves to death like debauched expatriots in some colonial outpost who long ago lost the battle for their souls and have only to contend with the reality of their bodies and unrestrained basest instincts for the rest of their useless days on earth.
Let us call this what it is — the theft and murder of a civilization.
I would not call this “progress” and I wouldn’t claim somebody is smart for provoking it through policy maneuvers.
To be fair though, perhaps I too joyfully extend your argument to a logical extreme that reaches far beyond your more technical observations. :)
An additional point.
It makes sense that some smart people (Geithner et al) have figured this out, a while back…
Another point that follows from the above is simply that as the Fed did QE (printed), well….yeah, this is the mechanism (“strategic default” and just plain old default) whereby the money is…er…transmitted (since the banks can extend and get bailed).
Altogether, it’s really pretty clever. All those brains going into finance were not 100% wasted (perhaps only 95% wasted).
I disagree completely. I don’t think it’s remotely clever.
If you want to recapitalize private individuals, there are thousands of ways to do that directly, from the tax system to other distributions. We tried them, and people saved the money. Those can be targeted, (relatively) equitable, and above the board. I still disagree with this approach, because the Treasury will still be deeply in debt trying to save individuals from their own poor decisions, but it’s more defensible.
What you’re suggesting was done is a sort-of recapitalization of individuals through the banking system. If that’s the case, then the banking system that took such a vast cut of the infusion that it paid out record bonuses even as underemployment hits record highs. And, additionally, all lenders have been made whole and then some, even as a large number of individuals find themselves unable to repay the loans(which are now owned by the Fed).
Those debtors have no direct assistance. Their only benefit is being free of the lien, something that COULD have been done WITHOUT recapitalizing the banks this way. It’s called bankruptcy and nobody is arguing that bankruptcy is bad.
This is only clever if your over-arching concern is the banking system’s primacy in its present state, and not the private citizens.
A minor point: when recipients of tax cuts save more, it is we must remember only delayed demand (they’ll spend relatively more later, and some of that extra spending will begin within months.) This is why Obama’s modest tax cut in the stimulus was a good idea. Sooner or later that appears as demand and supports the real economy.
About how the bailouts were done, I railed against making bank creditors completely whole, and against saving Citi, though I recognized at some point the reality of a generalized bank run (on most all banks everywhere at once) forces the generalized bailout. I simply would have put more of the losses of Citi onto their creditors, and I’d have worked harder to break up Citi.
That generalized bank run though, that’s the rub.
The transfer via banks I think was less a plan than simply something they realized at some point was starting to occur, and then…they realized it might be for the best for the economy.
If we insist everyone pay their loans, and only extend that, we have Japan.
About your point regarding the windfall for bank officers, I could not agree more. Voters are rightfully angry.
If we insist everyone pay their loans, and only extend that, we have Japan.
What? We’ve done absolutely nothing to recognize our NPL’s other than change the accounting rules, literally, and to offload a lot of them to the Government. It’s a separate problem. Japan wrote off a bunch of the NPL’s through the ’90’s and mid-’00’s (PDF from Koo) and had a lot of deleveraging, all to no avail. Most of them were gone by 2000. Way too late, yes, but we’re not acting faster here.
That generalized bank run though, that’s the rub.
What about the Swedish solution, i.e. nationalization? Or an enforced bank holiday? Or saying, straight up, “All your deposits under $100,000 will be saved by the FDIC. We will do our absolute best to preserve the value of all other deposits. We will not permit withdrawals greater than either $5,000, or 2% of your account, daily, whichever is greater.” If you were feeling insane, you could say, “the U.S. government will stand behind all commercial and individual deposits. The U.S. government is under no obligation to honor or preserve the value of the equity or bond holders of the institutions.”
There’s a ton of other choices that could have been made. Many of them had been well tested and studied by that point, and the Swedish approach was held to be the gold standard. We forgot that, when it was our money at risk.
Re Japan NPL’s, I think the US system and response is definitely better. We don’t have zombie corporations, mostly (exceptions are small in number). We’ve been faster, so the psychology of deflation hasn’t set in. Re household NPL’s, our walk-away is a good system. (Trying to squeeze water from a stone only injuries the hand.)
I won’t claim to have a crystal ball, but I think we are going to do better than Japan. But…other factors are in play also. This isn’t easy to predict.
About Swedish style nationalization, I’ve thought that was the best idea since Krugman or someone first mentioned it.
Perhaps you and I should form a committee and write the new rules. :-)
I’m an American, but I got to say the Muslim culture has some useful tools to conform society, like debtor’s prison and cutting a finger off of a thief. Not sure what they do to cheaters and liars, but whatever it is, its got to be better than rewarding them like we do here.
Remember the Muslim context: the taking of monetary interest is strictly forbidden (like the first 1000 years of Christianity, IIRC), so that “debtor’s prison” won’t bite for “missed interest payments” only.
ndk – why is your government allowing this? Your government has been captured, that’s why. The financial elite are running your government, and Obama takes his marching orders from them.
The liars and cheaters at the top (the bankers) are essentially in league with the liars and cheaters at the bottom (people walking away because they made a bad bet at the housing roulette wheel), and together they are going to destroy the middle class of this country. No, they are going to destroy the country.
If house prices had continued to climb, how many of these homeowners would have walked away? None. If house prices had continued to climb, but people couldn’t make their mortgage payments, how many banks would have stalled on foreclosure proceedings for one/two years? None.
The party continues on because there is no downside for the bankers or the homeowners. They know they will be bailed out AGAIN.
At this present moment in America, the irresponsible of society are being rewarded while the responsible are being heavily penalized.
First, thanks for the genuine and heartfelt response. I think there may be a lot of truth in it.
But there are two parts of your explanation that I find unsatisfactory, and I hope for elaboration.
How can the liars and cheaters across society make a compact like that? You guys get to keep the houses, and we get to keep the money and the government, and it’s all good?
While in practice you can make an argument that that’s basically what occurred, it was clearly not premeditated on the part of virtually all the borrowers out there. It’s very clear to everyone now that that’s the way things worked out, and would probably work out again, but I don’t think moral hazard was widespread amongst the lower classes until now. Indeed, that’s the point of this post.
The other part I wonder is, is the U.S. Government unique in suffering the capture you describe? Are many, or all countries, captive to financial elites? If not, what makes the U.S. unique, and if so, why do we see the most severe symptoms here?
ndk – sorry, I was in a hurry when I posted my comments and I wasn’t as clear as I wanted to be.
No, I do not think there was any collusion or compact amongst bankers and borrowers or between borrowers and borrowers. I meant instead that “like-minded” people ended up in a no-money down, high leverage game. The bankers offloaded their risk onto unsuspecting investors, and the homeowners basically got a house with no stake in the game (no down payment), guaranteed to walk at the first sign of trouble. “Privatize the profits and socialize the losses” types of people. (See my next post).
This was a well-planned and well-executed windfall by the financial elite.
Capture? All of the central banks.
ndk: “…but I don’t think moral hazard was widespread amongst the lower classes until now.”
But why would so many homeowners with bad credit who were stretched thin decide to rapidly prepay their mortgages? At that point, they weren’t refinancing to take advantage of lower interest rates, and almost all of them faced prepayment penalties.
The answer reflects the dirty little secrets of the subprime sector. SAIL was also typical in that about 33% of its mortgages were no doc loans, otherwise aptly named liar loans.
After the subprime market began collapsing in 2007, Fitch reviewed a sampling of subprime mortgages with characteristics similar to those held by SAIL 2005-HE3. Fitch found that the vast majority of loans in its sampling were secured by fraud.
About 2/3 of the loans involved occupancy fraud. In other words the borrowers claimed the property as their home but lived somewhere else. Almost half of the borrowers falsely claimed to be first-time homebuyers, who, in fact, had held mortgages somewhere else. A slight majority of the loans involved some kind of appraisal fraud.
Clearly, a lot of these borrowers were seeking to make quick money by flipping a piece of real estate financed by a lender who didn’t ask too many questions. Almost half of the mortgages in the Fitch sampling were in the state with the biggest bubble, California. Of course, none of this was news. Back in 2000, HUD Secretary Andrew Cuomo was alerting everyone that fraud had gone viral in the subprime mortgage sector.
Debt repudiation is not going to solve the problem in an economy based on consumerism.
It may clear some old debt and free up resources for consumption in the short-term, however it doesn’t do anything to address mid- and longterm issues.
Any future consumption must be paid for by salaries that are elevated enough to pay for consumption. That requires well paying jobs. However, the trend is falling salaries.
If there are no well paying jobs, or no jobs at all, then future consumption would have to come from debt. That will just start the whole debt cycle again.
The game for Capitalism is over.
Income support for individuals, not capital support for big banks and corps, is what is needed.
Start cutting bigger Government cheques: for people to spend locally.
Choices: Inflate like FDR, or deflate like Hoover/Mellon?
(Have we not been here before? And since military spending is already pretty high – and the weaponry too fierce – that “way out” seems closed this time (thankfully).)
Of course people are not going to pay for a mortgage that is underwater. The get filthy rich scheme is over, and government stimulus in housing won’t change that fact. Many people bought these houses, because they thought they would get wealthy easy. It’s quite obvious that the housing bubble was fueled by speculative buying on part of the home buyer, and not just speculation on part of financial institutions. People these days buy houses for value, not simply to live in them. There was rampant speculation. The gig is up, and of course a person who isn’t paying off his mortgage, is likely spending that money somewhere. I doubt they are doing much else with it.
I’ve spent the past 5 years living in virtual hermitage while I pay off my student loans. I realize student loans are different from all other types of debt, but man, I feel like a sucker now!
Yes, unfortunately student loans are not dischargeable in bankruptcy and will follow you to your grave.
Personally I have no problem with people looking to take care of themselves and their families. I rent but if I were in their shoes I’d do the same thing–and yes, I know of two couples who are doing exactly that: walking away from underwater mortgages.
Why not? Businesses do it all the time. It’s a business decision to walk away from a bad investment. And it’s legal, it says right there in the contract that if you don’t pay your mortgage, the bank gets the house back. So, “come and get it.” The bank should have been a little more careful with who it lent money to.
The government we have is wholly unresponsive to the people and exists, it seems, only to serve banks and other corporations. People are being forced to fend for themselves, the mercy of economic forces they can neither understand or control. If this gives them some measure of self-determination and gets them out from under, so be it. There is no help coming from anywhere else, and most people have realized that fact.
A few thoughts on the wave of strategic defaults:
First, most states are not non-recourse, and the issue of refi’s falling under those that are is questionable. That stated, whose money is it that the holding companies collect by mortgage payments. It is no longer the local bank who has to hold it on the books, it is in some exotic and now toxic MBS. what is the obligation and the incentive to collect it.
Next, because in most states the debt does exist and is enforceable, once there is a strategic default, will someone, later try to collect it? The statute of limitations, while not long is still several years in most states? If some hedge fund bought the MBS, they could easily find a strategy to send to collections a strategic defaulters $xxx,xxx.00 debt and make a profit. I’m not sure that strategic default is completely free, but hey it sounds like a high pay-off risk.
Finally, how much of this default debt has the government accepted/guaranteed and thus no one cares?
So we understand the situation. Massive defaults on loans without recourse from the lenders. Now we should ask ourselves why such a situation should be allowed to exist and continue to exist.
Several reasons spring to mind, it could be any of these or none of these or something else all together.
1. Last man standing scenario, our biggest treasury holder and largest financial competitor is China. If our government knows China’s economy is a huge bubble, it may allow things to occur in our economy to make it look better than it is, in the hope that China will collapse, before we do.
2. Peak Oil, the government knows that peak oil will be here in a matter of months or a few short years, it can’t do anything about it. It will let the orgy continue while the richest prepare to bail out of the system altogether collapsing the world economy, so our present situation matters naught.
3.Some other sort of disaster is close at hand, World War, incoming astronomical body, gamma ray blasts, climate and ecological collapse, etc. – no point in worrying about the future, let the game roll on until the suckers die standing at the gaming tables.
4. Economic collapse is inevitable, those who have seen the real numbers realize it and are letting things unfurl, for they are powerless to stop them and have already prepared their estates to live in feudal society.
Perhaps it is just human nature, but it is highly illogical that it has gotten this bad and nothing is being done but conjuring and prestidigitation.