Mortgage default as economic stimulus

Early in the year, I posted a few times on a coming wave of mortgage defaults generally and the economic effect of living in defaulted accommodation specifically. My conclusion at the time was that, while the consumer spending due to the free rent defaulters received was large, it was not a major factor in the overall economic growth of the economy.

Please see "Strategic default: In come the waves again," "Three potential explanations for the continued fall in US savings rate," and "Why the fall in the savings rate is not meaningless," and "How strategic defaults are boosting consumer spending" for the relevant posts. The quote I want to highlight comes from the fifth post in this series called "More on strategic defaults and retail sales" which tried to get to the effect of defaulters free rent on consumer spending.  I wrote:

[Rosenberg]’s numbers are even well above Mark Zandi’s who I quoted yesterday via Diana Olick as saying that defaults were freeing up $8 billion per month for spending. That works out to almost $100 billion a year.

Honestly, those numbers seem incredibly high to me. If you take the 7.9 million people who are non-current on their loans according to LPS, a leading provider of mortgage processing services, it would mean that every mortgagee who had defaulted was spending an extra $1000 per month in retail sales. That’s enormous.  The numbers to get to the Columbia or Rosenberg estimates would be even higher.

Bottom line: I think the anecdotal evidence is compelling that defaults are goosing retail sales.  The question, though, is by how much. While we can make estimates, this is unknowable. $1000 per month per defaulter seems impossibly high to me. But, given the anecdotal evidence and the sheer number of people in default still living in their homes rent-free, the number is not negligible.

Here I was discussing some numbers put forward by two economists on the economic effect of the boost to consumer spending from the rent-free accommodation (not including any multiplier effects). And you would have to assume that every single household in default was living rent-free for a year and spending $1000 extra each month as a result. We know that many people are being foreclosed, that many who have not been foreclosed are unemployed, and that many who have not been foreclosed have not been spending $1000s of dollars extra but are paying down other debt or saving. So, $100 billion is an order of magnitude too high.

Today Mark Whitehouse wrote an article at the Wall Street Journal which puts specific numbers out – all of which are well south of $1000 per month. Below is the graphic.

Again, these numbers are large and a boost to the economy but they are not a decisive factor in keeping consumption growth elevated (and it is elevated as the latest numbers on personal income and outlays attest. See here).

Whitehouse writes:

Some homeowners who have defaulted on their mortgage payments are cashing in by renting out their homes. Joe Mayol, a real-estate agent in Palmdale, Calif., estimates that in his area about two-thirds of houses with defaulted mortgages are occupied, and half of those by renters. "People are getting money out of these houses," he said.

Ms. Zelman says her research suggests defaulters do spend much of the money on consumer services and goods. "People are taking what they would have been spending on a mortgage and spending it somewhere else," she says.

To be sure, while the free rent might help some people through periods of unemployment, it’s not particularly encouraging to people who keep paying their mortgages, and it’s not going to drive a recovery. It’s also painful for local governments and school districts, which typically can’t collect property taxes from defaulters. The foreclosure troubles can also add to uncertainty in the housing market and delay its return to healthy growth.

"I don’t think that’s the kind of consumer recovery we want, if the only reason they’re spending a bit more is that they’re not paying their other bills," said Joseph Carson, director of global economic research at AllianceBernstein in New York.

As I see it, this article serves a political purpose as much as an anecdotal or factual one.  Whitehouse concludes "Still, at least some of the banks’ loss is the borrowers’ gain."  Clearly, the unwritten purpose is to put the spotlight on ‘deadbeat’ borrowers living high on the hog and off of the fraudulent and potentially criminal activities of mortgage lendersregarding the now-brewing foreclosure scandal. So you have to read the last paragraph understanding this. This is not a ‘neutral’ or objective piece – something I see ever more in the Murdoch-controlled reporting at the Wall Street Journal (see here for example).

That said, this extra money from rent-free accommodation does have a mitigating effect on the poor income growth we have seen since the technical recovery took hold over a year ago. In the scheme of things though, given the numbers from Zandi and the WSJ, we are probably talking about $25-50 billion dollars. That’s not going to be a major factor in an economy of $14-15 trillion.

Source: The Stealth Stimulus of Defaulters Living for Free – WSJ