Federal Government Policy Issues

Consumer purchasing has unexpectedly continued to be strong in spite of the various challenges to the health of the general economy posed by the credit crunch, foreclosures, falling real earnings and energy and food price increases. In part, it was the fear of a negative impact on the general economy that prompted the FOMC to cut the federal funds rate by 2.75% since September 2007.

The fact that consumer purchases have remained strong continues to perplex the market analysts so the question is, how has the consumer continued to fund the spending spree given that borrowing on increasing home equity is no longer an option. It may be that the housing crisis has provided a significant although temporary benefit to consumer purchasing ability.

Consider that in June 2007, 87% of all mortgage loans in default were on owner occupied homes with the remaining 13% primarily on homes purchased by the owner as an investment. Also consider that in 2007 the number of new foreclosure filings was 2.2 million. Given the declining values of homes and the glut of homes on the market, the holders of delinquent mortgages have been very slow to foreclose. If a mortgage holder forecloses on a home then the mortgage holder will be responsible for paying property taxes and utilities and, in the case of condos, maintenance fees until the mortgage holder is able to resell the property.

If someone has quit paying their mortgage and property taxes then this money is available for other purposes such as paying for gas, clothes, etc. I suspect that the foreclosure problem has unexpectedly put a large amount of extra cash into consumption. Additionally, credit card debt is up and a higher percentage of credit card spending is going for essentials.

Now, in the case of owner occupied homes that are delinquent on their mortgage payments, assume that the owner is no longer paying any of the monthly mortgage payments or the property taxes, that owners continue to live in 50% of the homes on which the mortgage is delinquent and that the average mortgage and property tax payment for these people was $1,500 per month. This situation makes $19.8 billion per year that was previously spent on mortgage payments and taxes available for other purposes. The $19.8b only represents home in foreclosure. The number of homes in foreclosure represented 0.83% of all mortgages in 4Q07. Additionally, the mortgage delinquency rate (mortgage payments more than 30 days past due that are not in foreclosure) was 5.82% in 4Q07. Using the same assumptions above, the total value of delinquent payments would add approximately $143b in additional funds available for consumer spending. Note that total consumer spending runs about $8 trillion per year but much of this spending is non discretionary (income taxes, government paid medical care, etc.).

Neither the increased credit card debt nor the continued residency by non-paying owners in foreclosed homes can last forever.