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US subprime saga phase two could be deadly

Subprime mortgage crisis | US subprime saga phase two could be deadly Anthony Harrington

The bursting of any major asset bubble leaves ruin and woe in its wake, but few recent bubbles have caused havoc on the scale of the bursting of the American dream. The old market cliché, “the trend is your friend” has a rider to it that every trader knows in his/her bones, namely that trends are trends because they are moving away from a norm, and sooner or later, they flip back.

At which point, of course, they aren’t your friend at all, particularly if you’ve bet your shirt on things continuing in line with the trend that was – as banks in developed countries did in spades with the US subprime mortgage fiasco. In his analysis of the subprime crash in a brilliant paper appropriately titled “Walk Away: The Rise and Fall of the Home Ownership Myth”, Douglas French points out that it wasn’t just home values that crashed when the dream ended. A whole way of life based on the 30-year mortgage might well have gone out the window as well – with as yet unplumbed consequences for the US (and other) economies.

“The home was the very foundation of community, of freedom, of the American dream. It embodied who we are and what we do. Beginning in 2007 and culminating in 2008 this dream was smashed as home values all over the country plummeted, wiping out a primary means of savings. Some homes fell by as much as 75-80% instilling shock and awe all across the country. The thing that was never supposed to happen had happened. This meant more than mere asset depreciation. An article of faith had fallen, and there were many spillover effects. The home was the foundation of our financial strategy, our love of accumulating large things, the core of our strategic outlook for our lives. Once that goes, much more goes besides. The things in the home suddenly become devalued. We look around us in astonishment at how much stuff we have, and we are weighed down by the very prospect of moving. We are longing for a different way, perhaps for the first time in a century.”

French argues that a new phenomenon, which has appeared since the crash, is just starting to find its way into the mainstream media, namely the appearance of a whole generation of young people no longer committed to putting down long-term roots in a fixed patch of the countryside, or even in any particular country. The well known modern trend towards the portfolio career, he suggests, gained a new spin from the crash, with the protagonists discovering that hey, they didn't need to be burdened with fixed assets. There were other things to do with whatever surplus cash they might be accumulating, and the home certainly didn’t look like a particularly attractive value store any more.

If this idea were to catch on big time, then America’s banks, and by extension, banks in developed markets everywhere, would be in even deeper doo-doo than they currently are – which is where the title to his paper comes in. What if a large segment of home owners just started mailing the keys back to their mortgage providers and, yes, just walking away? Two things would happen. One, the bad debt on many a bank’s books would swiftly reach catastrophic proportions. Two, the global market for short-lease rented properties would boom, but too late to save those financial institutions who were already heading down the tubes.

French points out that the main attempt society appears to be making to prevent a pandemic of “walk aways”, is to urge “responsibility”. “Where would society be if everyone reneged on their contracts?” is the moral line being taken in the media. However, he points out, if you look for role models to support this approach in the commercial property world, you will find that such role models as appear to be on offer, are 100% on the side of the walkaways.

At the height of the boom, many a commercial property purchase of a major office block or shopping mall was on a “no-recourse” contract. Basically this means that the other party foregoes the right to reach beyond the contract to any other assets their counterparty might have if the contract goes wrong. They can take possession of the item in question, a supermarket, a shopping mall, or whatever, but that is that. If the asset has crashed in value, so that it no longer makes sense for the buyer to pay a huge fee to the lender, they can just hand the keys back and the property becomes the lender’s problem.

The lender, of course, will be massively out of pocket, but, hey, that’s what “no recourse” means. The buyer will lose everything they have paid so far, but as the saying has it, there is no point in throwing good money after bad. If this catches on to an even greater extent, and private homeowners take their cue from big commercial owners who have no qualms about “protecting their shareholders” and walking away from property debts that have become dysfunctional, US banks will face an even more severe crisis – one that, French suggests, many of them will not be able to survive.

Further information on the US subprime mortgage crisis:




Tags: commercial property , home ownership , non-recourse , real estate , residential property , subprime , the 30 year mortgage
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