Proving once more that Imperfect Knowledge Economics by Roman Frydman and Michael D. Goldberg is one of last year's most topical books in economics. From a recent article in the Financial Times, January 31 2008:
“The downgrades [of securities related to U.S. subprime mortgages] have also left policymakers and analysts scrambling to determine what has gone so badly wrong. As this search intensifies, some economists are starting to suspect that the answer lies in a striking recent change in American household choices – a shift that could have important implications for policymakers and investors alike.”
“The issue at stake revolves around so-called delinquency rates, the proportion of people who fall behind on their debt repayments. When American households have faced hard times in previous decades, they tended to default on unsecured loans such as credit cards and car loans first – and stopped paying their mortgage only as a last resort. However, in the last couple of years households have become delinquent on their mortgages much faster than trends in the wider economy might suggest. That is particularly true of the less creditworthy subprime borrowers. Moreover, consumers have stopped paying mortgages before they halt payments on their credit cards or automotive loans – turning the traditional delinquency pattern on its head. As a result, mortgage lenders have started to face losses at a much earlier stage than in the past.”
A further explanation, not mentioned in the article in the FT, is that the availability of cheaper alternative forms of housing, may lead households to give up on their mortgage payments and move out of their house.
The media tend to portray subprime borrowers, who took out adjustable-rate mortgages that give a lower initial interest rate, which may increase steeply after two years, as stupid. But perhaps some simply took the gamble, knowing that they could default on their mortgage payments and return to their former standard of living. If the (social) costs associated with default are low, this behavior may even be rational.
Krishna Guha and Gillian Tett, Last year’s model: stricken US homeowners confound predictions. Financial Times, January 31 2008.
Les Christie, Putting the card before the house. CNN Money, June 25, 2007.
Imperfect Knowledge Economics. Part 1.
When To Buy a New Digital Camera? Imperfect Knowledge Economics Part 3.