Strategic Defaults and Consumption

Annie Lowrey writes “Are Homeowners Really Skipping Out on Their Mortgages to Spend at the Mall?”:

It was Paul Jackson, the founder of Housing Wire, who first put the economic pieces together and said that strategic defaulters — people walking away from their mortgages — must be the reason consumption is rising despite high unemployment and declining real wages. “[M]illions upon millions of consumers in the U.S. [are] meeting their shelter needs for free, even if only temporarily; and what’s becoming of any extra disposable income, since no rent or mortgage need be paid?” Jackson wrote. “[W]e’re seeing consumer spending head northward, and for five straight months, too…. Put simply: people are spending their mortgages.”

The argument earned some guffaws — from, for instance, prominent economics and housing blogger Barry Ritholtz, who called it “bass ackwards.” People defaulting on their mortgages had run out of credit and still had high debt burdens, he argued. How could they be buying enough to raise consumption on a national scale?…

Christopher Thornberg — an economist, the principal at Beacon Economics in Los Angeles, and an early identifier of the real-estate bubble — calls Jackson’s theory an “urban legend,” compelling but illusory. “I did some calculations, and even being generous, all the money not being spent on mortgage payments equals about 0.7 percent of income, compared to 0.3 percent of income three years ago,” he says. “Consumer spending is rising at a 3 percent annualized pace [meaning] only a small portion of [rising consumer spending] can be explained by strategic defaults.” The rest simply stems from a better economic climate and many wage-earners and families tentatively deciding to open up their wallets.

I’m with Barry on this. Two points:

1) I ran a long email from a reader who couldn’t sell his underwater home, and who decided to strategically default in order to take a job in a new city. The house still, as of that writing in February, hadn’t been foreclosed on even though there have been no payments made on it, though that family moved to a new city and was paying rent on a new place.

Housing wire writes “We’ve got 7.4 million non-current loans in this country, according to data source Lender Processing Services, Inc…that’s an awful lot of households still living in a house, without a mortgage or rent payment draining their available disposable income” but, as far as I understand the data he’s using, there’s no reason to believe each loan is for a house that is occupied and non-current. The reader I profiled probably adds to the 7.4 million statistic as the loan is treated as non-curent but doesn’t live in that house, and pays for new housing.

So anecdotes can run both ways with these stories.

2) A simple fact is that debt-to-income ratios are worsening for those trying to participate in HAMP. Consumption for most Americans was debt fueled over the past 10 years, and in the middle of huge unemployment numbers it makes sense that it is getting worse for those most desperate. Those who strategically default possibly have incredibly high other debts that they need to service, and unless they are defaulting across the board the sad fact is that the income from not paying their mortgage is likely going to other debt services, be it Visa or health care.

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