2010: Walking away will gain cachet

December 31, 2009

Why bother? That’s the question more underwater Americans are asking themselves about their mortgage.

Trapped in the abyss of negative equity, more will decide to quit paying. As they should.

About a quarter of all mortgages in the United States are on houses that are worth less than the unpaid balance of the mortgage, according to real estate consultant First American CoreLogic. About half of that group, 5.3 million borrowers, are 20 percent or more underwater. For 2.2 million, the property is worth less than half the mortgage balance.

Those folks are called “homeowners,” but “homeborrowers” would be more accurate. All they own is an obligation to whatever entity services their mortgage. They’re essentially renters paying above-market prices.

But that “ownership” tag is often felt to be important. Americans who are trained to believe that a mortgage is a moral obligation fear punishment or a bad conscience if they walk away.

But foreclosure is hardly the mark of Cain, especially in states like California and Arizona, where lenders have no practical recourse to pursue a borrower’s other assets.

As more underwater homeowners realize there’s no hope to regain their equity, more will cut their losses. The reduction of liabilities brings immediate debt relief and often a lower cash outlay — on rent — for comparable housing. The financial shot in the arm should outweigh the stigma of foreclosure.

Financial self-interest is likely to be contagious. A study by three economists suggests that when a few borrowers in a neighborhood just say no, others are likely to follow.

Lenders do what they can to keep the disease of economic rationality from spreading. They try to “extend and pretend” with lower interest rates, extended terms, and the pretence that eventually the borrower will make good. Anything, really, to avoid the hit to capital that comes from a writedown of the principal.

Until now, borrower guilt has helped protect bank balance sheets. That is likely to change. If it does, the next chapter of the financial crisis could be a painful one.

Comments

The economy is terribly interesting right now.

Pimco was shouting from the rooftops that the Fed needs to not merely stabilize but actually reflate. In other words, they felt it was important for the Fed to bring house equity levels back toward where they were so people aren’t underwater in large numbers. They are not convinced that reflation has happened.

Pimco is now actually backing the truck up on long bonds, which on its face seems crazy with quantitative easing and the like. But they are terribly smart. Apparently they have judged that deflation is winning. Tightening of lending standards together with debt repudiation by Americans is shrinking the money supply steeply.

Meanwhile, efficiency and productivity by companies and prudence and thrift by individuals is soaring. While that’s terrific, it means high unemployment for quite a while.

We are in for a slog. The decline in the money supply caused by the collapse of lending is in the tens of trillions.

There may be one last bond rally yet! As the next round of resets hit and many cannot refinance, there may be a second deflationary gust. If the fed comes to the rescue again at that time, the decades-long super-rally in treasurys may be over at last!

Posted by Dan Hess | Report as abusive
 

Just as we, the working class people, took a huge risk (and lost) when we invested our retirement savings in our 401ks and other investments in corporate stock, many banks took a huge business risk when they chose to issue the types and quality of loans that they did. Pulling up stakes and abandoning a bad business decision has often made millionaires into billionaires. Its time we the people reexamined our relationships with the TBTF banks and corporations and began rebuilding our communities at the local level, investing at the local level, and improving lives at the local level. The way “the economy” treats the American people will change only when we act decisively and in large numbers.

Posted by Molly | Report as abusive
 

I for one am among this crowd. I have a new home being built that I am paying cash for. Thanks to hard work, a few investments, and saving, I am able to have enough $$$ to do this. Once I close on the new home in March, I will be calling the mortgage holder on my existing home and telling them the keys are on the counter…it’s all theirs.

Posted by Mitch | Report as abusive
 

“Those folks are called “homeowners,” but “homeborrowers” would be more accurate”
Home debtors or home losers would be even more accurate.

“Lenders do what they can to keep the disease of economic rationality from spreading”

You forgot the Fed and Treasury. I am sure there will be villification of defaulters, but the fact remains these people will take a loss – it is better for a responsible free market system if the other tango partner shares in the loss that they (the banks) helped to insure by there poor underwriting standards.

Posted by fresno dan | Report as abusive
 

I am astonished that you would endorse reneging on contracts. Why limiit it to housing. I don’t like the item I bought, don’t pay the credit card. I don’t like the stock I bought, don’t pay for it. It’s called capitalism folks, you pays your money and YOU takes your chances. Grow up people. YOU bought it. YOU agreed to pay for it. Now stand by YOUR word. If the price had doubled would YOU have split the profit with anyone?

Posted by John | Report as abusive
 

Perhaps it’s foolish to bring up ethics on a financial blog, but I guess I would have expected it to at least come up in your post, Rolf. There’s a difference between renting and buying. A concrete, legal difference. I question the ethics of someone who has the money to buy a house in cash but refuses to pay the mortgage on her existing home. It srikes me as basically lying. Thanks to hard work, a few investments, and saving, someone was able to have enough $$$ to put in a bank and that bank lent the money to Mitch for his house. Right?

I suppose someone like Donald Trump has built an empire on business practices like this, but he’s also a huge douche…maybe it’s worth the tradeoff. Maybe this is an appendage of the inevitable backlash against corporate malfeasance (Enron, MCI) and Wall Street foolishness…but is that a legitimate justification?

On the other hand, bankruptcy is an important part of a capitalist system and a mortgage, unlike a credit card, is associated with a hard asset that lives on…that is, the bank is left with at least something. And perhaps they are best able to manage finding a new person for the place. I wonder if banks shouldn’t ban together and create a management company to rent all these foreclosed homes?

I don’t have the answers here and who knows where my lofty ideas about ethics would be if I was underwater on a mortgage, but there’s the point–many of us weren’t foolish enough to bury ourselves up to our eyeballs in housing.

Posted by Jon | Report as abusive
 

One belief behind the precursors to the institutions that have evolved into what-is-now Fannie Mae and Freddie Mac (and the like), was some underlying notion that the country would be better if the citizenry held a “stake” in the society — in the form of home ownership. This belief also lead to laws like tax deductibility of mortgage interest and other gimmicks.

If the “home” is now viewed as some sort of financial put option, that is, a speculative endeavor that you simply walk away from when it’s price doesn’t appreciate … well then, it seems that the viewpoint of Home-OwnerShip = A-Valuable-Aspect-of-Citizenry-In-A-Soci ety is severely flawed.

Without the underlying “belief”, call it “moral” or whatever, I see no reason why the society should subsidize homeownership.

We must get out of the current dilemma(caused in large part by Fannie and Freddie, the 2 HIGHLY REGULATED institutions at the epicenter of our current crisis). However, in the longer run, things like tax credits for mortgages and Fannie and Freddie should be elimated BECAUSE their is no longer an underlying societal benefit to “homeownership”. As evidenced by this article, modern home ownership is viewed as nothing more than a financial derivative — a put option.

Posted by Kent | Report as abusive
 

From the buyer’s point of view, 2010:
1. I paid 4x for my house
2. House prices have gone down
3. It’s now worth x.
4. I’m walking away from it.

From the bank’s point of view, 2000-2008:
1. I sold the house for x
2. House prices have gone up
3. It’s now worth 4x.
4. I could kick the buyer out and sell it for more, but I guess that’s just my loss.

 

I am always interested in “personal responsibility” arguments.

What about those of us who will lose their homes and financial stability due to job losses? I did all of the “right” things. I saved for a down payment, bought only what I could afford, and sacrificed to get my home. No matter, I am still out of luck.

Cheap foreign labor, outsourcing, downsizing, offshoring, age discrimination, lost pensions, lost savings, no health insurance, food stamps, temporary employment contracts with absolutely no benefits, taking low-level jobs that pay significantly less in order to live even with significant experience and a college education…how about discussing those topics for a change? The rest is total BS!

Posted by Fred | Report as abusive
 

@fresno dan,
The other side of capitalism says..you lends your money, you take your chances. Maybe, just maybe, prudent lending would involve forcing 20% down and less than 30% debt to income ratios for ALL SUCH LENDING. BUT NOOOOOOOO…that’s not even close to what happened. Instead we have “capitalists” simply ignoring risk and lending stupidly because they they figured there was always another sucker in line. Well, these “capitalists” can suck it. You are blind to what real capitalism is.
-rufus

Posted by rufusmcbufus | Report as abusive
 

I note that promoting your own blog posts, and apparently dissent of any sort, is not allowed at Red State; I suppose in order to maintain ideological purity…Is there a certain double standard in railing against folks not living up to the rules while breaking ones own rules?

Posted by Jon | Report as abusive
 

@ Repair_Man_Jack of Red State since comments are not allowed on your post:

While your considerations are valid, and I share a skepticism about the ethics of walking away, part of the mortgage contract is that the bank can repossess in the case that your “scumbag” stops paying. That is a condition in the contract which the bank also signed. Firms do this as part of their regular business practices and one could claim such action is fundamental to the functioning of a capitalist system.

I go back and forth with my feelings about walking away, but there are two parties here and at the end of the day it can be argued that the contract is indeed being honored: if “scumbag” doesn’t pay, the bank gets the house. I’m not so sure this is much different from a call option. We can talk about the recklessness of the buyer, but certainly the bank is also to blame for extending excessive credit. And there is asymmetric information involved–surely it is the bank and not the widget factory worker that should have the market understanding to know better.

Posted by Jon | Report as abusive
 

It’s interesting that in a capitalist society where we expect people to quit jobs to make more money, etc., we ascribe an “ethical” angle for home purchases. Why? Who cares? Do what is best for yourself and your family within the confines of the law.

There is a well-accepted line of thinking being taught in U.S. law school called “efficient breach.” It is the idea when the benefit (to either party) of a contract is outweighed by the burdens of the agreement, that party should decide whether the consequences of the breach still result in a better outcome for them than continuing with the contract. Sometimes, that will mean paying damages in court, in others, it will mean taking a hit on a credit score. For everyone who owns a home, there is a scenario under which it would make no sense to keep the house and continue to pay. Given the events of the last 5 years, it’s not a complete surprise that many borrowers are confronted with this decision. Ultimately, it may make more sense.

Posted by AmicusDye | Report as abusive
 

The normal consequences of a short sale have been suspended, unbalancing the efficient breach principle.
The hit on the credit score is not and should not be the only consequence. In a short sale, the bank should issue a 1099 to a borrower for the amount of loan forgiveness. The borrower should have to pay the taxes on that income. Congress actually redlined that important consequence, making walking away easier.

Posted by Richard Whitney | Report as abusive
 

By Winker’s astonishing logic, EVERY homeowner should walk away.

Have you ever looked at the true amount of your “mortgage” over a 30 year loan?! You think you’re paying, say “300,000″ on a home, when, in reality, when you look at the actual mortgage contract, you’re paying $750,000 [or some such breathtaking amount] when all the costs are figured over a 30-year period of the mortgage.

Whether or not people walk away [Default is the proper term here] is up to them; but no one should be fooled: If you’ve ever bought a home with a mortgage, you’re “underwater” before you ever move in! It’s only if you happen to sell in a hot market, prior to completing your mortgage time table, that you can walk away without much of a loss. Everyone denies the total cost of their mortgage, ignoring it as if it doesn’t exist.

The moral of the story is really whether or not people should EVER buy a home with a “mortgage.” You shouldn’t.

Posted by mountainaires | Report as abusive
 

This is a risk/reward for every transaction. If the bankers and other mortgage investors are forced to take a loss, that’s just part of the process. Caveat Emptor.

Posted by vectorvictor | Report as abusive
 

This piece is excellent: I wish every op/ed page in the country could print it for drowning homeowners to see. The quicker we get these losses cut across the country, the quicker we get thru the “painful chapter” and into recovery. And wouldn’t it be nice if the Millenials actually LEARNED from our fiasco? I hear they’re renting in great numbers; maybe they’re simultaneously SAVING for houses??? One can hope…

Posted by CyberSquirt | Report as abusive
 

My husband purchased a home in 2005 for $395K. I was skeptical about purcashing a home but figured a lender would never finance the purchase with only his income. Boy was I wrong.. I couldn’t understand it. Fast forward to today, our house is work $215K with similar homes now selling for $175K. We can afford our mortgage now because it is an interest only. In a few years we may not be able to. We certainly cannot refinance. We’ve gotten the run around on a loan modification. We want to keep to promise to pay. However, I keep wondering if my home was a business would I keep putting money into a sinking ship. I hate feeling this way… but leaving would save us at least $1k per month.

 

I owe over twice what my house is worth. It is mortgaged for 248,000; now worth $115000 or so in Florida’s terrible market. My neighborhood has declined to the point where I feel unsafe there. I made the mistake of buying a home in 2007, and even though I put down a healthy downpayment and got a fixed rate and could afford the home, here I am. I am planning to strategically walk within the next twelve months. I am fortunate to have a wonderful significant other who can support my effort and purchase or rent another property. I’ll be undertaking the “efficient breach” by defaulting strategically and then setting myself up for a Ch. 7 in order to avoid a deficiency judgment.

Posted by PB | Report as abusive
 

How Mortgages Work

1) Everybody pays THEIR OWN mortgage (that’s the one you agreed to when you got your house. Remember?).
2) Those who can’t pay, or don’t feel like paying their mortgage can RENT.
3) Banks and speculators who lent money to those who can’t pay or don’t feel like paying their mortgage can foreclose. If they aren’t happy with the amount of money they recover in a foreclosure, that is officially TOO BAD.

Posted by Fedphucksfrugal | Report as abusive
 

All I know is… I had a good income.. The bank had time for me… I had a 2 month break between contracts (for promotion reasons) and needed help, so I asked them for some.I felt rushed, I couldn`t speak to anyone in authority. The bank clerk spouted jargon from his training….They just charged me on my overdraft adding to the debt.. I have good money coming and can prove it… They don`t want to know… And said `its the credit crunch` So now I will walk away and they can take a hike… I once cared about morals and personal responsibility, but since the government bailed them out before helping real working people, and gave bankers huge payouts. I have no morals for them left…

Posted by anthonies | Report as abusive
 

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