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Consumers Get Businesslike; Business Gets Nervous

by danps Sat May 15th, 2010 at 07:32:41 AM EST

While the political class waits for the economic crisis to resolve itself, homeowners have started to show considerably more initiative.  It's making the titans of finance very edgy.

Cross posted from Pruning Shears.

No Associated Press content was harmed in the writing of this post

On Tuesday Shahien Nasiripour wrote about the growing problem of strategic defaults, where homeowners who are able to pay their mortgages instead let them go into foreclosure.  Generally the homes are worth substantially less than the principal, and if there was a relatively small down payment it can make a lot more sense to just walk away.  Why spend ten years paying a mortgage just to get to break even?  That is a lot of money that could be used for other things, and in fact there is some evidence that's what is happening.

Nasiripour's article states "the threat posed by strategic defaults has gotten so large that a top executive at taxpayer-supported Freddie Mac posted a note on the firm's website pleading with homeowners to not intentionally walk away from their homes."  The executive claims defaulting is not "good social policy," which seems like a laughably quaint notion coming from one of the big players in the housing meltdown.  In the last generation large institutions have taught consumers some hard lessons, and are now finding out to their chagrin that consumers learned them all too well.

The death throes of the old way of thinking were highlighted by Megan McArdle in a fabulously hypocritical pair of posts just six weeks apart.  First she wrote homeowners who default on residential real estate loans are a "New Breed of Deadbeat," then that a speculator who defaults on a commercial real estate loan "turns the keys" over to the bank (think of the old Mad Magazine "When you're poor/When you're rich" article).

There have always been different rules for the wealthy and powerful, but in the last few years it has become nakedly obvious.  Efforts to allow judges to modify the terms of mortgages repeatedly fail, yet money has been lavished on financial institutions that drove the economic meltdown in the first place.  News of their paying it back gets trumpeted, while the many other forms (via) of assistance used to prop them up are politely ignored.

(I like Zachary Roth and maybe this post was just a quick exercise in contrarian wankery, but claiming our comprehensive financial welfare program is a rousing success because one part of it - TARP - will at best lose tens of billions of dollars has a really strong whiff of catapulted propaganda.)

Furthermore, the transformed environment for the largest players is so outrageously tilted in their favor that it is nearly impossible for them to lose, and evidence of that is taken not as a sign of a fundamentally compromised system but as proof of magnificent management skills.  The New York Times characterized the unbroken string of profitable days by the four largest banks as the "equivalent of a perfect game of baseball," leading John Cole to tartly reply, "They didn't play a perfect game. They played a rigged game."

The public response to Washington's inability or unwillingness to crack down on the worst abuses - finger wagging scoldings in brightly lit committee hearings do not count, thanks - has been an especially hot anger towards incumbents of both parties.  The government flooded the banks with money, but from there it has only trickled out - and no one seems bothered enough to do anything about it.

Unemployment remains near double digits, yet there seems to be no sense of urgency by the president or Congress.  Barack Obama says it is unacceptably high, but not what he proposes to do about it.  Tom Coburn gravely intones on the risks of extending unemployment benefits even though demand for entire skill sets has nearly vanished.  How exactly do you find a job as an administrative assistant when that job description is disappearing?  And of course the hostility to extending them is exquisitely myopic considering they are also among the most stimulative uses of public money.  All in all, the paralysis on economic policy foreshadows a rough November for anyone standing for re-election.

But the public response towards those they are doing business with seems, if anything, cooly rational.  It used to be shameful to default on a loan.  Maybe there was more stigma attached before loans were securitized, bundled and shipped off to investors - when you might actually bump into one of the employees at the bank whose loan you had stopped paying.  There may be more to it, though.  We have gotten a good long look at the audacity of shamelessness, and seen how well it worked out for those who dared try it.  It is entirely logical for anyone who has been paying attention to think, why not try a little of this myself?

by danps (dan at pruningshears (dot) us) on Sat May 15th, 2010 at 07:33:09 AM EST
Neo-Classical economics assures us it is not "rational" to pay $100 for something worth $75.  Therefore, consumers walking away from depreciating assets is the proper economic action.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Sat May 15th, 2010 at 01:19:15 PM EST
Quite: neoclassical economics is supposed to be a cover story. As Dean Baker shows constantly with quite conventional economics, they violate the supposed fundamentals of their intellectual system all the time. Of course, he does not go on to say, "as anyone with any sense would do, since it is radically incomplete".

Case in point: the $75m liability cap on drillers in the Gulf of Mexico is expropriating the private property of thousands, perhaps millions of property owners in the Gulf Coast states (and probably US Eastern Seaboard) ... because in the hypothetical free market, private property system, a producer that does damage to the property of others would be liable for all damages, up to their ability to pay. But under our corporate-socialist Congress's rules, any oil company that can succeed in doing more than $75m in damage simple has the lost value in their property nationalized and handed to the oil producers.

Since the API says it would add 25% to the costs of drilling to have $10b in liability, then clearly the costs after this subsidy are 80% (or less) of the full economic costs and the oil companies are receiving a 20% (likely more) subsidy.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Sat May 15th, 2010 at 11:45:46 PM EST
[ Parent ]
I think that JP Morgan term shift is really a sign of the nervousness.  This has moved from "strategic default", a value-free term, to something that could be considered "negative" in tone but simply right in line with pure capitalist ethos: be ruthless in your business dealings and your home is part of business, thus treat it that way.

Blogging regularly at Get Energy Smart. NOW!!!
by a siegel (siegeadATgmailIGNORETHISdotPLEASEcom) on Sun May 16th, 2010 at 06:49:04 AM EST
Economic View - Will More Borrowers Walk Away From Their Mortgages? - NYTimes.com

MUCH has been said about the high rate of home foreclosures, but the most interesting question may be this: Why is the mortgage default rate so low?

After all, millions of American homeowners are "underwater," meaning that they owe more on their mortgages than their homes are worth. In Nevada, nearly two-thirds of homeowners are in this category. Yet most of them are dutifully continuing to pay their mortgages, despite substantial financial incentives for walking away from them.

Some homeowners may keep paying because they think it's immoral to default. This view has been reinforced by government officials like former Treasury Secretary Henry M. Paulson Jr., who while in office said that anyone who walked away from a mortgage would be "simply a speculator -- and one who is not honoring his obligation." (The irony of a former investment banker denouncing speculation seems to have been lost on him.)

But does this really come down to a question of morality?

A provocative paper by Brent White, a law professor at the University of Arizona, makes the case that borrowers are actually suffering from a "norm asymmetry." In other words, they think they are obligated to repay their loans even if it is not in their financial interest to do so, while their lenders are free to do whatever maximizes profits. It's as if borrowers are playing in a poker game in which they are the only ones who think bluffing is unethical.

[Emphasis mine]

by Bernard on Sun May 16th, 2010 at 07:10:32 AM EST
ET: The Poor are Honest by ChrisCook on February 12th, 2009 (quoting Information Clearinghouse)
I learned the reality a few years ago in London, talking to a commercial bank strategist there. "We've had an intellectual breakthrough," he said. "It's changed our credit philosophy."

"What is it?" I asked, imagining that he was about to come out with yet a new junk mathematics formula?

"The poor are honest," he said, accompanying his words with his jaw dropping open as if to say, "Who could have guessed?"

By laying out pros and cons we risk inducing people to join the debate, and losing control of a process that only we fully understand. - Alan Greenspan
by Migeru (migeru at eurotrib dot com) on Sun May 16th, 2010 at 07:16:30 AM EST
[ Parent ]
"We're poor but we're honest."

"No, you are poor because you are honest."

- Li'l Abner

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun May 16th, 2010 at 07:40:43 AM EST
[ Parent ]
Since the vast majority of mortgages in the USA today are taxpayer owned, I'm not sure how businesslike this behavior really is. It has the sheen of business on it in a rather simple calculation, but if taxpayers lose on these deals, then you will just have more reduction in social services, poorer economy, fewer jobs.

Oh wait: it is very businesslike.

by Upstate NY on Sun May 16th, 2010 at 10:04:25 AM EST
Why is this strange behaviour even legal? It certainly isn't legal over here. If you borrow a million from the bank, you still owe the bank a million, not matter if you spend it on overpriced real estate or if you spend it on cocaine and hookers.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Sun May 16th, 2010 at 01:58:30 PM EST
"Non-recourse" loans.
by Colman (colman at eurotrib.com) on Sun May 16th, 2010 at 02:15:34 PM EST
[ Parent ]
Why do banks issue those kinds of loans? Seems silly. Like the bank takes on all the risk but leaves the borrowers with the potential upside.

Peak oil is not an energy crisis. It is a liquid fuel crisis.
by Starvid on Sun May 16th, 2010 at 03:06:46 PM EST
[ Parent ]
Because housing prices can only go up.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Sun May 16th, 2010 at 03:37:40 PM EST
[ Parent ]
Houses are safe as... well, houses.

By laying out pros and cons we risk inducing people to join the debate, and losing control of a process that only we fully understand. - Alan Greenspan
by Migeru (migeru at eurotrib dot com) on Sun May 16th, 2010 at 05:14:03 PM EST
[ Parent ]
Apparently, the many empty apartments fuelling the Chinese property bubble are not even stored in a "suitable to live in" condition, as additional work is still needed to reach that point...

Un roi sans divertissement est un homme plein de misères
by linca (antonin POINT lucas AROBASE gmail.com) on Mon May 17th, 2010 at 07:15:14 AM EST
[ Parent ]
It doesn't seem like banks are taking risk management very seriously lately. Banking has become an origination/sales/marketing/PR business, just like any other.

By laying out pros and cons we risk inducing people to join the debate, and losing control of a process that only we fully understand. - Alan Greenspan
by Migeru (migeru at eurotrib dot com) on Sun May 16th, 2010 at 05:27:51 PM EST
[ Parent ]
What risk?

It's well proven the government will pick-up any loses.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sun May 16th, 2010 at 06:36:03 PM EST
[ Parent ]
but providing non-recourse loans is an honorable, and profitable line of business, if you do it properly.

(It's my line of business)

Wind power

by Jerome a Paris (etg@eurotrib.com) on Sun May 23rd, 2010 at 04:11:03 PM EST
[ Parent ]
We call that a casino here in the States.

Align culture with our nature. Ot else!
by ormondotvos (ormond.otvosnospamgmialcon) on Sun May 23rd, 2010 at 09:24:35 PM EST
[ Parent ]
Except if it is Pantlån which in the case of realestate is called hypotekarisk pant.

A standard loan on a house in Sweden is not in the form of hypotekarisk pant, but I would guess they exist.

Sweden's finest (and perhaps only) collaborative, leftist e-newspaper Synapze.se

by A swedish kind of death on Tue May 25th, 2010 at 10:51:39 AM EST
[ Parent ]

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