Strategic Defaults and The Moral Imperative 0comments
published in 2010-02-09 21:59:20
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Are you morally obligated to make your mortgage payment? What if you could legally stop paying your mortgage and stay in your house with clear title? Would you do it?These are questions more an ...
Are you morally obligated to make your mortgage payment? What if you could legally stop paying your mortgage and stay in your house with clear title? Would you do it?
These are questions more and more people are asking themselves as it is now obvious that neither the government nor the banks are going to help homeowners who are upside down or having difficulty making their payments.
A year after the Obama administration launched its housing rescue program foreclosure filings continue to set records.
Foreclosure filings were reported on more than 2.8 million properties in 2009 up 21 percent from the previous year and 120 percent from 2007 according to RealtyTrac.
Ten percent of all mortgages are currently delinquent which suggests that even more homeowners will face foreclosure this year.
"A massive supply of delinquent loans continues to gloom over the housing market" RealtyTrac CEO James J. Saccacio said in a statement. "Many of those delinquencies will end up in the foreclosure process in 2010 and beyond."
Meanwhile the number of "strategic defaults" more than doubled to 588000 from 2007 to 2008 according to a study by Experian and Oliver Wyman. A separate 2009 survey found that more than a quarter of all existing defaults were strategic.
Recently experts have suggested simply walking away. "Homeowners should be walking away in droves" Brent T. White a University of Arizona law school professor said in a recent paper. "The financial costs of foreclosure while not insignificant are minimal compared to the financial benefit of strategic default."
The pressure to default
Homeowners have found themselves in foreclosure for a number of reasons most beyond their control and not the result of poor decisions by them.
Because the economy was largely derived from betting on economic failure mounting and compounding failures are taking their predictable toll on the lives of hardworking people who did not get rich as a result of the greatest transfer of wealth in history.
They have lost jobs'>jobs and businesses as a direct result of "financial intermediaries" leveraging failure. If they work in retail construction financial services'>services or even government it is difficult to see much improvement in their prospects. (See "White Washed Windows and Vacant Stores")
We are told that unemployment is over 10% but that is extremely conservative in that it does not include those who are no longer collecting unemployment insurance those who are discouraged and no longer look for work and those who have had to accept reduced hours or a reduction in pay.
Here is the more telling figure: the average work week is only 33 hours. One source suggests that the real unemployment impact is closer to 20%.
Considering that only 10% of mortgages are in default it is likely that more defaults will arise from loss of income.
Personal and business bankruptcies spiked in 2009 and the real trickle down from that has yet to be felt.
Uninsured or under insured accident or illness victims are often confronted with the double whammy; the medical costs and possible additional loss of income during and after recovery.
Many are victims of predatory lending forced into one of those designed to fail loans rather than the loan their credit score really warranted. This increased the yield spread premiums on the front end and would pay out several times the loan amount when the loan defaulted.
Is it business or personal?
As real estate values continue to decline some borrowers who are capable of making their payments have begun to ask "Why continue to throw good money after bad?"
People might voluntarily stop making their mortgage payments for one of two reasons: because they no longer want the home or because they want to force a confrontation with their pretender lender to determine the true holder of the note for the purpose of seeking redress regarding claims of predatory lending which might result in a mortgage modification and even damages. (See "Are You A Victim".)
Most borrowers continue to make their payments either because they want the home or because they believe they are either legally or morally obligated to do so.
Professor White suggests that misplaced loyalties and antiquated values prevent otherwise clear-headed individuals from simply walking away from a bad business deal.
Most people underwater on their mortgages stay current "as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosures perceived consequences." In addition he notes societal norms push individuals "to ignore market and legal norms under which strategic default might not only be a viable option but also the wisest financial decision."
The commercial market is about to become a hotbed of strategic defaults for reasons related to balloon payments business declines or reduced value making it unwise to hold from a business prospective and impossible to refinance. (See "White Washed Windows and Vacant Stores".)
Upside down and sinking
In the residential market the reality of lost equity will eventually sink in and homeowners who have grudgingly been making a payment on a loan twice the value of the home will look into their options.
According to First American CoreLogic a real-estate information company about 5.3 million U.S. households have mortgage balances at least 20% higher than their home's value and 2.2 million of those households are at least 50% under water.
They should have no trouble finding hungry agents willing to help them buy the same floorplan down the street and close prior to defaulting on their loans.
Defaults will increase but will a wave of foreclosures follow?
Not necessarily. The bank doesn't really want your home-that isn't their deal and remember it isn't even their money at risk.
For this to make sense we have to change our antiquated view of banking and lending. Banks only call themselves banks to confuse you. In reality they have morphed into "financial intermediaries". They do not lend their own money.
These financial intermediaries during the 10 years since the repeal of the Glass Stegal Act have sold out America and engineered its demise. Here is what they really do.
They receive bundles of cash from investors and promise those investors a monthly payment. They keep half of the cash as their "yield spread premium" and loan the rest at a rate sufficient to make the monthly payment promised to the investor.
Then they pay a premium to a counterparty or insurer such as AIG for a credit default swap. The terms of the default swap agreement such as "triggers" events that trigger the payout are determined by the financial intermediary.
Trigger events could be as benign as a certain number of borrowers paying off loans early or a certain number of defaults within a pool. A good example might be the 2/28 adjustable loan. A pool of those loans was the gold standard of the whole scheme. The financial intermediary would simply make a huge side bet maybe thirty times the value of all the loans in the pool that a large number would default within three years. A certainty by actuarial calculations.
Once a certain percentage of defaults occur within a particular pool of loans the "financial intermediary" declares the entire pool of loans in default keeps all the payments on the loans in the pool that continue to perform and collects on the credit default swaps.
The last thing "financial intermediaries" want is for all of the loans in a pool to get paid back in full. The investor will want the original investment back but they will only get the half actually loaned out. The "financial intermediary" must make a certain percentage of loans fail or give back the yield spread premiums and pass up on the credit default swaps.
This also helps explain part of the motivation behind all of the defaults recorded on people who made their payments on time every month. Missing a payment is a default and they want to keep you in default. (See. "The Sub Prime Servicing Scam".)
The same with modifications. If they modify the loan it's still performing and there is no trigger event. That is why I do not believe that many trial modifications will result in permanent loans. As long as they pretend and extend you are still in default.
Did you get all that? The "financial intermediary" collects insurance on the default but has multiple problems if you pay back your loan. And there are no limits on credit default swaps so "financial intermediaries" bought multiple times the loan amount. That is why there are stray more derivatives traded than there is stuff to underline their value.
Surprise! Your lender actually wants you to default.
And that is why values are going down because the financial intermediaries who once overvalued them to sell more debt are pushing back on appraisals because they know that a certain number of people are going to agree with Professor White and when values reach a certain point they will default.
First they take our money now they want our homes?
Oh they want you to default alright but not because they really want your house or the rip mall. They don't really want the houses but if they can make a tittle money on the side they'll take that too.
In many communities the financial intermediaries aren't even completing the foreclosure process because they don't want the property while in others they simply abandon them post-foreclosure and walk away.
Here it is right from the horse's mouth. A spokesperson for GMAC Jeannine Bruin put it this way "We do the cost-benefit analysis (for) the investor. Is he going to recoup any money for us to go through the whole process of foreclosing fixing the property up marketing it selling it? Is anything coming back to that investor? If not it's best to just let the borrower keep ownership of the home."
Translation: if we can make a little money selling it we'll take it if not it isn't our money what do we care.
The problem is that they are not telling the homeowners this and homeowners are moving out. Either the homeowner or the community will now be left to deal with it but does GMAC ware about that?
Joseph SchillingAssociate Director of the Metropolitan Institute at Virginia Tech and an expert on abandoned propertysaid the issue of bank walkaways is increasing. Lenders may decide that given low prices and their mounting inventory of foreclosed property it makes sense to walk away. "But as a result it leaves the property in this type of legal limbo and it leaves the community and local government really holding the bag" Schilling said.
Cities all over the country are starting to sue financial intermediaries who have simply abandoned thousands of homes in there communities. And it's getting worse.
As long as you are in default they don't actually need to obsess the property to collect on the default swaps. As long as they aren't receiving payments or they make it appear as though you have defaulted they keep the swap payoff. Remember they had no interest in the property when they purchased the default swaps; they had already sold off the pool of loans. This was just a side bet but because of the size of the payout the real reason for doing the loan in the first place.
As more people become aware of the difficulty lenders are now having legally foreclosing loans that were securitized in the pools they may be inclined to default. Either the pretender lenders cannot or they will not produce a proper chain of evidence showing who the actual assigned holder of the promissory note is. (See. "60 Million Mortgages May Have Fatal Flaws".)
Do not leave your home
Because of this it is important that you not leave your home until forced to. People all over the country who left their homes have discovered after the fact that the bank did not take title to their property leaving the borrower on the crook for tens of thousands of dollars in legal expenses and sometimes demolition costs.
And that brings us back to the moral question: is this loan just a bad deal that no business person would honor or should we honor our pledge even though we were defrauded by a scheme that destroyed our economy?
The rules of the game
There are no rules. It is all about money. That is the arena you are playing in so you might as well understand that.
Here's how the business world sees it:
Morgan Stanley a pillar of the investment community serving鈥?ell themselves actually.
Despite the first annual loss in its 74-year history Morgan Stanley earmarked 62 cents of every dollar of revenue for compensation. Not 62 percent of the profit 62 percent of all of the dollars coming into a company that lost money. Isn't that a sort of Ponzi scheme? I know of no business where that could work. I went to their web site to see how they explain it.
"Since its founding in 1935 Morgan Stanley and its people have helped redefine the meaning of financial services."
Redefine the meaning of financial services yeah that's the ticket. Just get rid of regulation and oversight. The age old joke in the financial services industry is that if you told the client the truth it would sound something like this "My goal is to take your net worth and turn it into my commissions."
Recently Morgan Stanley said it would turn over five San Francisco office buildings to lenders rather than pay the debt on them. This is by definition a "strategic default". It isn't as though they cannot pay. They currently rank number 5 on a list of the companies with the most cash on hand with almost $300 billion.
That sure redefines financial services alright. I have a new slogan for them "Morgan Stanley we never lose".
They bought these buildings in 2007 at the peak of the market. The values have plummeted and tenants are scarce. They do not want these payments lowering the cash available for bonuses. Their simple business decision-strategic default.
Other financial intermediaries who gorged themselves on pricy high-rises and more branches than Starbuck's will follow suit to stop draining away cash.
But the entertainment world and other types of businesses also practice the theory of strategic default.
Six Flags amusement-park operator filed for bankruptcy protection because it could not make a $300 million interest payment. Its largest share holders Daniel Snyder owner of the Washington Redskins and Microsoft's Bill Gates certainly have the resources but most analysts and investors think they would have been stupid to bailout the company.
Serial defaulter developer Ian Bruce Eichner and his Cosmopolitan group defaulted on a $760 million Deutsche Bank loan in August of 2008 and the bank bought the Cosmopolitan out of foreclosure for $1 billion. In the early 1990s Eichner lost the 70- story Cityspire and the 42-story tower at 1540 Broadway in Manhattan to creditors.
Nor does billionaire real estate investor Sam Zell feel any shame or guilt because his buyout of the Tribune Co. which had $12.9 billion in debt ended in bankruptcy. He just won't answer any questions about it.
Corporate bonds practice the theory of strategic default.
Like mortgages corporate bonds are legal arrangements in which parties-in this case companies or partnerships or limited liability corporations-agree to pay money back.
According to Standard & Poor's through Dec. 18 262 corporations had defaulted on bonds they had sold to the public twice the total of 2008 and "the highest default count since our series began in 1981."
And then came news last week that the biggest residential real estate deal in history was ending in a strategic default as Tishman Speyer walked away from the massive and sprawling Stuyvesant Town and Peter Cooper Village apartment complex in Manhattan.
This was a strategic default in that they have ample resources to have made their payments. They only had a small stake in the deal but pension funds and other investors lost their entire stake. That's kind of personal but they would say it's just good business.
I could go on and on but I think you get the picture; it isn't a moral issue to them it's just about money. And since they didn't lend it to you but did in fact commit fraud against borrower and investor alike your moral obligation has been extinguished.
These are not your daddy's bankers they are more like grifters. They had a good thing going and if this year's bonuses are any indication still have a good thing going but you needn't feel any moral obligation to financial intermediaries. Just say to the holders of the default swaps okay I'll let you file notice on my house but I'm keeping it.
Stay in your homes fight back and make them stop the illegal foreclosures. As they themselves acknowledge they don't really want your home and it's just business. Fine if they are in business we are in business.
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