What is disheartening here is that this could be fixed, perhaps even today by the method I proposed back in September.
When a market that operates on margin which is certainly the housing market enters a collapse mode, the big and immediate losers are the borrowers. The problem is to avoid having those borrowers folding their positions and walking away because there is never a sufficient ready market available to absorb the inventory. After all, everyone who could be persuaded to buy got sold an over priced property already.
You must return to the borrowers and make it worthwhile for them to support the house. What is more, it must be done universally so all distressed inventory exits the market at roughly the same time. That results in a rapidly improving market that stimulates new building.
This way we will have lenders running around converting their problems into government bailouts while beggaring their neighbor through ongoing property sales even when the land value is driven to zero and the bid price is less than replacement. The inventory is so huge that it must drag on for years.
As a result it will be decades before housing is considered a store of wealth again and consumer liquidity will remain suppressed since they have no other easy mechanism to release capital.
Further on we face the additional reality that the job market has been hurt badly and no government program ever did much to turn that around. It takes growing companies to do that with ready access to fresh capital.
The most probable scenario, unless Obama surprises, is a continuing erosion of housing prices over several years as the inventory is slowly worked off. This also implies an ongoing diversion of consumer’s cash into that market in order to preserve capital. The impact of this is to make it difficult for the consumer to prosper at all. During this period, we can expect credit card debt to contract also. This hardly is a recipe for a buoyant economy.
While demand is been suppressed by financial failure, we will experience a grinding dragged out recession that will surpass previous records. It does not need to be this way, but I see little to cheer about.
June 26, 2009, 11:02 AM ET
When Is It Cheaper to Ditch a Home Than Pay?
By Sudeep Reddy
Foreclosures aren’t only due to homeowners facing a cash crunch. One out of four defaults on mortgage loans is “strategic,” a new study says, due to a mortgage’s value exceeding the value of a house even if the homeowner can afford to pay.
Strategic default is most likely when home values have fallen by more than 15%, according to the study by authors of the Financial Trust Index, a joint project of the University of Chicago’s Booth School of Business and Northwestern University’s Kellogg School of Management. (Read the paper here by authors Northwestern’s Paola Sapienza, Chicago’s Luigi Zingales and Luigi Guiso of the European University Institute.)
The researchers found that homeowners start to default once their negative equity passes 10% of the home’s value. After that, they “walk away massively” after decreases of 15%. About 17% of households would default — even if they could pay the mortgage — when the equity shortfall hits 50% of the house’s value, they found.
“Housing policy under the current administration has focused on reducing households’ cash flow problems in response to the housing crisis, but no one has addressed the negative equity issue as part of public policy regarding housing,” Sapienza said.
The research is based on homeowner surveys, which also considered moral and social factors involved. People who said it was immoral to default were 77% less likely to declare their intention to do so, the authors write, while those who know someone who defaulted were 82% more likely to say they would default themselves.
“Our research showed there is a multiplication effect, where the social pressure not to default is weakened when homeowners live in areas of high frequency of foreclosures or know others who defaulted strategically,” Zingales said. “The predisposition to default increases with the number of foreclosures in the same ZIP code.”
Among the other findings:
People under 35 years and over 65 said were less likely to say it was morally wrong to default, compared to middle-aged respondents.
People with a higher education and African-Americans are less likely to think it’s morally wrong to default, while respondents with higher incomes were more likely to think it’s morally wrong.
Republicans and Democrats showed little difference in moral views of strategic default, while independents were less likely to say defaulting is immoral.
People who supported government intervention to help homeowners were 12 percentage points less likely to say strategic default is immoral, the authors found.
Wage and salary income, which is key for consumer spending, fell… While lower taxes and one time checks from the government are obviously a net positive for the consumer, they tend to have a short-lived effect on spending growth as they only affect the rate of change in disposable income when they are implemented or shortly thereafter. Of more importance to ongoing spending growth is the rate of growth in wages and salaries and other continuing sources of income flow. –Joshua Shapiro, MFR Inc.
The lion’s share (94.3%) of the increase in income came from one-time increases of $250 per eligible recipient of social security, supplemental security, veterans benefits, and railroad retirement benefits. The $13.1 billion of these transfers boosted May income by about $158 billion (annualized). These transfers are not recurring so incomes will fall by a like amount in June. Spending from this actual $13.1 billion is likely to be spread out over several months or even years if recipients use the proceeds to increase saving or reduce debt. The key fundamental driver of spending — wage and salary income — fell 0.1% after a slightly smaller advance in April. –Nomura Global Economics
Today’s data does not particularly change the view in any way. We know that the consumer remains backed into a corner, and any ‘green shoots’ of improvement will be tempered by the fundamentals at play, including an increasing unemployment rate, and an overall negative wealth effect (primarily coming from loss in home values). As such, we don’t suspect future gains of this magnitude will be sustainable outside of the influence of government stimulus. However, at the end of the day this is a better than expected report regardless of the one-off factors that are giving the data a beauty makeover. –Ian Pollick, TD Securities
Almost all the jump in incomes reflects the impact of the stimulus package, which gave $250 one-time payments to people receiving a variety of social security benefits. By contrast, wage and salary income fell 0.1%. It will continue falling as wage gains slow and payrolls fall. Most of the stimulus money was not immediately spent, so the saving rate jumped to a 16-year high of 6.9%. It has further to go… Not a green shoot, in our book. –Ian Shepherdson, High Frequency Economics
Real consumption has struggled to increase so far despite a torrent of government income support: real PCE has fallen 0.4% annualized over the last three months despite a 11.9% annualized increase in real disposable income. It is important to keep this in mind as we go into the second half of the year, when income support will unwind some. With households smoothing their consumption, a drop in second half real disposable income need not necessarily lead to a drop in spending, though this is naturally something we will watch closely. –Abiel Reinhart, J.P. Morgan
I have argued for months that it would be the consumer who would lead the way out of this mess and that is starting to happen. Consumer spending rose at a moderate rate in May as people bought more durable goods and soft goods. Interestingly, demand for services, which had been holding in, was essentially flat. So far this quarter household spending has been essentially flat compare to the first quarter. That is not as strong as had been hoped given the stimulus bill. Indeed, it appears that so far the stimulus money has gone more to savings than spending. –Naroff Economic Advisors
Reduced wealth, high debt, tight credit, and a weakening labor market are all weighing on consumers. Wages and salaries were down in May, and have fallen in four out of five months this year. And higher gasoline prices are biting into spending power… Looking forward, we expect consumers to stay cautious. But we do expect spending to creep slowly higher in the second half of the year as the labor market deterioration becomes less severe. –Nigel Gault, IHS Global Insight
As an indication of how weak labor market conditions have become — recall it is not only significant job losses but also declining aggregate hours worked amongst those with jobs — yesterday’s revised GDP data show that during the first quarter, aggregate wage and salary disbursements fell on a year-over-year basis. While this may not seem much of a surprise, this is the first over-the-year decline in wage and salary disbursements since the second quarter of 1958. While the rate of job losses appears to have moderated, employment is nonetheless still declining, as are aggregate hours and aggregate labor earnings. Throw in the significant decline in household net worth over recent quarters and restricted access to credit, and it is no surprise that consumers remain cautious in their spending behavior and continue to add to household savings. –Richard F. Moody, Forward Capital