January 31, 2010

Analysis of Strategic Defaults – Conclusion

Filed under: Civil Disobedience, Land Reform, Law, Reformism Can't Work — Tags: — Russ @ 4:13 am


(Concluding the discussion of Brent White’s report on underwater mortgages.)
In spite of the destruction of the housing market and the wholesale massacre of jobs across the economy (eight million and counting), the collapse of social services just when they are most needed, and the overall sense of peril, the Obama administration just like the Bush before it has gratified itself solely through bailouts for the same banks who destroyed the economy. This unconcern for the suffering people is epitomized in the administration’s anemic response to the mortgage meltdown.
Obama’s modification plan is like a caricature of fecklessness. In theory it allows a narrowly defined subset of homeowners to refinance part of their mortgages at somewhat lower rates. The bloated principal, usually the result of predatory lending and bubble-blowing, is sacrosanct. And that’s just the theory.
In practice the banks grudgingly grant some temporary mods in order to string people along, but have refused to make any significant number of permanent mods. To help with obstructionism and obfuscation they tend to “lose” the intricate paperwork required for the applications, or play gotcha on technicalities.
All of this was predictable. Everybody knows the one and only real relief would be to write down principal to reality-based values. But this would hurt the banks’ balance sheets and profits. It would also contradict the entire reflate-the-bubble agenda, which is the only policy the Wall Street-Fed system has left.
Government policy has focused completely on making the monthly payments more affordable, which in turn is based on the premise that if homeowners can afford the payments, they won’t walk away even if underwater. This is consistent with data from earlier, less severe housing busts and dovetails with the government’s propaganda program to discourage defaults through reinforcement of guilt and fear.
But even here they’ve been incompetent and venal. The HAMP simply defines “affordable” by the procrustean measure of the monthly payment not exceeding 30% of income, without reference to any other factor including negative equity. There are many ways that 30% may be unaffordable or otherwise irrational, but the government just wants to steamroll people into accepting that this is a good program which has the public’s best interests at heart.
There have been various well-meaning but equally weak alternative proposals, like using stimulus money to buy out underwater mortgages or provide grants to struggling homeowners. These are clearly meant to prop up bank assets. Stiglitz wanted the government to directly write mortgages at low interest rates.
But all this nibbling at the fringes is still designed to ignore the obvious yet illusion-shattering fact that there’s no way out of this but for principal to come down. These “values” were the result of a fantastic bubble, and now reality wants to deflate. Principal must come down, principal must come down, and principal must come down. If lenders won’t write it down, homeowners will have to default, one way or another, voluntary walkaway or final involuntary default.
The only worthwhile policy suggestion was to empower bankruptcy judges to write down the mortgages themselves. But this has been repeatedly rejected by both parties. Anyway, this could directly help only those who were on the verge of involuntary default because they couldn’t afford the payments. It would do little for those saddled with underwater mortgages but who technically can afford to keep paying.
Besides modifications of principal and cramdowns, White suggests several other helpful things the government could do if it really wanted to help people. It could cease from fear-mongering and provide accurate information on the financial and legal implications of default. An excellent reform would be to amend the Fair Credit Reporting Act. As we said in part 3, when the lender rats out the defaulting borrower to the credit rackets, he’s adding an extralegal punitive element which is not a legitimate part of the contract. From p. 45:

The suggestion that Congress should amend the Fair Credit Reporting Act to prevent lenders from reporting mortgage defaults is premised upon the underlying mortgage contract, in which lenders agree to hold the house alone as collateral. In the case of underwater mortgages, however, the portion of the mortgage above the home’s present value essentially becomes unsecured. Lenders compensate for this by holding the borrowers’ credit score, and thus their human worth, as collateral – thereby altering the underlying agreement that the home serves as the sole collateral. As a consequence, lenders are often able to reap the benefit, but escape the costs, of their bargain.

If instead of being able to engage in this blackmail the lender had to either deal fairly with the borrower or take back the property in the event if default, so that the lender had an incentive to work out a deal whereby both parties shared the hit from the debubbling of the loan price, we’d have far more equitable outcomes in individual cases, and take a real step toward tackling the systemic problem.
White comments, “the proposal to eliminate the credit threat is, at heart, a market-based solution. It should thus be preferable to a government bailout of homeowners or a government take-over of the lending industry.” The end result, contrary to the scare stories from detractors, would likely be fewer defaults, as lenders would now have the incentive to seriously negotiate much earlier in the process.
So we have:
1. Amend the act, stop the fear-mongering, give accurate info.
2. People will then be more willing to walk away, which is the point.
3. Yet people still prefer not to walk even when they have this information, so even when underwater they’ll usually still want to stay if they can make a deal.
4. Now lenders would have the incentive to find a mutually satisfactory deal.
5. End result, fewer defaults.
“Moreover, barring the reporting of mortgage defaults could have positive effects on future lender behavior.” (p. 51) Where the outrageous asymmetry between lender and borrower no longer holds, the lender will no longer have such an incentive for such reckless, predatory lending. Doing away with the asymmetry would force lenders, and therefore the system as a whole, back to the responsible conduct everyone in power claims to revere. We’d get back to the basics of lending and borrowing based on realistic price-to-rent ratios and solid down payments.
As White acknowledges, all of this is predicated on a government which actually serves the public interest and a finance sector which isn’t completely psychopathic. In other words, it presupposes a world which does not exist. As we know, we have no such government. The best ideas, principal reduction, forced cramdowns, and ending credit reporting extortion, are all repugnant to it.
White brings up the possibility of bottom-up public education (p.44):

Understanding norm asymmetry suggests other possibilities. One solution that naturally follows, for example, would be for the government – or some consumer advocacy group – to begin a public education campaign encouraging underwater homeowners to walk if their lender is unwilling to negotiate. Whether or not such an approach would be effective, it would likely be so distasteful to most policy makers, and many readers of this article, that this idea will not be pursued further here.

I trust readers of this blog won’t find the idea so distasteful.
(Of course the whole paper is “pursuing the idea”. Is this a contradiction of the claim that education doesn’t work? The answer is that factual education within the existing sociomoral indoctrination regime doesn’t work much. But if informational education was coupled with new moral education, maybe that could work. It hasn’t been tried.)
White concludes:

Regardless of the precise policy prescription, it is time to put to rest the assumption that a borrower who exercises the option to default is somehow immoral or irresponsible. To the contrary, walking away may be the most financially responsible choice if it allows one to meet one’s unsecured credit obligations or provide for the future economic stability of one’s family. Individuals should not be artificially discouraged on the basis of “morality” from making financially prudent decisions, particularly when the party on the other side is amorally operating according to market norms and could have acted to protect itself by following prudent underwriting practices. The current housing bust should be viewed for what it is: a market failure – not a moral failure on the part of American homeowners. That being the case, it is time to take morals out of the picture and search for an equitable solution to the negative equity problem.

A market failure, not a moral failure on the part of homeowners. I only disagree with the final sentence about taking morals out of this completely. For this was not just a market failure but a tremendous moral failure on the part of the system. The big banks are not just amoral but immoral. We need a restored morality, which must grow again from the ground up. We won’t find remnants of it in existing structures.
And as I wrote at the outset, history proves that you can’t fight ideas, however twisted, with reason alone. We need new ideas to completely overcome the discredited ones.
If our great project is to take back the country from corporate tyranny and relocalize our economies for the sake of human freedom and resource sustainability, then taking back the land is a key part of the mission.
Dissolving the false social morality of mortgage debt, and the premise which underlies it, that banks should hold the feudal land monopoly, can be a potent weapon for this mission.
We don’t know exactly how we the people shall flow as water into the crevices of the seemingly impregnable fortress, but we shall do so. We’ll erode, we’ll undermine, we’ll loosen and weaken them, in the end we shall bring them down.



  1. Excellent as always. Always the best.

    Boy, if we could just get Russ into congress – anywhere.

    Profound statement by Yves Smith today –

    “The big reason banks are too big to fail is that they control infrastructure which has become critical to commerce. Most important, they control the credit markets. And credit is essential to any economy beyond the barter stage.”

    Talk about cutting to the chase. Seems like everything should start from Yves’s statement.

    Comment by chas — January 31, 2010 @ 7:41 pm

  2. Thanks, Chas.

    The Yves quote sums up the problem – we’ve let the big banks get a stranglehold on the economy, and now they’re running a protection racket, enforced by their snivelling little goons in government.

    Of course we really don’t need to have big banks existing at all, and would be much better off without them.

    Comment by Russ — February 1, 2010 @ 5:59 am

  3. Predatory Lending is a major contributor to the economic turmoil we are currently experiencing.

    Here is an example of what I am talking about:
    Scott Veerkamp / Predatory Lending (Franklin Township School Board Member.)

    Please review this information from U.S. Senator Jeff Merkley regarding deceptive lending practices:
    “Steering payments were made to brokers who enticed unsuspecting homeowners into deceptive and expensive mortgages. These secret bonus payments, often called Yield Spread Premiums, turned home mortgages into a SCAM.”

    The Center for Responsible Lending says YSP “steals equity from struggling families.”
    1. Scott collected nearly $10,000 on two separate mortgages using YSP and junk fees. 2. This is an average of $5,000 per loan. 3. The median value of the properties was $135,000. 4. Clearly, this type of lending represents a major ripoff for consumers.


    Comment by jmb27 — February 1, 2010 @ 5:44 pm

  4. “Walking away” is irrelevant if the borrower doesn’t have a job. No mortgage terms are affordable if the borrower is unemployed. I encourage everyone to watch carefully how this plays out in the media. Most stories are about homeowners who game the system and walk away, not about the much larger number forced out due to joblessness and cutbacks in hours and pay. The corporate media have a telling blindness to the victims of the financial collapse. They much prefer to point the finger at so-called ruthless defaulters in order to cow the rest of us into line.

    If it’s moral for the bank to throw my family out on the street when I don’t pay — contracts are contracts, after all — it is moral in exactly the same way for me to protect my family from wasting thousands of dollars on vanished home equity that will never return.

    Modifications that do not include principal forgiveness are a joke. We can only hope the jesters on Capitol Hill figure this out before they drive all of us into penury.

    Comment by reslez — February 3, 2010 @ 10:46 pm

    • Thanks reslez, you sum it up well.

      Comment by Russ — February 4, 2010 @ 4:21 am

  5. […] the payments. In my previous series on strategic defaults (part 1, part 2, part 3, part 4, and part 5) I discussed the reasons for this. The system’s actions are predicated on this. That’s […]

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