There is an article in the New York Times about a growing group of homeowners choosing strategic default.
New research suggests that when a home’s value falls below 75 percent of the amount owed on the mortgage, the owner starts to think hard about walking away, even if he or she has the money to keep paying.
Source: New York Times
My problem with the financial industry is that all of this is 100% foreseeable. Here is a quote from an executive at Wachovia:
An executive with Wachovia, one of the country’s biggest and most aggressive lenders, said during a conference call in January 2008 that the bank was bewildered by customers who had “the capacity to pay, but have basically just decided not to.”
Bewildered? On the front end, lenders couldn’t figure out that if a borrower had negative equity they might not walk away? Come on. Why would anyone sink money into a property that is worth substantially less than you paid if you can walk away and get a fresh start?
It makes sense to do so. The current regime permits borrowers to shift their losses to the bank. The stakeholders in the bank don’t feel the pain either since it is ultimately backstopped by the government. So ultimately, the current regime permits borrowers to keep the upside and externalize losses on society (ie., the taxpayer).
In places such as California where loans are non-recourse, the only incentive not to walk away is harming your credit score. If your credit is already in the dumps, then there is literally no incentive to keep paying.
Strategic default is always a worry in commercial lending and precautions are taken on the front end to prevent it. Similar precautions should be taken with residential mortgages and we would not be in this mess. Two simple fixes:
1. Full Recourse. Residential loans should be full recourse loans in all states. In many states, residential loans are fully recourse. So even if the borrower sends “jingle mail” to the lender, the lender can still pursue the borrower personally for the total amount of the indebtedness less the amount of proceeds received at a foreclosure sale.
Keep in mind that even if the lender does not want to deal with suing the borrower, there are vultures out there that do. There are companies out there buying these notes for pennies on the dollar and pursuing borrowers. My point is that a full recourse loan would provide a tremendous disincentive to simply walk away. It would also force home buyers on the front end to carefully analyze taking out a loan for hundreds of thousands of dollars.
Imagine if borrower’s had to carry this risk during the bubble years? If an “investor” knew they might have their wages garnished or other assets seized if the house lost value and the investor defaulted (either on a voluntary or involuntary basis), many of these investors would not be lining up to enter the house flipping business. The investors would have to carry the risk of loss rather than the federal government.
This may sound a bit harsh, but it should be a big deal to take out a loan for hundreds of thousands of dollars. In this country, there are people that cannot afford a $1,000 LCD TV yet are able to “afford” a $250,000 house because of the government’s intervention in the housing industry.
2. Equity. Homebuyers need to come up with a 20% down payment. The homeowner must have a skin in the game. If the home declines in value, the homeowner needs to take the hit first. Not the bank (or the FHA, Fannie or Freddie). It is not that I care about banks, but the problem is banks (and GSEs) are ultimately supported by the government meaning if the bank picks up the bill than it means there is a high probability that the loss of value is being externalized on society rather than on the homeowner.
I’ll end my rant by saying that it a joke that many are bewildered by how this housing mess occurred. Besides the obvious structural problems with home loans I have mentioned above, the government’s intervention in residential lending will continue to cause bubbles and financial instability. Two other changes we need:
1. Abolish the FHA. Loans with 3-5% down breaks the equity requirement I mentioned. The FHA cannot exist because the risk of borrower default is carried by the government (and externalized on society) rather than the borrower. We then end up with the strategic default problem when the loans go into default.
2. Retool Fannie and Freddie. The original mandate for the GSEs was to package mortgages into a pool and sell them to investors. Under no circumstances should a GSE be allowed to hold mortgages for their own account. Because of scumbags like Barney Frank (the guy should be in jail), the government owns by some estimates over 50% of the residential mortgages in this country. So the losses are taken on by the government rather than by the originating lender and the borrower. Put another way, how do we have a system where the government takes the risk on a home loan? Shouldn’t 100% of the risk be allocated between the lender and the borrower? Why should society pay?
Banker caught on national television watching porn.
Link: http://bit.ly/a2vfev
Post about FHA blowing up. I agree. It might be 6 months, it might be six years …
http://www.businessinsider.com/sorry-folks-the-...
Banker caught on national television watching porn.
Link: http://bit.ly/a2vfev
Imagine Joe Blow wants a house. He goes to a lender that quotes him $1500.00 a month payment. Joe knows he can carry $1500.00 with his eyes closed. Besides this is how he has been taught to buy cars and other items on credit. Our public school system certainly never mentioned anything to the contrary, and the lender is a professional. We all know that professionals wouldn't lend money that was impossible to pay back. The trouble is that the varable interest rate has gone up and Joe's payment has now doubled or tripled. Maybe the professional mentioned something under his breath about variable interest but Joe didn't understand the full importance of what it meant. How likely would it be that the professional lender would loan Joe the money with full knowledge that in a year or two there would be no way on God's green earth that Joe could pay back that loan even if Joe worked two jobs and got a paper-route.
The lenders knew the loans were junk and that's why they sold as many of them as they could to hot-shot investors.
The truth is that the lenders SWINDLED Joe and CHEATED the investors and then walked away clean.
Instead of jailing these CRIMINALS our then President Bush bailed them out!
What a country!
Post about FHA blowing up. I agree. It might be 6 months, it might be six years …
http://www.businessinsider.com/sorry-folks-the-...
I Love the comment re: can't buy a TV, but can get a home… love it!
Imagine Joe Blow wants a house. He goes to a lender that quotes him $1500.00 a month payment. Joe knows he can carry $1500.00 with his eyes closed. Besides this is how he has been taught to buy cars and other items on credit. Our public school system certainly never mentioned anything to the contrary, and the lender is a professional. We all know that professionals wouldn't lend money that was impossible to pay back. The trouble is that the varable interest rate has gone up and Joe's payment has now doubled or tripled. Maybe the professional mentioned something under his breath about variable interest but Joe didn't understand the full importance of what it meant. How likely would it be that the professional lender would loan Joe the money with full knowledge that in a year or two there would be no way on God's green earth that Joe could pay back that loan even if Joe worked two jobs and got a paper-route.
The lenders knew the loans were junk and that's why they sold as many of them as they could to hot-shot investors.
The truth is that the lenders SWINDLED Joe and CHEATED the investors and then walked away clean.
Instead of jailing these CRIMINALS our then President Bush bailed them out!
What a country!
I Love the comment re: can't buy a TV, but can get a home… love it!
William, I agree with you about the part of lenders duping Joe Blow. I've seen it with my own eyes when representing pro-bono clients in the past.
The thing is, if some of the changes I made were suggested, the lenders would not have the ability to create a product with a teaser rate, get a loan closed, and the borrower go into default in a matter of months. The 20% equity would get rid of a lot of these interest only products.
We could also get rid of negative amortization loans (ie., teaser rates). These loans serve no purpose. Subprime really has no reason to exist either. If you need a subprime loan to get a house, you should be renting.
William, I agree with you about the part of lenders duping Joe Blow. I've seen it with my own eyes when representing pro-bono clients in the past.
The thing is, if some of the changes I made were suggested, the lenders would not have the ability to create a product with a teaser rate, get a loan closed, and the borrower go into default in a matter of months. The 20% equity would get rid of a lot of these interest only products.
We could also get rid of negative amortization loans (ie., teaser rates). These loans serve no purpose. Subprime really has no reason to exist either. If you need a subprime loan to get a house, you should be renting.
William, I agree with you about the part of lenders duping Joe Blow. I've seen it with my own eyes when representing pro-bono clients in the past.
The thing is, if some of the changes I made were suggested, the lenders would not have the ability to create a product with a teaser rate, get a loan closed, and the borrower go into default in a matter of months. The 20% equity would get rid of a lot of these interest only products.
We could also get rid of negative amortization loans (ie., teaser rates). These loans serve no purpose. Subprime really has no reason to exist either. If you need a subprime loan to get a house, you should be renting.
None of the residential loans should be recourse loans. Either bank does a good loan or does not do it at all. How come corporation can walk away from mortgage and assets of owners are protected?
None of the residential loans should be recourse loans. Either bank does a good loan or does not do it at all. How come corporation can walk away from mortgage and assets of owners are protected?
Actually, most commercial real estate loans are backed by a guaranty by the
company or the principals. There are some non-recourse loans, but those are
mainly a thing of the past in commercial real estate. Even the non-recourse
loans today are really recourse because of all the carveouts in the
documents. The banks calls some of these loans “non-recourse with bad boy
carveouts,” but when you dig into the documents you're really getting a
recourse loan. These kinds of provisions used to be negotiated in favor of
the borrower, but with the economy the way it is the lenders dictate the
terms.
Actually, most commercial real estate loans are backed by a guaranty by the
company or the principals. There are some non-recourse loans, but those are
mainly a thing of the past in commercial real estate. Even the non-recourse
loans today are really recourse because of all the carveouts in the
documents. The banks calls some of these loans “non-recourse with bad boy
carveouts,” but when you dig into the documents you're really getting a
recourse loan. These kinds of provisions used to be negotiated in favor of
the borrower, but with the economy the way it is the lenders dictate the
terms.