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Housing or Consumer Spending--A Hobson's Choice

An overstrapped consumer can pay down his/her mortgage. This consumer can maintain the historical spending profile on goods. The same consumer cannot do both.

The housing bubble was founded on a big lie: That we could have our cake and eat it too. That is, one could buy a home, and use that home equity to finance consumption because housing "always" goes up.

That, in effect, it is premise of a reverse mortgage. And old person with home equity can turn that equity into an annuity based on actuarial life expectancy. When the person dies, ownership of the house reverts to the payor of the annuity, rather than the person's heirs. Such a person may be accused of "spending their grandchildren's inheritance," but fiscally, they are on reasonably sound ground.

The problem with home equity lending, cash out refis, and the like, is that the people spend their future home equity during their working years. Which is to say that they have NO old age equity. More to the point, this spending is usually not controlled by the discipline of the actuarial tables, as in the case of an older person.

The result is that a spender can end up with NEGATIVE home equity when the market tanks. This is NOT what the lender bargained for. Having lost the value of the house as collateral for its loan, the bank is basically using the homeowner's earnings power as security.

But what if the homeowner has been laid off. Or worse, what if the homeowner is employed, but chooses to spend earnings on something other than mortgage payments. Then the lender is up a creek. This appears to be what's happening now, with "strategic default."

One way or another, SOMEONE is going to bear the burden for the foolish borrowing/lending. We can put the homeowners into what amounts to indentured servitude, paying off the banks. Or we can let the homeowners off the hook and let the banks take the losses that they so blithely underwrote.