Walking Away: The Next Mortgage Crisis

Subprime was just the beginning. Wait until California's prime borrowers start handing their keys to the bank.

Slate is writing Here Comes the Next Mortgage Crisis.

Riverside County, outside Los Angeles, may be the foreclosure capital of the country, with a rate close to six times the national average. And housing prices are in freefall.

Over the next several months, we're going to be subjected to a chorus of hand-wringing about the moral turpitude of people who walk away from their mortgages and pronouncements like last month's warning from Treasury Secretary Henry Paulson that people should honor their mortgage obligations. The problem with finger-wagging on what you "should" or "ought" to do is that, when it comes to money, you're usually given the lecture only when it's in your interest to do the opposite.

Certainly, that's the case for all the California homeowners who in the next year or two are going to find themselves with the choice of whether, faced with a huge new wave of interest resets and a historic decline in the value of their homes, they will simply walk away.

My Comment: Paulson does not want you to do what is in your best interest he wants you to do what is in the lender's best interest. If walking away makes sense, just do it. Inquiring minds may wish to review the Moral Obligations Of Walking Away and
Businesses Advised To Walk Away.

Just two banks, Washington Mutual and Countrywide, wrote more than $300 billion worth of option ARMs in the three years from 2005 to 2007, concentrated in California. Others—IndyMac, Golden West (the creator of the option ARM, and now a part of Wachovia)—wrote many billions more. The really amazing thing is that the meltdown in California is already happening and virtually none of these loans have yet reset.

My Comment: This mirrors what I said in Closer Look At The ARMs Reset Problem.

Looking ahead to 2010-2011 I see a different set of problems. Those problems are Alt-A and Pay Option ARMS. And that is where the liar loans (no-doc loans) are hidden. Liar loans are likely to blow up long before we get to 2011. I discussed a particular Alt-A pool in WaMu Alt-A Pool Revisited and WaMu Alt-A Pool Deteriorates Further

The subprime rate reset in and of itself is not so much an issue as the fact that those borrowers are now underwater, and have every temptation to walk away. Slate continues...

When those dominoes start falling next year, we may or may not have a subprime bailout plan, and the discussion will start about how to bail out this next tranche of borrowers. The bailout plans on the table now, such as the one put forward by Barney Frank (one of Congress' genuinely cogent financial minds), are reasonably based on the principle of bringing payments down to a point that homeowners can afford.

But where prices fall 40 percent to 60 percent, all that goes out the window. Why? Because in expensive locales like San Diego, tens of thousands of people with 100 percent loan-to-value mortgages and option ARMs are living in homes in which they have no equity and on which they owe a lot more than the house is worth.

Bet on this: Whatever moral qualms are being urged on borrowers to keep them from walking away from their mortgages, they'll count for a lot less than the economic reality facing borrowers whose homes have fallen in value by half. Lenders had no reservations about selling borrowers loans with rising payments that would be poisonous in a rising market. Now it seems borrowers have no reservations about leaving those lenders with the risks they begged to take.

Foreclosures Jump 57% as Homeowners Walk Away

Bloomberg is reporting U.S. Foreclosures Jump 57% as Homeowners Walk Away.

U.S. foreclosure filings jumped 57 percent and bank repossessions more than doubled in March from a year earlier as adjustable mortgages increased and more owners lost their homes to lenders.

More than 234,000 properties were in some stage of foreclosure, or one in every 538 U.S. households, Irvine, California-based RealtyTrac Inc., a seller of default data, said today in a statement. Nevada, California and Florida had the highest foreclosure rates. Filings rose 5 percent from February.

My Comment: Record Home Price Drop In Southern California are clearly tempting many home owners to walk away.

Auction notices rose 32 percent from a year ago, a sign that more defaulting homeowners are "simply walking away and deeding their properties back to the foreclosing lender" rather than letting the home be auctioned, RealtyTrac Chief Executive Officer James Saccacio said in the statement.

"We're not near the bottom of this at all," said Kenneth Rosen, chairman of Rosen Real Estate Securities LLC, a hedge fund in Berkeley, California and chairman of the Fisher Center for Real Estate at the University of California at Berkeley. "The foreclosure process will accelerate throughout the year."

My Comment: We are years away from the bottom.

About 2.5 million foreclosed properties will be on the market this year and in 2009, Lehman Brothers Holdings Inc. analysts led by Michelle Meyer said in an April 10 report. U.S. home price declines will probably double to a national average of 20 percent by next year, with lower values most likely in metropolitan areas in California, Florida, Arizona and Nevada, mortgage insurer PMI Group Inc. said last week in a report.

My Comment: Anyone remember how 2.0 million foreclosed homes seemed absurd? Well now the number is 2.5 million and rising. 3.5 million might be even more realistic.

"At least 2 million jobs will be lost because of this recession, so we'll get a cumulative negative spiral," Rosen said. "A normal recession is 10 months. We think this one may be twice as long."

My Comment: Good call. A Case for an "L" Shaped Recession has been presented.

Nevada had the highest U.S. foreclosure rate in March at one for every 139 households, almost four times the national rate, RealtyTrac said.

California had the second-highest rate at one filing for every 204 households, and the most filings for the 15th consecutive month at 64,711.

Florida had the third-highest rate, one filing for every 282 households, and ranked second in total filings at 30,254. Foreclosures increased 112 percent from a year earlier and decreased almost 7 percent from February, RealtyTrac said.

Ohio ranked third in filings at 11,273 and had the seventh- highest foreclosure rate, one for every 448 households.

Some borrowers are "hanging on at the margins" in the face of resets, said Mark Goldman, a loan officer at Windsor Capital Mortgage Corp. in San Diego.

"I've had people sitting in my office in tears because there are no loans available," said Goldman. "There are no loans for someone who's upside down on their house."

Attempting to "hang on" often makes little sense, except for the lender. That is why we are seeing Misinformation From Fannie and Freddie On Walking Away.

California Attorney Chimes In

I have been in communication with "HCL", a California attorney over real estate law in California. HCL writes:

As a California real estate attorney I can tell you this:

1) Mortgage debt, whether it's a first or second loan, is nonrecourse if it is "purchase money", used initially to purchase the property;

2) Mortgage debt that exists due to a refinancing and/or to second loan taken out after purchase is recourse, but -- and it's a BIG but -- only if the lender elects to file a lawsuit for judicial foreclosure rather than going through the usual foreclosure process;

3) Suits for judicial foreclosure are in my experience of 28 years extremely rare, due mostly to the fact that any buyer at a judicial foreclosure sale has to give the foreclosed-upon party a full year to redeem the property. This of course is a complete deal-killer.

An interesting side-note: California's anti-deficiency law originated during the Depression years, in order to place the burden of properly valuing real property and risk of loss on lenders (who presumably were more sophisticated and able to assess value) rather than buyers. Fast-forward to now, when it turns out that rampant greed prevented lenders from acting rationally in their own self interest. Now they are paying the price with walk-aways and "jingle mail".

If you can arrange a short sale that is preferable to walking away. But a short sale requires two things: 1) a buyer in hand 2) a lender willing to go along.

Furthermore, the short sale process takes time and there is a huge lack of qualified buyers.

Unsurprisingly, walking Away is picking up steam. California is the poster child. There is little Fannie or Freddie can do about it either.

If you are in agony over a pending decision to walk away, just remember, your moral obligation is not to Paulson or your lender, nor is there any patriotic duty to bankrupt yourself for benefit of others. Please don't blow your life savings, tap your IRA, or use credit card debt to forestall the inevitable. Your moral obligation is to yourself and your family. If it makes economic sense to walk, then walk.

Comments

[bluesmoke:]

Good article. All your points are valid, and sadly true. The only questions I would counter with are-

1) Where are these people supposed to live? At least they have a roof over their head with tax deductible interest. Property taxes should drop over time as well.

2) Investing should be long term. When I buy a stock, I don't expect it to go up overnight.

Granted, the numbers are a lot larger and the situation is more complicated. But in this case I think time is your friend.

2008 Apr 18 09:57 AM

[drmalaka:]

Good information, thanks.

Bluesmoke, the people who walk from their homes can go and rent homes for one third the price of their mortgage payment.

If the government wants to do something about the mortgage mess instead of stealing my money to give to deadbeats who bought houses they could not afford they should not issue any building permits for the next six months.

2008 Apr 18 12:44 PM

[Jason Tillberg:]

To answer the question above, 1) rent the house accross the street for less $ per month.

Great analysis. I'm on very similar lines of thought.

2008 Apr 18 12:57 PM

[sashak:]

I don't think we should lecture any one on what to do with their property, market will never function on moral obligations only. This is capitalism and money should work. However, our lawmakers have outdone themselves with the most idiotic piece of legislation, that is a part of that stimulus package. I am talking about the paragraph that relieves a person of an income tax liability on forgiven debt if their house is foreclosed upon. So at this time it is really a no brainer whether one should or should not walk away from the property, if your house is worth 500K and you owe 600K, just walk away, there is no down side, other than damage to one's credit rating that is already ruined anyway. Well perhaps, some homeowners who are in a marginal position, would put forth more effort to save their house from foreclosure, if they new that they may be faced with a huge tax bill should they walk away from the property. And that would not even require a lecture about ethics on honoring one's obligations under the terms of the contract etc.
But it's too late now. This reminds me of proposals to eliminate gas tax, when there is shortage of fuel and it gets to be too expensive, I think that's the time to increase fuel tax. My point is that taxes should not encourage people to do bad things, and we have a clear case of misplaced intentions. If IRS wants to relieve taxpayers in true hardship, they can do so on case by case basis.

2008 Apr 18 02:54 PM

[karchad:]

1. Articles like this are inevitable written by George Bush haters. They're looking to influence the election. If Hillary were in office right now, these articles wouldn't be written.

2. Since the middle of January, homebuilder stocks are up. I trust the movement of the market far more than these left-leaning articles.

2008 Apr 18 03:56 PM

[bowlmar:]

Is this why the market rallied this week? Same guys who brought us the mortgage crisis are "investing" our money in stocks.

2008 Apr 18 04:51 PM

[Willy@post:]

I'ts sad , lenders have made this mess, no home should be sold Without a 10% down pament.

2008 Apr 19 09:11 AM

[WAKEUP:]

When I predicted such a mess , six months ago, and said that upside-down homeowners should walk away from bad mortgages,other commentors assailed me, with "pessimist!," and other silly terms. Interesting, what a short span of six months has done.

2008 Apr 19 10:23 AM

[lorddarley:]

The "big picture" about home values is where the Baby Boom will move for their retirement years, and where they will exit.

For example, California is an Eden, except for its fiscal mismanagement that mandates a 9% income tax rate, high sales taxes, and a quirky system of local tax assesment which penalizes new purchasers and "grandfathers" long time owners.

Personally, we are New Englanders who would love to retire to California and to buy a nice place for a few million. We would then more other assets, hire local professionals and trades people, and be a modest boost to California. However, the tax rules in California keep us out.

Real estate values will reflect the local choice of tax systems. The retiring Baby Boom, searching to maintain living standards, will shun jurisdictions (and real estate) that are based on philosophies which do not understand the needs of retirees who have capital.

LD

2008 Apr 19 10:45 AM

[pcat:]

I think fl. in the winter months and washington state in the summer to retire to.No income taxes and if the housing prices goes down to the levels projected by this article then I will be shopping for a place soon.Arizona might be an option if the prices go low enough but that would require one to live up in the cold state over six months a yr to avoid that income taxes on unearned income.California will survive but not with my money,lol.

2008 Apr 19 11:39 AM

[Paul Bishop:]

Ken Rosen who you reference in this article sat on the Board of Golden West (GDW) parent to World Savings, one of the "portfolio lenders" who allowed a great many of these ARM's and at the height of the insanity handed all their molten loans and $125 billion dollar portfolio to Wachovia for $25.5 B Do you think long term Board member Rosen profited from that at all??? For him to be sanctimonious now and take the appearance that he was not involved is beyond the pale. Google his name and check his remarks in the WSJ in '03,'04,'05,'06 (when they sold to Wachovia) The Sales force for his Company World Savings was doing $4 B of loans a month, a large majority of which were no doc or QQ ( quick qualifier, World's term) those are a lot of the $8 + billion that Wachovia is going to eat. Not to mention the destruction of good neighborhoods, families credit, cities tax base, and the general decline in value. Rosen was right in the middle of all of it.

2008 Apr 19 01:20 PM

[Frogman:]

FINALLY SOMEONE ELSE WHO GETS IT!!! I have been POUNDING THE TABLE ON THIS VERY ISSUE BUT NOBODY WILL LISTEN!! 70% of our economy is proped up by the homeowner who mortgaged thier house to buy a hummer, max out thier credit cards and then walk away. I know PRIME BORROWERS (MAKING 250k /year!) with 700+ credit who rented before they walked away so their credit won't get nailed before they were foreclosed on....that is how they are doing it (To the person who asked) ..don't believe me or the article???....listen to Wachovia's and BOFA's conference call last quarter...WE HAVE JUST BEGUN the PRIME MESS!!!!!!!!!!!
RECOVERY ABSOLUTE BS!!!! This is a trading market that started on APRIL fools..."suckers rally" we will get some relief but nothing in the economic cards or otherwise suggest that we are headed to an or even stabilizing.... People just don't get what is happening....GREAT ARTICLE!!

2008 Apr 19 05:27 PM

[StateofConf...:]

I agree with Frogman. However, I don't see how all these people can find places to rent. Any house in foreclosure is not going to be rented so all who walk away will leave empty places unless someone buys them.
I do believe that resets should only go to a market rate (maybe 6.5%) not some rediculous rate, this would save many. Leaving your house just because the value dropped is immoral. Do you leave your new car when you drive it off the lot?
Finally, Bush and his neoconservative (do anything for business and nothing for people) administration is responsible. His is one job that should have been outsourced.

2008 Apr 19 11:31 PM

[jjason:]

As a landlord, why would I want to rent to someone who broke a contract that was not in their best interest. Immoral people would stiff the landlord too. Let's face it, if you screwed up, let someone else pay for it. That will really teach everyone that THERE IS A FREE LUNCH.

2008 Apr 20 06:11 AM

[curious cat:]

ok, i still need to know about laws outside the great tax state land bubble of california. most of the country is not in this mess, because most of us had more sense than to pay more for a home than we could afford. can the people in other states turn in the keys and walk? also, don't the mortgagors have a big incentive to keep rates the same? so what if the contract says they can raise the rate, when they see real estate prices dropping, recognize that borrowers are underwater and have walking papers, won't they just unilaterally act in their own best interests? why would they need government pressure to readjust?

2008 Apr 20 04:08 PM

[Frogman:]

JJ I am a landlord to...This should make you feel secure because the renter now has 'no other options' than to rent...they will certainly pay you because the next stop is the streets...also my rent is half of what thier mortgage was ....so they are automatically beginning to save. You are now the hero... People will always screw you in the business, part of it, if you haven't been screwed yet you haven't been doing it long enough. Avoiding it takes experience but even then it is managed risk like anything else...also people make a vow in marriage and now most are divorced...over 50% ...do you fault them the same way? Isn't that a more serious morality issue (if we are really chosing to play morality or contract police!?!?! ) Hardly...I think I made my point...so fast forward...home prices will continue to be slammed till 2009 and 50/50 chance they stabilize with no "cataylst" to rise ESPECIALLY WITH THE BANKS TIGHTENING CREDIT!!! They won't lend you five dollares now!!..As a result we will flatline like the 8o's for 5-10 years just to be teed up for the Social Security and Health Care crisis which is like a hurricane forming off of the coast of Africa but it is already a CAT 5 ....we will be forced once again to print a ton of dollars making it totally worthless but I am hoping that our manufacturing will go crazy and we will be at the cusp of a secondary industrial revolution because of our worthless dollar..BTW which is why Buffet bought BNI he trades ahead 5 years....that is the only positive that I can draw at this point....

2008 Apr 20 04:18 PM

[PA007:]

Curious cat,
Securitization resulted in a mess where there is no longer a single lender making a decision on rates/repayment terms. The mortgage got bundled, sliced and sold in tranches to a point where there is no single authority to make rational decisions.
Lawyers will be making a ton of money as lawsuits sprout up about every adjustment (rate, principal or other terms).

2008 Apr 20 09:56 PM

[Mortgage se...:]

Thank you frogman! Wish I could count how many of our "moral" friends with no problem making payments, buy the house down the street which has depreciated 30%, then let the lender foreclose on the existing house. Why not, it's all the lenders fault. Who did they think they were tricking the poor borrower into buying a house that would depreciate. This isn't all sub prime mess out there. There are plenty of people trying to benefit at others expense.

2008 Apr 25 10:34 PM

[Ames Tiedeman:]

Many of us predicted exactly what has happened to California, years ago.

Take Housing:

Back in 1998 and even as late as 2002 when everyone was saying to buy homes in places like Los Angeles and San Diego many of us looked with bewilderment. Home prices in these areas were over valued back then and they still are today. The income to housing cost data shows that the median house should cost around 200k in San Diego. This is exactly where prices are headed. Prices will continue to fall with a few small bounces in certain areas, but you will not see a real bottom until 2012 or 2013. When this bottom is put it you will not see a ramp up of any sort. Adjusted for inflation homes in California, particularly in Los Angeles and San Diego will be lower 15 years from now. There is no catalyst for a California housing boom. California no longer gets the huge influx of migrants from other parts of the United States. These educated folk that California could count on since after WWII no longer chose California. In fact, the educated are leaving California in droves, destined for much better managed states such as Texas, Colorado, Oregon, Utah, Nevada, and Arizona. Georgia and the Carolina's as well. The demographic shift spells longer term, certain trouble for Southern California real estate. The uneducated hispanic population is not going to produce the wealth needed to support sky high home valuations. This will begin to be evident by 2025. Those who chose to call this comment racist, then be my guest. I don't care. The long term forecast for the entire state of California is dismal at best.

2008 Dec 20 02:00 PM