I've previously posted on my dislike of the notion that it's acceptable for homeowners who can afford to make their monthly payments but refuse to do so to walk away from their homes simply because they feel like it. They made a bad decision (or decisions if they took out home equity loans based on the assumption that the value of their homes would never fall) and should have to bear a major part of the total costs involved. Walking away from the obligation will increase the costs that I and others who are not in this situation have to pay the next time we try to buy a home. I want that externality captured in a significant way to make it less likely that it will happen.
(Note to this commenter on my previous post on this subject...I specifically was not talking about people in your situation, where you couldn't make your payment and defaulting on your loan was one of your very few options. My comments were directed at people who can but refuse to make the payment.)
An article in today's New York Times by Richard Thaler raised the walking away issue and took the discussion in several interesting directions. But Thaler's suggestions raise at least as many questions as it provides answers.
For example, he cites an idea that would allow a homeowner whose mortgage is underwater and who lives in a zip code where home prices have fallen at least 20 percent to receive a loan modification that would reduce the mortgage by the average price reduction of other homes in the neighborhood. In return, the bank would get 50 percent of the average gain in neighborhood prices when the house is eventually sold. Presumably the bank would get nothing if prices do not rise adequately at the time of the sale.
What if a mortgage isn't underwater but the value of the home has fallen by 20 percent? Would that homeowner also be eligible for the modification? Shouldn't he or she get the same benefit and not be penalized because the house was bought a while ago rather than at the height of the market? Isn't this proposal just a way to reward someone who bought high and now has to sell low?
It is an interesting notion to force the mortgage owners and investors to have to bear part of the risk of the mortgage that is now underwater. They did, after all, either originate or buy the bad loan. I have serious doubts, however, about whether mortgage holders and investors would be willing to do this given the virtually immediate hit they would take to their balance sheets. This especially would be the case if they've borrowed against the asset and writing down the value of the loan would result in a need for additional capital.
I also have some doubts about whether the sanction many say will occur when financial institutions report to the credit bureaus everyone who walks away from their mortgage is really going to occur. If the current numbers are true, that would reduce the size of the market by about one-fifth by preventing these homeowners from buying another house for 5 to 7 years. Do lenders really want to do this?
Wait. There's More. Over at Economist's View, Mark Thoma has an interesting take on the Thaler piece from the New York Times and several of the comments he received on nonrecourse mortgages. Here's the money quote:
If you were underwater and lost your job and had to move to get a new job, that was one thing, there was little choice but to default and use the protection embedded in non-recourse. But simply walking away when you were still employed and could still afford the mortgage was another. That wasn't the option embedded in the implicit contract. Following this implicit rule lowers costs for everyone, that's the sense in which, contrary to claims above, there's a financial incentive to follow this norm -- should I pay more for my loan so that you can speculate and then walk away from a bad bet (there are unrecoverable costs each time a default is socialized)? That's different than using non-recourse as a form of social insurance against contingencies beyond a household's control, and paying extra closing costs for that insurance.
I was also particularly interested in a comment Mark received from "johnchx." He asked how it was possible for California to be both a housing bubble and a nonrecourse state because the nonrecourse provision of the law is supposed to make lenders more likely to value a home (and, therefore, the mortgage) properly.
The answer has to do with the role of securitization, which took the risk out of all of the mortgages originators chose not to hold themselves. Except in the early days after the mortgage was signed and could be returned to the lender if it went bad, the originator bore virtually no risk of any kind. Instead, the investor was the one completely on the hook.
That completely neuters the nonrecourse provisions.
Question: Why haven't investors been more aggressive in demanding restitution from the institutions who sold them nonperforming and underwater loans?
Simple remedy.
Walking away from the obligation will increase the costs that I and others who are not in this situation have to pay the next time we try to buy a home. I want that externality captured in a significant way to make it less likely that it will happen.
1) Make mortgages recourse loans, like in almost all the rest of the world, so one can't walk away.
2) Require a down payment of say 15% or 20%, and only allow home equity borrowing up to a point that preserves that much equity in the home, so borrowers don't want to walk away.
Done.
Note well that both these are a matter of government policy -- nonrecourse status is granted by law, and the FHA is still flogging minimal- and zero-down loans today as we post.
If the politicians and mortgage market "reformers" are not willing to embrace this common sense, they are not serious about ending this problem.
Because obviously -- pretty much by definition -- they are preserving a situation in which equity can readily drop below zero, and when it does borrowers have a legal right to walk away.
In which case all their fancy formulas along the lines of "in zip codes where prices have fallen by x%, and interest cost/income >y%, a stepped-rate adjustment of z1% reduced by adjusted gross income at a ratio of z2/z3 ..." are mere posing.
where did all the anticapitalists come from?
I remain puzzled.
A mortgage in a nonrecourse state contains an explicit embedded put option. Your policy preference, if I read you right, is for individuals not to exercise their deep-in-the-money puts out of some altruistic concern for your personal future mortgage rates. Do I have that right?
This would strike me as one of the manifold places where individual virtue does not solve a collective action problem. If you want to change this behavior, you need to change the law. So long as these contracts exist in current form, your stance asks economic actors to engage in uneconomic behavior. As a bit of an anticapitlist myself I may sympathize with this latter desire, but its expression by moderate establishmentarians deeply puzzles me.
Back on-topic, if you want a policy prescription that captures this dynamic, I suggest use of a modified charitable deduction with an unlimited carryback feature. Define and regulate all financial institutions as 403c charities. Allow underwater homeowners the option of vacating their embedded-put rights in return for a deduction in the amount of its fair market value. Homeowners could get cash refunds on past taxes (just like the homebuilding industry), allowing them to monetize this gift. Mortgage books all over would get a shot in the arm. You'd get your preferred policy. What's not to like?
Just a business decision...
Tell me, exactly, where the "responsibility" for the "bad decision" fits in this case?
"Huge N.Y. Housing Complex Is Returned to Creditors"
NY Times, Jan. 25
Or is it that "this" is different because it's a "business decision". Surely. Surely! Blackrock and Tishman have the money to keep paying on their "obligations". They could, for starters, sell Rockfeller Plaza!
So just get back on your horse and find another town to sheriff 'cause this one doesn't want or need your opinion.
Norms
Your cherry piking economic arguments as your try to rationalize what is really a ethical position.
Having a large swath of the population pushed down the economic ladder is, I think, going to do more systemic harm than your somewhat abstract concern that the cost of borrowing might go up.
I note that your ignore Thaler's first reference. You may prefer the norms adopted by the classic mortgage holder but you put him at a serious economic disadvantage when his counter party is playing by entirely different norms.
Who gets to decide what the implicit contract is?
If I had bought a house in a non-recourse state, I would have done so knowing that my downside risk was limited to losing the house, and that the lender bore the risk of the house being over-valued. I would have assumed that the lender had priced the loan accordingly. All of this social pressure to keep borrowers from making the financially rational decision to walk away from a deeply underwater home in a non-recourse state seems to me to be an attempt to avoid forcing lenders to bear the cost of their mistakes.
Amusingly, today the WSJ reports that "Tishman Venture Gives Up Stuyvesant Project"; apparently, Tishman Speyer Properties and BlackRock Realty are walking away from the property they pruchased, even though they have the financial capacity to keep paying their debts. But I'm sure that's different.
Default Only for Investors? - might help to push loan mods
In the NYT Magazine of January 7, 2010
http://www.nytimes.com/2010/01/10/magazine/10FOB-wwln-t.html
we read in an article by R. Lowenstein"
"Morgan Stanley recently decided to stop making payments on five San Francisco office buildings. A Morgan Stanley fund purchased the buildings at the height of the boom, and their value has plunged. Nobody has said Morgan Stanley is immoral..."
Then, widespread 'strategic default' by private borrowers might actually help:
" White [of U. of Arizona] has argued that the government should stop perpetuating default “scare stories” and, indeed, should encourage borrowers to default when it’s in their economic interest. This would correct a prevailing imbalance: homeowners operate under a “powerful moral constraint” while lenders are busily trying to maximize profits. More important, it might get the system unstuck. If lenders feared an avalanche of strategic defaults, they would have an incentive to renegotiate loan terms. In theory, this could produce a wave of loan modifications — the very goal the Treasury has been pursuing to end the crisis."
And we note that homeowners so far didn't get any help, only borrowers did get bailouts for their bad investments (for which they also got paid enormous fees and bonuses, presumably for all their hard work in due diligence).
Mispriced Externality
"Walking away from the obligation will increase the costs that I and others who are not in this situation have to pay the next time we try to buy a home."
Stan, what you don't quite seem to understand is that if it were to increase the costs, the lower price you would've paid in the absence of strategic defaults is an artifact of mispriced risk. Nobody is entitled to a misprice.
A lender in a non-recourse state should, if they were doing their job correctly, include in their price the possibility that people would walk away (and the Thaler article points to data suggesting they may already do to the tune of $800 per $100k borrowed). They should include those costs because the law permits walkaways, making it a nonzero risk that needs to be priced in.
This leads to a few conclusions:
- If costs do increase, they increase because previously the bankers had mispriced the risk of default. While it's always nice to get a good deal, you're not really entitled to mispriced loans.
- If some amount extra was paid in non-recourse mortgage as the HUD study suggests, that suggests that (a) costs will not increase because they were already higher, and that (b) borrowers would be irresponsible not to avail themselves of a put option which they have paid for.
Stan: "I've previously
Stan: "I've previously posted on my dislike of the notion that it's acceptable for homeowners who can afford to make their monthly payments but refuse to do so to walk away from their homes simply because they feel like it. They made a bad decision (or decisions if they took out home equity loans based on the assumption that the value of their homes would never fall) and should have to bear a major part of the total costs involved. Walking away from the obligation will increase the costs that I and others who are not in this situation have to pay the next time we try to buy a home. I want that externality captured in a significant way to make it less likely that it will happen."
IOW, you're mad that many mortgage-holders will do something like what the bankers have already done. And the mortgage-defaulters will not get government-funded bonuses to do so, unlike bankers.
Tell ya what - after the bankers get reined in, I'll help you go after the evul mortgage defaulters. I figure that this is promise I won't have to worry too much about.
Big N.Y. Housing Complex Is Returned to Creditors - NYTimes
Big N.Y. Housing Complex Is Returned to Creditors [NYTimes, 2010-01-25]
Interesting that there is no talk of moral hazard or any comments that Tishman Speyer Properties had a duty to keep making payments to preserve the neighborhood. In articles like this it is a pure business decision, TSP payed too much during a boom and are going to let the creditors deal with it during the bust.
Double standard
This just enforces the double standard that more or less defines American life: corporate persons have rights, but no moral obligations, but human persons have both (though their rights are often dependent on the legal help they have available).
Any well-run corporation will do whatever the present legal and economic conditions make it rational to do. To do otherwise would be a failure to exercise fiduciary responsibility on the part of management, and might be actionable. If fighting liability suits brought by wretched and pitiful human persons to the bitter end is more profitable than either paying off the victims or fixing the problem, then the problem won't be fixed and the victims won't be paid off. (Two women I know are still waiting for their late father's settlement from the Exxon Valdez case. Perhaps their children will inherit the settlement, and it will be passed down in the family forever like a lapsed medieval title.)
But we (human persons) are better than that. We have ethics. We wouldn't want to be like them. Sure, corporate persons rule our lives, and human persons who put themselves at the service of corporate persons live much better than the rest of us. But we are above that. We're too good and pure.
Others say that, when contending with amoral entities like banks, any morality you happen to have is a detriment that can only work to your disadvantage. But this conclusion is horribly wrong and immoral, and all decent people should condemn it, and corporation condemn it even more strongly.