How to lose your debt without losing your health

By Felix Salmon
October 3, 2011
lethal:

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Deleveraging is painful. It’s so painful, indeed, that it can actually be lethal:

Foreclosure is not just a metaphorical epidemic, but a bona fide public health crisis…

The N.B.E.R. study found significantly more suicide attempts in high-foreclosure neighborhoods. For every 100 foreclosures, it found a 12 percent increase in anxiety-related emergency-room visits and hospitalizations by adults under 50. Losing a home disrupts social ties to neighbors, schools, jobs and health care providers — ties that under better circumstances promote good health. Neighborhoods suffer, not just homeowners.

This is a problem that’s going to get worse before it gets better. No matter how many refinancings and principal writedowns we get, the number of foreclosures is bound to rise sooner or later. There are 11 million homeowners underwater; those people have to deleverage somehow, and foreclosure is, sadly, top of the list of ways for them to do so. The only other way of getting a principal writedown, these days, is a short sale — but given how long it’s taking banks to foreclose, it makes sense to just sit in your house and wait for the bank to kick you out, rather than going to all the effort of trying to find a buyer just so that you can be forced to live elsewhere that much sooner.

I worry too about Ireland, in particular, where foreclosures haven’t even started yet, mainly because underwater homeowners there have been surprisingly diligent about making their mortgage payments. That’s partly a cultural thing, and partly a function of the fact that Irish mortgages are all recourse: if you default on your mortgage, the bank will seize essentially everything you own. But develeraging is even more necessary in Ireland than it is in the US, and again it’s hard to see how it’s going to happen without defaults and foreclosures.

The “great haircut” idea where everybody sees their debts written off simply isn’t going to happen: there’s not enough capital in the banking system, for starters. And for as long as Ireland remains in the euro, it’s hard to see how the country can deleverage through inflation. But that’s more of an option in the US — the more we inflate our way out of our excessive debt burden, the healthier we’ll all be. Literally.

11 comments

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The problem with not writing down the loans is that the houses lose most if not all of their non land value. They become essentially tear downs. I’ve looked at buying a couple of houses. The value of the homes is lower because of material defects. Things like the roof leaking, mold, smashed walls, ruined plumbing. If the lenders think they are going to save money by not writing down the values to a value that either the owner can sell or can pay the mortgage they are mistaken. What is left after months of a foreclosure process is a ruined house with much less value than if the lenders cut a sensible deal.

Posted by kevin2007 | Report as abusive

It really isn’t strictly necessary for Ireland to have a parallel foreclosure situation to the US. There is another model. Consider Japan, in which culture militates that debt should be repaid.

Here is a story of a man who bought 20 years ago. He just labors away, living a much reduced life. No walking away, he just lives an underwater life in a cramped and distant apartment where he can never move.

http://www.nytimes.com/2005/12/25/busine ss/yourmoney/25japan.html?pagewanted=all

“So Mr. Nakashima, a Tokyo city government employee who was then 36, took out a loan for almost the entire $400,000 price of a cramped four-bedroom apartment. With property values rising at double-digit rates, he would easily earn back the loan and then some when he decided to sell.

Or so he thought. Not long after he bought the apartment, Japan’s property market collapsed. Today, the apartment is worth half what he paid. He said he would like to move closer to the city but cannot: the sale price would not cover the $300,000 he still owes the bank.”

I presume the impressive man in the article will eventually pay off his debt. The article is from 2005, so he has presumably made a little more headway since then. Eventually his mortgage will run out. It goes on,
“Mr. Nakashima says he is resigned to spending the rest of his days in Kashiwa. It is peaceful here, after all, he said.”

Posted by DanHess | Report as abusive

I guess that Felix wants us to feel sympathy for those who are overleveraged. But what about the real victims of the credit bubble?

How does Felix feel about someone who was hardworking and carefully practiced self-denial, lived on a written budget every month for years on end and NEVER went out to restaurants or the theatre, took public transit everywhere so they could direct the money that they’d usually have to pay for auto insurance or an auto loan to savings towards their eventual down payment, and in all other respects lived frugally and saved up an amount that would normally constitute a solid 20% down payment on an affordable home during non-bubble years, but happened to be attempting to make their purchase during a bubble and was priced out of the market at the bubble housing era price levels?

A bubble that we being inflated and sustained by the majority of people around this responsible individual buying with no-money down, “pick a pay” and “teaser rate” ARMs and interest-only loans, and then out and out lying on their mortgage application with regard to their household income level because their mortgage broker told them that the bank wouldn’t try to verify their income and that it was the only way they’d get approved for a mortgage at the bubble-inflated price level? You know, the people who are only now being foreclosed on or being forced into a short sale situation.

Of these two classes of people, which one was the true victim?

Posted by Strych09 | Report as abusive

Strych09, every person’s story in this tragedy is unique. There were those who were flipping as fast as they could buy, con men defrauding on mortgage, the person you describe, and millions of others. All egged on by the real estate industry, who told them that house prices never go down, and at worst they would just stop rising as fast. And most even believed it, having never experienced anything else. And in any case, they were salesmen, and their job was to sell.

The point is that the press has done far too much generalizing about everyone in this mess. Sorting the guilty from the innocent from the incompetent (see Serin, Casey) is simply impossible. We are where we are, and just need to move forward. Some have had their lives irreparably damaged, some have done far better than they deserve, and the vast majority will somehow muddle through.

Posted by Curmudgeon | Report as abusive

Inflating out of debt is a short term solution only; not being able to forces governments and societies to face the uncomfortable truth: they need to change their ways.

Posted by FifthDecade | Report as abusive

Dan Hess, you said Parallel Foreclosure!

Felix, Banks are killing the world’s economy by requiring that all restructuring of debt occur only after a default.

Restructuring of debt should NOT require a default. The impact of this would be profound. The erosion of main street’s wealth would cease, original principle would still be paid back, only at much better terms for main street.

http://www.bankprotests.com

Posted by N0Chase | Report as abusive

There is nothing wrong with bankruptcy and/or foreclosure. It is the way we deal with bad debts. What’s wrong is the idea that our credit system should punish those same people for the rest of their lives on that basis alone.

Posted by silliness | Report as abusive

Haven’t read the study, but I’d expect a real effort to disentangle correlation and causation is required for such subjects.

Posted by TGGP | Report as abusive

To ‘N0Chase’ and ‘silliness’, what you’re observing is a direct result of the mortgage loan industry being turned into a casino by the banksters on Wall Street.

Banks require that debt restructuring only occur after a default because securitization of loans means that too many people have to be involved for a loan workout to be arranged before a default happens. In many, if not most, circumstances, a servicer simply cannot agree to a principal reduction or workout without the prior approval of mortgage-backed security holders, and that approval is often very difficult to obtain. And then there’s the interests of CDS holders and what ratings agencies will consider a default to take into consideration.

As far as going after people after they’ve taken a short sale or mortgage default via a “deficiency judgment”, that doesn’t “punish those same people for the rest of their lives on that basis alone” because as you’ve allowed, they can get out of the debt by declaring bankruptcy.

Posted by Strych09 | Report as abusive

“How does Felix feel about someone who was hardworking and carefully practiced self-denial, lived on a written budget every month for years on end and NEVER went out to restaurants or the theatre, took public transit everywhere so they could direct the money that they’d usually have to pay for auto insurance or an auto loan to savings towards their eventual down payment, and in all other respects lived frugally and saved up an amount that would normally constitute a solid 20% down payment on an affordable home during non-bubble years, but happened to be attempting to make their purchase during a bubble and was priced out of the market at the bubble housing era price levels?”

I don’t understand the point here. The frugal miser bought in the bubble years and all his hard work to save a solid 20% has been wiped out by the collapse of the bubble – so he is now 10% underwater. Without either a restructuring or inflation, he remains underwater for the next 15-20 years (the average 30 year loan doesn’t see significant principle paydowns till fairly late in the amortization curve). Keeping his zero-down neighbors out of foreclosure will prevent his property value from further eroding, leaving him deeper underwater.

Actually, inflation would be the better option for him – his home value would increase and equity would build while the over-leveraged would just break-even.

Plus I am not sure that a miserly existance, which reduces economic activity for the resteraunts, theaters and auto makers would really be that beneficial. Where does Mr Frugal Miser work? If it is in any business with actual customers, he can credit much of that 20% down to the spending of his less frugal neighbors.

Posted by Ragweed | Report as abusive

“How does Felix feel about someone who was hardworking and carefully practiced self-denial, lived on a written budget every month for years on end and NEVER went out to restaurants or the theatre, took public transit everywhere so they could direct the money that they’d usually have to pay for auto insurance or an auto loan to savings towards their eventual down payment, and in all other respects lived frugally and saved up an amount that would normally constitute a solid 20% down payment on an affordable home during non-bubble years, but happened to be attempting to make their purchase during a bubble and was priced out of the market at the bubble housing era price levels?”

I don’t understand the point here. The frugal miser bought in the bubble years and all his hard work to save a solid 20% has been wiped out by the collapse of the bubble – so he is now 10% underwater. Without either a restructuring or inflation, he remains underwater for the next 15-20 years (the average 30 year loan doesn’t see significant principle paydowns till fairly late in the amortization curve). Keeping his zero-down neighbors out of foreclosure will prevent his property value from further eroding, leaving him deeper underwater.

Actually, inflation would be the better option for him – his home value would increase and equity would build while the over-leveraged would just break-even.

Plus I am not sure that a miserly existance, which reduces economic activity for the resteraunts, theaters and auto makers would really be that beneficial. Where does Mr Frugal Miser work? If it is in any business with actual customers, he can credit much of that 20% down to the spending of his less frugal neighbors.

Posted by Ragweed | Report as abusive