The central cause of the current recession (or maybe depression) wasÂ the overextension of credit, especially in the housing sector. So, how do you get out of that kind of jam? Foreclosures and time. Those that can’t afford their homes will have to lose them, and the banks will get back as much as they can, allowing their balance sheets to be repaired up to a point. Those that can afford their houses will just have to stop taking on more debt, and begin the process of paying off the principle to the point where the loan is rightside up. This will eventually lead to healthy bank balance sheets, and thus the resumption of normal (but hopefully not excessive) lending that will get industry moving again.
If you really wanted to screw with the country, what would be the worst thing you could do? Halt foreclosures and/or slow down the repayment of debt. And yet that’s exactly what Arnold “I am here from the future to destroy your economy”Â SchwarzeneggerÂ has just proposed. He has asked that state lawmakers impose a 90 day moratorium on foreclosures. That sounds really good, but another way of saying it is that it’s a three month state imposed time window wherein banks will not be able to repair their balance sheets. Given that California is ground zero for the housing bubble, this is pretty significant, and in my amateur opinion is tantamount to extending the recession by at least three months. It’s also a slippery slope, and given that it’s highly unlikely a farm hand living in a $750k house (yes, true anecdote) will be able to suddenly improve his cash flow in 90 days in the middle of a recession, I can’t imagine the moratorium will do anything besides delay the day of reckoning.
It would also be the height of selfishness for Californians to use the power of their state government to clog up the nation’s financial system in order toÂ avoid having to deal with the consequences of their feckless consumerism. Where California goes, so goes the country, and that includes really bad ideas. I expect other states, such as Nevada, to follow suit with similar populist legislation. Hopefully the Feds will clamp down before this gets out of hand, because otherwise I can see economically illiterate do-gooder state legislators launching the mother of all depressions by bringing down our entire financial system through a morass of legislation designed to prevent banks from clearing bad credit.
Why is foreclosure considered such an anathema, anyway, at least compared to the prospect of having our entire financial system collapse? People will be released of their debt burden, with the only consequence for their foolishness being that for the next seven years they’ll have to rent an apartment at a much cheaper monthly payment than they had before. I can’t imagine that’s such a bad thing, especially when the alternative is for the credit crunch to deepen, an outcome that would have potentially dire consequences for everybody. Given that the Fed has been only marginally successful in freeing credit markets, the last thing we need is for states to push the other way by obstructing the neccesary process of clearing out bad debt through default.
6 responses to “Schwarzenegger to nation: Let’s drag out the recession as long as possible, ok?”
Foreclosure is considered to be anathema for a wide variety of reasons.
First off, foreclosure can actually be worse than ordinary bankruptcy for a family. It involves an involuntary move and legal proceedings (with all that that entails in terms of cost), and may not even clear the debt to the bank. Children may be shifted from school to school and fall behind, and relationships get stressed to the breaking point — there’s a noted statistical correlation between foreclosure and divorce. If the family can find a place to stay, it may be too far away for existing jobs, meaning unemployment and further financial trouble. (You (and for that matter I) live in cities and near colleges, which means we’re used to there being a lot of apartments, but in smaller towns that isn’t always the case.) If they can’t find a place to stay, they get to become homeless, which in the U.S. is basically a point of no return. Joy!
Then there’s the bank. The bank doesn’t like owning property — it means paying property taxes on something which is gradually leaking value. Plus it requires paying for the legal processing and a good chance of losing money if the housing market is weak. (That is, if they can’t sell the house, they’re not making the money they would have made if they sold it and were then able to loan that money back out.) They have to do mortgages because that’s the sort of loan people want (and the sort of security they can use to back the loan), but they really don’t want the borrower to default; they want the money, instead.
And, of course, the people in the neighborhood don’t like a house to be foreclosed. Such a house will probably sell below its value, which lowers the statistical price of houses and influences the market price in the neighborhood. Plus the bank, which is hoping for a quick sale, is unlikely to do routine maintenance, meaning that the house is likely to start falling apart, thus genuinely lowering local property values. And there are always squatters looking for houses to live in, and animals looking for shelter. If the market is really bad, such houses can stand vacant until they have to be condemned, which is incredibly bad for local property values.
This is why, until 2005, when you declared bankruptcy you were allowed to prioritize your payments with the mortgage first: nobody involved likes foreclosures. But in 2005, the credit card companies pushed through a new law requiring people to pay off their credit card debt first, which is estimated to be causing an extra 32000 foreclosures per quarter now.
And when there are foreclosures on a large scale, as is happening now, there are knock-on effects to the economy as well: people going through foreclosure tend to do less spending of all types (even food!), so lots of foreclosures make things hard on local businesses, which can lead to business failures and more foreclosures.
So nobody really wants foreclosures on a large scale. But the homeowners agreed to them when they signed the contract, and the banks are generally obligated as companies to foreclose. The idea of the three-month break is that it may allow people to keep their homes (possibly, if they’re lucky) AND let the banks get money they want instead of houses they don’t, AND keeps property values up, which makes everyone happy.
Thanks for writing.
I never said foreclosure doesn’t suck, especially for the person being foreclosed upon. But I would think nothing would be (or should be) worse than living in a house you can’t afford and struggling to make payments. At any rate, when there are lots of people voluntarily walking away from mortgages, you’re not really going to convince me that foreclosure is such a terrible thing. It’s actually an incredibly benign consequence for what is (in most cases) a profoundly big mistake. You blow hundreds of thousands of dollars of other people’s money, and you actually get to live to fight another day. In earlier times, these people would be thrown in jail or made indentured servants. (Or, in parts of New Jersey, beaten.) Now, they are just kicked out of their house and can’t get a credit card for seven years. Cry me a river.
People undergoing foreclosure spend less money because people undergoing foreclosure are broke. It’s a correlation, not a causation. Once they get out from under the house, and are living within their means, then they might actually spend.
Your point is well taken regarding the effects on the neighborhood. Again, I’m not saying foreclosure is good, I’m just saying it shouldn’t be avoided when its necessary. Bankrupting the nation so that people don’t have to see boarded up houses is just robbing Peter to pay Paul. We’ll get boarded up houses anyway. It’s just a matter of how many. If you prolong the housing crisis by governmental shenanigans like these bogus three month extensions, it will ultimately do more damage.
If you can’t afford your house now, exactly how is three months going to help? Employment is just getting worse and incomes are dropping. In fact, any further damage to the nation’s finance industry and credit markets by this three month extension will simply increase the number of people who will ultimately have to lose their homes. If a politician tries to solve an economic problem, the usual result is that they make it worse.
You’re very dogmatic.
There are, it is true, people walking away from mortgages. That does not mean that everyone who has a mortgage can afford to walk away. In fact, the people walking away are by and large the ones for whom foreclosure is actually a feasible plan. They have already found new housing somewhere and are making a smooth transition.
There are many things worse than living in a house you can’t afford. Leaving aside the flip answers which have nothing to do with housing, such as having spasmodic torticollis: being homeless is, of course, worse. Living in a house you can barely afford but which is deeply flawed in some way (no water, or a severe health-altering mold infestation, or next door to a crack house) is worse. You don’t seem to be looking at anything but the financial side of things — have you ever involuntarily missed a whole day’s worth of meals, or had to go without a coat in the winter? I think you would have a radically different perspective if you had ever actually lived in poverty.
As for “what good will a three-month extension do?”, there are two answers.
First off, it gives the banks time to renegotiate mortgage rates downward. In a bad housing market, banks would rather lose a point or two of interest than have to foreclose — it’s that “money they want rather than houses they don’t” thing. Most of the major banks (Citibank being an exception, last I heard) are in fact doing precisely this, and the three-month break gives them time to do so, whereas otherwise they would have to violate their contracts to do so. This moves some of the border cases into safe territory, which is a good thing for everyone involved.
Secondly, on January 20 we will have a new President sworn in who is apparently planning to do a massive spending package with a focus on job creation. This spending package is unlikely to help everyone who is facing foreclosure, but it is absolutely guaranteed not to help anyone who loses their home before the end of January, because there won’t be anything like enough time to get anything to anyone by then, even if the bill is pre-written and passed on the 21st.
And for that matter: why worry about keeping the banks solvent? Banks are nearly always insolvent in a practical sense. It’s what “fractional reserve banking” (the system followed by basically ALL U.S. banks) means. If everyone who had a balance at your bank came and tried to withdraw it over the next week, the bank would be unable to pay most of them. The rest of the value has been loaned out in various ways, and will theoretically be paid back with interest over time. Banks are allowed to leverage their assets up to a limit set by law, which was relaxed under Bush. (Up to, as I recall, 15 times — meaning they actually have only 1/15 of the assets they nominally own.) That being the case, the banks are used to this kind of thing. It’s part of their business plan. Let THEM worry about it.
If you are in a house, at all, you obviously have cash flow, just not enough. You free up cash flow by moving to an apartment. It’s pure appeal to emotion to just say everybody who is foreclosed upon is going to be on the streets. And you know what? If somebody is going to be on the streets if they get kicked out of their house, and can’t even afford an apartment or Section 8 housing, how the HELL are they going to pay for their huge house in three months? Are you seriously suggesting banks let otherwise homeless people live in houses they can’t even come close to paying for while our financial system collapses?
Look, I’m willing to say three months might help a few people. If California wants to try it, it probably won’t be the end of the world. But nor will it help much. We are guaranteed to lose more jobs between now and March, no matter what Obama does. As I said in my post, my worry is that it won’t just be three months. It will be the beginning of a slippery slope of lawmakers trying to “fix” the financial problems we have by legislative fiat.
And you betray your lack of understanding of the situation if you think that the banks will use the time to “renegotiate” the terms of the loan. Their hands are largely tied, because they’ve packaged the loans and sold them to hedge funds. The hedge funds aren’t willing to take a loss on the CDOs. If the banks could have made adjustments to the loans that would’ve kept people in their homes, don’t you think they would’ve done so by now?
And why worry about the banks being solvent? Because, if they’re not solvent, we as a country are not solvent. How’s that for a reason? If you have a job, your pay check is likely paid for by a short term loan via commercial paper. Growth is financed through credit lines. Our country wouldn’t function without a functioning credit market, and the banks are at the center of that.
You have to look at the financial side of things when having a financial discussion. That’s true by construction. My argument was that our finances would be worse if California allows a three month stay. You essentially addressed a financial argument with a violin.
But if you want to talk about sympathy, we can discuss that, too. My concern about finance is ultimately a matter of sympathy. I don’t want things to get worse, especially for future generations. If we have a financial collapse, lots of people will suffer. Unfortunately, it’s much easier and more satisfying to just wax self-righteous about the poor souls losing their houses. If we really cares about people suffering, and not just the warm feeling that comes from patting ourselves on the back for being sympathetic, I think we should be very worried about the financial system of the country. It does nobody any good to make glib suggestions like we “let the banks worry about it.”
Your position sounds like it is coming from anger at the banks (which is totally understandable) and not really a concern for the long term health of the country. And I presume that your deep concern for the folks losing their house and your haughty suggestion that I can’t empathize with them is really just a rhetorical device. I’m quite certain, from seeing this far too many times, that for all your grandiosity about those “without a coat in the winter”, you probably devote very little of your time and money to helping the poor. In fact, I’m willing to wager that I spend a far greater portion of my time and money helping the poor than you do.
But this is pointless. Do you want to have a rational debate about the potential consequences of legislation, or a liberal pissing match about who is more sympathetic?
Even though I haven’t blogged in months (for reasons I discussed in my email to you) I often think about posts I should make. One involved one of those famous CNN pieces using an anecdote to describe the entire problem.
In this case they were using a case of a woman facing foreclosure in New York and how she planned to fight foreclosure with ACORN ‘home defenders’. Basically they are ACORN agitators who try and block the process servers from giving notice of foreclosure.
Reading the piece I was struck by a couple of things. First, the woman was portrayed very sympathetically. The author talked about the homey touches in the decor and how clean and obviously well-cared-for the house was, trying to engender sympathy by making the reader think she was a responsible owner.
Well, if she is such a hard-working, responsible homeowner, why is she facing foreclosure? Simple. She took an adjustable rate mortgage. But does the CNN piece blame her? Of course not. She, and the CNN writer, blame the mortgage underwriter for not explaining to her that her rate could go up. Sorry. No sale. As the person taking out the mortgage, you have a responsibility to understand the type of transaction you are undertaking. If you don’t understand something as important as a mortgage you have two choices, find someone – a friend, a lawyer, the banker – who can explain it to you, or don’t sign the damn thing.
Also missing from the piece was any discussion of the economics of the situation. I found this very telling. No mention was made of the woman’s income or the value of her mortgage. My guess is she took on way more mortgage than she should have. And, sorry, just as I believe there is no such thing as ‘price gouging’ nor do I believe there is any such thing as ‘predatory lending’.
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