Strategic Defaults No Longer on the “Fringe”

Sunday, April 25, 2010
Posted in category housing bubble

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.

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7 Responses to Strategic Defaults No Longer on the “Fringe”

  1. liberranter says:

    April 25th, 2010 at 8:47 pm

    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.

    A statement that perfectly summarizes the attitude of all statist (read: non-Austrian) economists: that the only meaningful and legitimate purpose behind an individual’s economic decisions is to generate revenue for the State. Whatever else Newman might have written in this article that appeals to Austrian ears and eyes, this statement by itself would seem to reveal his real understanding of economics.

  2. Jeannie Queenie says:

    April 25th, 2010 at 11:18 pm

    It has never failed to amaze me that americans are so easily duped into thinking that the mortgage interest deduction is so red hot. Would make a helluva lot more sense to make 1-2 more payments a year applied ONLY TO PRINCIPLE..and that loan would be paid off much sooner than pretending uncle sam is giving you a great gift with that deduction. Basically what Sam is doing is keeping you on the hook much longer than need be. Once you don’t have that hellish mortgage payment life is a whole lot smoother, for that payment is more often than not the largest payment out of anyone’s monthly budget.

  3. Michael says:

    April 26th, 2010 at 11:06 am

    What I always found peculiar, is that when a business strategically defaults on a loan payment, nobody bats an eye lash, except of course, the loan originators.

    However, when a mortgage holder (read: individual person or couple) decides to strategically default, they’re lambasted in the media as “inconsiderate” or “irresponsible” or some other unfitting label.

    Why the disconnect?

  4. Iluvatar says:

    April 27th, 2010 at 12:29 am

    @ ALL: Hey,what happened to “bottom-line” thinking?? You evaluate a financial decision on your bottom line – taken over multiple years? It isn’t that difficult after all! A decision to buy a house falls into that exact category. You do a bottom line financial analysis. You figure it out! And sometimes, it makes sense to rent!

    Why is doing a “budget” (and a Long Term Strategic Plan) so fricking challenging anyway – you can DO it on an MSXCEL spreadsheet for Pete’s sakes!

    @Karen: I have really enjoyed your previous posts on Lew Rockwell’s about this – just taking a strategic default and walking away from dirt – YOU were so BANG ON there! Big Business makes the same decisions EVERY day. SO should WE. Economy be damned. That will right size it.

    We are SO living on unreal stuff right now///

    One thing I learned from you? A house is NOTHING OTHER than a durable good. That’s it. If it is not working out for you; THEN WALK AWAY (quickly – and then rent). We would really “un-distort” the market then!

    Let’s get out of TZ, pleaze?

    @ Michael: Dude – it’s not. You are bang on. Owning a house and then letting it go is a BUSINESS decision. If it ain’t working for you then you move your business ELSEWHERE. DONE! And this includes home ownership!!!!!!!!! Please fight every so-called moral pressure thrust upon you in your effort to make the “best” decision for you & your family. If it involves walking away then – so BE IT! It was the right choice for you to make!!!

    9 typos??????

  5. Jeannie Queenie says:

    April 28th, 2010 at 12:47 am

    It doesn’t help that the ‘tards’ on the Hill, if the Senate passes the Crap and Turd bill, will really make home ownership a real drag. In fact, it’s suggested that you sell your home before the next year is up for a License will be required for your house. Take a look at H.R. 2454 (Cap/Trade bill) if you contemplate selling. If this bill passes you won’t be able to sell your home unless you retrofit it to comply with the energy and water efficiency standards that the politboro requires. If the Senate passes this, it will be the largest tax increase ever foisted on all of us.
    Which is pretty stinking rotten, for the healthcare bill will do it first as they attempt to bury us all. So some govt a–hole comes to your house, checks everything over and makes a determination on improvements you must make before selling! Meaning if you don’t have the moolah, you are surely screwed.
    Yes, Iluvatar, you are right, they now have us coming and going. I am amazed that each day now, sometimes every hour I learn of some new catastrophe they’re sending our way.

  6. Jeannie Queenie says:

    April 28th, 2010 at 1:08 am

    Ohmigod, I don’t know how I forgot to put this in with previous comment. It is must viewing for those wanting to know what crapola is in store with the crap/trade bill. Glenn Beck is the funniest in this video whereby he shows how the mortgage fiasco, Al Gore,
    Goldman Sachs, all coalesce to bring us some pretty freaking scary stuff to a neighborhood close to you. Make sure you listen to his piece on the Chicago Carbon exchange…yep, this is actually on the market and you can trade it…you won’t believe what these jokers are up to. Glenn slices through the smokescreen of this planned faux bill.
    First 20 minutes of 4/26/10 show: Be patient with the 15 second commercial first.

    http://video.foxnews.com/v/4167372/the-one-thing-426?playlist_id=87937

    View the last 5 minutes of this at: http://www.glennbeck.com/content/videos/?uri=channels/338018/879397. It is truly an eye opener.

  7. Iluvatar says:

    April 29th, 2010 at 11:34 pm

    @JQ: “Eye opener” my A**.

    This stuff rips your whole soul apart.

    Hey? Life is really simple: Just ask yourself? What would Jesus, Kant, Nietzsche, Santayana, or Watts say?

    Trust me, these dudes NEVER messed around!

    They drew a line in the sand and said: “DO NOT CROSS IT!”

    I relish being a simple man – no complications.

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