October 8, 2010
The big question from the mortgage meltdown isn't why so many distressed homeowners are defaulting on their loans.
It's why any of them are still making payments.
In the worst-hit areas millions have no equity left, and little hope of seeing any anytime soon. The market value of their homes is far below the size of the mortgage.
If they just stop paying, what is going to happen to them? In many cases they may get to live in the home rent-free for months, even years, until the bank gets around to seizing it.
If Frank Abagnale—the con man played by Leonardo DiCaprio in the film "Catch Me If You Can"—were operating today, he'd probably be living rent-free in a super-luxury high-rise in Miami.
Consider the latest revelations. The big banks are so backed up with foreclosures that some of them resorted to hustling through repossessions without the proper paperwork. Some of them—including Bank of America, J.P. Morgan Chase and Ally Financial's GMAC Home Mortgage—have announced a temporary freeze in some states on further foreclosures while they sort through the mess.
In one case, a bank employee said she was approving 8,000 foreclosures a month. By my math, that's roughly one for every minute and a half. No, she wasn't reading all the documents thoroughly. (As one wit observed, the banks paid about as much attention to foreclosing on the loans as they did to making them five years ago.)
In many cases, thanks to the fallout from securitization, it's not even clear who owns the mortgage. The payments may be due to different financial institutions around the world, some of which have gone the way of all flesh.
No wonder a fair number of borrowers have simply gone on strike. Nobody knows exactly how many are doing so deliberately—a so-called strategic default—though some estimates suggest these may account for nearly a third of recent defaults.
According to the Federal Reserve Bank of New York, one mortgage borrower in five in Florida and Nevada is more than 90 days' late on payments, and in Arizona and California it's about one in eight. It's a wonder it's not more.
A while back I received an email from a woman in Florida that illustrates the issue.
Her neighbor across the road had stopped paying his mortgage about a year and a half earlier, she wrote. He was still living in his "luxury condo," and the lender hadn't come after him yet. After all, he told her, they were so backed up with the housing collapse it might take them years.
My correspondent—a lawyer—was wondering whether she was being stupid for continuing to make her own payments. After all, she, too, was deeply underwater; her mortgage was far bigger than the value of the home.
So what happens to those who simply go on strike?
Even where the bank is coming after them to evict them, it is taking months, maybe years. During that time they are living rent-free.
When they are evicted, the bank then puts the home on the market. It may take months more to sell. Let's assume it sells, but for a lot less than the size of the mortgage. What can the bank do then?
In some states, the bank can do very little. In so-called nonrecourse states—which include California and Arizona, two of the worst-hit in the housing collapse—banks basically have to eat the loss.
In other states, the banks have some ability to come after the homeowners for the shortfall. But for most distressed homeowners, this threat is more theory than reality. Why? The banks have too many cases to handle. And distressed homeowners typically have so little in surplus capital that there may not be much point.
Imagine you're the bank executive. The loss on the home came to, say, $200,000. The borrower is unemployed, driving a 10-year-old Chevy and living on food stamps. In another state. Or he has a part-time job in gas station, maybe $2,000 in savings, and two kids. How much do you want to spend on lawyers and debt collectors to hunt him down? How much do you think you're going to get back, after costs? You've got 5,000 cases like this.
Indeed, there's a lot the banks can't touch anyway. Money held in a 401(k) account, pension plan or individual retirement account is beyond the reach of creditors. So is college money for the children or grandchildren if held in a 529 plan for more than two years. And so are other assets; it varies by state. Often life insurance is sheltered: That may include mutual funds held in a variable annuity account. Once the borrower files for bankruptcy, the lender ends up with nothing.
Assuming people have taken legal advice, and taken the smart steps, the rules give many of them strong economic incentives to stop paying. In some circumstances, there might be state-tax consequences. They may find it harder to get a mortgage in the future. And their credit score will get dinged, sure, but in the grand scheme of things, is this really a fate worse than death?
The ruthless and the reckless have already walked. Meanwhile, the middle class continues to pay through the nose. It's that old "middle-class morality" that George Bernard Shaw mocked a century ago.
But is this really a case of morality anyway?
I'll confess this issue makes me uneasy. But my feelings are almost certainly awry. We live, alas, in a world, and an economy, which rewards ruthless self-interest and penalizes "morality." Just look at the big banks.
A mortgage isn't a blood oath, it's a business contract—a collateralized loan. It isn't simply a promise to repay the lender. It's a promise to repay the lender or to forfeit the home. Isn't someone simply fulfilling their contract by handing over the keys when asked?
The banks knew full well what the fine print said when they made the loan. And so they should: They wrote the fine print.
The economy will suffer if more homeowners default. But it will suffer if they don't. Those bad debts are doomed and need to be written off. Why should the homeowners eat them rather than the banks? Why is the reckless lender more at fault than the reckless borrower?
Japan struggled for 20 years with "zombie banks"—so called because their debts, if properly recognized, made them insolvent. Here in America, we have millions of zombie homeowners. Why is this any better?
Businesses make secured loans against property or collateral all the time. If the loan goes bad, the lender takes the collateral. Nobody expects executives to dip into their own pockets (a fortunate thing, as they never do). Bank executives pocketed tens of millions in the run-up to the financial crisis, directly as a result of the phony profits from reckless lending. Stockholders pocketed billions in dividends for the same reason. If the taxpayers hadn't stepped in, those banks would have collapsed and creditors would have lost a fortune. But they would have had no recourse—absent proof of fraud—against executives or those who owned equity.
Look through the financial statements of the big companies involved in the housing market, including major homebuilders and property developers, and you'll find frequent references to all the "nonrecourse financing" they've obtained. It's a boast. "Look," they're telling stockholders, "even if things go bad, the lenders can't touch us."
Apparently the only people who haven't gotten the memo are the middle class. For how much longer?
The big question from the mortgage meltdown isn't why so many distressed homeowners are defaulting on their loans.
It's why any of them are still making payments.
In the worst-hit areas millions have no equity left, and little hope of seeing any anytime soon. The market value of their homes is far below the size of the mortgage.
If they just stop paying, what is going to happen to them? In many cases they may get to live in the home rent-free for months, even years, until the bank gets around to seizing it.
If Frank Abagnale—the con man played by Leonardo DiCaprio in the film "Catch Me If You Can"—were operating today, he'd probably be living rent-free in a super-luxury high-rise in Miami.
Consider the latest revelations. The big banks are so backed up with foreclosures that some of them resorted to hustling through repossessions without the proper paperwork. Some of them—including Bank of America, J.P. Morgan Chase and Ally Financial's GMAC Home Mortgage—have announced a temporary freeze in some states on further foreclosures while they sort through the mess.
In one case, a bank employee said she was approving 8,000 foreclosures a month. By my math, that's roughly one for every minute and a half. No, she wasn't reading all the documents thoroughly. (As one wit observed, the banks paid about as much attention to foreclosing on the loans as they did to making them five years ago.)
In many cases, thanks to the fallout from securitization, it's not even clear who owns the mortgage. The payments may be due to different financial institutions around the world, some of which have gone the way of all flesh.
No wonder a fair number of borrowers have simply gone on strike. Nobody knows exactly how many are doing so deliberately—a so-called strategic default—though some estimates suggest these may account for nearly a third of recent defaults.
According to the Federal Reserve Bank of New York, one mortgage borrower in five in Florida and Nevada is more than 90 days' late on payments, and in Arizona and California it's about one in eight. It's a wonder it's not more.
A while back I received an email from a woman in Florida that illustrates the issue.
Her neighbor across the road had stopped paying his mortgage about a year and a half earlier, she wrote. He was still living in his "luxury condo," and the lender hadn't come after him yet. After all, he told her, they were so backed up with the housing collapse it might take them years.
My correspondent—a lawyer—was wondering whether she was being stupid for continuing to make her own payments. After all, she, too, was deeply underwater; her mortgage was far bigger than the value of the home.
So what happens to those who simply go on strike?
Even where the bank is coming after them to evict them, it is taking months, maybe years. During that time they are living rent-free.
When they are evicted, the bank then puts the home on the market. It may take months more to sell. Let's assume it sells, but for a lot less than the size of the mortgage. What can the bank do then?
In some states, the bank can do very little. In so-called nonrecourse states—which include California and Arizona, two of the worst-hit in the housing collapse—banks basically have to eat the loss.
In other states, the banks have some ability to come after the homeowners for the shortfall. But for most distressed homeowners, this threat is more theory than reality. Why? The banks have too many cases to handle. And distressed homeowners typically have so little in surplus capital that there may not be much point.
Imagine you're the bank executive. The loss on the home came to, say, $200,000. The borrower is unemployed, driving a 10-year-old Chevy and living on food stamps. In another state. Or he has a part-time job in gas station, maybe $2,000 in savings, and two kids. How much do you want to spend on lawyers and debt collectors to hunt him down? How much do you think you're going to get back, after costs? You've got 5,000 cases like this.
Indeed, there's a lot the banks can't touch anyway. Money held in a 401(k) account, pension plan or individual retirement account is beyond the reach of creditors. So is college money for the children or grandchildren if held in a 529 plan for more than two years. And so are other assets; it varies by state. Often life insurance is sheltered: That may include mutual funds held in a variable annuity account. Once the borrower files for bankruptcy, the lender ends up with nothing.
Assuming people have taken legal advice, and taken the smart steps, the rules give many of them strong economic incentives to stop paying. In some circumstances, there might be state-tax consequences. They may find it harder to get a mortgage in the future. And their credit score will get dinged, sure, but in the grand scheme of things, is this really a fate worse than death?
The ruthless and the reckless have already walked. Meanwhile, the middle class continues to pay through the nose. It's that old "middle-class morality" that George Bernard Shaw mocked a century ago.
But is this really a case of morality anyway?
I'll confess this issue makes me uneasy. But my feelings are almost certainly awry. We live, alas, in a world, and an economy, which rewards ruthless self-interest and penalizes "morality." Just look at the big banks.
A mortgage isn't a blood oath, it's a business contract—a collateralized loan. It isn't simply a promise to repay the lender. It's a promise to repay the lender or to forfeit the home. Isn't someone simply fulfilling their contract by handing over the keys when asked?
The banks knew full well what the fine print said when they made the loan. And so they should: They wrote the fine print.
The economy will suffer if more homeowners default. But it will suffer if they don't. Those bad debts are doomed and need to be written off. Why should the homeowners eat them rather than the banks? Why is the reckless lender more at fault than the reckless borrower?
Japan struggled for 20 years with "zombie banks"—so called because their debts, if properly recognized, made them insolvent. Here in America, we have millions of zombie homeowners. Why is this any better?
Businesses make secured loans against property or collateral all the time. If the loan goes bad, the lender takes the collateral. Nobody expects executives to dip into their own pockets (a fortunate thing, as they never do). Bank executives pocketed tens of millions in the run-up to the financial crisis, directly as a result of the phony profits from reckless lending. Stockholders pocketed billions in dividends for the same reason. If the taxpayers hadn't stepped in, those banks would have collapsed and creditors would have lost a fortune. But they would have had no recourse—absent proof of fraud—against executives or those who owned equity.
Look through the financial statements of the big companies involved in the housing market, including major homebuilders and property developers, and you'll find frequent references to all the "nonrecourse financing" they've obtained. It's a boast. "Look," they're telling stockholders, "even if things go bad, the lenders can't touch us."
Apparently the only people who haven't gotten the memo are the middle class. For how much longer?
Closed November 2010
) are just making a big mess bigger.
Home prices are still artificially inflated right now due to the government and the banks not wanting the housing market to collapse. Postponed forclosures, modifications, and home buying credits are keeping the housing market artificially high. This will work it way out sooner or later though, and then, when housing has truly hit bottom, buying will make sense again.
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