Thursday, June 3, 2010


Have you ever wondered about the fairness of Wall Street running the economy into the ground, getting bailout after bailout, paying out big bonuses, and then going after you with higher interest rates, canceled credit, and record foreclosures ... and then making you feel like the bad guy? Well wonder no more. In "Default, Please" (from we gain insight into why walking away from your mortgage and/or declaring bankruptcy might actually be a good thing, for everyone.

Indeed, after reading this piece you might want to start thinking about creating your own personal Debt Jubilee or, more appropriately, creating your own personal bailout. Here's what one of the analysts is saying about bankruptcy and foreclosure, and why you might want to consider it if you're looking down the barrel of a financial gun ...

What we are experiencing is called the global credit crisis for a reason. There is too much debt in the world. More and more economists are talking about the threat of a deflationary crisis ahead. What does this mean for you? Well, if you have a house that is under water, or more debt than you can reasonably hope to repay, your best options may be the unthinkable. But it really should not be unthinkable to default on a loan or even to declare bankruptcy. Don’t stop reading. It is really a good option for many, it is moral, legal and good for the country. It is also become very common. You and your children will look back in a generation with pride.

In small amounts, debt is good. Home ownership is only possible for the young with mortgages, and many college degrees are partially supported with student loans. Working capital for growing businesses allow for inventory and distribution expenses. Lenders benefit as well: high interest rates are paid to pensioners on their life savings.

When debt exceeds a certain level it becomes a cancer on society. Easy credit fuels speculation which triggers bubbles. These bubbles lead to a temporary lift in apparent wealth, which increases economic activity beyond its sustainable level. But eventually more and more debt triggers economic decline with the inevitable glut of goods produced by an overheated economy.

What people are discovering too late is that their debt is not repayable. Ever. They once had a hope they could wait out their bad times. This is true of many homeowners, many businesses and many governmental bodies. The “great unwind” is going to be deflationary. Prices and salaries will decline, jobs will become more scarce, and debt will continue to increase.

The earlier you pull the rip cord the better off you will be later. In many states mortgage loans are non-recourse. Never make another mortgage payment. Turn over the keys after foreclosure. You will lose all of your down payment, but the lender can never get another penny from you. Your credit score will fall. But you do not want any more credit. Right? If you are trying to quit crack, how would feel about your pusher reducing your crack score? Stay off credit for a few years, and they will take you back with open arms.

There should no longer be any moral question about whether it is wrong to walk away from debt legally. The advent of limited liability corporations and the legal ‘personhood’ of corporate shells have allowed business to create one sided bets for years, and they happily walk away when the tide shifts. This is the calculus of 21st century finance, and you are a bit player in this game [Mark here; emphasis mine].

But it is the macro effects of a large transfer of wealth from creditors to debtors that interests me the most. I am not talking about ‘redistributive change’ in a liberal political sense. Creditors are not all bad, and debtors are not all good. There is a terrible corrosive force that excess debt has on societies. Ken Rogoff and Carmen Reinhart have written an excellent book on the subject “This time is different”, and suffice it to say the outcome for societies can be a generation of high unemployment and low economic growth. No serious economist challenges this data. However there is a lot of debate about what to do about it.

The current administration is implementing a policy of recapitalizing the banks (whose assets are still worth far less than their own debts) by lending them money through the Fed for nothing and borrowing back the money through the treasury for a lot more. This is called transferring debt from the banks to the government. But government debt has the same drag on societies in the long run, they can just hold their breath longer.

In the end deft default always occurs in these situations. The debts cannot be paid by the combined debtors in a society. The default may occur when inflation destroys the value of the debt over time. Or the default may occur with the eventual death of the debtor. Or the debt is discharged legally.

The longer this process takes, the more damage occurs to the society. There are strange incentives that a person has when their debt is unpayable. Why would you try to earn more? The more you earn the more debt you pay. But you cannot earn enough to get out of debt. So you stop trying. If you owe too much on your house, you might decide you have nothing more to lose on your house. So you will simply decide to wait it out. You will minimize the repairs and improvements on the house, rent the house out to frat boys and hope for the best.

The banks are great examples of distorted incentives. They have sucked up a $1T of government money. They are still paying huge bonuses. They are not lending to businesses in need. Distorted incentives indeed.

In the ancient days the Christian nations would have a debt Jubilee every 30 years. It sounds like a party because it was. Debts were forgiven en-masse when societies became constipated with debt.

The economy will continue to stagnate, and unemployment will increase. Asset values will continue to decrease until the defaults begin. When the rot is finally purged from our system, the great American wealth machine will start anew. It is time to party like its 1454. Start your own personal debt jubilee.
Former Labor Secretary, Robert Reich, offers an interesting take on these dynamics as well.

Specifically, Reich points to the hypocrisy of pundits and industry officials who shamelessly criticize homeowners for taking on loans they can't afford, and then argue the "deadbeats" deserve whatever losses come their way. Yet, at the same time, they don't apply the same scrutiny to individual executives, the financial institutions, or the federal government (through the Federal Reserve) who seem to have no problem saving irresponsible “lenders, the credit-rating agencies, financial intermediaries, and hedge funds” with taxpayer dollars. As Reich points out, no one compelled banks to hand out and underwrite loans without documentation of income, jobs, assets, etc.

Let me repeat this, at the end of the day no one compelled banks to hand out and underwrite loans without documentation of income, jobs, assets, etc.

Still, for years there has been a tendency to euphemistically label billion dollar bail-outs as “moral hazard” and struggling homeowners and other debtors as "irresponsible" and "undeserving" deadbeats. The social stigma and the wrecked mental state of "irresponsible" debtors that follows is what the financial institutions bank on. Shifting blame, rather than accepting (even partial) responsibility, has become a corporate strategy.

These dynamics encourage financial institutions to recklessly make loans, take on big risks, and make dumb decisions. And why not? Banks now have the luxury of privatizing the profits when the going is good, and socializing the losses when the going gets tough. Better yet (for them), they have convinced the world that the American consumer is the irresponsible party if they can't meet their obligations. What a racket.

I'll have more to say about this at a later date, when I discuss the Lehman Brothers bankruptcy, and why the American taxpayer is playing the sucker in today's economy.

- Mark

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