I’ve previously mentioned
University of Arizona law professor Brent White’s report
on strategic mortgage defaults. I want to delve into this paper further.
One of the great challenges we face is resetting the moral thermostat of this country. It’s been lounging at the most frigid levels.
The place to start with this reform, as with all reform, is with the land. Nothing will work without Land Reform.
In today’s case the question is walking away from your mortgage when you’re underwater. This refers to where people took out home mortgages at the peak of the bubble, where the nominal prices were absurdly bloated beyond anything supported by market fundamentals. When the bubble inevitably burst and housing prices began to seek their real levels (a process nowhere near complete), millions found themselves owing more on their mortgages, in many cases far more, than the home is now worth on the market, or likely ever will be worth again. This is called being “underwater”, or in a state of negative equity.
The people we’re talking about are mostly not “flippers” or those who knowingly took on debt they could never possibly afford. The vast majority were simply Americans looking to buy a house, just like Americans have long been doing as an everyday activity. Just like the government, the corporations, and the media hve been drumming into their heads and supporting with every sort of incentive for many decades now.
Home ownership, the keystone of the American Dream.
And over the last decade the bank-government-media nexus has relentlessly pumped up and cheered on the housing bubble. The subprime craze was instilled and enabled from the top down. No amount of irresponsibility on the part of ignorant borrowers could be meaningful compared to the systematic recklessness of lenders and government, recklessness as policy.
No, 100% of the blame for the bubble and the crash lies with the establishment, while the underwater homeowners are victims. If a con man takes advantage of an ignoramus, and the result is disaster, there’s no point blaming anyone but the crook.
In this case, for many homeowners the rational thing to do would be to simply stop paying the mortgage and either walk away or wait to be foreclosed upon. But so far relatively few people are making this decision.
At least in part this is because of false social conditioning and inaccurate media propaganda.
White’s abstract describes the situation well:
Despite reports that homeowners are increasingly “walking away” from their mortgages, most homeowners continue to make their payments even when they are significantly underwater. This article suggests that most homeowners choose not to strategically default as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure’s perceived consequences. Moreover, these emotional constraints are actively cultivated by the government and other social control agents in order to encourage homeowners to follow social and moral norms related to the honoring of financial obligations – and to ignore market and legal norms under which strategic default might be both viable and the wisest financial decision. Norms governing homeowner behavior stand in sharp contrast to norms governing lenders, who seek to maximize profits or minimize losses irrespective of concerns of morality or social responsibility. This norm asymmetry leads to distributional inequalities in which individual homeowners shoulder a disproportionate burden from the housing collapse.
The “social control agents” try to enforce a potemkin moral norm in place of a reality-based market norm. But this is really the abdication of morality. We shall recover true morality only when we rediscover our communities and recognize the federal and corporate system as an alien, immoral tyranny over us.
We must be clear that reason alone will not work against this top-down social fraud. White’s paper provides a case study in how the Enlightenment pretense is really the Enlightenment Myth. We need an idea to fight an idea, morality to fight immorality, vision to fight meanness.
Let’s start with the data (from White’s paper).
As of June 2009, nationally 32% of homeowners were underwater on their mortgages. This is expected to rise to 48% by the first quarter of 2011, by which time prices in the hundred biggest metropolitan areas will have plunged 42% from their peak.
Regionally it’s far worse. As of 6/09 66% in Nevada were underwater, in Arizona 51%, Florida 49%, Michigan 48%, California 42%. Many metro areas in these states are running above 70%, some above 80%.
As of the second quarter of 2009 22% of homeowners were in negative equity greater than 10% of the home’s mortgage value. 16% were underwater more than 20%.
Again it’s worse regionally. 47% of Nevada homeowners were down deeper than 25%. In Florida 30%, Arizona 29, California 25. In these cases, where the bubble prices were really extraordinary, many of these homeowners are now down by hundreds of thousands of dollars.
All this has led to a combined foreclosure plus 30-day-or-greater delinquency rate of greater than 13% of all mortgages, an all-time high.
But these aren’t from strategic defaults. Rather, 75% are on account of hardship – job loss, medical disaster, divorce. “In other words, for the vast majority of homeowners, negative equity is a necessary but not a sufficient condition for default.” (p. 5)
Put it all together, and although over 32% of US homeowners were underwater, the strategic default rate was only 3%.
The pattern is similar in the hardest-hit regions, where the default rate tracks the unemployment rate more closely than it does the underwater rate. So here too, people aren’t walking away just because they’re in the red.
White comments, “Given the striking disparity between the percentage of underwater homeowners and the percentage of defaults, the real mystery is not – as media coverage has suggested – why large numbers of homeowners are walking away, but why, given the percentage of underwater mortgages, more homeowners are not.” (p.7)
White goes into the textbook explanation of when and why economically rational people would walk away. Basically, it’s when the net cost of renting is lower than the net cost of buying. Many variables go into this calculus – mortgage payments vs. rent payments, but also tax implications, expectations for the housing market, potential to accrue equity, costs of maintenance, homeowners insurance, selling transaction costs, etc.
Put it all together, and “as a rule of thumb, a potential homebuyer is generally better off renting when the home price exceeds 15 or 16 times the annual rent for comparable homes.” (p.8)
If it’s a question of walking away from a mortgage, there’s the considerations of a realistic view of the real current value of the house, existing negative equity, cost of foreclosure, cost to rent a similar space, how long one intended to stay, and a realistic assessment of what you expect the market to do during that time. You need to calculate the various current balances and monthly payments, and based on all that calculate how much you’d save or lose by walking away, monthly and in the long run.
If everyone calculated this way, then millions of homeowners, especially in the most beleaguered states, “could save hundreds of thousands of dollars by strategically defaulting on their mortgages….Homeowners should be walking away in droves.” (p.11)
It’s also untrue that you’d be likely to have your credit permanently ruined. The hit could be temporarily harsh. Generally, the penalty is 100-150 points on account of foreclosure, as well as demerits per late payment. The total hit is likely to be from 300-400 points, which could take 7 years to completely clear.
But if your credit was otherwise good, you could see significant improvement within 2 years.
(In a subsequent post we’ll get into how the credit rating regime is unjust in principle, and why defying its veto over our actions is in itself a valuable action.
Beyond that, there’s the general campaign to get out of debt completely, in which case the credit rating issue would become moot, especially if enough people did it. That’s beyond the scope of White’s paper.)
The basic point is that for most underwater homeowners the cost of an impaired credit rating is likely to still be dwarfed by the savings from walking away.
White concludes: “While a good credit rating might save an average person tens of thousands of dollars over the course of a lifetime, a few years of poor credit shouldn’t cost more than a few thousand dollars.” (p.12)
White goes on to add, in a much misunderstood and misrepresented quote:
“Moreover, one who plans to strategically default can take steps to minimize even this marginal cost. For example, one could purchase a new vehicle, secure a new home to rent, or even purchase a new house before beginning the process of defaulting on one’s mortgage. Most individuals should be able to plan in advance for a few years of limited credit.” (p.12)
Bank flacks rushed to paint this as some wicked incitement. In fact it’s perfectly sound, legally and morally. White is not proposing that people default on their credit cards or other debts, but only on their underwater mortgages. What he’s saying here is that if you’re planning any large purchase or expenditure, you should make it before you default, before your credit rating takes the hit and your rates go up.
Even in a recourse state, it’s rare for the lender to seek a deficiency judgement unless you have valuable assets beyond your house. As far as tax liability for “forgiven” mortgage debt (for which the banks would certainly rat you out to the taxman), the Mortgage Debt Relief Act of 2007 excludes principal residences from this, for debt forgiven in the calendar years 2007-2012. So at least through 2012 that’s not an issue for a primary residence.
So to sum up: In most cases the benefits of walking away from an underwater mortgage far outweigh the costs. If homeowners were “rational” the way the economics textbooks say we all are, they’d be “walking away in droves.” So why aren’t they?
Behavioral economists think it’s on account of “cognitive bias”, a fancy way of saying people simply don’t understand the situation. But in fact people fail to act “rationally” even where they know what’s in their best interest. This is because of moral concerns.
They don’t just come up with these concerns on their own. Rather, the whole bank-government-MSM-NGO complex actively seeks to indoctrinate them with certain alleged “moral” concepts.
Meanwhile the lenders are under no such restraint, cognitively or morally. They are allowed and encouraged to act in an anti-social way.
The result is that individuals are more likely to do what they’re falsely told is morally responsible and socially beneficial, even as this is against their interests, individually and socially. Meanwhile lenders consistently do what is in their short-term financial interest even though their behavior is socially harmful and morally despicable.
What’s the answer, socially and morally? Permanent mortgage modifications. That means reduce the principal. The bubble price was a scam to begin with, as we know. The loans based upon it constituted fraud. If the government refuses to indict the fraud, the system can at least rectify the principal on these mortgages.
But of course they refuse to do that as well. They won’t legislate it themselves, they won’t give bankruptcy judges cramdown power. Obama won’t even use the bully pulpit. It’s scorched earth. So the people need to take matters into their own hands.
In part 2 we’ll analyze homeowner choices.