The NY Times has an article today that I think is fascinating. It points out that, for people with no downpayment on a home who can no longer afford their mortgage, foreclosure pays.
Maybe this was obvious to some people, but not until I read this article did I see some light at the end of this housing bust. See
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. See also the company referenced there,
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. Youwalkaway.com makes me proud of America's legal tradition. For many months I have been feeling sorry for the "little guy/gal" who was unsophisticated and bought during the housing bubble, using an ARM with no downpayment or an interest only mortgage. Shame on those lenders, I thought, for extracting money from people that, statistically speaking, they knew could likely not afford a house on these terms.
Turns out, as the article suggests, that this was actually a pretty savvy decision on the part of borrowers. (Whether they knew it or not!) One expert noted: "Now it's like they can do their renting from the bank, and if house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren't any worse off than renting, and you got a chance to do extremely well. If it's heads I win, tails the bank loses, it's worth the gamble."
As a shareholder in a few banks, I want these lenders to start cooperating. Better to re-negotiate the terms of the mortgage than be stuck with a house worth much less than what the bank paid (on behalf of the borrower). They really have no other choice anyway, right? (That's not rhetorical. I welcome commentary on what alternatives lenders have.)
My only regret is that those who run lending businesses did not have the intelligence to anticipate this and, to date, have not generally conceded that their backs are against the wall. It is tempting to urge the firing of whole Boards of Directors (like WaMu's), or other such severe punishment as shareholders are able to mete out. Though maybe it takes a morass like this burst bubble for people to learn anything, even ostensibly well educated pillars of the banking community. As perhaps Sgt. Sausage would suggest.
In today's Times is also an article on how talks between Republicans and Dems have stalled. Dems want a bailout of homeowners. Republicans do not. At this point I see no reason for a bailout. Let the lenders eat cake.
Now at last I can also explain the justification for requiring downpayments on the order of 20% and/or penalizing those who put down less.
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In most states, California excepted, mortgages are not "non-recourse" loans. The borrower is legally and morally obligated to repay the loan regardless of changes in the market value of the house. You may be correct in calling voluntary defaults on mortgages "savvy" if ethical considerations can be ignored, but so is stealing, by those standards. I'd call it slimy.
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Don't you also feel there is a moral obligation not to take financial advantage of someone either (1) incapable of understanding the terms of a mortgage; or (2) who has a high probability of not being able to make payments? Alternatively let us assume there is no such moral obligation, and both sides are responsible for understanding the fine print. Fact is many lenders failed to consider the fine print regarding defaulting on mortgages. Folks in poverty are a reality. Lenders know that defaulting is a possibility. Else why would things like PMI exist?
I am not confirming or denying your "most states" claim without a citation. On the other hand, from the article:
Though many states give banks recourse to sue borrowers for their losses, [Wellesley Econ Professor Karl E. Case] said, in practice it's not often done. "It's tough to do recourse," he said. "It's costly, and the amount of people's nonhousing wealth tends to be pretty slim."
I think what's happening here is reasonable market action. Let the lenders reap what they sowed. Of course, one of the burning issues of 2008 may quickly become (or already is) the hit that the private mortgage insurance industry takes, since in theory the insurers are supposed to make up for much or all of the loss the lender suffers.
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I've always been a caveat emptor kind of guy and I've never had much pity for ignorance. Furthermore, I firmly believe if there are no consequences to one's actions there is no incentive to learn otherwise. But all of that is personal belief and widely disagreed upon.
That said, is it accurate to say that the value of this article hinges on the readers opinion of "who is responsible"? My feeling after reading it was thus: If you believe the lenders are responsible this is one way to screw 'em. If you believe the borrowers are responsible, this is essentially stealing.
Unfortunately, the article neglects going any deeper that the primary affects of borrowers walking away. We don't honestly believe the banks will quietly stomach the losses alone do we? Government bail-outs, declining stock prices, increased regulation, and myriad other repercussions that I oppose will likely be borne out the actions discussed in the article.
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Banks don't want to own houses, they want to make loans. It seems to make sense to work out a mortgage if possible. Too often, the borrowers couldn't make payments on even a simple 30 year fixed at 6%. They may have been paying interest only at 2% teaser rate. Or worse, the borrower doesn't contact the bank or respond to the bank contacting them until the constable shows up at the door.
There is also the moral hazard argument. If banks relax loan terms every time someone is in trouble, no one is going to take loan terms seriously.
I think my attitude to date has been similar to yours. The people who are getting burned are the ones who played with fire.
I haven't backed off that, but The Dallas Morning News had a big feature today on foreclosures in the Dallas Area.
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Some highlights include that there are 19,000 foreclosed houses in the area last year -- and Dallas has not suffered big price declines. Overall the market is about flat.
Each foreclosed house in a neighborhood lowers the value of other houses by 1% and increases the crime rate by 2.3% according to the article. A map accompanying the article shows the foreclosures are heavily concentrated in the poorer areas of town (south and east).
The TV news last night had a story about renters getting evicted because the bank foreclosed on the landlord.
Please, I am just commenting. I *don't* think a bailout is a good idea.
-- Doug
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Lending standards could change, so an individual who walked away from an underwater loan faces higher interest rates on future borrowing (or couldn't even borrow). If this turns into a significant problem that creates big losses for lenders, it would be rational for them to react to that.
That would happen in my imaginary world where every dot-com stock analyst found it impossible to get another job requiring grade-school math, every CEO of a company that went bankrupt ended up as a dishwasher, "performance bonuses" weren't given out to executives running companies with losses, etc...dare to dream!
-Tad
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Oh - the other thing I've seen mentioned is "negative equity" certificates that would run with the borrower, as part of refinancing for underwater homes. The mortgage is refinanced at affordable payment levels, and a lower mortgage value, and the unrealized loss becomes a lien against that home/borrower that matures only when the home is eventually sold. That would give the lender a lien against future appreciation, but only if happens, in effect delaying any realized losses (and leaving open the possibility they won't happen). The borrower doesn't lose the home and gets lower payments, but doesn't get the windfall. It's such an economically rational approach that I'm sure it won't be implemented.
-Tad
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That's a worthwhile article, IMO. One thing it suggests to me is that things should not get worse. Indeed, some folks are starting to pick up bargains.
I was hunting around on realtor.com this morning in some of the places in the U.S. (nice places) I have considered from time to time and see prices are way down. It's a good sign that some sanity has returned.
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Ha, that made me laugh. My personal dream is for Warren Buffet to be put in charge of the Federal Reserve, Medicare, and Social Security.
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With apologies in advance for length and lack of references, I've put in a lot of time recently reading, talking, and trying to think through this mess, and I may have a couple of simple clarifying statements. There are really two parts: the value of homes, and the value of the mortgages.
As to the first: the census bureau has a very interesting document that is remarkable for its clarity and ease of use. The title is Demographic Trends in the 20th Century" a .pdf file the link to which is found in a blue box to the left of the page to which the link is supplied below.
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Much in that document explains the remarkable rise in housing prices this past century. I believe per capita GDP numbers have to be factored in to complete the picture (e.g. if that number is five times in 2000 what it was in 1900, then that may be a better indicator than CPI which does not include housing).
Nevertheless, the price of housing got overbid in 2005, and like any other market, is "correcting." Some prescient poster on this site years ago put up a link to an article on the FNMA site talking about housing booms and busts - in 2005! We have had similar housing corrections in the past, people upside down, walking away, desperate "Price Reduced!!" notices, and so on.
The second part, the value of the mortgages, is the BIG problem. Apparently CDO's are simply renamed instruments of the type first seen back to 1984. These are highly leveraged. So , take the housing decline and multiply it by the leverage in CDO's, and you see this is a bigger problem today than it was in times when CDO's were not so widespread.
This little problem is what banks are writing off - I believe the running count estimate is between $175 and $200 billion. The writeoffs are not over yet. The sheer volume of doubt about the worthiness of debt can be seen in the low T-Bill rates, but that still isn't the real problem. The real problem is that unwillingness or inability to borrow and lend ANYTHING has the banks and broker/ dealers who were involved in the leveraged CDO's (and other so-called 'derivatives') scrambling for cash. The past few weeks' lack of liquidity in municipal bond markets reflects this lack of cash, and led up to the near melt-down in the municipal bond markets Friday. Tax free A+ municipal paper (short-term!) is paying almost twice what taxable T- Bills are. This is not a lack of faith in municipal issues, it is not a credit issue, it is a liquidity issue.
Students of finance will be writing theses about this for years, probably, but this liquidity crisis does have ripples, and this is the problem the Fed is trying to ease. The US housing market is, if I recall estimates correctly, about $27 trillion dollars. The estimates for derivatives of all kinds is in the order of $450 trillion. (Fun, huh, being greedy?) The total municipal bond market is about $2.6 trillion. When a number as "small" as $2.6 trillion goes un-funded, things must be pretty bad on the liquidity front. This is not funny stuff at all. This illiquidity comes back around to haunt all - if municipalities such as in CA cannot fund projects, workers don't work, can't pay their mortgages, and so on in a vicious downward spiral.
Some sharp guy (Kudlow, I believe) suggested the Fed step in and buy what the banks are writing down. Two years from now, those CDO's will have recovered their MARKET value. This is what a consortium of banks finally agreed to do to prevent a disaster centered around LTCM (Long Ter Capital Management, a hedge fund that collapsed). For Fed is apparently very reluctanct to get involved directly. But his time, the banks did not learn from LTCM, and there are no bank consortiums able to bail themselves out.
So yes, the homeowners or speculators overbought, some greedily, some out of fear. But that is the smaller part of the problem. The bigger part is the leveraged mortgages the financial community has been passing around like popcorn in a movie theatre. I blame the hedge funds. A 20% drop in the stock market doesn't bother someone who is not leveraged. But to some guy who is leveraged 20 to 1 in the stock market, a 2% drop has him sweating bullets and having nightmares. That's what's going on with the CDO's and other debt. There's a liquidity crisis and a panic - a crash in that market - there simply isn't an index like the SP500 that we can see and point to and gasp at and easily understand. The insurers are in crisis - they don't have the capital to cover. The entire house of cards was built on probability theory of risk, and now the unthinkable has happened, contrary to all "probability" the "black swan" has appeared, and that house of cards is collapsing.
That's my analysis, and if it turns out to be wrong, I'm sorry, but many of the pieces are there.
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Am I the only one who finds the relative ease with which some people make the decision to walk away from their homes disturbing?
I agree that many mortgage loans have been made to buyers that really never were able to afford them. In those cases, the lenders must share the blame for making loans which should never have been made.
However, I have seen a number of recent stories in the media where people walk away from their mortgages/homes simply because they are "upside-down" due to falling home values. Even people with fixed mortgages. They ask the question - "Why should I keep making payments on something that's worth less than what I owe on it?"
I'll tell you Why! How about the fact that you signed a contract with a lender to make all of the monthly payments? (There was never any guarantee that home values would always rise.) How about taking some responsibility for your decisions? How about the fact that, if you continue making payments on the home, you'll eventually pay it off no matter what the value of the home ends up being?
It seems to me that this type of scenario is part of a disturbing trend of "blaming the other guy" when things don't work out the way they had hoped.
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No, you're not. What's worse, many of these people walking out of mortgages don't mind being "upside-down" on their car loan the moment the drive it out of the dealer lot. All I can say is that apparently people are that stupid...
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They walk away because there is no pain. They feel that in time the same guys who send credit cards to debtors will lend them money for another mortgage.
May be its time to go back in time (1966) when you required 20% down for a mortgage and the monthly payments could not exceed a weeks earnings. There would be less upward pressure on home prices because fewer could afford one.
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Sounds good at first glance, but all this does is stretch out the problem for a VERY long time. IMHO this would needlessly prolong the credit crunch as the banks sat on these bad loans for years hoping they might eventually pay off and result in an extended slowdown like we saw in Japan. Far better, it seems to me, to endure the pain now and then we can all go back to making rational economic decisions. Kinda like pulling off a Band-Aid. Faster is better.
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The above is the only part of your post which I question. It seems to me that today's crisis is very similar to that of c. 1991. For a few years prior to 1991, lenders were too generous in credit for financing commercial real estate, among other things, as I bet you recall. The bubble burst. Many banks failed. Others cut their dividends, which happens rarely. IIRC from general reading, some change to regulation and oversight of lending practices occurred. Searching the NY Times from about 1989-1991 using keywords like {banks dividend cut} turns up articles that one would think were written in the last few months.
I think many people who lived through this foresaw the current crisis. The lesson for individuals is to beware the seduction of bubbles in any sector, and stay diversified.
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While Elle is quite capable of speaking for herself, I'm going to jump in an say that no one is disputing that this crisis is bigger than previous ones. Just that every generation seems to find a new way to make the same old mistakes. The details differ and each new version is bigger and badder than the previous ones. But the mistakes are the same.
At least in Texas, the 80's S&L crisis had liquidity effects with banks pulling back loans and businesses closing because of it.
-- Doug
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Clap, clap, clap, clap! The article is prescient for the date it was written. It softpedals the extent of the leverage and the potential damage, either because the "brain-children mafia" of leverage do not want anyone to see what they've done, or by the article's deliberate intent to promote calm.
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