Strategic Defaults No Longer on the “Fringe”Sunday, April 25, 2010
Any Austrian economist has got to snigger at Rick Newman’s opening paragraph in his article in US News & World Report:
One thing that’s fascinating about an economic crisis is the way ordinary people confound the experts. Consumers are expected to behave according to sophisticated economic models that have been built over decades, but sometimes they don’t do what they’re supposed to. That’s happening now in the housing market.
Austrians abstain from treating humans as particles whose behavior can be predicted and explained by mathematical equations. Humans don’t behave according to “sophisticated economic models” because human behavior is complex and markets are flexible and continually evolving, making mathematical models ineffectual, except for those who desire to use such models to plan the economy and shape social engineering policies (academics/house intellectuals and bureaucrats).
Overall, it’s a decent article on how strategic defaults are reshaping the economy. I think the title is incorrect, however: the housing dilemma, overall, is reshaping the economy – not strategic defaults alone. Newman brings up some sane financial logic and lays out some consequences of a strategic default. He notes that Moody’s is estimating that 20 – 25% of all foreclosures are strategic defaults, and that is certainly no surprise for those of us who understand the many benefits some people will gain from such an action. I love his last paragraph:
Even more significant could be the changing role of the home itself, which may no longer be the centerpiece of the typical American’s financial life. The whole U.S. economy is built around the premise that home ownership should be every family’s goal. The mortgage-interest tax deduction, for example, is a powerful inducement to buy rather than rent, yet it costs the government about $100 billion a year in lost revenue. Fannie Mae and Freddie Mac were founded to promote homeownership, yet ended up as a colossal financial disaster. And for years, home equity loans helped finance the purchase of cars, appliances, and many other accoutrements of middle-class life—until home equity went the wrong way. If a million home owners or more are walking away from their homes, then maybe owning a home isn’t all that—and it’s time to redefine the American Dream.
Now cut to another article, also from US News & World Report, about the ten cities facing a “double whammy of default risks.”
Mike Larson of Weiss Research points to two key factors behind these high delinquencies. Sharply falling real estate values have put about 21 percent of homeowners underwater, meaning that they owe more on their mortgage than their home is worth. Property owners in this position–which is also known as having negative equity–may find it in their best interest to simply walk away from the home (even, in some cases, when they can afford to make their monthly payments). At the same time, an uncomfortably high national unemployment rate of 9.7 percent means that many Americans won’t have the income they need to pay their bills.
Again, even those homeowners who can financially make ends meet on their mortgages are finding that the financial disaster created by the Fed – and the agents who help to carry out its dirty deeds – is making their financial future look pretty bleak. And the bleak picture for some is further exacerbated by their local economy. Hence the double whammy in areas such as California, Florida, Las Vegas, and Detroit.