Blogs For Victory

Mish links to an excellent article on the subject of “strategic default” – a homeowner deliberately letting a house go in to foreclosure once significantly “underwater” on the mortgage (ie, the unpaid mortgage amount is vastly greater than the current market value of the house). I strongly recommend reading the whole thing. Here’s a part I found most interesting:

Before examining why more underwater homeowners are not strategically defaulting, it might be helpful to explore why they should. A textbook premise of economics is that the value of a home, even an owner occupied one, is “the current value of the rent payments that could be earned from renting the property at market prices.”

In other words, when the net cost of buying a home exceeds the net cost of renting, one is better off renting. The equation is not as simple, however, as comparing total mortgage payments to rent payments because home ownership carries certain benefits including tax breaks and the potential for appreciation. Additionally, assuming a non-depreciating market, the portion of the mortgage payment that goes to principle rather than interest will eventually inure to the homeowner at the time of sale…

…As a rule of thumb, a potential homebuyer is generally better off renting when the home price exceeds 15 or 16 times the annual rent for comparable homes.

For example, a homeowner who bought an average home in Miami at the peak would have paid around $355,400. That home would now be worth only $198,00038 and, assuming a 5% down payment, the homeowner would have approximately $132,000 in negative equity. He could save approximately $116,000 by walking away and renting a comparable home. Or, he could stay and take 20 years just to recover lost equity – all the while throwing away $1300 a month in net savings that he could invest elsewhere.

The advantage of walking is even starker for the large percentage of individuals who bought more-expensive-than-average homes in the Miami area – or in any bubble market for that matter – in the last five years. Millions of U.S. homeowners could save hundreds of thousands of dollars by strategically defaulting on their mortgages. Homeowners should be walking away in droves. But they aren’t.

And why not? As the article goes on to note, a lot of people have an ingrained reluctance to default and this reluctance is being played upon by government, banks and “consumer credit” agencies. In other words, while a large corporation (GM, for instance) can default and no one bats an eye (and, indeed, Uncle Sam will come riding to the rescue), average Americans are being pressured in to maintaining valueless investments for the sole purpose of propping up the banks and, by extension, the government.

A large number banks (and perhaps all of them which are heavily in to residential mortgages) are probably insolvent and if the millions of “underwater” people suddenly forced these banks to let the houses go at fire-sale, foreclosure prices, the insolvency of the banks would be revealed in spite of any Fed or Treasury attempts to disguise the de-facto bankruptcy. It is massively in the interests of the banks and the government to keep people in their “underwater” houses even though doing so provides no or very limited benefit to the homeowner (in the form of tax breaks for interest payments).

A friend of mine did the “loan modification” song and dance for 11 months with the bank – and a few days before the foreclosure sale date, this friend received – out of the blue – a loan modification massively reducing the monthly payment (and I mean by more than 40%). Why? Because the homeowner showed that credit score was no longer a concern and that the fear of losing the house and the alleged shame of default were no such thing at all…pressed to the point, the bank would rather not foreclose because then the value of the mortgage on the books would have to be written down to whatever could be obtained in a foreclosure sale (which for Las Vegas is 50% or so less than the mortgage amount).

My friends, we’re being scammed – a massive swindle where banks and government are working us over, trying to get us to be suckers and keep the “underwater” houses at the current payment/mortgage balance. The banks would default in a heartbeat if their debts exceeded their value…but we’re being told to keep up on our debts no matter how low our asset values go down. They are playing it on business terms and asking us to play it on moral terms…but this only works as long as we think we have a moral obligation to pay any and all debts, regardless of changed circumstances.

Do we have such a moral obligation? I’m not enough of a theologian to answer conclusively, but I will say this: The banks lent the money – often with very poor underwriting practices encouraged by the government – on the supposition that the asset values would not just remain constant, but would go up. The people borrowed the money – often more than they could afford but encouraged to plunge by happy tales of never-ending home price increases put out by banks and government – on the same supposition. Well, banks, government and people got it wrong. Perhaps everyone was being greedy. Perhaps everyone was being stupid. But I can’t see how the only people with an absolute moral obligation to absorb loss are the average folks who borrowed the money. Its either everyone has an obligation to pay the price, or no one does.

There is much to be cleaned up in our government and our economy – and our banking system is one of the messier areas. We daren’t just let things go as they are, and I can’t think of any way to force them to reason except by direct, citizen action.