Bloomberg provides a summary of a report by Morgan Stanley that has tried to quantify the level of strategic defaults. The analysis seeks to identify borrowers who walk away from mortgages that they can arguably afford, and defines that group as those who go from paying on time to missing three mortgage payments in a row, while still paying on time on other consumer debts that are greater than $10,000.
This definition highlights some interesting issues. First, it’s a reminder of how pervasive consumer indebtedness is in America. In the 1980s, it would be almost unheard of to get a car loan or run a credit card balance. Second, it also suggests that some of these strategic defaulters are simply “pre defaulting”, as in recognizing their ability to service the mortgage is tenuous (as in they may be straining to stay current, and recognize that one shock will put them in arrears) and they’ve decided, with the home under water, that it’s better to face the inevitable early. Third, and perhaps most important, the defaults again illustrate the perverse side effects of securitization. In the old world of a mere 20 years ago, most banks would work with a borrower that was facing financial stress and needed a mortgage mod. The lender would recognize that as long as a mod left it with appreciably lower losses than getting the house back, principal reduction was a sound move. And as we’ve argued repeatedly, deep principal mods have been shown to produce lower redefault rates than payment modification programs.
The report contained other findings:
A fifth of U.S. homes carrying mortgages were worth less than their loans in the fourth quarter, according to Seattle- based Zillow.com, which runs a real estate data Web site. Home prices in 20 metropolitan areas tumbled 33 percent from July 2006 through April 2009, then rose for five months before falling for the next five, leaving them up 2.8 percent from lows, according to an S&P/Case-Shiller index….
For mortgage-bond investors, the data signals a problem with prime-jumbo debt and strengthens the case for investing in subprime, the analysts wrote. That’s in part because strategic defaults are less prevalent among borrowers with subprime characteristics and they may benefit from government-aid programs that don’t target large loans, the analysts wrote.
Yves again. This indirectly raises an issue that Tanta wrote about, that many subprime borrowers did not initially borrow as subprime, but as their financial condition deteriorated, refied into subprime.
And this problem is not going away…..
Housing won’t recover for three to five years as mounting foreclosures hold down prices, mortgage-bond pioneer Lewis Ranieri said yesterday in a panel discussion at the Milken Institute Global Conference in Beverly Hills, California.
“There’s another big leg down,” he said. “You can’t have much of a rally when you’ve got this big overhang.”
I have been patiently renting in the SF bay area (east bay suburbs) for the past 6 years, waiting out the bubble. Recently, for the first time, I noticed that rents on single family homes seemed comparable to 30 year mortgage payments, in suburban east bay. This is the first time in more than 10 years that has been true. I have been wondering whether to take the plunge now and buy or wait for further declines. There is plenty of inventory out there, with even more shadow inventory (foreclosures) not yet listed. Another refreshing change – realtors are not at all pushy. In fact, many seem downright apologetic about the homes they list; listing realtors say things like “This is an old house, it would look nicer with some care”, in the hope of earning my trust – and the fun part is that the house looked just fine to me!
Should I wait or buy?
This is not a financial advice blog. But since I’m not a financial advisor, it all depends on your price range. The bottom of the market (subprime level) has largely collapsed, and prices aren’t likely to go much lower. For the rest of the market (Alt-A, Option ARM, Jumbo prime), TSHTF about now.
I agree with John and can only offer my personal thoughts…. with unemployment looming at what it is, i’ve tried to stay away from any major purchases. Granted some times i will not have a choice aka i had to buy a car recently, but even then i did not buy what i could afford, i bought something much, much cheaper. If i absolutely positively wanted (not needed) to buy a house now, i’d buy a new car instead… I can pay it off in less time ;)
Patient Renter, I live in Silicon Valley in a condo bought during the last real estate collapse, 14 years ago. so I have a bit of a perspective (but no special expertise!). I take it you already read burbed, and patrick.net. I wouldn’t buy yet if I were you, for two reasons.
one is that although *everyone* says that the less expensive areas have bottomed out, I don’t see why that should be at all true. with credit tightening, unemployment high, taxes going up, and costs of necessities rising, why shouldn’t lower priced houses (and rents) go down another leg??
another reason is that areas that are now safe, may become unsafe, as values decrease.
my aunt lives in Hayward, in a working class area where houses reached 600K at the top of the bubble. you can now get one for 250K there. but the median household income in Hayward is about 50k. I would wait until such houses reach 150k. there should be no premium to owning in that neighborhood; 3X income should be plenty.
As to supply, you should know that BofA recently announced its intention to increase foreclosures 600% by the end of 2010. As for demand, the world’s most sophisticated bond man is predicting higher interest rates in the near future, the Fed is not anticipating purchases of more MBS, and Congress will not extend the home buyer credit. You can do the math.
Given the big imponderable (will we have an inflationary environment, which would reward borrowing to buy real assets, or a deflationary one, which will punish borrowing), approaching this as an investment problem is not a good template.
You need to consider:
1. How long you will realistically stay in a house you buy. Transactions costs on RE (particularly fix up for sale and brokerage) are killers. Unless you are VERY confident you will either be there 10 years or more, or if you move, will have a corporate employer who will pick up some of the costs, as we say in the Bronx, fugeddaboudit.
2. How much better is the purchase RE stock than the rental? If you are NOW getting better properties for the same (after tax) price, that is a consideration
3. How confident are you of your income? What would you do if your income fell to 40% of its current level for 2 years in a rental v. purchase scenario? Work through that
nakedcap hq is in the bronx?
Whatever gave you that idea?
NC has no headquarters. I’ve posted from all sorts of places. While my residence is technically New York, it is not the Bronx. Not that I have anything against the Bronx, mind you.
I think John was pulling your leg, Yves…..
Valuable discussion and comments about the buy/rent subject, thanks.
… as they say in all sorts of places, and technically New York, but not the Bronx (unless they do), “fugeddaboudit”.
“…defines that group as those who go from paying on time to missing three mortgage payments in a row, while still paying on time on other consumer debts that are greater than $10,000”
Isn’t there another possible explanation here, Yves? We have heard repeatedly that banks will not modify mortgages until borrowers are in arrears in their payments. So some (a lot?) of this could simply be borrowers stopping payments so they can move forward in renegotiating their loans.
Greg, maybe I am missing something, but your scenario sure sounds like a strategic default to me. Do you think if the lenders tell them to go pound some sand that a certain significant percentage of these borrowers plan to resume payments?
And I also read that there was a lot of buying on spec, people buying up two, three, four houses in order to flip them, the so-called liar loans. Apparently in the Las Vegas area this was more the norm than not. One blogger wrote that these flippers were renting out their houses for $1,000.00/month, but still had not received a foreclosure notice after more than a year or two.
California and Florida had a lot of this going on too, the bubble states, but I don’t know how pervasive it was throughout the rest of the country.
In theory it could be, but in practice, the HAMP programs don’t provide for meaningful principal reductions (the powers that be are supposedly now allowing in HAMP v. 2.0, but I’ll believe it when I see it). The report indicates the level of defaults is correlated with how far the mortgage is under water, which would support the walk-away thesis.
The other issue is the mortgage mod programs have gotten super bad press. Plenty of stories of people skipping a payment to qualify, having trouble getting through the bureaucratic hoops, losing their house (when that was NOT their intent) and getting their credit trashed too.
There are additionally three other forces besides securitization keeping lenders from offering principal reductions. First is that they are waiting on every opportunity to shift risk of loss to the public balance sheet….bailout limits for Fannie/Freddie were not eliminated for no reason is their thinking. They sure would feel dumb tossing $60,000 overboard if they only needed to wait another couple of months to get the taxpayer to offer to supply $50,000 of it. Second, it is a delicate balance between imporving the results of one loan while setting a precedent that encourages 3 more borrowers to seek help they otherwise might not have considered. The reluctance to defaulting is eroding, and with it this reason should be diminishing, particularly in the areas with the worst loan to value ratios. Lastly, so long as liquidity is practically guaranteed by the Fed, why would you want to acknowledge a hit to earnings by actually doing a principal reduction when you can just pretend that your loan portfolio has retained most of its value? That wouldn’t be so good for the bonus pool, now would it?
Freddie and Fannie are not a dumping ground for weak mortgages (they are being used to prop up the housing market, but there are a lot of ways to skin that cat). Both agencies are now aggressively going after banks (as in seeking billions in restitution) for having had loans purveyed to them by bank that were misrepresented (as in the bank had to represent that they met certain criteria, like being an owner-occupied primary residence, certain credit quality, etc). Banks are going to be a LOT more careful in their dealings with Freddie and Fannie going forward.
“Housing won’t recover for three to five years as mounting foreclosures hold down prices, mortgage-bond pioneer Lewis Ranieri said yesterday….”
IIRC shadow inventory in some problem areas is at 103 months. When he says ‘recover’ he needs to be one hell of a lot more specific. In California particularly, (where he held his meeting in Beverly Hills), he’s delusional if there’s a recovery in 3 – 5 years.
We essentially don’t have any ‘industry’ left here except for Starbucks, surfboards, and sativa.
I hope this means that these defaults, as strategic, are showing people are becoming more careful about their finances.
‘In the 1980s, it would be almost unheard of to get a car loan or run a credit card balance.’
Huh? having been alive in the 80’s, I can assure you people had car loans and credit card debt. Maybe less proportionately than now, but it was there.
I grew up in the 80s, so my only points of reference were car prices on The Price is Right. I seem to remember most cars being sold for well under 10k. But I have no clue what the levels were for median income, housing prices or credit card debt at the time. I can only imagine the scale was a lot less than it has been over the past 15 years.
A significant, but not the only, reason lenders don’t write down home loans is that there is no bankruptcy pressure to do so.
In 2005, Congress enacted the Bankruptcy Abuse Protection and Consumer Protection Act (BAPCPA) besides creating lots of protections for the derivatives industry, BAPCPA removed the authority from bankruptcy judges to allow individual borrowers to “cram down” lenders on their home loans, i.e., shrink the loans to the value of the property and re-cut the mortgage on terms based on the shrunk value. What is wild is that the borrower could cram down a lender on a boat loan, a car loan or a loan on their resort condo, but not on their primary residence — so much for promoting home ownership.
A similar study was published last Fall, with a bit more detail around strategic default trends:
It’s worth noting that the current study was performed by MS & TransUnion…the latter of which competes with Experian (co-author of the linked study)
“In the 1980’s, it would be almost unheard of to get a car loan or run a credit card balance.”
Maybe there’s a typo and you meant 1950’s. I have been in the insurance biz since 1980 and it has always been my experience that at least 90% of all new cars I cover for my clients have a lienholder (i.e. are financed).
It was in the 1980s that people really started to use their credit cards for everyday expenses. What’s interesting about cars is that so many people now lease them, rather than purchasing them. (And leasing does provide a much cheaper monthly payment–at the time we bought our little Honda Civic, we could have leased an Accord for a smaller monthly payment.)
We don’t lease
we buy the whole car
as you should
“First, it’s a reminder of how pervasive consumer indebtedness is in America.”
Maybe its a reminder that much of the “prosperity” of the last 20 years is built upon borrowing (i.e., lending). New kinds of borrowing, inovative borrowing, subordinated CDO’s cubed and insured by CDS’s, which made them impossible to default, because they were all insured! Perpetual money motion machine.
Well that’s what happens in the stamped to bring purchases forward, burnishing the stairs of the temple, achieve greater/multiple cash stream flows, equity ratings, bond yields…BONUSES.
Skippy…almost everyone bought too much, too soon apart, in a pumped up market and correction is directly connected to income and ability to service this pile of over priced consumption. Realisation of loss is the monster under the bed…eh.
Yves, I think you’re giving too much “credit” where none at all is due. A “strategic default” implies that, as you correctly allude, a “premeditated,” consciously calculated decision. I haven’t seen ANY evidence that there are that many people that “smart.” I will contend that, at best, a great many people have finally become [barely] aware that they’ve been cheated and don’t have any compunction about cheating the cheaters.
Furthermore, according to everything I’ve read, HAMP is an abysmal failure in that the mortgage lenders ONLY provide an incessant run-around and less than 10% of those seeking a loan modification have been “helped” by that program! Moreover, I’ve yet to read/hear about ANY mortgage lender offering anything but an ARM regardless of it being a “new” loan or related to any form of “compromise.”
Lastly, I sincerely doubt that the housing market has reached bottom. By all reputable accounts there is a more catastrophic “crash” coming in the commercial real estate market and, rest assured, that is NOT going to “improve” the residential side.
Yves,I have seen only a small amount of coverage about potential problems with MERS.I understand that MERS is the Mortgage holder of record in many cases and is actually “bringing” foreclosure actions.Since MERS did not make the loan,does not have the right to recieve payments on the loan and is not a servicer…isn’t this a bit odd?Does the change in Title insurance coverage by ALTA and CLTA have anything to do with this? I have seen little coverage of this matter and if anyone can point me to decent analysis of the problems I would appreciate it.
Here’s a good rundown Yves wrote on MERS:
And here’s my own humble effort:
I have a fantasy that that great solid middle with underwater mortgages will just get fed up, calmly pick a month, say July and simply refuse to pay that month’s mortgage, en masse. It seems we’re overdue for a nice old fashioned rent strike.
At this point there’s little downside risk to impairing your credit report by missing 1 mortgage payment. If people want to really strategicly default, doing it together in on hot summer month in the midst of continuing, and expanding coverage of WS horrors seems like an effective inducement to modify.
How much of this slight uptick in consumer spending is connected to:
1. The coupon-clipping class and high earners doing fine so for them consumption as usual or even a bit more…
2. The poor still just as poor and already spending all they’ve got so not much change…
3. The falling middle-class losing their homes and/or defaulting so TEMPORARILY while they’re saving on mortgage payments and have a bit more free cash than before…
I’d also be curious to see some stats about small business bankruptcies, liquidations, etc vs small business creation over time.
Despite the anecdotal evidence of people purposefully taking advantage of the system, I think most people aren’t paying mortgages because they can’t afford to pay them any more. Perhaps not on the finance and econ blogs which have a finanically savvier reader, but in real life most people still feel a sense of shame about their inability to pay their mortgage. I have two examples from friends and family.
My elderly dad and his wife bought a condo north of Atlanta almost years ago with an interest an interest-only mortgage for the 1st 5 years then it ballooned after that. Although my husband and I felt uneasy about it at the time, they had friends and family (some in the RE business) in the Atlanta area that encouraged them and due to the specifics of their situation it did make sense. They had been long term renters of a good sized apartment and then the owners decide to condo-ize the complex. So they looked around and found another apartment complex they liked and moved it, though it was more expensive. Then they realized there were lots of things they didn’t like about the new building and location so when their previous apartment, now beautifully remodelled, became available for sale as a condo they jumped at the chance to go back to an area they loved. Since they are elderly they figured the condo would go up in price and they would move out before the 5 years were up, make a little money on the deal, and then move into some kind of senior housing/assisted living. Obviously the RE crash ruined those plans as their condo dropped 60-70,000 in value (so now it’s a good thing they went with interest only!). So sometime in the near future my dad is going to stop paying his mortgage for 3 months then they will move on to some sort of senior housing. They were very reluctant to come to this conclusion as they are both very conscientious about their bill paying. However they have been encouraged from many quarters to walk away and they have an accountant who is going to help them. They have gradually come to terms with their default strategy but they aren’t happy about it.
My other story involves a friend who took out a second mortgage on her lovely Long Island home in order to buy and rehab an old house in upstate NY where she grew up and has family. Everything was fine until her business tanked (long story but basically due to an unpredicted industry change that effect her niche). She has been scrambling to retarget her business and potential customer with some success, but mostly she’s struggling so was now stuck with paying this huge mortgage with virtually no income. She has been trying to sell the house for the last 18 months but not had any luck, and so used up alot of her savings just to pay the mortgage. Finally a few months ago, she gave up and did not renew the lease on her office space, she stopped paying the mortgage on her LI home and she moved to her house in upstate NY (which is paid off) where she has been finishing up a novel that she is going to be sending to her newly acquired agent in the very near future. She has been writing as a sideline for many years and is a good writer, with some small publishing connections so I think that will work out for her. In her dreams she gets a large advance (or her business picks up) and is able to catch up on the LI mortgage and continue with her attempts to sell that house. However she is a realist and knows she may end up losing the LI house. She is a very hard working person who has always been very conscientious about paying her bills, so this is a new experience for her. She is able to rationalize her decision due to all the news about others who are walking away from their mortgages.
Sorry for the long post, but I thought it would be useful to have a counter example to all the stories about freeloaders, etc, that I typically read on finance blogs. I think my examples are probably more typical of real life folks.
Not paying my mortgage and proud of it. I feel we have a patriotic duty at this point to do as much as we can to hurt the big banks and I am doing my part. They will lose $250,000 once they finally take back my home. I actually did save all my payments and purchased a small residence for cash. It feels good to stick it to the man.
You are not one of the Good Guys in this story.
I am not lending you my lawnmower.
I understand why that’s said, and acknowledge Tanta’s explanation. I don’t have data points to say conclusively.
But my gut says that’s not right… not by a long shot.
First, it was initial VRM resets which set off this slide in the first place. 2nd, (again I don’t have data points but) Countrwide’s lending was, at least in markets where I was (SF Bay Area, Albuquerque, San Diego), was largely 1st mortgage (eg. not re-fies).
One thing I don’t understand at all: home sales here (ABQ) are definately up in last few months. We live in older, very desirable neighborhood near the University. There’s been a big glut of medium (+/- 1500 sq. ft) size, generally well kept homes which were either…
a) pulled from market 2 > yrs ago when things had slid big,
and now relisted w/above bottom prices, but still way
(+/- 30%) under peak of ’05/6.
b) newly listed (first time) in similar size/price as
c) builders have started some new construction here (west
side of ABQ: RIO RANCHO), after the big boys folded shop
over a year ago and left… some selling their
undeveloped property holdings (tax incentives to sell
cheap) in the process.
Meanwhile, unemployment remains at NM’s peak. State/county/city budgets are springing leaks w/each new more austere incarnation. Tech spending (my field) is definitely up, but moderately: not much hardware, but mostly long overdue maintenance and some incremental (I’d say necessary) minor upgrades to systems, mostly software/network related.
So anyway, moderately rebounding housing sector here a real mystery to me. Personally, I don’t trust it as bell-weather recovery signal, rather think I’ll wait to see what happens in larger econ environment.
Can I achieve results right away or will it take some time to show up?