Fantastic real estate and banking article in The New York Times today entitled Borrowers Refuse to Pay Billions in Home Equity Loans regarding the fallout of America’s popped real estate bubble:

Each deal financed the next. “I was taught in real estate that you use your leverage to grow. I never dreamed the properties would go from $265,000 to $65,000.”

– Shawn Schlegel, a real estate agent who is in default on his $94,873 home equity loan.

I suppose this is what happens when the delusional, and possibly corrupt, are allowed to teach the inexperienced and impressionable who fell headfirst for the Greater Fool theory by chasing easy money. I would bet that somewhere in pro-real estate propaganda, those in supervisory positions (e.g. National Association of Realtors, lenders, etc.) failed to mention little things like dangers of herding behavior, the dangers of over-leveraging, and reversion to the historical mean as they were increasing their ranks to perpetuate the cycle.

Perhaps even more telling are quotes regarding home equity loans:

The result [of the real estate bubble collapsing] is one of the paradoxes of the recession: the more money you borrowed, the less likely you will have to pay up.

Even when a lender forces a borrower to settle through legal action, it can rarely extract more than 10 cents on the dollar. “People got 90 cents for free,” Mr. Combs [a real estate lawyer] said. “It rewards immorality, to some extent.”

Being a student of social anthropology, it’s interesting how one’s point of view, or what team one plays for, influences their thought processes.

If one reads between the lines of Mr. Combs’ statement, you could quite easily infer that when consumers default on a loan, it’s immoral. But when businesses, governments, or even the bankers themselves, default on their loans, it’s just business. Membership does indeed has it’s privileges.

And such discrepancies between the belief about debt repayment between the classes is a sublime illustration of how uniquely fragile the American economic system (e.g. repayment of one’s debt) really is: if the middle class adopts the belief that it is not immoral to default on one’s debt (like the upper class), the whole system could, at least in theory, collapse inward on itself.

From an architectural and engineering perspective, this theory makes perfect sense. When the core infrastructure of a building is weakened, there is little to keep the structure standing.

Flashback to our current real estate debacle, and it’s entirely plausible why the government is throwing trillions of dollars in stimulus funds, even though it has to borrow them, by doing everything it can to keep the anvil (e.g. home prices) floating in the sky.

Only problem is, historically low mortgage rates are not liquidating excess inventory, the savings rate among Americans is still rising (6.4% savings is the highest savings rate of 2010 based on Bureau of Economic Analysis data), and an increasing number of influential economists are saying sector specific deflation would be a good thing for the U.S. economy.

As I predicted in my trends to influence financial markets in 2010 post in early January, and as as the NYT article so correctly states: there is strength in numbers. Once that trend is in place, and it benefits the masses, it’s going to catch on.

And no reason exists, at least from my purely non-professional analysis can see, that suggests the trend of sector specific deflation is weakening.

If anything, it’s gaining momentum.