The Great Unwind and the Final Redemption

What we are experiencing is called the global credit crisis for a reason. There is too much debt in the world. There is too much oil in the Gulf of Mexico and too little oil in the rest of the world.  What used to be up now seems to be down.  The stock market is going up on Monday and dropping more than 1,000 points Tuesday afternoon.  The economy is in a “recovery mode” but the unemployment numbers keep going up and up and up.  What is wrong with these pictures?

More and more economists are talking about the threat of a deflationary crisis ahead. Some are discussing hyperinflation.  Others refer to a “double-dip” recession.  A few even predict another depression.  What we know for sure is that Greece, Italy and Spain are broke.  The Euro has lost more value than the latest big fish just lost in Vegas.  Foreclosures are at historic highs and unemployment keeps going up.

So, what does this mean for you? Well, if you have a house that is under water, or more debt than you can reasonably hope to repay, your best options may be the unthinkable as in filing for personal bankruptcy. But it really should not be unthinkable to default on a loan or even to declare bankruptcy. Don’t stop reading. It is really a good option for many; it is moral, legal and good for the country. It has also become very common. You and your children will look back in a generation with pride.

In small amounts, debt is good. Home ownership is only possible for the young with mortgages, and many college degrees seem to be totally supported with student loans (don’t get me started on student loan debt). Working capital for growing businesses allow for inventory and distribution expenses. Lenders benefit as well: high interest rates are paid to pensioners on their life savings.

When debt exceeds a certain level it becomes a cancer on society. Easy credit fuels speculation which triggers bubbles. These bubbles lead to a temporary lift in apparent wealth, which increases economic activity beyond its sustainable level. But eventually more and more debt triggers economic decline with the inevitable glut of goods produced by an overheated economy.

What people are discovering too late is that their debt is not repayable. Not now, not in the future, not ever. They once had a hope they could wait out their bad times. This is true of many homeowners, many businesses and many governmental bodies. The “great unwind” is now upon us and is picking up reverse speed every day.  And, the unwind is going to be deflationary. Prices and salaries will decline, jobs will become more scarce, and debt will continue to increase.

The earlier you pull the rip cord the better off you will be later. In many states mortgage loans are non-recourse debts. This means that the homeowner has no personal liability for the debt after foreclosure.  Never make another mortgage payment in these states. Turn over the keys after foreclosure. You will lose all of your down payment, but the lender can never get another penny from you. Your credit score will fall. But you do not want any more credit. Right? If you are trying to quit crack, how would feel about your pusher reducing your crack score? Does that make sense?  If you plan to fight the war on drugs, you fight to win, right?  Stay off crack (I mean credit) for a few years, and they will take you back with open arms.  Just be sure to look before you leap back into the credit patch.

There should no longer be any moral question about whether it is wrong to walk away from debt legally. The advent of limited liability corporations and the legal ‘personhood’ of corporate shells have allowed business to create one sided bets for years, and they happily walk away from “corporate debt” when the tide shifts. Donald Trump, the famed “Donald”, surely knows how to play this game.  The Donald is a credit gamer.  Whatever you say about Trump, the guy is a real player at in the debt cancellation game.  This may even be the basis for a new show—The Bankrupt.

But, Trump is not the exception to the rule.  The Trumpum tactics are the calculus of 21st century finance, and you are a bit player in this game.  The Big Players are General Motors, Chrysler, Lehman Brothers,   Bear Stearns, Washington Mutual and Countrywide.  They have either eliminated their heavy debt-loads by bankruptcies or by forced liquidations and mergers with the FDIC picking up the financial pieces.  And, even the Great Mortgage Bankers Association of America recently accepted a $40 million dollar short sale and walked-away from its former world headquarters on K Street in Washington along with about $45 million in unpaid debt.  If you want to talk about moral hazards, then these are the players to talk about.  Forget about John and Mary Smith on Main Street.  John and Mary are mere pebbles in the sand on a very large beach.  Nobody notices John and Mary and from my point of view nobody in Washington really cares.

The current administration is implementing a policy of recapitalizing the banks (whose assets are still worth far less than their own debts) by lending them money through the Fed for nothing and borrowing back the money through the treasury for a lot more. This is called transferring debt from the banks to the government. But government debt has the same drag on societies in the long-run, they can just hold their breath longer.  And, the so-called HAMP program is nothing more than a smoke and mirrors game designed to make us think that something is being done when in fact nothing is happening other than secretly extending the day of the final reckoning.  In short, there is no value in the Net Present Value Test of HAMP.

In the end debt default always occurs in these situations. The debts cannot be paid by the combined debtors in a society. The default may occur when inflation destroys the value of the debt over time. Or the default may occur with the eventual death of the debtor. Or the debt is discharged legally.

The longer this process takes, the more damage occurs to the society. And this process, in my view, is the true moral hazard for America.  The hazard of not legally and effectively dealing with these mountains of consumer debt.  There are strange incentives that a person has when their debt is unpayable. Why would you try to earn more? The more you earn the more debt you pay. But you cannot earn enough to get out of debt. So you stop trying. If you owe too much on your house, you might decide you have nothing more to lose on your house so you will simply decide to wait it out. You will minimize the repairs and improvements on the house, rent the house out to frat boys and hope for the best.  You might as well best your nest-eggs on winning the Power Ball next Wednesday. The odds are not in your favor.  The wait it out strategy will only prolong the financial and emotional agony.

The banks are great examples of distorted incentives. They have sucked up well over $3 trillion of government money. They are still paying huge bonuses. They are not lending to businesses in need. They are not lending to consumers.  They have “raised” their consumer credit standards.  They have not changed any of their prior internal “standards.”  Distorted incentives indeed.

In the ancient days the Christian nations would have a debt Jubilee every 30 years. It sounds like a party because it was. Debts were forgiven en-masse when societies became constipated with debt.  And, in the days of the Old Testament, individual debts were discharged once every 7 years.  It was also considered a sin to try and collect debts after this 7 year discharge.

Suffice it to say we are currently a nation of many, many sinners, the vast majority of whom are trying to collect debts owed by consumers.  The only way to run these money changers out of the temple, and to secure true redemption, is to declare personal bankruptcy.  You need to legally purge yourself of your debts and your houses and your expensive cars and start working for yourself and for your family.  Praise the Lord and pass around those bankruptcy petitions.  Like now. Like yesterday.

Update: 6/8/10.  Bob Goodwin was added as co-author due to an error.

O. Max Gardner III

Bob Goodwin