Saturday, December 29, 2007

Debt Revolt - Could It Happen? What If It Did?

The New England Patriots look to make history tonight. One game stands between them and a perfect regular season record. Not since the 1972 Miami Dolphins went undefeated has the NFL had this occurrence. Is this amazing? It certainly is in the modern era. "Parody" is a key term in the NFL and it makes it extremely difficult to have a consistent winning team. I have already heard that the Patriots will be undefeated, but that their schedule was weak. That is pure fantasy. A look at the teams they have beaten this year is a roll call of most playoff teams. The Patriots have soundly beaten:
  • San Diego Chargers, 38-14. This beating was the reason for the start of the Charger poor run which they have turned around.
  • Cleveland Browns, 34-14. A young, talented, almost playoff team.
  • Dallas Cowboys, 48-27. The best team in the NFC crushed on the road.
  • Washington Redskins, 52-7. A probable playoff team, the Redskins have been serious trouble for every team they have played, except one!
  • Indianapolis Colts, 24-20. A tough, gritty win on the road against the defending super bowl champions and the second best team in the league. A great win.
  • Pittsburgh Steelers, 34-13. A dominating win against the leagues best defense.

So clearly the Patriots have taken and beaten all comers. Does it matter? Not if they lose in the playoffs! History only remembers the final trophy holder. With that said, it is still a worthy accomplishment by the New England team and I salute them. Of course, they could always lose the game tonight and this is all for nothing, but I think they will pull one more out. The only thing that stands between the Pats and another title is the looming rematch against the Colts which may take place in poor weather. That game is a huge one.

Karl Denninger's 2008 Outlook Post

Market Ticker has his 2008 review and forecast up tonight. The post is excellent as usual, but it takes some time to read. I recommend setting aside a few moments to fully understand the great explanation Karl provides of the current mess. Here is the link: http://market-ticker.denninger.net/2007/12/year-in-review-and-look-ahead.html

In the Hyperinflation vs. Deflation debate, Denninger comes down strongly in favor of Deflation. His reasoning is extremely hard to argue with. The prospects for Gold and mining stocks may not be what you think they are, so pay special attention to that section.

Of course, I cannot compete with such a post so my own humble prediction post will come another night!

Debt Revolt - Could It Happen? What If It Did?

I am going to skip the headline type content and instead put out a theoretical idea I have been kicking around for a while. Let's try to flesh it out and start a discussion.

It is well known and documented that a large part of the country is populated by people with less than stellar financial knowledge. These masses have absorbed the "use debt to live like a king" mentality. They use multiple credit cards, rolling car loans, and trick mortgages with home equity extractions to live far beyond their means. How large is this contingent? I have no idea. It is probably smaller than I would guess, but possibly 10-15% of adults over the age of 25 operate this way. With their entire money input accounted for, they save nothing and rely on low interest rates and new credit streams to play the monthly payment game.

But something is amiss. Home prices are falling and will continue to do so. Wages, stagnant for the last 5 years now may even go down or disappear when unemployment goes up. New credit streams may be nonexistent, or so expensive that they are not feasible. Without the ATM of home appreciation and without low interest credit cards this consumer may FINALLY look at the pile of debt they have amassed and come to a profound conclusion.

The conclusion? Screw It!

The type of person that lives this way is gullible to start with. They have bought into this debt bomb idea and were promised all the way that things will eventually work out for them. That is becoming a real problem for all but the most silly to recognize right now. Faced with a pile of debt for things that have nowhere near the value expected, why not just default on the lot of it?

One argument I hear is that there is a stigma attached to bankruptcy. I have been told that losing a home to foreclosure is an embarrassment. I think bankers must start those rumors. The type of people I am discussing knew they were gambling financially, in fact, they sought it out. The bet has gone bad now and I do not see any reason why they will stick things out and try to repay. If I was a financial advisor to someone in this spot I would counsel defaulting on all debts.

So if there is no shame (everyone is in the same boat) and no stigma (it's the smart thing to do!) then what could stop it from cascading? Laws that keep debt on the books and attempts to recover losses by creditors would be a problem. Wage attachments could also be an issue. The problem I see is that the sheer numbers involved here would make chasing defaulters impossible. Think about it. If after 2008 every "homeowner" that was 20% or more underwater on their mortgage defaulted, just what in the world do you think the banks can do? At that point the banks would be fighting for life and looking to the government for help, not chasing joe smoe for his mortgage payment. Likewise for credit cards. Imagine car repossessions in the millions! It is just not feasible.

I do not think we are anywhere near this kind of event. I have just been thinking about it over the last week. The question boiled down is this:

  • If US consumers that are up to the ears in debt make a decision to let it all go and try to start over 1) What would things look like? and 2) What could stop them?

Hopefully this idea will catch on and a real debate can be started. Use the comments section and by all means try and link this question anywhere else you may read. I think it is an interesting mental exercise.

For some fun stuff on Saturday Night!

I love the whistle song from Gheorghe Zamfir in the film "Kill Bill Volume I". Very good tune used at great points throughout the film:

Christmas Opossums?

Funny Pictures
moar funny pictures

Remember the film "The Birds"?

Funny Pictures
moar funny pictures

Have a good night.

11 comments:

cyclepro said...

One deterent that I am aware of may be the IRS. In the 1980's housing bust I knew several who walked away from underwater mortgages only to be later notified by the IRS that they owed taxes and penalties on the "gain" they received by defaulting on their loan. Apparently this process was strengthened when Congress modified the bankrupcy laws several years ago.

Basically it works like this, suppose your outstanding mortgage balance is $300,000 on a house that if you were forced to sell right now might only get $250,000. If you walk away from the mortgage contract and the bank forecloses and sells the property, then that $50,000 loss to the bank is treated as a gain to you. And, the IRS taxes you on your financial gains, plus a penalty for not paying the tax on it the moment you defaulted on the mortgage.

Since you began your article by saying that "...a large part of the country is populated by people with less than stellar financial knowledge..." then I'd assume that a lot of these people will try to walk away believing that a default is simply part of the game. Make a mistake, accept it, clean up, move on. The IRS says, not so fast.

Anonymous said...

This stipulation of the IRS code is now being kick around in Congress, and even Bush has talked about its repeal.

Hey, BK didn't slow down Donald Trump one iota.

You only have to worry if you have assets. If you defaulted on your home, your car is upside down or leased, credit cards to the max, with no cash in the bank, you can't get blood from a stone.

What are all your creditor to do? Are they all going to spend money in legal and court fees to obtain a judgement when you can simply move to another state where they have to start all over again. Most of the claims will not be worth chasing.

Why even file for BK and possibly be forced into Chapter 13, under the new BK law, where part of your salary can be attached on a long term payment plan.

You can still have a debit card for convience, and when the housing market hits its low, you might find someone who owns free and clear to give you credit (be the banker) just to unload their unsalable property.

There should be no moral issue or shame about defaulting on loans or filing for BK. That was your grandparents generation.

When a creditor lends money, they charge interest. Interest is calculated for the use of the lender's funds over time. A risk premium is added for the possibility of default. If there was no risk premium, then my 30 year mortgage would have the same rate as a 3 month tresury.

Mortgage lenders require the house as collateral. This is why credit cards charge upwards to 20% interest. These debts are unscured.

The point is lenders charge a risk premium to which you agreed, and paid. If the loan goes south, the collateral and the risk premium is, IMHO, the only thing to which the lender is entitled. The lender made a bad business decision, and in a capitalistic system suffers the consquences, i.e., loss.

Before BK laws were changed to force some borrowers into Chapter 13 repayment schedules, BK would wipe the slate clean. When enough voters face the grim reaper, political pressure will insue to change the BK code back to allow for debt repudiation. The BK laws will change to allow people to start over and relive the anguish of being chased by creditors.

watchtower said...

Well, I`ve read KD`s 2008 forecast, and I guess I`m one of those tin-foil hat wearing people he talks about. It never hurts to get both sides to a story, and I would highly recommend reading Jim Willies article over at the Financial Sense website before selling off all my PM`s.
Here is the link,

http://tinyurl.com/yw89kn

As far as there being a stigma on people walking away from a loan on a house, I don`t think it exists in this day and age. There is no longer a stigma on divorce, so defaulting on a loan that they didn`t understand, and maybe was manipulated into seems quite feasible. This looks to me like it could get out of hand in a hurry if(when) the economy falters.

Genesis said...

Watchtower - the problem with the other side of this thesis isn't that it might not be right.

Its that if it is, metals are stupid to buy.

If there is a hyperinflation and the rest of the world does "ok", America will be "on sale."

Do you want to buy gold at $800 and have it go to $1600, or do you want to buy Jan 09 DIA $160 CALLs for $2.00 and sell them for anywhere from $40-140 each next year?

Who's the chump - the guy who buys something that doubles (exactly keeps up with dollar debasement) but has to pay a 28% tax rate on his capital gains, or the guy who makes 20:1 to 70:1 on his investment, pays his 39.6% on the capital gains, and laughs at the poor yellow metal holder who actually lost purchasing power?

If you believe in hyperinflation you're an idiot to buy metals - you buy Index CALLs in that scenario, because the markets will moonshot in nominal dollars and you want the leverage so you stay ahead in purchasing power.

Matching the dollar's debasement, if it occurs, is an actual lose due to tax considerations. You must do better in order to remain ahead.

Faiure to realize this is the fundamental foolishness that comes with the "metalhead" position.

watchtower said...

Hello Mr. Denninger, thank you for taking the time to respond to my comment. My point wasn`t to give advice on how to profit from a falling dollar, but to simply suggest that we might be undergoing a monetary crisis of historical proportion, and having a few physical coins tucked away might not be such a bad thing.
Take care.

getyourselfconnected said...

WOW!
Thanks for the excellent discussion. I cannot believe we had a visit from Mr. Denninger himself!
As far as the IRS being an issue, I forsee that during an election season there will be all kinds of "get out of debt free" type of promises made. I think the political pandering will reach a point where defaulting is made very livable. We will see.

Anonymous said...

Watchtower and genesis offer, for the sake of argument, two different, diametrically opposed points of views.

Let me offer a third, i.e., muddle through; more of the same; grind. Powerful forces will try to prevent either of the above proposed theories to happen without a massive battle.

Historically, we have two comparisons: the depressionary 1920’s, and the inflationary 1970’s. Looking at what happened to stocks and gold during these periods might provide guidance.

Gold and its proxy gold stocks, e.g., Homestake Mining did very well and stocks went into the crapper, during the 20’s. Gold and its proxies did well in the 70’s with stocks basically grinding sideways for a decade with sharp corrections.

Another case study would be Japan during the 90’s. Gold was flat and stocks collapsed.

The problem with puts and calls is you can be 100% correct in your analysis and, if your timing is wrong, lose all your premium. With an election year coming, political forces will do whatever is necessary to prevent financial calamity (or at least jawbone it) until after the elections.

Until 2009, the Fed will continue to lower interest rates causing the dollar to go down, which is good for gold. The Treasury will create new money to finance increased budget deficits as tax revenues sink, causing inflation to rise, which will be good for both gold and stocks. After the election, Big Ben might just pull a Volker who raised interests rates into double digits to stop inflation expectations in their tracks, and stuck Regan, who had four years, with the job of straightening out the mess with fiscal policy.

My conclusion is either case might happen, only not within the coming year.

Anonymous said...

While I believe Mr. Denninger will be right on gold but I also belive it will make a new high in the first part of they year before rolling over with the rest of the market. I also belive this may coinside with a double bottom in the dollar. Agriculture looks like a better bet to me.

Mr. Denninger also points out how the FED, ECB actually works and what it does like Hussman has been pounding the table on for some time now.

http://www.hussmanfunds.com/wmc/wmc071224.htm

I think Real Estate will bottom in the 4q of 09 and stay depressed for several years. The boom time from studies of different countries I have followed show a typical 4 year boom with a 4 year bust followed by about 8 year climb before reaching peak noiminal values.

There is one thing I was told long ago and it is this:

As goes housing - so goes the economy.
As goes the US - so goes the world.
What's good for the US is good for the world.

Kevin

TexasRadio said...

What is the probability of a hyperinflation in the US? Just about nil. What about a deflationary asset spiral? Just about 99.9%. I think everybody would do well to carefully re-read the famous "helicopter drop" speech. In this work, Bernanke effectively outlines what is going to happen in a US deflation. One of the more important points is his emphasis on how political interference could defeat the fed's ability to stop deflation. That is exactly what is going to happen. In fact, it's already happening as politicians scramble to prevent foreclosures.

When all paper becomes suspect - and the process is already well underway - the dollar price of gold will continue to go up. What else are you going to buy? Stocks? Real estate? Bonds? Fine art? ALL of these asset classes lose value in a credit impairment driven deflationary asset spiral.

Anonymous said...

"What else are you going to buy? Stocks? Real estate? Bonds? Fine art? ALL of these asset classes lose value in a credit impairment driven deflationary asset spiral."


Guns and ammo.

Kevin

Russ DoGG said...

I'm vegging out over the holidays with football and see these TV ads to get out of debt for less than you owe!! The commercial was pandering to people who didn't like making credit card payments.
I'd say that is the begining of a debt revolt, because there must be something valid in that promise.
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If the advertisers would pay cash for TV airtime and put such expectations in the minds of callers, then they must be able to do something, right? Otherwise it would be a waste of their advertising dollars...
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MY concern is that large numbers of these ccard debtors will now begin to form expectations that they don't really need to repay these debts- that a good company can negotiate their debts down ot 70% or even 50%.

And even more importantly that they would be suckers/foolish to pay these credit card debts in full when their neighbors were using these serrvices to negotiate Credit card debts down. In this way the STIGMA of not paying debts it is being minimized.

A lot of this packaged debt is held by money funds, teachers pension funds, senior citizens (bond investors), banks... And so the implications of massive defaults are staggering.