Are homeowners really skipping out on their mortgages to spend at the mall?
The case is now famous. The homeowner had applied for the Home Affordable Mortgage Program, or HAMP, an Obama administration initiative to give distressed and tapped-out borrowers lower monthly payments. Applicants are meant to be just scraping by — they have to file hardship affidavits and the government presumes they have trimmed all the fat from their budgets. But this “HAMPlicant,” the writer on the blog Calculated Risk noted, had given up on a $1,880 a month mortgage and instead had spent hundreds of dollars at a spa, tanning salon, gourmet grocery store and liquor store, capping it all off with $1,700 in charges to mall stores from Baby Gap to Best Buy.
Bloggers seized upon the case, and used it to make a broader argument. Such “foreclosure queens,” to coin a term (and to try to capture some of the scorn heaped on these strategic defaulters on the Internet) are stopping paying their mortgages and taking to the malls in big enough numbers to account for a surprising rise in consumer spending. Put another way: People ditching out on their mortgages are holding up America’s consumption.
Anecdotally, at least, it seems true. Millions of homeowners now owe more on their mortgage than their house is worth (meaning that if even if they sold the house, they would still owe the bank) and therefore have simply stopped paying their mortgages. Mortgage lenders and courts are so backed up with foreclosures — hundreds of thousands of them per month — that the time between the first late payment and eviction now stretches as long as 20 or 24 months in some parts of the country. That means that when a homeowner decides to stop sending off that $1,000 or $1,500 or $5,000 check to the bank, she has that much more spending cash until she needs to move out and find a new home.
But the anecdotes do not yet an economic reality make — and other economists caution that the evidence that the phenomenon is widespread enough to change the macroeconomic picture is thin. Despite that reality, the mortgage-distress and foreclosure blogs have hundreds of such stories of people “relieved” once they decide to default, determining that it makes more sense for the bank to take the house back. One young couple, for instance, wildly overpaid for their home in 2006. Six months ago, they decided to stop sending in checks, and to wait for the bank to contact them. They just returned from a week-long New York City vacation and have not heard a word from the bank.
It was Paul Jackson, the founder of Housing Wire, who first put the economic pieces together and said that strategic defaulters — people walking away from their mortgages — must be the reason consumption is rising despite high unemployment and declining real wages. “[M]illions upon millions of consumers in the U.S. [are] meeting their shelter needs for free, even if only temporarily; and what’s becoming of any extra disposable income, since no rent or mortgage need be paid?” Jackson wrote. “[W]e’re seeing consumer spending head northward, and for five straight months, too…. Put simply: people are spending their mortgages.”
The argument earned some guffaws — from, for instance, prominent economics and housing blogger Barry Ritholtz, who called it “bass ackwards.” People defaulting on their mortgages had run out of credit and still had high debt burdens, he argued. How could they be buying enough to raise consumption on a national scale?
But the idea gained support from some major economists who declared the logic impeccable. Mark Zandi, the chief economist at Moody’s Economy.com and a much-followed economic prognosticator, declared it a convincing case, and did some back-of-the-envelope math to support it. “Some 6 million homeowners not making mortgage payments [are] probably freeing up roughly $8 billion in cash each month,” he said. “Assuming this cash is spent (not too bad an assumption), it amounts to nearly one percent of consumer spending.”
Still, the hypothesis remains a hypothesis say other economists that specialize in housing — and ultimately the numbers do not add up, at least not yet. While the microeconomic phenomenon (of strategic defaulters spending more) is certainly occuring, the macroeconomic one (of strategic defaulters spending enough to lift national consumption rates) is not. Strategic defaulters on the loose in the malls account for just a small fraction of the gains in consumer spending, better explained by pent-up demand, continued low prices and improving sentiment on Main Street.
Christopher Thornberg — an economist, the principal at Beacon Economics in Los Angeles, and an early identifier of the real-estate bubble — calls Jackson’s theory an “urban legend,” compelling but illusory. “I did some calculations, and even being generous, all the money not being spent on mortgage payments equals about 0.7 percent of income, compared to 0.3 percent of income three years ago,” he says. “Consumer spending is rising at a 3 percent annualized pace [meaning] only a small portion of [rising consumer spending] can be explained by strategic defaults.” The rest simply stems from a better economic climate and many wage-earners and families tentatively deciding to open up their wallets.
Dean Baker, the co-director of the Center for Economic and Policy Research in Washington, D.C., agrees. He argues that the rise in consumption is simply a rebound from an unusually deep trough in 2009. “We had such a sharp fall-off last year that to some extent it’s going to be self-correcting,” he notes. “The fact that we’ve somewhat of an uptick is not that surprising to me.” He adds that most of the proponents of the theory on the internet were looking to March purchasing data that was unusually high due to the early Easter. “I’m just not conviced we’ve seen so much of a jump in consumption that we need to explain it,” he adds.
That said, the rising number of defaulters will only increase the backlog for banks and courts. The growing awareness of the phenomenon could further fuel it, as well. And in the next year — with unemployment still high and the foreclosure crisis worsening — the effect of the cash-rich strategic defaulters could become more and more outsize. To see if strategic defaulters are moving the national consumption figure, Baker says, look to to California, Florida, and Nevada – three states with sky-high unemployment and the highest rates of foreclosure. Thus far, consumer spending has not turned around in those three states. And if it does, and sharply, it might be the strategic defaulters to blame.