I don’t have time to go into too much detail but just wanted to make a point inspired by a few pieces I have read lately.

That is the foreclosure process is deleveraging and a wealth transfer from the financial sector to homeowners. This may seem obvious or silly to various folks but let me give one quick thought experiment to see if I can hit on the importance of this.

Suppose there was a massive housing bubble and all the homes in America roughly doubled in price. Also suppose that many people either traded up homes or cashed out home equity so that in the aggregate homeowners had very little equity. Now suppose the bubble burst and home prices headed back down towards normal, further reducing total equity.

Perhaps this is a plausible scenario.

Now, suppose that while trying to set-up his ITunes playlist Chris Dodd accidently presses the Financial Armageddon Button. That button triggers immediate universal non-judicial non-recourse foreclosures for everyone with a mortgage, whether they are current on their payments or not.

What happens?

Well all of the mortgage debt goes away and the banking sector is left with a bunch of houses which it must sell. For the sake of argument lets assume that virtually no one can get credit.

So the prices of all of these will collapse until the inventory can be cleared even in a no credit world.

What does this mean for homeowners.

It means that they now have houses, but no mortgages.

They lost little because they had no equity. They gained a lot because they now have houses, but no debt. So they are much wealthier, at least in this part of the analysis

Where did the “wealth” come from? It was a transfer from the financial sector to homeowners.

Now of course there are a lot of other questions people will immediately ask about knock-on effects, financial collapse and who in the end owns the financial obligations, but this core dynamic is I think underappreciated.

About these ads