One Less Than Optimal Solution to Big Sh-tpile

One problem stemming from the collapse of housing prices is that many households, even if they can still make their overpriced mortgages, are going to be paying far more for their houses than they should. That means less money for other things, from the frivolous to the important. So I’ve always wondered if we’ll ever get a flood of walkaways–people who let the bank foreclose on the house. I realize some people will want to stay in their homes–maybe they don’t want to pull their kids out of a school they like, or it’s just the wrong time to think about a move. But for many, the rational option would be to walk away. As Numerian observes, the last decade has done a good job of convincing people that honoring debts isn’t, well, an honorable thing to do anymore (italics mine):

The morality of paying back what you owe is therefore a matter of self-interest, and not something motivated by a sense of personal ethical behavior or contributing in some way to the common good. If there has been a breakdown in the willingness of some borrowers to pay back what they owe, and if this trend is growing, then something must be happening that makes it in the self-interest of borrowers to deliberately default.
…banks have severed their relationship with the homeowners to whom they have initially extended a mortgage. If you have a mortgage, you do not have a traditional borrower-lender relationship, and in most cases you don’t have a relationship at all. The homeowner is at the mercy of whatever mortgage servicer may be responsible for ensuring the homeowner makes their payment. The servicer works for the bank currently owning the mortgage, or for the investors, each of whom owns a small portion of the mortgage. When it comes to other products like credit cards or debit cards, banks have become so avaricious in imposing fees and penalties that the relationship has become that of predator to prey….
The only logical response Americans can make is, unfortunately, to become like the banks, and in certain circumstances walk away from their mortgages after weighing the consequences in a rational, business-like manner.

Investment manager Marshall Auerback argues that massive debtor revolt might be a good thing (italics mine):

On the other side, households and other non-financial institutions, whose dire finance is at the heart of the crisis, have received very limited help. Loan modifications programs and fiscal measures to raise their income and restore their creditworthiness have been too small to deal with the massive size of their financial problems, as we discussed in an earlier post.

All of which would suggest that it would not take that much to engender a situation where the country experienced a widespread debt revulsion. It might come to that, despite eminently more just historic alternatives, which Obama’s economic advisors could have drawn on, but chose not to….

if the American household sector repudiates debt by living in the house until the sheriff shows up without paying a mortgage, and then paying rent once they get kicked out, banks will then do what – shut new credit off to the private sector? Already done. In the meantime, the household sector (like Argentina when it repudiated its foreign debt) will have just increased the discretionary income and wiped the liability side of its balance sheet. Then it is just a matter of Mr Geithner figuring out another way to stress test the banks back into Treasury Dept. seals of approval, and voila, presto change!
Or maybe a debt repudiation of the magnitude we envisage might force President Obama to stop his seemingly endless appeasement of the Rubinite wing of the Democrats and embrace an approach which prevents US households from losing wealth of an amount equal to the negative equity they have in their respective homes, while the banks write down their assets to market.
Ironically, by overplaying their hand, the banks might be forcing the households to adopt an approach that will ultimately weaken the banks and expose them as the emperor with no clothes. They will take huge hits to their capital if faced with widespread debt repudiation. Now, I expect you’ll get a host of lawsuits and the very essence of the law of contract will come under attack if this scenario occurs, but the average American household might feel he has no choice and Obama might accommodate himself to these populist winds as he did in the Chrysler case, in effect overturning years of established bankruptcy law with no particular political cost to himself.

We already have congressional representatives telling people to squat in their homes. It could start to get very interesting in a year or two.

This entry was posted in Bidness, Big Shitpile, Economics, Housing. Bookmark the permalink.

11 Responses to One Less Than Optimal Solution to Big Sh-tpile

  1. Miguelito says:

    “One problem stemming from the collapse of housing prices is that many households, even if they can still make their overpriced mortgages, are going to be paying far more for their houses than they should.”
    And here I am thinking that what people should pay is written in the contract they signed.
    To put the shoe on the other foot, if housing prices jumped dramatically and the mortgage holders were paying dramatically “less” than the house was worth, would the bank be allowed to kick the mortgage holders out so the bank could then sell the house at current market value?

  2. Miguelito,
    How about instead of putting the shoe on the other foot, we take the shoes off and rethink all this…
    Do the research about what is really going on here before you go advocating for banks or say pay what the contract says. Well that contract was never a contract… Even if it was, it does not apply anymore in millions of cases.
    During the housing boom, lenders passed around mortgages as if they were whiskey bottles at a frat party. Notes were lost, destroyed, sold into multiple pools. Mortgages were not recorded and exorbitant fees were collected by the big firms on Wall Street.
    Now that the bubble has burst, these “lenders” are trying to collect on loans they do not own, in most cases never lent a dime on the transaction, have no right to, or were paid 30 times over in bailouts, insurance, credit default swaps, etc.
    Why are they doing this? They are doing this because they can. They are steamrolling the courts rocket dockets because hardly anyone is contesting their foreclosures. Think about it. If you could go into a court and file thousands of foreclosures a week, and only a mere 10% challenged the authority of the foreclosing entity, what would you do if you were the greedy bankster?
    The crises is even worse in non judicial states… There is hardly ant protection there…
    In almost every case these pretender lenders do not and did not own the loan. Almost all loans during the boom were securitized and it was investors that put up the money. Not the banks. Now these “pretender lenders” are trying to steal the homes by filing fraudulent assignments, by the thousands, if not millions, to process the foreclosures.
    Don’t believe me?
    See for you yourself.

  3. Troublesome Frog says:

    To put the shoe on the other foot, if housing prices jumped dramatically and the mortgage holders were paying dramatically “less” than the house was worth, would the bank be allowed to kick the mortgage holders out so the bank could then sell the house at current market value?

    I don’t really have much sympathy for people who are under water because they bought more than they could afford, but I don’t think that’s an accurate way of putting the shoe on the other foot. If you partnered with a bank in a venture that turned out to be a money loser and there was a provision in the contract that would let them bail out and leave you holding the bag, do you think they’d gut it out with you? I would be astonished if that was the case.
    Widespread walk-aways would simply be a case of borrowers starting to behave like the financial institutions on the other side of the deal always have. I hope it doesn’t happen, since it would be an ungodly disaster for us all. But if it did, I can’t say I’d be able to work up any real moral outrage over it.

  4. David Harmon says:

    Oh, the banks will definitely be losing lots of money on the foreclosures — because even if every mortgage-holder was a paragon of good faith, you can’t squeeze blood from a turnip!

  5. Katkinkate says:

    The whole mortgage system is a rip-off. Even in good times when you get a loan to buy a house, you end up paying at least 2-3 times the value of the original loan back to the bank.

  6. Kelly says:

    Being underwater =/= buying more house than you can afford.
    I am in no danger of not being able to pay my mortgage. I was stubborn in the amount I would spend when I bought my house.
    However, I owe more than I could get if I sold the house today.
    Thus, I am underwater.

  7. Jim Lund says:

    As the banks say, “We reserve the right to change these terms and conditions at any time…”. Home owners taking advantage when it favors them is only fair.
    And also, walking away when it makes financial sense is *good capitalism*. A mortgage payer who fails to walk away is behaving irrationally, while rational actors make for good capitalism and that’s what made America great. So paying your mortgage when it doesn’t make financial sense is bad for America, it’s like punching Uncle Sam.

  8. Eric Lund says:

    No, there is no reason for moral outrage. The deal with any mortgage is that if you fail to adhere to the payment schedule, the bank has the right to take the house. Depending on state law, they may also have the right to sue you for any outstanding balance, although in practice they will do so only when they expect their recovery to exceed the cost of litigation. It’s less than ideal because future borrowers will have to pay higher interest rates to make up for the increase in perceived default risk, but that’s life.
    Walking away is nothing new in the commercial real estate world. Donald Trump has walked away from more than one deal that went badly for him. Why shouldn’t Joe Sixpack take that option, especially when he can’t make the payments?

  9. Troublesome Frog says:

    Being underwater =/= buying more house than you can afford.

    There’s a correlation, given that people who reach beyond where they should typically put far less money down than would be wise. Putting $1 on a million dollar home is a pretty good way of finding yourself in the red pretty quickly. If you only have the change in your couch as a capital buffer, it’s probably not all that wise to borrow the other $999,999.
    Actually, let me amend my original statement. I don’t have much sympathy for people who are underwater in general. Borrowing money to buy expensive assets that fluctuate in value does that. If you paid the amount you’d be willing to pay for a place to live (as you seemed to), it shouldn’t be much of a problem. People who bought more than they should have on the assumption that it was an “investment” can eat it.
    In the spirit of Mr. T, I do have a bit of a pity list. I have *minimal* sympathy for people who got in over their heads because they were financially unsophisticated and got swindled by unscrupulous lenders. I have a *lot* of sympathy for people who were doing just fine until the housing market collapsed and they lost their jobs, and now they’re having trouble making the mortgage payment.
    The least pity goes to financial institutions that should have known better and who leave other people holding the bag all the time. They know how the game is played. I’m just against mass walk-aways because I don’t have enough canned food and ammunition to wait out a financial meltdown, and I’m the type of frail, nerdy guy who never does well in the Road Warrior type stories.

  10. Marty from North Dakota says:

    Credit comes from credibility. When this mess finally collapses, credit will be very hard to come by; in fact, already is. People who ride a scooter will be much better off than those on rollerblades.

  11. james barrick says:

    Don’t like Banks? Use CASH as much as possible. Drop the Fee cards, uh I mean, the Debit and credit cards.
    Use CASH.
    Your grandparents most probably employed this strategy.
    Transactions are between people, no government bureaucrats, no IRS agents or Revenuers, no interest rates or fees. Just CASH. ( Having said that publicly I now expect to be audited.)

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