Thursday, March 12, 2009

Why Are Delinquencies So Common?

Employment has fallen 3 percent so far in this recession (about 4 million). Full time employment has fallen 5 percent.

Thanks to unemployment compensation, high rates of pay for many of those who still have jobs, and last year's increase in social security benefits, real disposable personal incomes have been rising for the last six months.

Yet 12 percent of households with mortgages are late on their mortgage payments. Just yesterday I read how, in a Catholic high school near Chicago, 20 percent (sic) of the students were taken out of class because they were delinquent on their tuition payments [employment in the Chicago area has fallen about the same -- a bit less -- than it has in the nation].

The press account of delinquencies is that people lost their jobs. But the arithmetic doesn't add up. Either the official statistics on job loss are way too low, or most of the delinquencies are by people who kept their jobs.

Why would so many people who kept their jobs be delinquent?

When it comes to mortgage payments, I understand:
  • housing prices have fallen, leaving many houses under water (the house is worth less than the mortgage)
  • under water mortgages (12 million or more) are much more common than job loss (4 million)
  • often, it is a good financial decision to stop paying the bank on an underwater mortgage -- you could move into a nicer house for cheaper than you're paying now

But why pay the Catholic school tuition late (and likely other bills too)?

Were a lot of people using home equity to pay high school tuition? I am dubious of that explanation, because the home equity was already gone when school started last fall.

Any ideas, commenters?


Anonymous said...

Perhaps the students were concentrated in families that had suffered the loss of a job.

Tino said...

1. Straightforward answer: shock to future income means that people clustered around zero savings go to 5-10 percent savings, cutting down on luxeries like good schools.

2. Politically incorrect answer: students in Chicago catholic schools are disproporionally ( lower middle class) Hispanic and black. Not only are those groups hit harder by the crisis, they even in normal times have 2-3 times the white default rate on loans (studies have documented this pattern as far as I know for car loans, student loans and mortgages). Whatever makes households poorer, say discount rate, norms or judjement, in addition makes them worse at making economic decisions.

Historically banks responded by rationing credit, but recent market innovations expanded credit to marginal groups, who are now in over their heads and defaulting.

3. Your own hyp sounds plausible, at worst Americans were taking out 300 billion in home equity per year and spending it.

Unknown said...

Consumers expanded their portfolio of debt on two bases

1) Increases in net worth that smoothed through the purchases of durables on credit.

2) An expansion of credit to previously liquidity constrained households.

The second is probably most relevant for Catholic School students.

The human story being that the family suddenly took out new credit card or car loans when credit was easy and then could not pay it back.

In short the household has a very high discount rate. So, high that they previously would have been denied credit.

However, when credit was easy they got in over their heads. Now they have to pull back and some are deciding to be late on their tuition payment rather than their car payment.

The story is similar with an asset boosted household although in this case we may be thinking of a household that chooses to default on tuition payments rather than a home equity loan.

Milton Recht said...

Homeownership according to the census bureau is around 68 percent of households.

There are about 75 million homeowners with about 49 million, or about two-thirds, with a mortgage.

Home mortgage delinquencies and foreclosures were at 8 percent at the end of 2007 and jumped to 12 percent. The 4 percent increase represents about 2 million additional homeowners with a mortgage who are not making mortgage payments.

2 million people are less than the total that lost their job in 2008. It is about half of the 4 million that lost their employment in 2008.

There is always a core base of borrowers who will default even in good economic times including those who can afford to pay. Additionally, some borrowers suffer a shock to their ability to pay their bills through a decrease in income or an increase in expenses. For example, the major earner can be in a car accident, lose income and have unexpected huge unreimbursed medical expenses.

As for catholic school tuition, many hourly workers are seeing reduced hours. Plus, commissions and other variable wages, e.g tips, are down.

Did the schools reduce scholarships because of lower donations?

Anonymous said...

Psychology: People say to themselves:

Wall street is not paying its bills, and they are getting away with it. My neighbor down the street stopped paying his mortgage, and found the bank had lost the paperwork so cannot evict him. He is getting away with it - and if the bank finds his paperwork, Obama is going to bail him out anyway. Why should I pay my bills? And why should I show up to work? AIG is getting billion dollar bonuses on the USA credit card. Gimmee a few beers.

Sheng said...

They used to pay believing the downturn will be just temporary; now they believe it is more severe and permanent than they thought. But this is hard to test.

Boonton said...

I think you are confusing national statistics with local. What is the unemployment rate in Chicago? If it's 8-9% nationwide I wouldn't be surprised if it's tracking near 10% in some areas like Chicago. Among minority communities unemployment has been much higher than the national average. I wouldn't be surprised if you can get pretty close to 20% from those facts alone.

Consider that urban areas are often hit hard in recessions and that the recession is already over a year old. Also consider that Catholic school is a discretionary good. If you're behind on the mortgage, getting your overtime cut etc. you can stiff the Catholic school a bit before they finally kick your kids out. If all else fails you can send the kids to public school for free.