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Source link: http://archive.mises.org/20512/ready-set-walk/

Ready, Set, Walk

January 16, 2012 by

More and more underwater borrowers are deciding it’s time to walk from their mortgage. “Guilt and morality are one side, and objective financial analysis are on the other side,” 68-year old David Martin told msnbc. “They’re coming to two opposite conclusions. I wonder how many other people are struggling with the same question.”

Three out of 10 foreclosures in 2010 were of the strategic variety, an increase from 22% in 2009. The Mortgage Bankers Association believes strategic defaults are spreading like a virus. In a study entitled “Strategic Default in the Context of a Social Network: An Epidemiological Approach,” conducted by Michael J. Seiler of Old Dominion University, Andrew J. Collins of the Virginia Modeling, Analysis and Simulation Center and Nina H. Fefferman of Rutgers University and sponsored by MBA’s Research Institute for Housing America (RIHA) the authors found “One default does little to negatively impact the price of surrounding homes. However, as more and more mortgages in the neighborhood go into default, the negative impact is felt at an increasing rate. Much the same way as a disease spreads throughout a population, so, too, do decisions to ‘strategically’ default.”

Despite some experts projecting that the worst is over for housing, the immense shadow inventory of homes is casting a …well…shadow over the housing market. These estimates of the number of homes in foreclosure or likely to be in foreclosure are all over the map from Corelogic’s 1.6 million to 10.3 million estimated by Laurie Goodman of Amherst Securities.

Michael Olenick pegs the number at 9.8 million with the exposure being $1 trillion. He writes,

It is unclear where the money from these write-offs will come from, or whether they losses have been adequately budgeted. Obvious sources are Fannie Mae, Freddie Mac, European and US banks, none of which have reported anywhere near this level of reserves. We know that the Federal Reserve has been buying up MBS and related instruments in bulk; maybe the central bank plans to print more money to cover the losses and enable the foreclosures. Printing this much money, for this purpose, in this political environment, in secret, seems unlikely.

The Fed can keep printing, but it won’t keep homeowners from walking away.

{ 38 comments }

Rory Carmichael January 16, 2012 at 4:55 pm

Strategic default is probably one of the best things that could happen for the economy in the short run. A defaulter trades easy access to future credit for reduced debt burden, which seems like exactly the sort of thing that would speed up de-leveraging/undoing malinvestment (Good according to Austrians) and increasing aggregate demand (good according to Keynesians). What’s not to like? I guess it is a “deflationary” pressure in some sense, because the prices of a large class of goods (houses) will shrink as supply from foreclosures grow, but you’d think the countervailing inflationary forces from a speeding up economy and loose money policies from the federal reserve would counteract that pressure to some extent. Hard to see a real strong downside (other than some creditors getting hurt of course, but that’s part of the giving out risky loans business).

nate-m January 16, 2012 at 7:21 pm

Of course defaulting on loans you can’t afford is a good thing.

What would end up happening in a ‘natural’ economy is that in a housing market like this the banks would rather see their mortgage payments drop to a fraction of the originally negotiated amounts in order to retain people in their houses. Empty houses lose value rapidly because without the minimal maintenance and protection they get from a tenant they quickly become dilapidated.

I’ve seen houses that had the bathtub stolen out of them, while the water service was still active. The result was that water flooded the basement for several weeks before somebody noticed and shut it off.

The house next to mine had all sorts of improvements put into it by the previous owner (extra room and a bunch of other stuff), then it was abandoned. A tree branch hit the roof and caused a small leak, which was never noticed and rectified. Eventually the ceiling caved in and another, larger, branch landed on the house and collapsed a different part of the roof. Now a house that was in the 90-100,000 dollar range on the market was condemned by the city and dropped to under 25,000 in real market value in a period of about 6 months.

All of this means that whoever is living in the house at the time, during a housing slump like this, has a HUGE amount of leverage over the bank. The bank would have no choice but to renegotiate at a huge disadvantage. This is the punishment you get for making bad loans.

But it’s all getting f*ked up. With ‘mortgage bailouts’ and artificially low interest rates and all that stuff the government is doing everything in it’s power to prop up falling prices. They are even doing things like having the government-ran mortgage companies put their houses up for rent, which means that they are effectively forcing people that can afford to pay mortgages out of business. They are doing things like buying up houses to just destroy them. All sorts of really stupid and horrific things.

All this means that it leaves the only choice for preservation for a underwater home owner is to simply walk away.

Wildberry January 17, 2012 at 12:36 pm

Hi nate-m…been awhile.

You are describing waste. All the money that went into the bubble is largely going to waste.

Everyone is trying to minimize their losses on the way down. That is what we are seeing.

In the end, the government attempts to control the market must fail. It cannot be stopped any more that the bursting bubble can be stopped.

I think the only question will be what the battle field looks like when it’s over. Therefore nothing, walking away or being a “good borrower” is all a good or bad thing. Any move has consequences that cannot be explained away with a slogan here or a declaration there.

I think it was Hoover who bragged how he protected falling wages during the depression, but his self-congratulation ignores the consequences of that policy on the other factors, like employment, etc.

If in fact everything is connected, then no single move can be viewed as all good or bad, only better than other moves or standing still for the individual in question.

I don’t think any of us are smart enough to figure out how to navigate ourselves through this.

Have you heard of Mises’s arguments on the calculation problem? Same thing…

nate-m January 17, 2012 at 3:26 pm

The government interfering with the market to protect the banks from their own bad decisions, which is invariably resulting in damage to everybody else who isn’t as politically connection, would be accurately described as a ‘bad thing’.

Otherwise I don’t really understand anything your trying to say. It seems like your floating in space rather then collecting together a rational series of ideas.

Wildberry January 17, 2012 at 5:20 pm

Thanks for trying; I remember your sarcasim from previous encounters.

A society which lacks a moral imperitive to honor one’s promisses will create negative consequences, too. That is the other side of the coin.

I am not arguing which side is better, but unlike you apparently, I do see two sides.

I do see that government intervention also creates consequences. Their involvement in the housing market is a negative in the way you describe, I agree.

I guess my position would be that the intervention should be eliminated as much as possible, while not undermining the fundamental moral value of making promises you intend to keep. That is also a good thing, don’t you agree?

Sione January 18, 2012 at 1:53 am

Wildberry

It is simple enough.

A contract is contextual. It is an agreement between a borrower and a lender. Both parties assume risk.

Should it be the case that the borrower can’t service the loan, then he can try renegotiating terms or, should that fail, default the loan and walk, especially where his circumstances do not allow him to service it.

The contract between borrower and lender is not one that allows the lender to force the borrower into slavery for the rest of his life. Such a thing would indeed be utterly immoral.

Sione

Gil January 18, 2012 at 3:31 am

Why not Sione? Why should a borrower walk away and the lender has to suck up the loss? A person who doesn’t offer collateral in lieu of non-payment should indeed be obliged to pay back the loan with all effort and not simply walk away when it gets inconvenient. In fact, yes, a person should be enslaved until the loan has been repaid because they’re thieves – they’re stealing the lender’s money by not paying them back. If I borrowed your car and I decided to keep your car then you have every right to call the police and have me thrown into jail for car theft.

Dagnytg January 18, 2012 at 5:43 am

Gil,

I can’t believe you’ve written something I agree with…the world is truly upside down…but your observation is definitely worth consideration.

It seems to me that people are confusing “walking away” with the filing of bankruptcy but the two are very different. I also believe that people are forgetting money is property.

Therefore, your assessment of the situation is very relevant…and I applaud the observation.

For the record, I’m on the fence with this issue.

Wildberry January 18, 2012 at 7:52 am

Sione,
If we are talking about a contract, the parties have a duty to act in good faith. Under that condition, the contract usually allocates the risk between the parties.

I have no problem with either party taking whatever action under the contract terms, they are entitled to, including the consequences of breach. That is not to say that in the bank/homeowner relationship, it is always and completely the risk of the bank. A loan is a bilateral agreement. Both parties have legal and moral obligations to act in good faith.

Wildberry January 18, 2012 at 7:56 am

Gil,

We outlawed debtor’s prision some time ago, for good reason.

If you loan your car to someone with losts of money, or one with nothing, as long as both parties acted in good faith, you take your lumps for your decision.

Do you honestly think that if I loaned you my car, and I knew you were homeless with no assets, and you then totaled it, I would have the right to make you a slave or prisoner for the value of the car? What about my responsibility here?

If it was purely an accident, or if you were on drugs and drifting it at the time, wouldn’t that make a difference?

CT January 18, 2012 at 10:29 am

Even without bankruptcy laws (which I am in favour of), I think most private contracts would include the option for the borrower to declare bankruptcy and walk away. The interest rate charged would be higher, obviously.

Wildberry January 18, 2012 at 11:25 am

CT,

Bankruptcy is not a matter of the contract, it is a matter of public policy based on our rejection of slavery, and economics (a debtor in prision is a net cost to society).

The alternative is debtor’s prision, which we’ve rejected.

Anyone is free to breach a contract, as long as they are willing to accept the consequences. All a contract can do is allocate the risks between the parties, and maybe create an agreement that changes the operation of law, say being personally responsible for something that you are not otherwise required to be responsible for, etc. A contract can establish collateral; i.e. the mortgage for the note.

Bankruptcy is always an option, but it is not inconsequential. That is a good thing for those of us who pay our bills. Otherwise, we (payers) would have to subsidize non-payers with higher interest rates and qualifiation restrictions.

But, failure is part of the capatilist system, subject to good faith conduct.

CT January 18, 2012 at 2:08 pm

Wildberry,

I did not express myself clearly, my apologies. I am aware that bankruptcy laws are part of public policy (and not part of contracts – duh) – which I agree with. I don’t want to see a return of ‘debtor’s prison’ any more than you do. The point was that, in the anarchist society that this site tends to promote, the majority of contracts would include a bankruptcy clause. Many anarchists seem to think that people in an anarchist society would be on the hook for their debts until they were completely paid off. I beg to differ. Banktuptcy is legitimate and necessary and would exist without gov’t involvement. The question is whether or not there would still be poor saps having to work as near slaves to pay off their debts because they chose not to have a bankruptcy provision in their contract. This kind of question is why I’m a minarchist.

Anyway, I pretty much agree with your comment. I was just speaking hypothetically.

Wildberry January 18, 2012 at 3:34 pm

CT

I see. This is interesting:

in the anarchist society that this site tends to promote, the majority of contracts would include a bankruptcy clause.

I understand this is not be your position, but you are attributing it to the anarchists.

The assummption they seem to make is that nothing can exist outside the “contract” as described by TTT promoted by Rothbard. This is, IMHO, nonsense. It would mean in practical terms, that no contract could exist except within the terms of its own 4 corners of the document itself. You would either have to recreated volumes of legal code (try the UCC for example), or resort to physical enforcement in disputes that are not covered in the contract.

Under the UCC, for example, million dollar transactions can take place on a handshake and a minimal writing between merchants. Under an anarchist theory of contracts, contracts would each be volumes of text.

In the end, it would lead right back to where we are, which is that certain terms can be “assumed” if not specified based on legal rules.

This lack of understanding of simple reality is why I think the Ancaps here are irrelevant, in the grand scheme of things. They contruct a theory of society by simply omitting stuff that doesn’t fit very well.

In any case, I’m not sure how the concept of “debt forgiveness” as a term of a contract would work very well in the ancap society described here by most. It sounds like to me that the person with the biggest PDA wins.

Cheers

CT January 18, 2012 at 4:53 pm

I haven’t read all that much about Rothbard’s TTT. Right now I’m focussing on understanding all the important schools of economic thought and their ideas. Needless to say, there’s a lot of reading to be done.

justaluckyfool January 20, 2012 at 2:04 pm

“A society which lacks a moral imperitive to honor one’s promisses will create negative consequences, too. That is the other side of the coin.”

But a society that was mislead and lied to would create even more negative consequences by honor their promise !
The cause of the Financial crisis was not because of the borrower’s in ability to pay,That was taken into the consideration of making the loan.The lenders model dealt with that with the idea that the defaulted loan would be insured and replaced with a higher loan.
They did not take into consideration that the bubble would burst IF the ” rate of acceleration of the private debt” (Steve Keen) were to have to increase so rapidly that another “fool” either could not or would not sign.That plus the fact that on an average of 30 times leveraged,NO ONE could make the notes whole.

Bogart January 16, 2012 at 5:04 pm

Why leave the keys and split if you can pay a portion of the utilities. The backlog is 1.5 to 3 years in most states before the banks can even process the foreclosure. So the best solution is to stop paying all but the most necessary utilities and wait for the Fed-Bank Cartel to catch up. And the best part is that the Fed pays the tax through their member banks. Otherwise the Bank will lose the collateral as well as the cash.

And if the local school district sends the evil tax people by then just pay $100 and stiff em and they probably won’t be back for several months.

nate-m January 16, 2012 at 7:07 pm

Because you can do a short sell and get out in a gracious way. It allows for a greater control on your part (rather waiting on some bank to get around to kicking you out) and you hopefully end up with a good enough standing that you don’t end up having to live in shitholes for the next 7 years.

If you can’t sell short then, yeah, just stick around till you get evicted.

Bogart January 16, 2012 at 5:05 pm

I would recommend calling the bank and telling them that you do not have the money for the taxes. Then they will have to pay them or risk losing the property and mortgage paid on the property.

HL January 16, 2012 at 5:10 pm

I am a convert! Hoping to get the short sale paperwork started next month. Convinced wifey finally. “Baby, we are all Greeks now. Pass the feta.”

Craig January 16, 2012 at 8:22 pm

With all the bank wrongdoing during the mid-late part off last decade, I recommend just suing the bank. That way, you could protect your credit, protect against deficiency judgments, and potentially even get a part of the settlement. The program is simple, a US Residential representative qualifies you and your property, then you get a free consultation with local attorney to discuss the merits of your case. This program is currently available in only 28 states.

Disclosure – I am a US Residential representative in WA state.

Wildberry January 17, 2012 at 12:24 pm

Craig,
How do the financials work in this scheme?

How do you get “free” consultation? What is a “US Residential” representative?

Walt D. January 16, 2012 at 5:22 pm

One of the problems with “Extend and Pretend” or “Delay and Pray” in the residential real estate market is the built in retirement demographic. The 9% unemployment statistic lie may be able to “define away” people who have lose their jobs and take early retirement, it cannot define away the consequences. Many of the 400,000 people who are seeking unemployment benefits each week are in their 60′s and may never work again – they will collect their unemployment benefits and then retire. Also, many companies force people to retire at 65. In the past these people would have equity in their houses or even own them free and clear. They would sell them at a profit and downsize. Now many people are faced with a mortgage they can not afford and a house that is underwater.
What to do? Stop paying the mortgage, save the money and wait 2 years until you are evicted. Immoral? Perhaps. However, in an amoral society, with an immoral counterparty, there is no point in being moral.

Wildberry January 17, 2012 at 12:21 pm

Walt,

Do you admit it is a moral dilemma, but just come down on the side of the borrower?

There are social consequences for being a “shirker”. That is why it is partially a moral issue.

On the other hand, the lending policies of banks, backed up by FDIC, FRB, Fannie and Freddy, and the Treasury all contributed to the common practice of making bad investment decisions; loaning money to a party who had a high risk of failure, whether acknowledged at the time or not.

I tend to think of it like most big issues; there is no absolute right answer.

Walt D. January 17, 2012 at 7:29 pm

Wildberry,
I prefer to consider it as a business transaction governed by a contract that was drawn up by the mortgage company or the bank. If things work out in their favor – interest rates get hiked to a point where you can no longer pay, they are going to enforce their end of the bargain. they are not going to give a rat’s ass about your personal circumstances, so why give a rat’s ass about theirs? It not like they lent you the money for free. They are essentially borrowing from the Fed for free and lending it out a huge markup.
If you borrowed money (for free) from a member of your church, then I would say you have a moral obligation to pay it back.

Wildberry January 18, 2012 at 7:43 am

Walt,
I get that. I just don’t see a distinction between a transaction with a bank an a church.

All parties have a moral obligation to act in good faith. I don’t think that means one thing when you are opposite a banker v. a church.

It’s a business transaction. If it doesn’t work out and the parties involved acted in good faith, then I don’t see the problem.

I think I am reacting to the attitude that makes it out like the borrower is the victim against the big, bad bank. If we are making moral judgments, then I think we have to look at the intent of the parties. If the motive is bad faith exploitation, it is morally offensive.

If the conduct is in good faith, well, then s..t just happens. Everybody takes the lumps they signed up for.

Walt D. January 20, 2012 at 4:21 pm

” I just don’t see a distinction between a transaction with a bank an a church.”
I actually said a member of your church. Morality is a religious issue. The reason that I used member of a church is that members of a church or synagogue or a mosque have common moral values. Transactions between members are conducted on the tacit acceptance of the same moral values. Note that this would not necessarily be the same between two different religious institutions. For instances, Muslims consider charging interest to be immoral. Catholics consider high interest rates (such as some credit cards or store cards) to be immoral.
A legal contract has the advantage that it does not require the contracting parties to be of the same faith, (or for that matter to have any faith at all).
So the key question, as you state, is whether or not the two parties entered into the contract in good faith?

Wildberry January 20, 2012 at 6:48 pm

Walt,

Yes, I understood it would be with a member, not the church itself. But I disagree with this:

Morality is a religious issue.

Morality is an ethical issue. While it is true that ethical codes, as you say, may have commonality along religious lines, I think all ethical frameworks are a product of the social context. What I mean is that on certain principles, “thou shalt not kill” may bridge accross many different religious and non-religious groupings.

The ethical principles of private property, for example, are much more universal. Dependability as an ethical standard, is another important example.

It is true that these particular principles of ethics dictate what is good (respecting the santity of private property; being dependable upon your word), moral conduct is simply the measure of one’s conduct in relation to this code.

If honesty is the ethical principle, and I am dishonest, then it is proper to say I am engaging in immoral conduct, espeically where I myself believe in honesty, but give myself a pass in certain situations.

A legal contract is a product of at least two elements; the ethics that each party brings to the transaction (otherwise the contract could assume nothing, like “good faith”, and would have to be voluminous), and the intentions to agree to be bound that is created between the parties.

Contracts do not require that the parties be of the same faith, but they do require either a common understanding of the ethical context that is implied, (and an assessment of the risk, including the risk that one party will act in bad faith, and what remedies are available in that event).

The key issue depends on the question. I think the concept of good faith is one of those rather universal concepts. It is an ethical code that serves to predict what someone will and will not do, and what conduct would b e considered immoral.
Since we are likely to only want to do business with moral parties, there is a social imperrative to act morally. Otherwise, we find ourselves ostracized because of a poor reputation for morality.

Horst Muhlmann January 18, 2012 at 10:12 am

If your bank received TARP money, or your mortgage is owned by Frenron, YOU HAVE NO MORAL OBLIGATION to pay them one penny. At that point, all this “moral obligation to pay back your debts” crap goes right out the window.

Pay or don’t pay, depending on what makes you better off.

bill wald January 16, 2012 at 7:00 pm

I suspect that many of the people who default would be better (or no worse) off financially if they didn’t buy on credit and rented for the rest of their lives.

George January 17, 2012 at 10:31 am

Walking away from the house is easy enough, but walking away from the obligation to repay the loan is not so easy in some states.

The laws of the state you’re in have to be considered when making a decision like this, it may not be so simple for some. In Florida many strategic defaulters are being hit with deficiency judgments for $100,000 or more.

Many folks walk away and think they’re clear only to be hit with a deficiency judgment a year or two later.

The bill collectors are even staying in the background doing periodic credit checks on folks and when they see they’re in a better financial place they appear demanding their money and going to court and winning.

There are a lot of short and long-term consequences associated with walking away, so make sure you know what you’re doing before making the decision.

Wildberry January 17, 2012 at 12:15 pm

Bingo, George.

The only final solutionis bankruptcy, a much bigger pill to swallow. Borrowers remain personally liable for the note, not just the mortgage.

However, it is a right that can be exercised as part of a strategic foreclosure.

Sione January 18, 2012 at 1:44 am

Or, of course, the borrower can demand the lender proves they hold the “promissory” note. If the lender can’t deliver on that (and mostly the banks et al can’t it would seem), then they can’t enforce demand for payment. Game over. US law is weird but sometimes there are interesting details in it that can turn out to be very important and most useful for some. Anyway, check it out.

Sione

George January 18, 2012 at 10:13 am

That worked a time or two a few years, but lenders are wise to the ploy and now, especially after the robo signing fiasco they have the paperwork in order before going to court. Even if the bank doesn’t have the proper paperwork the first time they simply get it together and refile.

If this were something that would work on a large scale it would already be being done, it isn’t successful anymore because the banks are onto it. It’s also something that was more common to houses sold during the bubble, the loans processed before MERS are largely in order.

This may delay the inevitable, but you won’t get a free house out of the deal.

Walt D. January 20, 2012 at 4:38 pm

” Even if the bank doesn’t have the proper paperwork the first time they simply get it together and refile.”
The problem is that in many cases they can’t. They broke so many laws that in many cases they are in violation of the IRS securitization laws, State Real Estate laws, State Income Tax laws, US Bankruptcy laws. In California, where property is secured by a Deed of Trust, they are more likely to get away with a fraudulent foreclosure. However, if the chain of title is not correct, they can not resell the house – the Title Insurance Company will not issue a policy. Needless to say, the banks are not necessarily in a hurry – they would prefer to own a non-performing mortgage, where their own cost of carry is 0.01%, and “wait until the market goes back up”, rather that acquire a property that they can’t resell and then have to book a loss.

Wildberry January 20, 2012 at 7:02 pm

I think there is a distinction between a note and a mortgage to secure that note.

The note always belongs to someone connected to you, the borrower who promised to pay the debt.

Also, the property may not have a clear chain of title, and there may be some procedural obstacles to foreclosure, but George is very correct; you are not going to be unjustly enriched with a free house because somebody else screwed up.

You still are obligated under the note, and whether the foreclosure is subject to a mortgage or a deed of trust is simply a procedural/technical issue.

I think Walt is onto the real issue. What he says is that the economics of balance sheets, loss reserves, etc, favor holding rather than liquidation. To liquidate is highly deflationary, and deflation is the enemy of the banks who hold debts secured by assets. If those assets deflate in price, that is good for consumers, but very bad for lenders.

Since the cost of money is near zero, inflation alone, in theory, will eventually overtake price deflation. This favors a “wait and see” by the banks.

Their biggest problem is that they are slow and people are quick to adapt.

What would be the best, from an AET point of view, is for the inventory to clear at market prices. Even speculators are at a disadvantage in an environment of price deflation, so housing would tend to be purchased by owner/occupiers and the price would have some relation to income and cost of living.

I don’ think that is in the economic interests of banks though at the moment, for the basic reason that Walt states.

Mushindo January 18, 2012 at 6:23 am

The interesting thing about the concept of ‘strategic default’ , given the Austrian view of value subjectivity, is that however you try to differentiate it from (what one might call) ‘affordability default’ , you cant avoid drawing an arbitrary line in separating the categories.
the poorer defaulter at the affordability end of the default spectrum is still allocating SOME of his income, however modest, to ‘necessary’ costs or obligations, which he has determined take precedence over his mortgage obligations. the ‘obscenely wealthy’ defaulter at the ‘strategic’ end of the spectrum is probably easy enough to identify. But for all those who lie in the middle of th espectrum, by what objective standard would his ranking of his expenditure priority within his income constraint is right or wrong?
Put another way, One mand necessity is another mans luxury: for a so-called ‘affordability’ defaulter ( who may have a high time preference), is the cost of running his automobile a luxury, or a necessity warranting payment ahead of th emortgage payment? you can bet that most defaulters still drive cars! (and have TVs come to that…….) And for a so-called ‘strategic’ defaulter with low time preference, is his self-imposed savings regime to support his family in old age a necessity, warranting priority over his mortgage payment, or a luxury? I think that in both cases, the only relevant opinion is that of the person himself.
which leaves the question of whether any particular default is ‘strategic’ or ‘affordability-driven” moot.

Virginia Llorca January 18, 2012 at 2:53 pm

Strategic default is encouraged and rewarded by financial institutions. E.G.: BOA for sure. The same bank turned down purchase offers that would have been more profitable than offering the bonuses and processing the short sales and deeds in lieu. It is possible that this in itself is strategy for them. And I am pretty sure the algorithm for that strategy is printed out on a dartboard.

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