Monday, November 30, 2009

South Bay-Beach Cities: Who pays when homeowners walk away....

Yesterday there was a rather interesting article in the LA Times written by Brent T Wright,  a  law school professor at the University of Arizona.   Professor Wright is advocating that homeowners should just walk away from their homes if they owe more then the current value of the home.  He is not talking about people who have lost their jobs or had major financial problems.  He is suggesting that  consumers defaulting  on a loan they can pay is  not wrong but simply acting in your own self interest.  Phooey!

Not only is the professor advocating that folks walk away,  he also thinks they should  buy big ticket items  like a new car or even another home prior to defaulting.  He finds this to be prudent money management.  I think he is just one more jerk who thinks it's OK to stick it to the taxpayer.  That's right folks it isn't the banks who pay the price when this happens... it is you and me... the taxpayer  who ultimately takes the hit.

I'm guessing it has escaped the good professor's attention that banks rarely pay for their mistakes. Rather it is the consumer who gets hit every time someone defaults on loan.  We are the ones ultimately paying  the costs for TARP and to keep Fannie and Freddie solvent.   It is the consumer who pays the price when banks lose money.

I know of a couple of homes in the Beach Cities where the former owners did as the professor has suggested.  They borrowed as much as they could, bought new toys and new homes out of the area and then stopped making payments to the bank.   The lenders " lost"  hundred of thousands of dollars on these properties but  most of the loss will be made up by the bank charging higher fees on everything from accessing an ATM machine to rates for new loans .. oh and paying very low interest rates for folks who are trying to put a little aside for a rainy day.

There are banks that  go under, but they usually get picked up at bargain price by a new company and are  often financed by the Federal government... otherwise known as you and me.   So while I don't begrudge Professor Wright his opinion.... I would feel  far more comfortable if he was picking up the tab with his own money rather then mine when he tells folks it is OK skip out on their obligations.


Anonymous said...

borrowers entered into a legal contract with their bank. they are under no "moral" obligation to society to pursue a path that is clearly not in their financial best interest for the sake of some greater good.

similarly, banks have entered into a complex series of arrangements with the government to guarantee their deposits. the rules are set clearly at the outset and they agree to submit themselves to stringent regulation in exchange for their privileges. the contract clearly spells out the rights and obligations of both parties. their shareholders are under no moral obligation to "make whole" the FDIC in the event that the bank becomes insolvent.

if you don't want the private sector to take advantage of the free default option the government has sold lenders and borrowers, there are really only three options:

1. repeal deposit insurance, thereby forcing bank creditors (as opposed to taxpayers) to bear the losses associated with bad lending.

2. stringently regulate the banks and discourage them from engaging in "aggressive" lending practices.

3. dismantle the GSE's so that future mortgage loans are not subsidized by a government that mis-prices the default option in the name of the public interest.

i should point out that, in all three cases, the end result is a higher cost of capital for banks & borrowers. a likely byproduct is higher down payment requirements for mortgage customers, since the banks will not want to assume the risk of further price declines.

this, of course, will ultimately feed through to lower home prices.

the bottom line is that no amount of wishful thinking, or social pressure, can force millions of homeowners to stay current on mortgages that are 50-100% higher than the rents on comparable properties.

until that fundamental imbalance is rectified, the trend in home prices is lower, in my view.

Kaye said...

Anon 11:18,
I disagree on a few of your points...
First I have no issue with folks who are having serious financial issues as divorce, unemployment, a major illness or death that find themselves unable to meet their obligations. It may be necessary for them to seek bankruptcy protection along with losing their homes via foreclosure. Bad things happen to people.

My issue is with people who not only walk away from their financial obligation but up the ante so to speak by increasing the amount they owe to buy themselves new homes, cars etc.. that's fraud and it is done with purposeful intent.

I don't find it acceptable to defraud a lender, rob a bank or stick a gun in my face and take my money.

I find fault with someone who proposes that consumers defraud lenders. It is that type of thinking that costs all of us more in the long run.

Target, Macy's, Nordstrom all build extra fees into their costs because of shoplifting. You pay a higher price because someone else chooses to steal rather then pay for an item... this is no different. We all pay higher costs to cover those who steal...

Anonymous said...

I completely agree with the recent post by Anonymous.
It really disappoints me how heavily leverage individuals/lending institutions are. It's legal agreement and for the lenders to be that lax on the contracts/mortgages they wrote, was their fault.
I understand your point Kay and do agree, but I really put the blame on the financial institutions for lending out all the cheap money and creating the bubble - so in my mind, they are the ones to blame. I read the same article and agree it is not right to buy all the toys before you stop paying on your property.
In 2001 my wife and I looked at buying a home and could qualify for mid 300's on current income (did not buy) - then in 2006, on the same income we could qualify for a million. Interest rates were low, but not enough for our our buying power to 3X.
I will not buy in this market until fundamentals are right. When banks lend on proper debt/income ratios and require a decent down payment so buyers have skin in the game.
Agree with Anonymous, if this happens, prices will go down.

Kaye said...

Anon 7:03,
While I do agree that banks have created their own problems that still doesn't make it OK for people to deliberately defraud them. A lot of the anger at the financial community is because they failed the ethics test. We trusted them to do the right thing and they didn't. As my Mama used to say 2 wrongs never make a right.

I applaud you and your wife for using common sense about what you could afford. As incredibly stupid as banks were they had the help of consumers on the path to destruction. You knew you couldn't afford to buy a home with that kind of payment and so did most of the people who got caught up in the "I want to live like the rich and famous" frenzy.

The issues we now face are not completely real estate based. How else do you explain folks who used to shop at Penny's suddenly buying Prada from the Prada store. That's another reason I take issue with Professor Wright's advice. He's not just advising folks who made a bad decision to get out from under but rather to buy more stuff and then to stiff the lender.

As to tightening financial requirements that is happening as we speak. Lenders are tougher then they have been at anytime in the last 30 years. Prices have definitely declined as fewer folks can qualify for a loan. But don't set your expectations of prices rolling back to 15 year levels.

The other thing that is going to have to happen is that buyer expectations are going to have to change. One of the issues that helped create the real estate feeding frenzy was that buyers expected to get much more then they could afford. Folks said I make $XXX so I should be able/want/must buy a $XXXX home. With tighter loan requirements buyers may now only qualify for $XX. Prices may not drop enough to make them happy as their expectation levels are still at $XXXX. It is a conundrum to be sure.

Maggie Knowles said...

I'm sick and tired of the banks having all the benefits of bailouts and none of the responsibility for helping the folks they preyed on.

The point is, in every negotiation, you have to be willing to walk away from a deal that is not good for you, otherwise, you get screwed. I think that was the point of the conclusion of that study. Banks and servicers think they have the advantage because they expect guilt and shame to keep people in a situation that they will never get out from under. A perpetual debt slave.

Here's a link to an interesting video post by a former Bank of America customer service rep, posted just last week:

In it she says:

"Don't deny for a second that there are systematic practices put in place to keep America in debt."

Here's a link to a transcription of the video and an additional quote from the transpcription:

My name is Jackie Reynolds, and I would like to tell everyone a story. I am a former employee at Bank of America in Georgia. I worked in the customer assistance department from May 1st to November 23rd, 2009. And by the way, "customer assistance" is a euphemism for "the collections department."

Every day I came to work and did just as I was supposed to: I collected. In fact, I was one of the top performers of my department, even outdoing those who were more tenured than I was. But something was wrong. There was something inherently evil about my job."

Kaye said...

I don't dispute that banks are slugs but that still doesn't mean that playing the fraud game is right. All that does is make the situation worse for the rest of us.

What has to happen is that lenders need to have the restrictions that governed them after the Depression to keep them honest put back in place. The same is true for the stock market. Credit institutions were given unlimited power to do what they wanted by Greenspan and we all got screwed in the process.

Maggie Knowles said...

I agree fraud is never right, and there was (is still?) a lot of that going on. I had just read the discussion paper you referred to that was about using social controls to keep people paying for a mortgage that doesn't make sense. Why pay a $600,000 mortgage if the house is worth only $300,000 and the market is still declining? Because you feel guilty and ashamed? Most of these folks were told they would be able to refinance their way out of these loans in a couple of years. The banks need to take a hit, they need to be fair and they need to be generous. That would help a lot. I think the banks are out of control, I'm really concerned about it.

But I agree with you 100%, fraud is wrong, wrong, wrong, no matter who is doing it.