Mortgages Drifting in the Tide

On March 5th the New York Times printed this graphic showing the percentage of loans in default for various types of mortgages—ranging from conventional “prime” mortgages to “subprime”—as a function of the current ratio of all the mortgages on the home to the value of the home. The dancing waves at the 100%-level separate the houses that are “underwater”—valued at less than the amount owed on the mortgage—from those that have equity beyond the value of the loan.

The graphic is based on data from November 2008 to January 2009, and it accompanied an opinion piece by John D. Geanakoplos and Susan P. Koniak arguing that the best plan for solving the mortgage crisis would not be the interest payment reductions proposed by the Obama administration but reductions of principle. The argument proposed by Geanakoplos and Koniak is more radical but has merit, but I am struck by the orderliness of the graphic and the underlying debate about choice and personal responsibility hidden within it.

The axes of the graph are arranged in an unusual fashion so that those most underwater can be shown at the bottom of the graph. Four lines indicating different types of mortgages stream down from the upper left-hand corner, the point that represents a paid-off mortgage. The lines taper off to the right as they fall, as if they are blowing in a gentle breeze or slowly drifting in the tide. As the line moves to the right, more people are in default on their loans. The prime mortgage line hangs fairly tightly to the left. Even when their loans represent over 200% of the value of their homes only 4% of these homeowners are in default. In most cases, these borrowers had good credit ratings and a down payments when they bought their houses, and the overwhelming majority have maintained their good records.

But the subprime mortgage line on the far right is the most interesting. For some, these loans and the banking institutions who offered them are the source of our recent economic problems. The banks sold shady and deceptive loans to people how could not afford them, and the drifting line on the right is the result. High levels of defaults that caused the foreclosures, that caused the banking meltdown, that cause the stock market crash, that caused the layoffs, etc, etc. But look more closely at the subprime line. At the very worst point on the lowest point, people whose homes are worth less than half the value of their loans are defaulting at a rate of approximately 12%. A high rate, indeed, but flip it over. More than eight-eight percent of all people in these desperate circumstances are paying there mortgages on time.

The bankers would say borrowers who default on their loans are the ones who bear the responsibility for failure. These homeowners signed on the bottom line and then welched on their promises to pay. The subprime mortgage industry (many representatives of which have now gone out of business) argued that, had they not introduced these subprime mortgages to the public, many people would be denied the benefits of homeownership. Look at the 88% who are still in homes and still paying.

But this right-most line begs the question, at what cost? Is it fair for the majority to benefit at such a severe cost to the other 12%? Are these good enough odds? As it turns out, the answer is no. These mortgages were fragile enough that when bundled together into securities investments, they eventually fell apart. It turns out that subprime loans are a bad bet. Unable to weather a down-turn in real estate prices. Eight-eight percent may sound good, but it is not good enough.

More Adventures in Debt

Buying gas today, I noticed a sticker on the pump: “Now you can prepay with your credit card at the pump.” All self service pumps are designed to accept credit cards, so why would you prepay a fixed amount of money rather than just swiping your card and pumping? My guess is more people are bumping up against their credit limits. They know they have just a little room left on the card, so they want more control over the amount they spend. Rather than having to watch the mounting total and time the shutoff to the desired expenditure, prepaying guarantees that you hit the right amount. Furthermore, some people with just a small amount of juice left on their cards or who risk the possibility of having the purchase denied might rather prepay, wait to see whether the purchase is approved, and then either pump with confidence or move on.

As mentioned in my previous post, “Pay with Two Credit Cards,” in today’s economy, merchants need to make special accommodations for the growing number of people in trouble with debt.

The Detritus of Consumption

An unanticipated effect of the economic downturn: recyclables with no place to go. As the economy tanks, the demand for recyclable cardboard, plastic, and metal has fallen away. According to a front page article in yesterday’s NY Times, the market for junk has collapsed at a far more drastic rate than the stock market. On the West Coast, mixed paper that was bringing in $105 a ton in October now sells for $25. The recycler that Harvard University sends its junk to used to pay $10 a ton but now charges $20 a ton.

Our recycling system is a house of cards built on consumerism, a system that puts all its energy into the front end of the purchasing sequence. The crucial moment is when the shopper lifts the bottle of juice off the shelf and into the shopping cart. The more the bottle weighs, the fewer units will be sold. Fifty years ago, Sylan Goldman, a grocery store owner in Oklahoma, noticed his customers left the store when their hand baskets were full. To subvert this limitation, he mounted two hand baskets on a folding metal frame and thus was born the shopping cart.

Manufacturers and retailers understand the physics of consumption. The physical effort of a purchase strongly affects sales. For people in cars, drive-thru windows are easier than walking. So when it became possible to package products in inexpensive, light plastic containers, manufacturers switched. Glass bottles were ditched in favor of plastic “recyclable” containers, many of which now overfill our landfills. Business people know that maximizing consumer convenience maximizes profits. Furthermore, the life of the container after the product has been consumed has no affect on the manufacturer’s bottom line. Unless producers are required to bear the cost of recycling or storing used containers, this is a negative externality: a cost of production borne by someone else.

Interestingly, the Times article notes that demand for glass has not declined. According to Wikipedia, glass and aluminum are much easier to recycle than plastics. Both can be recycled indefinitely. Perhaps this is the moment to bring back reusable and recyclable glass and aluminum containers. They would have the dual effect of decreasing consumption—at this point in our history, a very desirable goal itself—and reducing the size of our junk heaps.

The Myth of Establishing Your Good Credit

One of the standard maxims mouthed by personal financial advisors is the need to establish your good credit. Young people are advised to get a credit card and use it, being careful to pay off the balances regularly, with the goal of creating a good credit record. The person who fails to do this is said to risk not being able to get a house in the future or achieve any number of other goals.

This has always struck me as crazy advice. First, it puts young people at risk of doing the opposite—getting into trouble with credit cards—in the name of a rather abstract goal. Second—and most importantly—for many years now there has been little problem getting credit. Indeed the problem has been the availability of too much credit. At the end of the housing boom, people were able to get home mortgages without having any assets or income, and anybody can get a credit card with a shockingly high credit limit. When I interviewed debtors for Going Broke, many told people me they continued to receive credit card offers after declaring bankruptcy and had little trouble getting credit. So why is it so important to establish good credit? Perhaps this was a valuable goal in the bygone era when lenders actually cared about the credit worthiness of their customers, but a loan is no longer a social bond. It is merely a product to be sold for a short-term gain.

Given the recent credit crisis and Wall Street tumble, one might assume this picture had changed. Not so. The latest installment in the New York Times debt series documents the continuing—and perhaps increasing—practice of preying upon people who have recently declared bankruptcy. Using sophisticated data mining techniques, banks are targeting people who have experienced recent debt problems with credit card offers. If there is a credit freeze, it has not hit individual consumers. Consumer debt is still a profitable engine for many banks, and the industry is discovering ever more innovative methods of finding vulnerable potential customers.

The Paulson Bailout Plan: A Profiles in Courage Moment

This may be the most important vote since the authorization of the Iraq war, and in many respects, the atmosphere is similar. Congressional leaders have been churned up by a worsening economic picture and the drama of last Thursday’s emergency meeting with Henry Paulson and Ben Bernanke, where lawmakers were told there was a serious risk of massive failures within days and that casualties could go beyond the banking industry to large “brand-name companies.” Senator Christopher Dodd described it as “as sobering a meeting as any of us have ever attended in our careers here.”

Furthermore, this is an election year, and Congress is set to go home and resume campaigning at the end of the week. So a plan to save the economy and bailout the financial firms that got us into this mess will be hammered out very hastily in the heat of emotion. And, like the Iraq war vote, decisions made this week will haunt us for years.

The amount of money at stake is staggering. $700 billion is more than the cost of the war in Iraq to date, more than the entire 2009 budget for medicaid and medicare, more than the 2009 budget for social security, and just under the 2009 military budget. It represents $2000 for every man, woman, and child in the country--above and beyond what we already pay for the actual services of the federal government. And for what? To keep us all from being damaged even more than we have already by the irresponsible business practices of the financial industry we are bailing out.

The great majority of our leaders failed us in the Iraq authorization vote. They made political decisions based on the emotion of the moment. Let’s hope they do better this time. If this deal does not go far enough to reign in the unfettered business practices that got us here, then our leaders must have the courage to walk away. This time, the administration cannot be given a blank check. The deal must provide strong oversight and powerful safeguards against future crises, or we must be willing to say, “No deal.”

Homeownership & the American Dream

Home ownership is perhaps the most tangible symbol of the American Dream, but in recent years it has been oversold. Many people who later wished they had remained renters were sold enticing low-interest mortgages. Thanks to an economic downturn, insufficient regulation of the mortgage lending and mortgage investment industries, and good old fashion overconfidence in the security of real estate investments, many of those same people are now headed back to rented dwellings, but too often their path will run through foreclosure.

As the graph below suggests, the US experienced a rapid acceleration in home purchases beginning in 1992 and topping out at 69 percent in 2003. Since that time the rate has declined to the present 68 percent, and it may drop further. Recent history suggests the line may have been pushed up too high, and the current economy is making a correction.

There is no reason why the American Dream should be dependent upon home ownership. Internationally homeownership rates vary widely and are not particularly tied to standards of living. For example, Germany, a country that enjoys a standard of living (measured in GDP per capita) of $23,819, has a homeownership rate of 42 percent, whereas in Slovenia (GDP per capita of $19,200) 82 percent of people own their homes. Several of the countries of old Europe (e.g., France, Denmark, Austria) have homeownership rates that are over 10 percent below those of the United States.

Owning your own home is a greater financial risk than many thought, and too much risk can make the dream—when defined as owning your own home—a bad bet. But happiness and security can come in different shapes, and life in a rented home can be just as happy as life in a mortgaged home.

Joe Biden & MBNA

I am a strong supporter of Barack Obama’s campaign, and I am very pleased with his selection of Joseph Biden for Vice President. Biden will bring needed experience, respect, and fire to the campaign. But Joe Biden is from Delaware, the home of MBNA, the credit card giant, now owned by Bank of America.

All politicians have warts of one kind or another, and as a citizen it is all but impossible to find a political leader with whom you always agree. But as someone who is concerned about Americans who struggle with debt, I find Biden’s stance on bankruptcy reform particularly troubling. He has been a consistent supporter of the credit card industry’s efforts to make bankruptcy rules more stringent and to make the process of declaring personal bankruptcy more onerous and more expensive. After nine years of lobbying, the banks were able get a new, tougher bankruptcy bill through Congress, and President Bush signed it into law in 2005.

Barack Obama voted against the bankruptcy bill and has been a steady opponent of the credit card industry, but Biden’s stance on this issue is a blemish on an otherwise very respectable voting history. Unfortunately, now that the economy is in a tailspin and foreclosures are bursting out all over, the hurdles imposed in the 2005 bankruptcy bill are making life even more difficult for many debt-burdened consumers who could use the second chance that bankruptcy is designed to provide.

To make matters worse, there is at least the appearance of an improper relationship between Biden and MBNA. Today, the NY Times is reporting that Hunter Biden, the senator’s son and an attorney, worked for MBNA for from 2001 to 2005, a period that coincides with the credit card industry’s bankruptcy lobbying effort. The Obama campaign is defending this messy bit of Biden history, but it is a troubling episode that provides yet another example of the pernicious influence of big money in our government.