The World's Largest Guilt Trip

Brent White shows that underwater homeowners across America are signally failing to take my advice (or that of Mark Gimein) and walk away from their homes:

Only about one-fourth of homeowner defaults are strategic, with the other three-fourths triggered by job losses, divorce or other financial difficulties, which when combined with negative equity give homeowners no option but to let go of their homes. In other words, for the vast majority of homeowners, negative equity is a necessary but not a sufficient condition for default… Though more than 32% of U.S. homeowners were underwater on their mortgages by the end of the second quarter of 2009, the strategic default rate was roughly 3%.

Not all property owners behave like this, of course, and the best example right now of an underwater property owner walking away from his obligations is that of Sheikh Mohammed bin Rashid al-Maktoum. As Willem Buiter explains,

The shareholder (the al-Maktoum family aka the government of Dubai) will decide on ordinary commercial principles whether to provide additional financial support to these companies.

If the shareholder of Dubai World and of Nakheel believes that a further capital injection makes commercial sense, it will inject additional capital (assuming it can find the financial resources to do so). If, as I suspect is the case with Nakheel, the company is so deep under water that injecting additional shareholder capital would be throwing good money after bad, the company will not be financially supported by the shareholder. That’s how financial capitalism works.

Except, of course, that’s not how financial capitalism works in the US. Here’s White:

Luigi Guiso, Paola Sapienza, and Luigi Zingales found that 81% of homeowners believe that it is immoral to default on a mortgage, and that homeowners who hold this attitude are 77% less likely to declare their intention to default than those who do not. Indeed, once the equity shortfall exceeds 10% of a home’s value, the study found that “moral and social considerations” are the “most important variables predicting strategic default.” So strong are these variables, in fact, that only 17% of homeowners indicted that they would default if the equity shortfall reached 50%…

Moreover, foreclosure rates are considerably lower than would be suggested by the Guiso, Sapienza, and Zingales study, as the percentage of people who actually default is much lower than the percentage that indicated they would default in the survey, moral qualms or not.

White goes on to enumerate an astonishingly long list of institutions, up to and including the president himself, which are speaking with a single voice on this question, and saying that paying an underwater mortgage in full is the morally correct thing to do. Hank Paulson did it, despite the fact that he would have fired anyone at Goldman (GS) who behaved similarly; Neil Cavuto likened people who walk away from their mortgages to people who would have “quit” and handed over Europe to the Nazis.

Even Gail Cunningham, of the National Foundation for Credit Counseling, declared in an interview on NPR that “Walking away from one’s home should be the absolute last resort. However desperate a situation might become for a homeowner, that does not relieve us of our responsibilities.” If you’re thinking of walking away, you’ll almost certainly do so while overcoming enormous feelings of guilt. And where there’s guilt, there’s belief in dire consequences:

Most people simply do not believe they will escape punishment for their moral transgressions. Guilt and fear of punishment go together. Thus, the notion that one will suffer great consequences for walking away from one’s financial obligations not only seems possible, but feels quite right. It just can’t be that one can walk away from their mortgage with no significant consequence. As such, people rarely question apocalyptic descriptions of foreclosure’s consequences.

The result is a system tilted enormously in favor of institutional lenders who exist in a world of morality-free contracts, and who conspire to lay the world’s largest-ever guilt trip on any borrower who might think about joining them in that world. It’s asymmetrical, it’s unfair, and it’s about time that homeowners started being informed that a ding to their credit score is not the end of the world; that no one would expect a capitalist company to behave in the way that individuals are being told to behave; and that their options are in fact broader than they might believe. White’s paper is the perfect place for them to start their reading.

(HT: Kedrosky)

Comments

[LKofEnglish]

tell that to the canadian who just bought the Pontiac Superdome for $300,000. Better yet, tell it to the whole city of Detroit where i hear there's a little of that special something flying in from Moscow this week.

2009 Nov 29 11:47 PM

[galt55812]

Given that the taxpayers will end up eating the losses on mortgages, the fair thing to do is the ensure that anyone who defaults on a mortgage is forever denied any taxpayer backed aid in gaining another mortgage. It is not immoral to walk away, but if you do, and stick us with the costs, it is also not immoral for the rest of us to say "No" when you come back asking for another FHA loan.

2009 Nov 30 12:21 AM

[bob adamson]

Isn’t there something reassuring about the fact that many people don’t see their home primarily as an investment; something to abandon forthwith if some month it transpires that their equity in the property has become negative? The kids are in school, they like the neighbourhood and the neighbours, they value their reputation in the community and they don’t want the hassle of starting again in another house somewhere else so why play their family’s home as though it was a penny stock?

Now should it happen that the value of the residential property has declined steeply, I see nothing wrong if the owner tries to renegotiate the terms of his or her mortgage to advantage but this is another matter.

There are other better ways for the society to address the problem of predatory mortgage lenders and other poor mortgage lending practices than to diminish the distinction between a house and a home.

2009 Nov 30 12:39 AM

[TinyTim]

Mish has dealt with the issue of strategic foreclosure at length on his blog. (Mike Shedlock). Bottom line is all your obligations are completely spelled out on the mortgage contract docs. There is no morality clause, although that doesn't preclude one from being reluctant to walk due to reasons along these lines if so desired.

Otherwise, if you opt not to meet the obligations spelled out in the docs, the bank has the option in that event of exercising their options in the contract. Technically, that's all of it. The guilt trip is the banks fall back position because they screwed up on the collateral and screening. If anyone should feel guilty, it's the loan officers for not doing their jobs.

The only caveat is being 100% sure of the consequences. This can be more than a credit hit. In loan recourse states, the short amount can follow you until satisfied. Non recourse states are being bullied by banks to amend legislation.

If one considers that banks are dragging their feet on delinquent mortgages so as not to take the hit on their books and the impact this "non-transparency" is having in dragging out the credit crisis, walking away is good for the economy.

2009 Nov 30 12:42 AM

[Al-USA]

Way to go, Chris Coonan, excellent comments.

2009 Nov 30 04:39 AM

[Carlos Lam]

I've always considered that every mortgage has an implicit put option: the buyer can always "put" the secured asset (the home) to the lender if he or she so desires and walk away. Obviously, this could be limited by contract (but I've never seen a contract where default is prohibited, and it would seem that such a type of contract might run afoul of the 13th Amendment). Additionally, the buyer could be subject to deficiency judgments (in recourse states) and to a black mark on his or her credit report. Nevertheless, it seems to make very little sense to keep paying on a $200,000 mortgage when the underlying asset has fallen in value to $150,000.

2009 Nov 30 05:45 AM

[Tony Petroski]

If you want to see the dead end of socialism. this article is a perfect illustration. Those who are trying to be honest are stupid, and those trying to game the system are wise.

2009 Nov 30 08:26 AM

[User1]

A depositor would be exposed to the credit risk of a bad bank, not a borrower. The borrower's behavior will be influenced by the bank's poor underwriting only to the extent that the bank is forced to raise interest rates to compensate for loan losses.


On Nov 30 12:48 AM chris coonan wrote:

> I think the US should establish a rating agency for banks, to record
> the number of mortgage foreclosures. It will have the same point
> system as a personal credit record. Banks will lose points everytime
> a foreclosure occurs, or a bad loan is written off. This rating system
> will then be posted on every entry door to the bank (similar to a
> Health Department Grade). Then borrowers can be reminded, on every
> visit to the bank, what risk they will take, by borrowing money from
> that institution.

2009 Nov 30 09:52 AM

[User1]

First, "usury" not "usary".

Second, why 18%? Why not 10%? Why not 30%?


On Nov 30 01:09 AM chris coonan wrote:

> Another enhancement to the Banking System would be to exclude credit
> card companies from reporting to Credit Rating Agencies if they are
> engaged in Usary. I would define Usary, as any Credit Card that exceeds
> an 18% APR. At that punitive rate, disadvantaged consumers have no
> chance of reducing balances. So defaults on that credit, should be
> punitive to the Credit Card company issuing the credit, as it undermines
> the American economy. Only sustainable borrowing and lending should
> be allowed in the land of the free.

2009 Nov 30 09:54 AM

[The Dark Years]

Let us all remember when you default on your HOME, mail the keys back to the bank, or whatever, you still may be on the hook with the IRS for the amount of the loan forgiven. Say you borrowed $400k to buy a house worth $500k and you went underwater when the value dropped to $300k so you returned the keys to the bank. Exclusive of any remedies that the bank has, the detriment to your credit, or having lost the original 100k you put down the IRS (and perhaps some states) views the forgiven (if that is the proper word) amount as a "windfall" and it is taxed as ordinary income. No you cannot as some believe use the $200k as a capital loss as far as I know. Corporations, however may have other options and they can hire better lawyers.

2009 Nov 30 11:15 AM

[realold]

Excellent idea but completely out of the current administration's line of thinking. The more welfare the better is the mantra of the Democratic party (it generates dependent voters forever). Deny people new loans and they will not vote for you, again and again, etc.


On Nov 30 12:21 AM galt55812 wrote:

> Given that the taxpayers will end up eating the losses on mortgages,
> the fair thing to do is the ensure that anyone who defaults on a
> mortgage is forever denied any taxpayer backed aid in gaining another
> mortgage. It is not immoral to walk away, but if you do, and stick
> us with the costs, it is also not immoral for the rest of us to say
> "No" when you come back asking for another FHA loan.

2009 Nov 30 10:19 PM

[User 399495]

Are we concerned about verification of bank's or borrower's creditworthiness? Banks are betting on their investment just like a trader on Wall Street. But, in doing so, at least they secure it with a collateral. Credit score already offer enough information to fund loans but who knows this score in the future. On of the solution to solve this issue is identify the cause of default and penalize those with strategic default. If banks have incorrectly appraised loans then they have also offered more in loan.


On Nov 30 12:48 AM chris coonan wrote:

> I think the US should establish a rating agency for banks, to record
> the number of mortgage foreclosures. It will have the same point
> system as a personal credit record. Banks will lose points everytime
> a foreclosure occurs, or a bad loan is written off. This rating
> system will then be posted on every entry door to the bank (similar
> to a Health Department Grade). Then borrowers can be reminded, on
> every visit to the bank, what risk they will take, by borrowing money
> from that institution.

2009 Nov 30 10:20 PM

[realold]

The "land of the free" went away last November. If you find a new one, let us know.


On Nov 30 09:54 AM User1 wrote:

> First, "usury" not "usary".
>
> Second, why 18%? Why not 10%? Why not 30%?

2009 Nov 30 10:20 PM

[scotty1560]

if one borrows money from the mob and can not pay up, we get the
general idea of the abuse the borrower will receive. Allowing banks
to hassle and abuse struggling homeowners, isn't quite the same but make no mistake in the banks strong arm tactics and games.

My two suggestions:
The home serves as collateral, no other recourse, that will lead to
prudent standards of under writing.

When a borrower is in default, no waiting 12-18 months to foreclose or "decide" on a 5th or 6th short sale offer. Liquidate the
property and reset the markets asap.

Of course we know accounting and bailouts have complicated doing the proper strategy, so we can expect the real estate
meltdown to last 2-3 more years just to find a true bottom and reset point.

2009 Dec 01 01:57 AM