Foreclosures Are Not the Problem. Those Who Build Financial Time Bombs, and Those Who Pick Them Up, Are the Problem

by cactus

Foreclosures Are Not the Problem. Those Who Build Financial Time Bombs, and Those Who Pick Them Up, Are the Problem

I hesitate to disagree with Hilzoy – she may not be an economist but she’s very smart is usually right – but she has two posts (here and here) which I think are based on a faulty premise. This is the last paragraph from the first one:

Under normal circumstances, I’d be opposed to the government stepping in to encourage banks to modify these loans, except in cases of fraud. But these are not normal circumstances. The economy is melting down, and foreclosures are a big part of the reason why. Foreclosures always impact people other than the people foreclosed on, for instance by driving down neighborhood property values. But now, of all times, they are having massive impacts on the rest of us. And the Obama plan, which does not just wave a magic wand and make people’s excess debt disappear, seems to me like a good start on addressing them.

cactus says
Foreclosures are not a big part of the reason the economy is melting down. Foreclosures are a symptom on the one hand, and part of the necessary cure on the other. Home prices are simply too high right now. My wife and are in a position to buy a house. There are, in fact, a few homes for sale in the neighborhood my wife and I want to buy in, and we have enough money squirreled away to pay cash for any of ’em if we chose. I hasten to add that we’re not rolling in the dough – assuming we wanted any of those houses, we’d be stupid to pay cash. Right now we’re down to one source of income, and my wife is starting a new business (for a long time, I expect 0
But we’ve done the analysis… Where we live, its still cheaper to rent than to buy, and that’s before you add a premium to take into account the fact that buying increasing your risk and reduces your mobility relative to renting. That little detail means that either rents have to rise, or home prices have to fall.

But wait, there’s more! You can get a nice summary factsheet for anyplace in the US from the Census. In our area, homes are considered affordable, but when I look at the median household income and the median value of a home in the area, it occurs to me that most households would have a hard time making ends meet. Given incomes in this area, and assuming a 20% (responsible) downpayment, throw in income and property taxes, and assuming a 4% interest rate, and I have a hard time seeing how all that many people could afford the payments on a house. They certainly can’t simultaneously pay the mortgage and save money for a rainy day, and they probably have to forego niceties like health insurance or dental work or any expenses at all on maintenance of the house along the way.

And there’s part of the problem – people bought homes they couldn’t afford. Debt was easy for a while, and home prices were assumed to be going to infinity (“buy now or be forever priced out of the market!”) but those days have come to an end, so fewer people are willing (or allowed to) buy homes they can’t afford now.

All of that means – either home prices are going to have to drop more, or incomes in the area are going to have to rise, or we’re going to institute a permanent class of homeowners and a permanent class of renters. I’m betting on the first option right now. And I’m also betting that Obama’s plan is just going to drag out the day that prices become affordable.

But the real problem, the cause of this whole mess, is simple: every few decades, our economic system morphs into a structure that rewards making things less than it rewards creating financial time bombs with multi-year fuses. We’ve been rewarding the financial time bomb makers more and more since Reagan took office. And this is also the second time since Reagan took office we’ve been bailing out the financial time bomb makers at great cost to the rest of us – the previous time was during the S&L crisis.

Things have now evolved to the point where for some reason, when the market for time bombs disappears its considered some sort of a tragedy. This time around, we’ve already helped out the grifters, including many investment banks, commercial banks, derivatives traders, and now we’ve moved on to helping the marks. And rewarding any of them, the grifters or the marks, is a problem for several reasons. It rewards the bad behavior of the financial time bomb makers and reduces the incentives the rest of us have to watch out for the crooks. (And yes, I know, people living next to foreclosed homes suffer too. But externalities come in both positive and negative varieties, and folks who benefited from home prices rising for no reason don’t have a complaint when the home prices drop back in value because people found out the rise happened shouldn’t have happened in the first place.) It also keeps an unviable system going, and it does so at great cost.

But there’s one more thing. Since this whole thought process, this current iteration of the art of rewarding of the financial time bomb makers, dates back to Reagan, it pays to go back to Reagan… And when Reagan conjured up images of the Cadillac-driving welfare queen, it pissed people off not because there were people who needed help, but because supposedly many people who were getting help were, according Reagan, living better than the people being taxed to help them. And while I for one have never had a problem with seeing some of my tax money go toward helping the unfortunate, and I’ve never had a problem with welfare, at this moment in time, I know with absolute certainty that more most of the new-fangled welfare from the last six months is directed to helping people who are better off than I or have lived much better than I in recent years (investment banks, commercial banks, derivatives traders, and now homeowners) than the poor. I resent it. Does Obama really want a country where the folks who make and pick up time bombs are rewarded at the expense of those who are too honest to make time bombs or were smart enough (and in some cases, lucky enough) not to pick them up?

In closing, I do have a suggestion – if for some reason its considered necessary to dump big piles of money into the economy, why not give it to folks who are neither grifters nor marks? After all, the goal seems to be to get people to spend. And those who are neither grifters nor marks are more likely to spend extra funds than the marks are, given the hole so many marks are in. They’re also less likely to spend the money figuring out how to build the next generation of time-bomb.
by cactus