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Foreclosures help release fresh funds into the economy

Abstract : Foreclosures are a market balancing mechanism that needs to be understood before we start to criticise, says Jeff Adams

The worst thing that can happen in any economy is to lock money up so it no longer flows. The saying “money makes the world go round” is true only because money is not static. It flows. It has a power that’s governed by its own sense of gravity and it flows from high value to lower value which then begins to elevate.

Let me explain precisely what I mean by this. You have, for instance, a low value home you have just purchased. You begin to put money in it, in terms of home improvements, decoration, re-structuring and enhancing. By the time you have finished your money will have flown into a lot of lower-cost purchases which, combined, will help the value of your house rise so that when you come to sell it (if you do) you will be able to make a profit on it which you will then pump back into another house higher up the value chain and the process will begin anew, only with greater sums involved each time.

Suppose, for argument’s sake, that you did not sell your house and did not improve it from the moment you purchased it. That would have deprived you from any value gains due to your activities. If you happened to be in a neighbourhood in which everyone thought like you, then your house price in that neighbourhood would not have appreciated as all property prices in the area would have remained static.

Worse still the economy at large would have been deprived of the amount of money you and your neighbours spend on improving your homes and that would have led to loss of jobs elsewhere and the shrinking of factories, the possible closure of DIY stores and the general stagnation and even decline of the American economy.

This is exactly what can happen in a real estate economy where no foreclosures are possible. More than a punishment to defaulting borrowers, a foreclosure is a correction mechanism that allows the flow of money to continue in the economy even when the credit crunch is on and the economy is undergoing a phase of correction.

Does that mean that foreclosures are a great thing to have in an economy? No, I would not go as far as to say that they are fantastic to see increasing but, by the same token, we must understand that they are necessary and should not be vilified either.

They are what they are: a market balancing mechanism that ensures that the flow of money does not stop and as such provide the savvy real estate investor as well as the new home buyer looking for a bargain with new opportunities which, when they are taken collectively, will help a slowing down economy pick up speed again.