I received an interesting email from “PR”, a Senior Equity Analyst in Retailers for a major firm that I agreed not to disclose. Here’s an interesting take about “walking away”, and how that might affect discretionary spending. Here goes from “PR”…

Hi Mike

I am fascinated with your take on walking away from debt.

Some background. I live in the far west ex-burbs of Chicago (Yorkville), and we are starting to see what you have been talking about for some time. The first house in our subdivision was foreclosed about 9 months ago. That wasn’t a walk away; that was a get out notice from the sheriff. A few months later, there was another house that had a for sale in the front lawn, and the owner moved out a few weeks later. Another house went on the market one day and the owner loaded up a U-haul the next and drove away at 4am. And since September, we have seen six more homes that are “for sale” but the owner is long gone. Interestingly, all three homeowners used those Pods trailers instead of a movers or U-haul. Note: our subdivision is about 4 years old and has about 110 homes.

After reading your work, I began to examine the attitudes of my neighborhood. The first foreclosure was one of those borderline families you often write about. They were in over their heads and couldn’t afford the house they were living in. Most likely mortgage reset. In any event, the scuttlebutt around the neighborhood was one of scorn, shame, and embarrassment. No thought was given to the negative impact to the value of all our homes in this subdivision. With each subsequent “pre-foreclosure,” people’s attitudes softened about their ex-neighbors. Gone was the Scarlet F; it was replaced with empathy, understanding, and even compassion. Maybe the attitudes have changed because people now realize that the value of their homes have fallen off a cliff. They don’t have time to shame their ex-neighbors when they are worrying about their wealth is being vaporized or a $400 natural gas bill or car payment or the kids or whatever.

Now, I understand that this is one neighborhood in one small town in the Midwest. I also know this is anecdotal evidence. But as I have learned covering retail stocks for so many years: I trust my eyes and common sense and ignore people with a vested interest in the outcome of a situation. My eyes and common sense tell me that times are changing. It has become more socially acceptable to walk away from your house. If one of my neighbors walked away today, most of the remaining neighbors would shrug their shoulders, say that’s too bad and move on. I will be looking for the next phase of this shift in attitude, when remaining homeowners think or say I wish that was me moving—getting out from this 3,000 square foot rock that has ruined me financially.

As an aside, I think this shift in behavior could be bullish for retailers. Those foreclosures and walk-aways are freeing up a lot of discretionary income. It makes a lot sense to walk away from your underwater house. Take a family of four with a $2000 mortgage with another $7500 in taxes. That’s a pretty standard profile out here. Move out of the house and rent a 3 bedroom town home for $1400. That frees up $900/ month in cash flow. At this point, attitudes haven’t changed enough to discourage discretionary spending when people have the money to spend. But that is another discussion.

Thanks for the insight and keep up the great work Mike.

Thanks “PR” for an interesting neighborhood perspective about changing attitudes in suburbia. Now what about the idea that this process will “free up discretionary spending”?

I don’t think so. Some who lost their houses may be looking to save up for another one. Others who lost their houses might have done so because they lost their jobs. In that case, making the rent payment will be hard enough. And finally, I believe still most of them will have learned something from the debt trap and vow “never again”.

A secular peak in credit lend and consumer spending has been reached. The attitude shift in just the past six months has been amazing. But the change has only just begun! We are still in the realization phase: realization that home prices are not coming back.

For everyone who has walked away, there must be 500 thinking about it. Those still thinking about it are not going on a spending spree anytime soon, unless of course it is also in preparation of walking away from their credit card debt as well.

Finally, unemployment is set to skyrocket as the boom in commercial real estate comes to an end.

Consumers, Credit, and Complications

John Mauldin had an interesting take on unemployment in Consumers, Credit, and Complications.

Last week jobless claims rose almost 20%, to 378,000. This week they came in at 356,000. These last two weeks represent a marked increase in initial unemployment claims but, as many bulls point out, that number is nowhere near the levels that would indicate a recession.

The problem is, if we’re in recession we should be seeing a higher initial unemployment claims number. The “we are not in a recession camp” is absolutely correct about that. And yes, we’ve seen a marked rise in continuing claims the last two weeks, but not as high as one would think to be the case if we were in a recession. Yet continuing claims are up by 10%, which based on the past would suggest we are in a recession. So why the seeming disconnect?

An answer comes from David Rosenberg, the North American economist for Merrill Lynch, who points out that jobless claims number may be suspect. Let’s look at what he says in his recent analysis:

“First, the jobless claims are being distorted right now because the seasonal factors are looking for retail sector layoffs in January but these layoffs are not happening because there was no hiring in November and December. So the seasonal factors are depressing the claims data to the downside right now – look for them to hook up in coming weeks. But anyone putting their faith in claims in January given all the early-year distortions … good luck. No mention made, by the way, that the backlog of continuing claims has spiked up 10% over the past year and the last time that happened, well, was in late December 2000 – the recession began the very next quarter.

“Second, the focus on payrolls at this stage of the cycle is fraught with risk. In 90% of the business cycle, the payroll survey is the one to focus on, given its lack of volatility and huge sample size. But the 10% of the time when the payroll survey does not work well is at turning points in the business cycle. Why? Because being a poll of companies, what the payroll number misses are the self-employed and there are more than 10 million of them.

click on chart for sharper image

“So the bottom line is that what the payroll data have missed is the fact that over the past six months, 520,000 self-employed individuals have fallen by the wayside (more than were lost in the entire 2001 recession).

This may also be why it is that claims are suppressed – having never paid into the unemployment insurance program, these people are not necessarily entitled to any benefits. The population- and payroll-concept adjusted data show that employment fell 400,000 in November-December combined (because Thanksgiving landed so late in 2007, both months have to be looked at together, whether it be for jobs or retail sales). So we think the view that job growth is hanging in is, just in plain simple language, wrong.”

Look for unemployment to rise to 6% (or more) in the coming quarters. This will of course put a damper on consumer spending.

Any increase in discretionary spending coming from those walking away (if indeed any at all) will pale in comparison to those who lost their jobs, those who still have a job but whose commissions have fallen off the cliff, those who are about to lose their job and are very afraid, and those who are OK but whose attitude toward spending has changed or is about to. For all these reasons, Fiscal “Stimulus” Doomed To Fail.

The service economy is now in reverse. Retailers have no choice but to cut employment. Look for this trend to pick up steam as things feed on themselves. Retail spending, especially discretionary spending, has only one way to go and that way is down, and down big time.

Mike “Mish” Shedlock
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