Dakota Beacon

Through the winter of 2009-2010 I have spoken on TV/Radio and through many public appearances, where I consistently stated that another wave of defaults were on the way again and that a double dip recession was a likely conclusion. The 1st groups of defaulters  in 2007-08 were individuals who were deluded into buying homes at teaser rates and had a very hard time making payments when rates reset to market rates. The next group was individuals with decent to good credit; this group started to default because one or both members of the family lost their jobs, and therefore, they could no longer make payments on the mortgage. Now we have the next wave; the strategic defaulters. This group’s decision to default is based on cold logic. The value of their homes has dropped so much that it no longer makes sense to make payments on a house that is trading well below market value.

“Strategic” defaults accounted for at least 12 percent of all defaults in February, up from about 4 percent in mid-2007, according to a recent Morgan Stanley report. Analysts led by Vishwanath Tirupattur classified a default as strategic when a homeowner who hadn’t previously been delinquent made an on-time mortgage payment one month; skipped payments for the next three months; and stayed current on other consumer debt of $10,000 or more. 

Note that morality as we knew it in the 20th century is now a thing of the past. You can’t watch a television show at 7 pm  on one of the networks and have a 9 year old in the room without fearing they will hear foul language or sexual innuendo’s in most jokes .  Thirty years ago it was a prideful thing to pay cash for a new car, now people talk openly about how low their 5 year payments are, having things paid for is passé. If this is how callous the consumer of debt has become , a massive wave of new defaults could hit the market, further souring an already weak real estate market. Knowing this is the understanding of socionomics. As the saying goes you reap what you sow. The banks have sowed too much debt, so they are going to reap the effects of too much debt.

Conclusion

Housing analysts say strategic defaults mainly occur when a home’s value has dropped below the balance remaining on the mortgage. A homeowner in that position may decide that continuing to make payments is throwing money away, or may default to get the lender to modify the loan. All told, borrowers who aren’t making mortgage payments are probably skipping roughly $100 billion annually, an amount equal to 1 percent of consumer spending, according to Mark Zandi, chief economist at Moody’s.  Zandi likens the money to “a form of stimulus, a little tax cut.”

Zillow.com states that one in five U.S. homes with a mortgage has “negative equity” so the number of potential strategic defaulters is rather huge; what we have on our hands is a ticking time bomb and purchasing real estate now is a more risky proposition then in the past, unless you are flipping a short sale after a quick improvement. Buying and holding is not in vogue. The long term price trend for housing nationally is still down.

Here is another fact to consider. Many of the individuals who are opting to strategically default understand that most banks are reluctant to foreclose immediately on homes that have a value of over $300,000. The higher the value, the more reluctant the banks are to foreclose. The reason is simple: once they foreclose, they can no longer lie and pretend that the house is worth $500,000. They now have to register the true value of the house and in most cases it is significantly lower than the existing mortgage. If they did this to all their properties the profits they are now claiming would drop significantly or completely vanish. In most cases banks wait up to 2 years to foreclose. In that time, a person could save a significant amount of money as they would be living rent free and that’s another reason why so many are choosing to strategically default.

Debt that is created by a Fiat currency (the term derives from the Latin fiat, meaning “let it be done”, as the money is established by government decree. Where fiat money is used as currency, the term fiat currency is used. Today, most national currencies are fiat currencies, including the US dollar, the euro, and all other reserve currencies, and have been since the Nixon Shock of 1971) is a double edged sword. The first edge is when the borrower gets in too deep with debt and thus yields power to the issuer of the loan. However, an issuer drunkenly pursuing profits and over borrowed can then be brought to the negotiating table in a more humbled manner.   Jean Paul Getty said it best , “If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem”. Housing will not have upside price pressures for years to come. The FDIC at the end of May is on record that 10 % of all banks are on a watch list. When you consider how banks cook the books, it is probably above 20%. This is why the banks will only want to loan  to credit worthy people now, and many of those have now left that category in droves.

North Dakota typically trails national trends of fashion, style, music and economics, with the latter measured in years. It is hard for most residents of this state to wrap their head around the national recession and its carnage. Can oil production continue to keep our state’s economy ahead of the country until it catches up to us, or do we get pulled into the muck with rest? Let’s hope the leaders of our state take the initiative to start planning for a rainy day and realize they can’t continue increasing the cost of government when the state populous is not growing at all comparatively. Now is the time to start saving money and cut spending when you can do it on your own terms. A natural cyclical down turn in energy prices will occur in the future, it is just a matter of when not if. With a congress and president that loath the use of petroleum and coal, could that natural cycle be expedited? As we go forward, I am reminded of a Chinese proverb “may you live in interesting times”, and of that I am convinced will occur.

Eugene Graner, CTA

Heartland Investor Capital Management