A Strange Anomaly: Increasing Foreclosures Equals Increased Consumer Spending

Just heard an intriguing observation on the CNBC show Fast Money from a guest commentator that the increase in foreclosures may actually be a cause of increased consumer spending. The argument is that people whose homes are in foreclosure stop making mortgage payments; therefore, they have more money to spend on other consumer goods. So, the more people who don't pay their mortgages, the better the consumer spending statistics appear.

If true, that means we are going to see a long list of foreclosures for a long time. If that occurs, home values will continue to decline or certainly won't rebound. And I don't think that reflects well on the economy long-term. If a significant segment of the population is soon to be potentially homeless, it is only a matter of time before the economy will see a downward effect on consumer spending.

Let's look at this simply. If people aren't paying their mortgages due to pending foreclosures, at some point they are going to have to find some place to live, and that probably means paying rent. Moreover, many of these delinquent homeowners are probably going to have to file for bankruptcy to wipe out the debt secured by their home mortgages and other obligations. Under recent amendments to the Bankruptcy Code it is harder to file for a straight liquidation under Chapter 7 as opposed to paying a portion of current income to creditors under a Chapter 13 plan. If and when we see a continuing increase in bankruptcy filings, consumer spending will necessarily be affected.

Not only will real estate values drop because of foreclosures, but automobile sales and durable goods sales will be impacted as well. If someone has to use his current income to pay living expenses and past debt, there isn't much left to fund new capital purchases. So maybe we are in the midst of a consumer spending fantasy period, before economic reality hits the severely indebted.

We constantly hear analysts say that unemployment is a lagging indicator. However, that assumes that the unemployed will find new jobs at comparable income levels as the economy rebounds. There is nothing to suggest that is going to happen this time around. Many jobs have been lost forever in the financial services industry, automobile industry and other manufacturing and service sectors. Unemployment statistics are also inherently unreliable because they don't count people who have exhausted unemployment benefits or never received them in the first place even though they are unemployed. It also doesn't count new entrants to the workforce.

It is therefore only logical that the unemployment rate will crest regardless of whether more people are actually working. This is a fundamental flaw in the computation of this statistic. A more reliable indicator would be the number of people who have jobs and whether that number continues to fall at a rate greater than the increase in the unemployment rate. As usual, many governmental statistics provide little value as to what they are intended to measure especially when they are continually revised within weeks of release.

The market is digesting all the bad news and sloughing it off as irrelevant. Is that a function of a fundamental belief in the economy's improvement or money managers jumping back into the market so as not to be outperformed by their peers? Certainly, the market's rise has become a self-fulfilling prophecy as the more conservative managers remained on the sidelines while the market swung back with very limited economic data confirming that the economy is improving to an extent to justify the rally. My concern is that the herd mentality is still with us. It has always ended in mayhem as the last of the holdouts buy into the rally. Soon after, the market will plunge as it usually does as there are no more buyers and those with profits will sell to preserve as much of them as possible.

The tepid volume in this rally should make one wary. The conviction isn't there, signaling that a reversal could occur if sentiment takes a pause or economic data begins to reflect the reality that consumer spending is nothing more that a temporary phenomenon not based on an improvement in the economy but a redistribution of household income away from housing expenses due to an unintended consequence of the foreclosure phenomenon (i.e., the artificial temporary increase in consumer spending that would otherwise be spent on housing expenses). If the uptick in consumer spending is to any degree based on this, which I believe it is based on personal observation of spending habits of those in foreclosure, we are headed for a rude awakening as economic statistics eventually confirm this anomaly.

Disclosure: Long SRS and SKF.

Comments

[doubleshortetf:]

Nice insights. Of course the idiot on CNBC (like CNBC itself) is wrong and more of polyana hopes.

Yep let's all default on our loans 'cos Hussein (AKA Obama real middle name) is going to tax the wealthy and "redistribute" the wealth!

"observation on the CNBC show Fast Money from a guest commentator that the increase in foreclosures may actually be a cause of increased consumer spending. The argument is that people whose homes are in foreclosure stop making mortgage payments; therefore, they have more money to spend on other consumer goods. So, the more people who don't pay their mortgages, the better the consumer spending statistics appear."

Jun 08 09:39 AM

[Alphameister:]

"It's an ill wind that bloweth no good!"

Jun 08 09:48 AM

[geewow:]

James, good posting. The idiot who was speaking to the idiot on Fast Money appears to not be able to connect the dots. The spending is called credit card debt. It was happening before the foreclosure and will continue thereafter. May was the month of graduations:college and HS with lots of spending by people who could not afford it. June and July brings more with credit card vacations. I believe we will see more contraction by consumers, and not more in the coming weeks and months.

Jun 08 11:13 AM

[Mr. Ed, Jr.:]

This is a beauty.....
People who are not paying ther mortgage are deciding to go to the mall ? To buy bigscreen TV's for the home they are about to be tossed out of ?
Are there that many non-payers turned mallrats that they could actually impact the stats ?
I must say I find this to be an illogical theory that just makes the head spin.
I would like to know the name of the person who said this. For my "reach for the remote" file.

Jun 08 09:39 PM

[BrunoT:]

Sorry, Mr Ed, but I think he has something here. I have witnessed it personally in the behavior of inlaws. Recently a brother in law with a family and a home came asking to borrow money from us. He could not pay his mortgage (even though it was modest and in a non-bubble state) and had credit card debt. Yet the day before he told us he had been to play golf at an exclusive course, then off to an Italian restaurant dinner, then a 125 mile round trip drive to visit his mother in law (when gas was $4/gallon and his van got 18mpg). The guy spent at least $125 on non-neccesities knowing full well that he was broke and going to lose his home soon.

He's since filed for bankruptcy and is happy as a clam. Hasn't paid a mortgage in 5 months and continues to live the same identical lifestyle and has not even been contacted about forclosure. He's got an extra $6,000 in his pocket from not paying the mortgage. Of course that's going to affect his spending habits. If he was living it up when dead broke, imagine what he can do with an extra $1200/month?

The shocking thing here is that Americans have such a sense of entitlement that even when losing a home they fail to change their spending habits sufficiently. Instead of saving a nest egg for the next rainy day, they are spending much of it. All they save is the deposit needed to rent an apt. I witness 2pm weekday traffic jams daily near the mall here. Some depression we're having.

Jun 09 07:46 PM