Wow, the efforts to find and discredit strategic defaulters and other types of mortgage borrower reprobates appear to be picking up steam at the New York Times.
Let’s be clear: there are not doubt more than a few people who bought more house than they could afford who had out of control spending habits. But there is a disturbing propensity in the media to find egregious cases and write them up, with the implication that they are representative. In fact, they are a tail end of behavior. It might be a pretty fat tail, but it would take a good deal of forensic work (construction of a large sample, detailed work on the motives and behaviors of borrowers, with efforts to check what they say about their motives now with evidence of their actions at the time the loans were entered into) to get to the bottom of why people are defaulting.
For a lot of subprime and option ARM borrowers, whether they understood it or not, their out was supposed to be yet another refi, but the ATM of ever-rising housing prices was shut down. Many other homeowners are in trouble due to un and underemployment, or the big historical source of bankruptcies, medical emergencies. Some, as Tanta pointed out, were people who had been prime who refied into subprime (who knows the motives, to pay off student or credit card debt, to invest in their house, to finance a business, to fund consumption) and their plans did not work out.
The reason my suspicions go up when I see an article like “Borrowers Refuse to Pay Billions in Home Equity Loans“as the title is that it clearly announces a point of view (although the web allows the NYT to show different versions in different views of the article, so the full page view has the comparatively anodyne, “Bad Debts Rise, and Go Unpaid, as Bust Erodes Home Equity.”
Let’s look at a critical fact, buried in the piece: the delinquency rate on home equity loans is 4.12% as of first quarter 2009, which is actually a smidge lower than in the previous quarter and far from a scary level in this crappy economy. What makes these loans troublesome to banks is the high loss severity, which is well over 90%. And the reason for the banks to freak out about this a bit is that home equity loans, a type of second mortgages, are junior to the first mortgage. If you are having to make deep writedowns on severely delinquent home equity loans, how can you justify rosy valuations of seconds that are in or are on their way to default?
Yet the article attempts to frame the issue as “ruthless borrowers are now defaulting in droves” with statistics that don’t bear that out, bolstered by a few stories. The bias here is that the report comes largely from Phoenix, ground zero of underwater mortgages. Now if you believe what passes for research on strategic defaults (and what there is is thin and poorly designed), it appears that the factors that make homeowners most receptive to the idea is first, how deeply underwater they are and second, whether they believe others who are similarly situated are doing so as well. So it is plausible that to the extent strategic defaults are happening, Phoenix would logically show one of the highest incidences. But the article never mentions that Phoenix is almost certain to be an outlier. (As an aside, I’m skeptical regarding discussions of this trend, since there are serious problems with classification. Most people would probably classify a strategic defaulter as someone who is perfectly capable of paying his housing-related obligations, but decides to default because his house is worth so much less than its mortgage balance that keeping it is a bad investment. By contrast, banks appear to regard anyone who is defaults suddenly as a strategic defaulter, since most borrowers fall in and out of arrears before becoming hopelessly delinquent. But more borrowers who are long-term goners may simply be operating rationally as the stigma of default is lessening, and choosing to pull the plug when they realize that they will hit the wall in the not-too-distant future).
The story has a notable pro-bank, anti-borrower bias, Even though it duly notes the level of home equity lending writeoffs in 2009 ($11.1 billion in home equity loans plus $19.9 billion in home equity lines of credit) and lists some banks seriously exposed (the usual suspects), we get the “whocoulddanode” defense:
The amount of bad home equity loan business during the boom is incalculable and in retrospect inexplicable, housing experts say….
“No one had ever seen a national real estate bubble,” said Keith Leggett, a senior economist with the American Bankers Association. “We would love to change history so more conservative underwriting practices were put in place.”
Yves here. So the ABA has never heard of Sweden, Finland, England, or Norway, all of which saw housing markets that suffered serious downdrafts in the early 1990s, or Japan, whose housing market after 20 years may still not have hit bottom.
Contrast this with the remarks of Christopher Combs, a Phoenix lawyer:
“When houses were doubling in value, mom and pop making $80,000 a year were taking out $300,000 home equity loans for new cars and boats,” said Christopher A. Combs, a real estate lawyer here, where the problem is especially pronounced. “Their chances are pretty good of walking away and not having the bank collect.”…..
“People got 90 cents for free,” Mr. Combs said. “It rewards immorality, to some extent.”
Yves here. Note the framing: borrowers treated as profilgate (when universe is varied) and default is voluntary. And no mention of the banks’ failure to anticipate that these were pretty risky loans and maybe they better not hand them out so freely.
The CEO of debt collector also takes to moralizing:
“Anything over $15,000 to $20,000 is not collectible,” Mr. Terry said. “Americans seem to believe that anything they can get away with is O.K.”
And we get a remarkably precise estimate of strategic defaulters from an attorney in a two partner firm handling 300 cases (which lawyers I know doing real estate say is a very large number). Google Earth shows his offices are in a what looks to be a markedly less than prime neighborhood and his website has a rather unusual list of resources and lists personal injury as another major practice area:
Marc McCain, a Phoenix lawyer, has been retained by about 300 new clients in the last year, many of whom were planning to walk away from properties they could afford but wanted to be rid of — strategic defaulters. On top of their unpaid mortgage obligations, they had home equity loans of $50,000 to $150,000.
Fewer than 5 percent of these clients said they would continue paying their home equity loan no matter what. Ten percent intend to negotiate a short sale on their house, where the holders of the primary mortgage and the home equity loan agree to accept less than what they are owed. In such deals primary mortgage holders get paid first.
The other 85 percent said they would default and worry about the debt only if and when they were forced to, Mr. McCain said.
“People want to have some green pastures in front of them,” said Mr. McCain, who recently negotiated a couple’s $75,000 home equity debt into a $3,500 settlement. “It’s come to the point where morality is no longer an issue.”
Yves here. Even the parts that give the borrower side of the story undercut it:
But the borrowers argue that they are simply rebuilding their ravaged lives. Many also say that the banks were predatory, or at least indiscriminate, in making loans, and nevertheless were bailed out by the federal government. Finally, they point to their trump card: they say will declare bankruptcy if a settlement is not on favorable terms.
“I am not going to be a slave to the bank,” said Shawn Schlegel, a real estate agent who is in default on a $94,873 home equity loan. His lender obtained a court order garnishing his wages, but that was 18 months ago. Mr. Schlegel, 38, has not heard from the lender since. “The case is sitting stagnant,” he said. “Maybe it will just go away.”
Yves here. Schlegel is one of three purported strategic defaulters presented (note we don’t know whether they are on good financial footing or not). He started speculating in real estate (it isn’t made clear as to whether it was on the side or as a job) and got in trouble. This sounds an awfully lot like what Wall Street did, just with a lot more zeros attached.
This case example is curious:
During the boom, he [Eric Hairston] bought as an investment a three-apartment property in Hoboken, N.J. At the peak, when the building was worth as much as $1.5 million, he took out a $190,000 home equity loan.
Mr. Hairston, who worked in the technology department of the investment bank Lehman Brothers, invested in a Northern California pizza catering company. When real estate cratered, Mr. Hairston went into default.
The building was sold this spring for $750,000. Only a small slice went to the home equity lender, which reserved the right to come after Mr. Hairston for the rest of what it was owed.
Mr. Hairston, who now works for the pizza company, has not heard again from his lender.
Yves here. Hhhm. A home equity loan….on an investment property? Sounds like a wee bit of misrepresentation. But it also sounds like he has some survival skills. His leveraging up his property and investing again has at least left him with a job in his investee company after Lehman cratered.
As I’ve said before, I’m a believer in honoring agreements, but it needs to be a two way street for it to have a chance of enduring as a social value. The reason for caviling about financiers and their (sometimes unwitting) allies harping about borrower morality is that it is banks who trained borrowers to take a narrow, contractual view of their commitments by acting in a fee-gouging, legalistic manner across all their products. It’s way too late to try to play the morality card.
“901 West McDowell Road
Phoenix, AZ 85007