Sunday Musings-DEBT

The recent downgrade by the S&P of US debt was lousy, but it was a wake up call. US citizens have too much debt- and it isn't all their fault. College tuition is rising faster than inflation. It's keeping pace with medical care. It's a crisis in the making, a real catch 22. So students take out loans for tuition then put their text books on credit cards. Hello!

Now the next big debt bubble: Student Loans- largely fueled by for-profit institutions. Problem here, folks, is that there is no way out for the borrows. Waltz on over to MyBudget360.com for a very good article on the next crash.

That was the morning coffee conversation with my fiance this morning. Then we went grocery shopping and we were having a conversation with the clerk. She and her husband are having trouble paying their mortgage. So they called the bank to see about renegotiating their 6% interest rate into something lower. The bank informed them that to do this, they would have to reassess the property and that they are not currently assessing property. End of conversation. She and her husband told them that they were considering strategic default. This had no effect on the bank. (People in my part of the world are rather open about their finances-oddly enough.)

After leaving the grocery store, my finance and I started to figure out what perverse incentive was keeping the bank from a simple re-negotiation. Of course, this has been written about all over, but not by me. So my turn. This is what we realized:

1) Banks don't pay property taxes on the homes they are holding.(thus the strapped states and counties)
2) Banks can keep inflated assets on their balance sheets, thus not having to recognize their losses to investors. The idea is to keep investors interested in Bank stocks. But investors have been bearish on banks stocks because of the confusing about what these banks actually hold on their balance sheets and because banks are keeping larger cash slush to cover bad debt,
3) Banks collected on the PMI. In other words, they got the insurance money on the loss.
4) all told, even if the bank tears the house down, they've made more money on it than they would have if they sold the houses at a loss.

The way this works is that the bank will foreclose. Then the house is supposed to go to auction. So the bank will bid whatever price is equal to the outstanding mortgage. Of course, the outstanding mortgage is usually based on very inflated prices. So the bank usually wins the house at auction. Then the county tax collector sends the bank a bill for the outstanding taxes, the banks asks for a deferment until they sell the house. Without the proper legal remedy, the tax collector agrees to to the deferment. But then the bank holds the property off the market, not wanting to further deflate prices with overstock.

So in the end, the original owner has a great incentive to walk away- believing that in 3 years he will be able to buy a new house at a cheaper price. The banks on the other hand were hoping to see interest rates rise. But the Fed just told them not to hold their breath. So score 1 to the people.

We need to start putting banks back in line- charging them property taxes and putting bans on their ability to package student loans into securities. They also need to change the rules on student loans. At this point, I must start to agree with those conservatives who point out that student loans encourage sharking by universities and colleges- particularly the for-profits. Loan limits need to be set lower. And students should be given a 20 day grace before interest accrues on their loans, like credit cards.