Saturday, July 10, 2010

Foreclosed mansions 

A friend sent a link to an article in the New York Times by reporter David Streitfeld, entitled, "Biggest Defaulters on Mortgages Are the Rich":
Whether it is their residence, a second home or a house bought as an investment, the rich have stopped paying the mortgage at a rate that greatly exceeds the rest of the population.

More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, according to data compiled for The New York Times by the real estate analytics firm CoreLogic.

By contrast, homeowners with less lavish housing are much more likely to keep writing checks to their lender. About one in 12 mortgages below the million-dollar mark is delinquent.
My first reaction was that it would be interesting to see a graph of default rates versus loan amount, perhaps in $100,000 increments, and see if a bimodal distribution existed at the low and high end. It would probably make sense to regionalize such a study, given the disparities in average home prices around the country. A $1.3 million home in Fairfield County, CT might sell for a third of that price in suburban Baltimore.

Second, reading the entire article at the link, it is reasonable to infer that in more than a few cases, borrowers do not lack the capacity to make payments, but simply don't want to, because they are so far underwater (in terms of the amount of the remaining loan relative to the lower fair market value of the house) that it does not make financial sense. In the view of those borrowers, there is no upside on the asset -- the note is effectively a call option that has expired worthless. It is hard to discern from the article what portion of the high-end defaults are elective and what portion involved people who stretched and genuinely do not have the means to pay the mortgage.

A generation ago, it was not unusual for lenders to ask for personal guarantees on so-called "jumbo loans" (non-conforming loans) on primary residences, and especially second homes. Also, loan-to-value ratios were lower, so a 15% decline in housing prices didn't put a mortgage underwater. Now, recourse is limited to just the specific asset. That's where the loan market went, as lenders pursued deals.

So, this raises the interesting question of the amorality of elective default (cases where the mortgage could be paid if the borrower chose to do so) and how that is intertwined with the enabling behavior of lenders, who structured a loan market where assets could be firewalled, and provided mortgages with high loan-to-value ratios.

In my view, one of the problems with elective default is the negative externality suffered by the neighbors. A house that a borrower walks away from will likely suffer from poor maintenance, and that will not help local home values recover. At the lower-priced end of the housing market, this might be how urban blight starts out on a particular block. Because there is an underlying physical asset, the condition of which has at least some impact on other families, a mortgage shouldn't be thought of as a call option on the potential appreciation of a house.

As with other aspects of the popping of the housing bubble, there is plenty of blame to go around, but this specific niche might be especially controversial.

UPDATE: I want to point out the difference between "amorality" and "immorality."

Corporations are often viewed as being "amoral," and I would characterize legal corporate entities as having officers who have specific fiduciary duties which, on balance, obligate the officers to act in the best interests of the shareholders. The president of an otherwise profitable corporation could choose to default on a limited recourse loan for a particular project or plant, simply because standing behind that project is not in the long-term interests of the shareholders. If the president tries to "do the right thing" from a societal point of view and keep the plant open, even though it is sucking cash down a black hole (as revenues have declined and expenses increased), then the company needs to prepare for shareholder litigation. An individual who has the capacity to make payments on a home loan, but chooses not to do so, does not bear that litigation risk.

Personally, I would be upset with my neighbor if he defaulted on his mortgage and walked away from maintaining his house, even though, for purposes of this example, I was aware that he had plenty of funds available to keep going -- that he is making a a narrow financial decision with respect to the relative amounts of his note and the future fair market value of his house. His monthly payment and maintenance costs haven't changed, nor his income, in this example, just the market prices for comparable homes has changed. I would be more sympathetic to a neighbor who got into financial difficulty and lacked the means to continue living in the house.


By Blogger Foxfier, formerly Sailorette, at Sat Jul 10, 03:06:00 PM:

Well, if you buy it as an investment-- as everyone's been harping on for years-- and it's a bad investment, and your financial guy (as required by law) tells you that you will be in the best financial shape if you walk away... you walk away.

Add regulation, reduce morality, get stuff like this. -.-  

By Blogger randian, at Sat Jul 10, 05:47:00 PM:

This does not surprise me. It is well known that in recessions the incomes of the wealthy drop much more (in both absolute and percentage terms) than the incomes of the middle class. The values of luxury assets suffer larger declines than more modest assets.  

By Blogger Trochilus, at Sat Jul 10, 06:30:00 PM:

Perhaps some of the elements of the Canadian banking system might be in order.

Mark J. Perry wrote about it back in late February.

And, if you look at how much more easily the Canadians are recovering from the recession -- jobs are returning without stimulus spending -- you begin to realize the extent to which lack of personal responsibility in the housing market not only contributed to causing the recession, but is also making it more difficult to get out of.  

By Anonymous Edward Lunny, at Sat Jul 10, 06:59:00 PM:

"So, this raises the interesting question of the amorality of elective default."....Question ? There is no question. Contracts and terms were agreed to and signed for. Contracts that indicated how much and when payment was to be made. That you misestimated the future value of your realestate, that you did not forsee the market collapse does not abrogate your responsibilities and obligations under the contract. Walking away from a contract isn't just amoral, it is, or should be, a financial crime. No one should be allowed to walk away, escape from an obligation that they have contracted to accept, without consequence.  

By Blogger TigerHawk, at Sat Jul 10, 10:38:00 PM:

Edward Lunny -- It has been a long time, generations, since breach of contract was considered amoral or a crime in American courts. In theory, you breach the contract, you pay damages for the breach. If the lender was stupid enough to lend money without recourse, silly lender.

The problem is that some states (California, for example) have outlawed recourse in home mortgages. Lenders can no longer freely bargain for that remedy. The defaulting borrowers in these states are, therefore, simply taking advantage of a right mandated by a bad law.

In my opinion, federal financial reform should preempt state laws that outlaw recourse mortgage loans. At a minimum. Perhaps we should also ban the use of insured deposits for nonrecourse mortgage loans. Restore the idea that you pay what you owe, regardless of the value of the pledged asset. People will be a lot more careful.  

By Blogger randian, at Sun Jul 11, 01:39:00 AM:

The problem is that some states (California, for example) have outlawed recourse in home mortgages.

Then one would expect rates and fees, and possibly down payments, to be higher in California. So what? If California's legislature wants to screw its citizens (as it does in so many other ways) by making home financing more expensive who am I to care? Besides, it's not true that California has outlawed recourse. First of all, that only applies to purchase money. Refinances and home equity loans don't count. Second, even in the case of purchase money they didn't outlaw recourse. What they did is require judicial foreclosure if you want recourse. Most lenders feel that the cost of judicial foreclosure outweighs the benefit of recourse, that's why they don't bother.

In my opinion, federal financial reform should preempt state laws that outlaw recourse mortgage loans.

Why? The risk is already priced into the loan. In the aggregate you should see no difference in losses between recourse and non-recourse loans. It's not as if lenders don't know up front that borrowers can execute a strategic default. I doubt there is any evidence that recourse matters.  

By Anonymous Edward Lunny, at Sun Jul 11, 09:14:00 AM:

" It has been a long time, generations, since breach of contract was considered amoral" Perhaps in the legal and financial worlds. I suspect that in middle America they are less sanguine about the theft of funds and the lack of moral concern on the part of the thief. " a crime in American courts " IANAL, nor a member of the financial community, but find that the deliberate theft of monies and/or services should go unpunished disturbing. That there are no consequences is unacceptable. That said, I don't think your statement inaccurate, just disturbing. The facts that is not the statement. The lack of consequence for this kind of behaviour is directly responsible for some of the collapse in our economy. Is it any wonder that a portion of our population do not accept any responsibilty for their life choices ? Grrrrr !  

By Anonymous Anonymous, at Sun Jul 11, 11:41:00 AM:

I think it is incomplete to view strategic default as only having negative externalities. There is a clear relationship between foreclosure and the value of the surronding property. However, I suspect there are additional externalities, including the movement of population to areas with higher employment, that exceed or at least offset those externalities.

More to the point, many actions we take result in negative externalities. The mere act of buying a good, and incrementally driving up the price for all other buyers, can be consdered causing negative externalities. The existence of this externalities is a poor justification for regulation. And moral condemnation is just... silly.

Take care of yourself. If you're underwater, maybe you should dump it. The contract is stil being followed. There are provisions for default. There aren't any for optional default. Maybe the banks should have thought of that. After all, they do have thousands of tier 1 lawyers making $160,000+ to think of things like this.  

By Anonymous Anonymous, at Sun Jul 11, 01:11:00 PM:

My BS meter is vibrating! Is this another example of proof that JournoList or it's heir is alive and well and still working for the destruction of America!
It is just too convenient to have another story to blame on the rich. What this story does is identify the "rich" by the value of the house. If I am a $6 and hour glass worker and an illegal alien with a wife and six kids (wasn't that a real example somewhere near LA?), why would I want a liar's mortgage on a 500K house when there is a community bank that will help extort from a lender, a liar's mortgage on a $1.5 million house?
These class warfare stories in the captive media in an administration that wants class warfare are troublesome and need to be carefully examined.  

By Blogger ruralcounsel, at Mon Jul 12, 10:30:00 AM:

"[T]heft of funds"?

Law does not protect you from making a bad deal. It is completely inaccurate to describe this as a "theft." It is also completely hypocritical to play the morality card on individuals, when business entities will breach contracts in the ordinary course of business. What we really have here is the fionaicial community aghast that individuals will actually utilise their full arrray of rights and legal actions the way businesses do. They've counted on the individual "morality" bonus to boost their profitability by getting individuals to make finacially stupid decisions under the guise of "it's the right thing to do." All risks are priced into the loan terms, unless you were an incompetent lender.  

By Anonymous Anonymous, at Sat Jul 31, 12:01:00 PM:

To ruralcounsel, at Mon Jul 12, 10:30:00 AM:

I agree. We're in IL not CA, but we know brokers who by their own admission sold millions in mortgages they knew the mortgagees wouldn't pay and the brokers are still in their McMansions with their Jaguars and Caddy SUVs and plethora of other toys (that I don't have though my mortgage is paid off), in-ground pools, big boats moored in one of the pricey Chicago slips and who knows what else...while the mortgagees (who also knew they wouldn't be paying and used endless re-fi to add cash and toys to their mortgages) may have got a government bailout. And as a taxpayer (with a paid-off house whose value is plummeting and a real estate tax bill that is RISING) I'm still on the hook for the bad loans that linger on the books of the big banks and Fannie/Freddie, while at the same time the government is planning to load billions of new bad debt via FDIC onto the backs of me and future generations...

Is this a rip-off or what?

When's the revoluation beginning, and what's the plan...so that we'll know when it happens.

Where's the Department of Injustice?

Where's the outrage?  

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