…and back at mortgages and foreclosures…

I’m just an astonishing misery-guts today, aren’t I? While out getting coffee, the missus pointed out the Atlanta story to me:

ATLANTA — Despite a vibrant local economy, Atlanta homeowners are falling behind on mortgage payments and losing their homes at one of the highest rates in the nation, offering a troubling glimpse of what experts fear may be in store for other parts of the country.

The real estate slump here and elsewhere is likely to worsen, given that most of the adjustable rate mortgages written in the last three years will be reset with higher interest rates, said Christopher F. Thornberg, an economist with Beacon Economics in Los Angeles. As a result, borrowers of an estimated $800 billion in loans will be forced in the next 12 months to 18 months to make bigger monthly payments, refinance or sell their homes.

All these economics groups of whom I’ve never heard – where do newspapers get these guys? Anyway, the other story related to this was the adjustable-rate mortgage reset.

NEW YORK – More than two million subprime adjustable rate mortgages (ARMs) are poised to reset at much higher rates in coming months, worsening an already suffering housing market.

Borrowers who took out hybrid ARMs in 2004 and 2005 to secure low “teaser” rates for the first two or three years of the loan may see their monthly mortgage payments climb by 35 percent or more.

Well, shit. At the same time, retailers are already feeling the pinch:

Sales at U.S. retailers stalled in June following the biggest gain in more than a year as the housing recession led consumers to tighten their belts, a report this week may show.

Retail sales were probably unchanged last month after a 1.4 percent gain in May, according to the median estimate in a Bloomberg News survey ahead of a July 13 report. Rising fuel prices boosted the cost of imports, caused the trade deficit to swell and hurt consumer confidence, other reports may show.

What effect does this have on the economy? Well, from the earlier post about Australia and inflation, remember that basic macroeconomic equilibrium:

Aggregate Demand = Consumption + Investment + Government Expenditure + Net Exports

“Consumption” is about 2/3 of Aggregate Demand, and it depends upon a few factors:

  • Current disposable income: increasing oil prices, food and energy bills, dilute disposable income. So does increasing mortgage payments, including the storm that ought to follow the ARM-rate reset
  • Household wealth: as we have more money/assets, we are less inclined to save money ‘for a rainy day’. Hence, as we become less assured that we will get to keep our house, we save more money and spend less.
  • Expected future income: same principle. If we are not confident that the economy will deliver increasing wealth to us, and/or we are not confident that our houses will do the same, we will need to save money, and spend less.
  • The price level: inflation decreases the purchasing power of our current incomes, and the real value of our household wealth – meaning we spend less money than before.
  • The interest rate: increasing interest rates mean less borrowing for assets, which encourage greater wealth and consumption. They also mean less borrowing for consumption itself.

So. The signals are anti-consumption (the blog Calculated Risk has a very cool post about this). This is, to some extent, a separate part of the macroeconomy from those employment figures. For me, at any rate – I’m not a macroeconomist.

The signals however are that the economy will need more help than it’s currently getting to expand. Home-owners, do not expect that to be in the form of interest rate decreases. Inflationary pressures, even without serious wage pressure, ought to be enough to hold the Fed’s hand. Same with the need to keep the demand for the US dollar at a reasonable level.

What to do? Well, foreclosures are on, for reals. Wishing for leniency in the banks will only get us so far. With deterioration of home equity across the economy comes a decline in consumption, in Aggregate Demand, in employment, etc. With the Fed holding on to interest rates in case inflation or currency speculation forces their hand, that leaves the other of the two macroeconomic tools at the disposal of the government: expansionary fiscal policy. This means the government spending money and/or cutting taxes – by which I mean intelligent tax cuts, not ones that reward the rich but do nothing for long-run economic growth.

Whatever fiscal policy is undertaken, though, it also needs to be undertaken delicately, so as not to give wind to inflation, which at this juncture really only needs some wage pressure to go. This is the fine line the government gets to walk this year, dealing with conflicting macroeconomic problems. Policy tools are designed to deal with one problem – a weak economy (employment) or a strong economy (inflation) – no policy can deal with both.

What we must hope for is soft, smart policy (see where central bank independence comes to the fore?), and an economy that can work its own way out of the problem. Take away the debt problem (Public Debt, Private Equity, hedge funds, CDOs, CMOs and sub-prime lending all together) and the US economy isn’t too bad* – it doesn’t manufacture enough, but that can be improved.

It’s like an old car that you can get going if you start her up ‘just right’. Cock it up and the US economy could end up like nothing we’ve seen before.

* I felt obliged to mention in a footnote that which Jim Kunstler calls the Happy Motoring Utopia. This is our dependence on exurbs, motorways, single-passenger motoring, big heavy cars, really shitty fuel mileage, etc. All of which requires cheap oil – at a time when oil is increasing in price, even as the US’ ability to refine the oil it has seems to be declining, if anything. Staying so will be disastrous, removing that needle from our arms will be very painful. When I say the economy can work its way out of the problem, I wasn’t suggesting it could do so quickly. The best we can get out of this, I believe, is a soft, but very long, landing, and an equally slow recovery.


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