Think of the foreclosures

We imagine residential streets with one for sale sign after another. Worse, there are images of foreclosures, of families being evicted from their homes, their furniture and belongings on the street.

And because we started this work around the time of the financial collapse, around the time when foreclosures were hitting the news, we said, hhmm, maybe we should actually start in the financial domain.

In the old days, when borrowers found it impossible to make their payments, mortgages would be restructured foreclosures were bad for both the borrower and the lender. Securitization made debt restructuring difficult, if not impossible.

As homeowners with large negative equity default, the foreclosed homes contribute to the excess supply that drives prices down further. And the lower prices lead to more negative equity and therefore to more defaults and foreclosures.

Residential investment is still at an historic low as a share of GDP as a result of overbuilding during the 2003 2008 housing boom and the tsunami of foreclosures that followed. But the headwinds in the housing market are dissipating.

As Dennis Kelleher of Better Markets has argued, the recent so called robo signing settlement in which five large banks settled their legal liability for carrying out fraudulent foreclosures on mortgages is a complete sell out to the financial industry.

House prices probably will fall further, so there will be more foreclosures, and no amount of talking up the market is going to change that. The bad loans, in turn, have created massive holes in banks balance sheets, which have to be repaired.

Throwing money at banks hasn t helped homeowners foreclosures continue to increase. Letting AIG fail might have hurt some systemically important institutions, but dealing with that would have been better than to gamble upwards of 150 billion and hope that some of it might stick where it is important.

Around the world, we have underutilized resources people who want to work, machines that lie idle, buildings that are empty and huge unmet needs fighting poverty, promoting development, and retrofitting the economy for global warming, to name just a few. In America, after more than seven million home foreclosures in recent years, we have empty homes and homeless people.

Moreover, political gridlock will ensure that little is done about the other festering problems confronting the American economy mortgage foreclosures are likely to continue unabated (legal complications aside) small and medium sized enterprises are likely to continue to be starved of funds and the small and medium sized banks that traditionally provide them with credit are likely to continue to struggle to survive.

If there is a sharp spike in interest rates caused either by capital flight in anticipation of a dollar decline or by tight monetary policy in reaction to a dollar decline comes to pass we will see how good the Federal Reserve really is. If interest rates rise too far, then the collapse in housing values will lead to large scale foreclosures and a collapse in consumption spending as well.

Households have slashed their debt often through painful foreclosures and bankruptcies and their debt relative to income has sunk to its 2005 level, significantly below its 2008 peak. Helped by low interest rates, debt service relative to household income has fallen back to levels not seen since the early 1980 s. But consumption will be hit by the expiration of the payroll tax cut, which will reduce household income by about 125 billion this year.

Households have slashed their debt often through painful foreclosures and bankruptcies and their debt relative to income has sunk to its 2005 level, significantly below its 2008 peak. 160 Helped by low interest rates, debt service relative to household income has fallen back to levels not seen since the early 1980 s. But consumption will be hit by the expiration of the payroll tax cut, which will reduce household income by about 125 billion this year.