[OPE] Subprimes and real wages: the FT versus the real world

adsl675281@tiscali.nl

In a sometimes funny though somewhat condescending piece on the financial troubles of their American cousins, the Financial Times notes how poorly economic models could forecast the sudden rise in mortgage foreclosures ("Last year's model: stricken US homeowners confound predictions", by Krishna Guha and Gillian Tett, January 31 2008). The "rational actor" model proposed suggests that either home owners must have realised that there was a negative discrepancy between the value of the mortgage and the value of the house, or that home owners had no equity yet in the house they were paying for anyway, and decided to ditch the house and keep the car. 
http://www.ft.com/cms/s/0/039614aa-d02b-11dc-9309-0000779fd2ac.html 

This however conveniently ignores not only the evidence that many Americans were sold mortgages without understanding what they were committed to, but also that inflation-adjusted gross wages (in America they call this "real wages", ignoring taxes) are actually dropping absolutely in many parts of the US. This is noted even by CNN news http://money.cnn.com/2006/01/30/pf/real_wage_growth_slow/index.htm . Point is a large group of US workers are caught between stagnant or falling real wages, rising consumer prices, and falling values of the homes they bought, while upward job mobility is declining rather than increasing. In that sense, their response is quite rational, though not quite in the way the Financial Times portrays it.

As regards the "average" American household, it spends an amount equal to about 35% of after-tax salary income on housing costs each year, but in fact for the "median" and below median households the percentage is often higher, i.e. it can be 40-50%  and these households earn much less non-wage income (other than social security or retirement benefits etc). About 45% of all US households in 2006 had a gross total household income of less than $40,000 according to CES data, even though the Census median household income was supposed to be about $48,000 at that time. 

It is meaningless to make a theory about the propensity to foreclose on mortgages, without taking into account the real incomes which are supposed to fund the mortgage payments. Those with the least discretionary income are most likely to be the first in line to foreclose on mortgages. 

Jurriaan

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