RISMEDIA, February 2, 2010—Should homeowners be morally obligated to make their mortgage payment? What if they could legally stop paying their mortgage and stay in their house with clear title? Should they do it?
These are questions more and more people are asking themselves, as it is now obvious that neither the government nor the banks are going to help homeowners who are upside down or having difficulty making their payments.
A year after the Obama administration launched its housing rescue program, foreclosure filings continue to set records.
Foreclosure filings were reported on more than 2.8 million properties in 2009, up 21 percent from the previous year and 120 percent from 2007, according to RealtyTrac.
Ten percent of all mortgages are currently delinquent which suggests that even more homeowners will face foreclosure this year.
“A massive supply of delinquent loans continues to loom over the housing market,” RealtyTrac CEO James J. Saccacio said in a statement. “Many of those delinquencies will end up in the foreclosure process in 2010 and beyond.”
Meanwhile, the number of “strategic defaults” more than doubled to 588,000 from 2007 to 2008, according to a study by Experian and Oliver Wyman. A separate 2009 survey found that more than a quarter of all existing defaults were strategic.
Recently, experts have suggested simply walking away. “Homeowners should be walking away in droves,” Brent T. White, a University of Arizona law school professor, said in a recent white paper. “The financial costs of foreclosure, while not insignificant, are minimal compared to the financial benefit of strategic default.”
The pressure to default
Homeowners have found themselves in foreclosure for a number of reasons, most beyond their control and not the result of poor decisions by them.
Because the economy was largely derived from betting on economic failure, mounting and compounding failures are taking their predictable toll on the lives of hardworking people who did not get rich as a result of the greatest transfer of wealth in history.
They have lost jobs and businesses as a direct result of “financial intermediaries” leveraging failure. If they work in retail, construction, financial services, or even government, it is difficult to see much improvement in their prospects. (See “White Washed Windows and Vacant Stores”)
We are told that unemployment is over 10%, but that is extremely conservative in that it does not include those who are no longer collecting unemployment insurance, those who are discouraged and no longer look for work, and those who have had to accept reduced hours or a reduction in pay.
Here is the more telling figure: the average work week is only 33 hours. One source suggests that the real unemployment impact is closer to 20%.
Considering that only 10% of mortgages are in default, it is likely that more defaults will arise from loss of income.
Personal and business bankruptcies spiked in 2009, and the real trickle down from that has yet to be felt.
Uninsured or under insured accident or illness victims are often confronted with the double whammy; the medical costs and possible additional loss of income during and after recovery.
Many are victims of predatory lending, forced into one of those designed to fail loans rather than the loan their credit score really warranted. This increased the yield spread premiums on the front end and would pay out several times the loan amount when the loan defaulted.
Is it business or personal?
As real estate values continue to decline, some borrowers who are capable of making their payments have begun to ask, “Why continue to throw good money after bad?”
People might voluntarily stop making their mortgage payments for one of two reasons: because they no longer want the home or because they want to force a confrontation with their pretender lender to determine the true holder of the note for the purpose of seeking redress regarding claims of predatory lending, which might result in a mortgage modification and even damages. (See, “Are You A Victim”)
Most borrowers continue to make their payments, either because they want the home or because they believe they are either legally or morally obligated to do so.
Professor White suggests that misplaced loyalties and antiquated values prevent otherwise clear-headed individuals from simply walking away from a bad business deal.
Most people underwater on their mortgages stay current “as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosures perceived consequences,” White says. In addition, he notes, societal norms push individuals “to ignore market and legal norms under which strategic default might not only be a viable option, but also the wisest financial decision.”
The commercial market is about to become a hotbed of strategic defaults for reasons related to balloon payments, business declines, or reduced value making it unwise to hold from a business prospective and impossible to refinance. (See, “White Washed Windows and Vacant Stores”)
Upside down and sinking
In the residential market, the reality of lost equity will eventually sink in and homeowners who have grudgingly been making a payment on a loan twice the value of the home will look into their options.
According to First American CoreLogic, a real-estate information company, about 5.3 million U.S. households have mortgage balances at least 20% higher than their home’s value, and 2.2 million of those households are at least 50% under water.
They should have no trouble finding hungry agents willing to help them buy the same floorplan down the street and close prior to defaulting on their loans.
Defaults will increase but will a wave of foreclosures follow?
Not necessarily. The bank doesn’t really want your home—that isn’t their deal and, remember, it isn’t even their money at risk.
For this to make sense, we have to change our antiquated view of banking and lending. Banks only call themselves banks to confuse you. In reality, they have morphed into “financial intermediaries.” They do not lend their own money.
These financial intermediaries, during the 10 years since the repeal of the Glass Stegal Act, have sold out America and engineered its demise. Here is what they really do.
They receive bundles of cash from investors and promise those investors a monthly payment. They keep half of the cash as their “yield spread premium” and loan the rest at a rate sufficient to make the monthly payment promised to the investor.
Then they pay a premium to a counterparty or insurer such as AIG for a credit default swap. The terms of the default swap agreement, such as “triggers,” events that trigger the payout, are determined by the financial intermediary.
Trigger events could be as benign as a certain number of borrowers paying off loans early, or a certain number of defaults within a pool. A good example might be the 2/28 adjustable loan. A pool of those loans was the gold standard of the whole scheme. The financial intermediary would simply make a huge side bet, maybe 30 times the value of all the loans in the pool, that a large number would default within three years. A certainty by actuarial calculations.
Once a certain percentage of defaults occur within a particular pool of loans, the “financial intermediary” declares the entire pool of loans in default, keeps all the payments on the loans in the pool that continue to perform, and collects on the credit default swaps.
The last thing “financial intermediaries” want is for all of the loans in a pool to get paid back in full. The investor will want the original investment back but they will only get the half actually loaned out. The “financial intermediary” must make a certain percentage of loans fail or give back the yield spread premiums and pass up on the credit default swaps.
This also helps explain part of the motivation behind all of the defaults recorded on people who made their payments on time every month. Missing a payment is a default, and they want to keep you in default.
The same with modifications. If they modify the loan, it’s still performing and there is no trigger event. That is why I do not believe that many trial modifications will result in permanent loans. As long as they pretend and extend, you are still in default.
Did you get all that? The “financial intermediary” collects insurance on the default but has multiple problems if you pay back your loan. And, there are no limits on credit default swaps, so “financial intermediaries” bought multiple times the loan amount. That is why there are way more derivatives traded than there is stuff to underline their value.
Surprise! What happens when you default
Lenders benefit when you default. And, that is why values are going down, because the financial intermediaries who once overvalued them to sell more debt are pushing back on appraisals because they know that a certain number of people are going to agree with Professor White, and when values reach a certain point, they will default.