If you borrow $10,000 from a family member or friend, should you pay back the loan as promised? What if you borrow that same amount from a bank or from a stranger? I think that most people would give an unqualified “yes” to the first question and an only slightly less positive answer to the second one.
What if you have the money to make payments against a loan but choose not to pay? In real estate, borrowers who could pay but choose not to because their house is worth less than what they owe on the mortgage are known as strategic defaulters. Six years ago, before the real estate crash hit hard, strategic defaulters would have been held in low esteem by most citizens. Today, with home prices continuing to fall and financial institutions being despised by much of the population, defaulting in this fashion has become more acceptable. I’ve read stories about people doing this, getting to live in the house for free for two years or more (foreclosures can sometimes take a long time), and buying new cars or taking vacations with the money that they have saved. To me, this is dishonest and disgusting behavior, while to others it is part of hitting back at “the man.” Of course, in my job as a California note buyer, I become a version of “the man” when trying to collect on a real estate note, so perhaps have a slight bias.
At a more global level, what should we think of institutions that have defaulted or are about to do so? European banks just borrowed $1.1 trillion in March from their central bank. Greece is leaning on others to borrow yet more money. The U.S. has run deficits of over $1 trillion for four straight years. All of these debts will be fully paid back at precisely the same time as pigs can fly to outer space!
The U.S. government has a special tool that allows it to deficit-spend for many more years. That tool is called a printing press, which allows the Fed to just print more money to pay off debts. The U.S. debt clock is now reading $15.5 trillion, and will exceed $16 trillion by the end of this year. Yet almost nobody is talking about that. Both Romney and Obama make occasional references to the debt, but neither has any serious plans for debt reduction. Theoretically, the bureaucrats could keep running up the credit card for years to come without ever worrying about a default. Yes, higher inflation and interest rates would have an impact at some point, but those can always be blamed on someone else.
For states, cities, companies, and individuals like you and I who have no money printing capabilities, there are really two choices for paying back a loan – either you make the payments or you default. If you make all of the payments on your house loan, then at the end of the term you can expect an “attaboy” from the bank along with a piece of paper saying that you officially own the property. If you default, you may end up losing your house or possibly be saved by a government (taxpayer) bailout.
For the remainder of this decade, my expectation is that fewer and fewer people will even qualify for home loans. There are two primary reasons for this, both of which also back up my forecast of home prices continuing to slowly decline. First, unemployment is still a huge issue. If you ignore the official government stats (which I generally advise), then you’ll find that the true unemployment rate is closer to the 22.2% shown by Shadow Stats. This figure includes the long-term unemployed and part-timers wanting to work full-time. Combine the folks who aren’t working with those who had to take lower-paying jobs, and you have a large percentage of the population with no chance of affording a home.
Second, many people in their late 20’s and their 30’s already suffer under enormous student debt loads. There are 37 billion borrowers carrying a combined total of $1 trillion in student loans. Federal student loans have quadrupled over the past four years as more people drank the college advertising Kool-Aid saying that a college education would bring them untold riches. By the way, that student loan debt size exceeds the gross domestic product for all but 15 of the 184 countries tracked by the International Monetary Fund (source: John Burns Real Estate Consulting).
People in the 25-34 year old age group tend to be the most likely first-time home buyers. If they have poor paying jobs and enormous student debts, they won’t be buying a house anytime soon. This also affects older people up the food chain who want to buy bigger houses for their families or otherwise have a need to sell.
Priorities among the young and middle-aged populations seem to have also changed. Apparently, the “coolest people” have an iPhone in one hand and a Starbucks coffee in the other. What could be considered frivolous by some are considered necessities by others. When any of these types of “necessities” are continually purchased, this further reduces the financial ability to buy a house and pay off debts.
So, going back to the title of this piece, debt really does matter. Paying back debt seems more important to individuals than it does to bureaucrats. Since the world has become a series of interconnected pieces, we are all impacted by the decisions of others. It will be interesting to see how the world reacts to the coming defaults by sovereign nations.
Alan Noblitt is a California note buyer and licensed real estate broker.