Strategic defaults – conditioning, morality, or naïveté?
The question of what motivates underwater homeowners to either stay put and continue to make their mortgage payments (if they can) or “walk away” from their home (and their financial obligations) has been receiving an increasing amount of attention in recent weeks.
In looking at this matter, a good place to begin is with the abstract below from the recent study Underwater and Not Walking Away(.pdf) by Brent White at the University of Arizona:
Contrary to reports that homeowners are increasingly “walking away” from their mortgages, most homeowners continue to make their payments even when they are significantly underwater. This article suggests that most homeowners do not strategically default as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure’s perceived consequences. Moreover, these emotional constraints are actively cultivated by the government and other social control agents in order to induce homeowners to ignore market and legal norms under which strategic default might not only be a viable option, but also the wisest financial decision. Unlike lenders, individual homeowners have thus generally not acted to minimize their losses and have born a disproportionate share of the burden from the housing collapse.
Brent probably has more than enough sample data in Arizona from which to draw and his conclusions are no doubt valid in many other parts of the country as well where the magnitude of the current “underwater homeowner” problem is highly correlated to the size of the mid-decade housing bubble.
But, what is most fascinating about this report is the aspect of “emotional constraints” that are “actively cultivated by the government and other social control agents”. Apparently, this has played a major role in getting underwater homeowners to act (or, in this case, not act) in ways that work against their own financial interests.
In the report, White noted comments by the former Treasury Secretary on one of the hottest housing market topics of the day – strategic defaults:
The worst criticism has been reserved, however, for those who would walk away from mortgages that they can afford. Typical of such criticism is that of Secretary of the Treasury Henry Paulson, who declared in a televised speech: “And let me emphasize, any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator – and one who is not honoring his obligations.”
It seems there is a national movement afoot to divert homeowners’ attention away from the degree to which they are underwater on their mortgage and focus on monthly payments, that being the thrust of the recent Making Home Affordable government program to slash interest rates while leaving the outstanding debt intact.
To this point, we have lived in a country where the “What’s my monthly payment?” culture has thrived, but that seems to be changing and the question that more and more underwater homeowners are now asking is, “If banks can walk away from their obligations, why can’t I?”
This is occurring with increasing frequency, Bloomberg reporting just yesterday that Morgan Stanley will “relinquish” five San Francisco office buildings after having purchased them more than two years ago near the top of the market. It’s probably no coincidence that the phrase “walking away” is noticeably absent from their account when, in fact, that is exactly what the investment bank is doing.
Maybe the rules are different for big banks than for homeowners.
You’d surely think that this is the case after reading part of this WSJ story, one in a series of excellent reports in the Journal in recent weeks about “strategic defaults” where the morality issue is neatly captured:
A standard mortgage-loan document reads, “I promise to pay” the amount borrowed plus interest, and some people say that promise should remain good even if it is no longer convenient.
George Brenkert, a professor of business ethics at Georgetown University, says borrowers who can pay — and weren’t deceived by the lender about the nature of the loan — have a moral responsibility to keep paying. It would be disastrous for the economy if Americans concluded they were free to walk away from such commitments, he says.
What banks have done in recent years has not been a disaster?
And Wall Street firms can walk away from their “obligations” but ordinary Americans can’t?
That sort of thinking should be about as popular as Wall Street bonuses right about now.
While simple laziness is surely a big reason why most homeowners will continue to pay $3,500 a month (if they can) for a house that is worth $200,000 less than what they owe instead of sending the keys back to the bank and renting a house down the street for about half the monthly payment, there is clearly a very big moral issue here, one that continues to surprise me every time I run across it.
No stranger to the idea of acting in one’s own self interest when it comes to real estate (as detailed here, my wife and I did a short sale back in 1995 when the previous California housing bubble went bust), it does continue to amaze me that, in light of some of the most wretched financial market excesses in history, many homeowners continue to think that we live in a world full of Jimmy Stewart-like bankers instead of those populated with the likes of Hank Paulson and Lloyd Blankfein.
It seems that one homeowner’s morality is another homeowner’s naïveté, that is, unless the latter truly believe that “the meek shall inherit the earth”.
We are, by far, the most religious of all western nations, but the idea of somehow being rewarded in the afterlife for continuing to make mortgage payments to Bank of America is beyond my ability to comprehend.
In a place like California, the terms of the deal are quite clear – the bank either gets the monthly mortgage payments until the loan is paid in full or it gets the house back with very few strings attached. And while the word “promise” appearing in the loan documents may prove too much for some borrowers to surmount, it is clearly not a legal impediment.
Without question, many underwater homeowners are acting against their own self interest by continuing to pay their mortgage if other dramatically less expensive housing arrangements can be made.
One could wait for home values to recoup a $200,000 decline, betting on an even bigger housing bubble materializing someday, all the while making good on the monthly mortgage obligations, but that may take much longer than you think and, in the end, it is sure to be much more costly than you could imagine.
Now, there’s a big distinction to be drawn here between, say, the just-married couple who bought a house at the top of the market because that’s what people do (that’s what we did 20 years ago) and your run-of-the-mill wild-eyed housing speculator circa 2005 who managed to amass a large real estate portfolio without ever having earned a high school diploma.
It’s not clear if there is any sympathy anywhere for the latter, but too few seem to see any distinction between the two to the detriment of the non-speculator who seems to go on believing that, today, “if you can continue to pay, you shouldn’t walk away”.
So, where does this all bring us?
A shocking decline in naïveté or, if you prefer, more immoral behavior on the part of the American public regarding their underwater mortgages may be one of the more important developments for the housing market over the next year or two.
ooo
Tim Iacono is a retired software engineer who writes the blog “The Mess That Greenspan Made”. He is also the founder of “Iacono Research” , a subscriber-based investment website focusing on natural resources.
December 18th, 2009 at 12:52 pm
Keeping up with the Joneses, in a perverse way. It seems that the elite and their fed enablers are counting on the Sheeple to go against its own personal best interests AGAIN.
December 18th, 2009 at 12:53 pm
the awareness of being able to “walk away” is just now starting to make some headway into the American psyche-
many people were unaware that if they walked away- the lender in most cases has no ability to secure a judgement against them for any deficiency not paid off through the bank sale-
for instance in a “non-recourse” state- a lender “by definition” has no recourse to secure payment through judgement and subsequent enforcement- and can only take back their collateral-
the lender can however- indicate that liability was “not paid as agreed” on a person’s credit file-
but who gives a shit- my advice-
find a place to rent- move- then send your keys to the bank-
and don’t worry- be happy- because the banks can’t do shit
December 18th, 2009 at 1:04 pm
Personal values to do that which is right in a quaint, naive, old fashion and honest way? Anyone else remember when most people actually believed in this?
But also, the costs involved in moving (both in time and expense) are substantial frictions to the “walk away” scenario.
December 18th, 2009 at 1:15 pm
While it has always been true that there are two sets of rules, those for the powers that be and those for the peasants, the Internet now makes this sad fact more obvious than ever before.
December 18th, 2009 at 1:18 pm
bsneath-
some amount of inertia for sure could be at play- however- that the banks have bent over the populace at every turn- have enriched themselves w/ billions in bonuses all the while sending the economy over the cliff-
makes it very easy to come to the conclusion the the $200,000 negative equity should no longer be your problem- but the bank’s problem-
and moving down the street to a rental unit- how hard can that really be? especially if it takes a $200,000 monkey off your back
December 18th, 2009 at 1:23 pm
bet it’s highly correlated with religion
December 18th, 2009 at 1:36 pm
@Blurtman: Precisely, but the peasants are waking up and are slowly starting to follow the morally and ethically bankrupt lead of their masters. Kind of poetic when you think about it.
December 18th, 2009 at 1:37 pm
What’s the old RE mantra: location, location, location. There are some states where even Morgan Stanley could get stung for mailing in the keys.
Non-recourse states are usually non-judicial foreclosure states so you can escape personal liability if you walk away from a home mortgage but those states won’t let you off the hook on a second mortgage which is almost always full-recourse; e.g., a deficiency judgment can be brought against you.
But even states that are listed as non-recourse may provide for an elective judicial foreclosure or for a deficiency judgment when foreclosure is non-judicial; e.g., Montana, Nevada and Texas.
And states like Michigan, Minnesota, North Carolina and a few others make it easy enough to seek a deficiency judgment that the chances of judicial foreclosure are fairly high.
Shorter version: Better to walk than wreck your family but don’t do it w/o seeking legal counsel beforehand; you can bet Morgan Stanley didn’t.
December 18th, 2009 at 1:48 pm
I feel that morals come into play when you have a handshake agreement or if you have an agreement with another individual. When it comes to “morals” when dealing with a corporation, the only thing that matters is the contractual agreement you have and whether you are behaving legally. In most cases, paying off mortgage debt or giving up the house as collateral are morally equivalent in my opinion. As you can see with Morgan Stanley today, companies are not above putting legality above a skewed sense of “morality,” no people should do like-wise.
HCF
December 18th, 2009 at 1:55 pm
RW-
I would have to disagree- any purchase money 2nd including HELOCS will be treated like the 1st trust-
if a HELOC or 2nd Trust was secured after the purchase- than the bank may be able to secure a judgement- so read the fine print
December 18th, 2009 at 2:01 pm
Inertia. And people refusing to go through the hassle of moving. That’s the only thing keeping a couple of my friends in their current place when they should walk away.
December 18th, 2009 at 2:02 pm
HCF-
exactly- you are giving up the collateral to the bank- what else should they get???
I would also wager- that even in those states where there are judicial foreclosures- a judge would be reluctant to smack a deficiency judgement against a homeowner-
just a guess- but those be the way winds are blowing- also -
I wonder if MS will get a deficiency judgement- hmmm . . . .probably not
December 18th, 2009 at 2:12 pm
[...] http://www.ritholtz.com/blog/2009/12/strategic-defaults-is-it-conditioning-morality-or-naivete/No stranger to the idea of acting in one’s own self interest when it comes to real estate (as detailed here, my wife and I did a short sale back in 1995 when the previous California housing bubble went bust), it does continue to amaze me that, in light of some of the most wretched … for instance in a “non-recourse” state- a lender “by definition” has no recourse to secure payment through judgement and subsequent enforcement- and can only take back their collateral- … [...]
December 18th, 2009 at 2:30 pm
I, too, wonder about the correlation to religion.
I’d also like to think that many Americans, based on my anecdotal conversations, believe that if they drop the ball (mail in the keys), then the entire base of America is weakened. Sure, the big boys at the top blew it, but this isn’t the first time. Americans believe that they are the foundation of our country, and I agree with that. I’ve wondered what I would do if I found myself in a negative equity situation. I’ve only been in my mortgage and my home for a little over 6 years now anyway. A significant fall in the price of $200,000 homes in the Birmingham, AL metro might send me into that situation. I can say I’d stay and pay. But you don’t really know what you will do until placed into that situation. Here’s hoping I don’t.
December 18th, 2009 at 2:34 pm
The efficient use of capital is the hallmark of true capitalism. Obviously when an institution does that (after making massive misjudgments) by walking away they are prudent. F the banksters and other elites who play by two sets of rules. Suzy Orman and the other personal finance blowhards would never in a million years tell anyone to walk away. Moral Hazard my butt. People should run not walk.
December 18th, 2009 at 2:37 pm
I think the author totally misses the mark on the whole subject. People are not walking away because the financial side is only one part of the equation. People continue to pay because 1) they need to live somewhere, 2) they actually like the house they bought, 3) they have made their house into a home with their own personal touches and 4) it is a paper loss until you sell. If financials are the only consideration, then why doesn’t every automobile owner with a 5 year loan walk away the second year, when the car is worth far less than loan? (If you think this is an apples to oranges comparison, consider you will pay less for a house in places like Detroit than you will pay for a car!)
The people who are walking away are leaving a house, not a home. The only naivete is thinking there is no human emotion involved.
December 18th, 2009 at 2:46 pm
@Porsche87: I agree with that to some extent, but it all depends on how far underwater you’re talking about. A “home” quickly becomes a “house”, or a complete irrational drag on one’s income and lifestyle when one could be living in a similar home at half the monthly payment.
December 18th, 2009 at 3:10 pm
“The people who are walking away are leaving a house, not a home. The only naivete is thinking there is no human emotion involved.”
sure- but anyplace can be your home-
attachment makes you a slave to your debt-
I keep waiting for the banks to come out with intergenerational loans so the payments can be lowered but the principal remain unimpaired-
then- true serfdom will be achieved and maybe your eyes will be opened
December 18th, 2009 at 3:19 pm
This entire discussion revolves a lack of understanding between commercial lending and personal lending. Morgan Stanley’s deals were commercial and by definition, non-recourse. Personal mortgages are generally (with some states and circumstances exempted) full recourse.
If you borrowed personally with full recourse, I’m happy to have the Bank foreclose and seek deficiency against you and if that ruins your credit and your financial life….well tough crap, honor your deals, dead beat. The relative morality argument of “the banks do it therefore it’s OK for everyone to do” simply points out a lack of understanding of basic lending practices. That said, I understand how it’s easy for the less intelligent among us to correlate these two unrelated concepts.
The Bank wasn’t your equity partner in a private investment..you wanted to buy a house and you asked the Bank to lend you the money and you promised to repay it with your cash flow….liquidation of the asset is not a source of repayment unless all other sources fail. Big difference.
If the majority of folks looking to walk away today had been offered commercial, non recourse terms, they likely wouldn’t have been able to afford to buy in the first place. Then they’d be bitching about that and the internet would be full of a-holes complaining about how unfair the bank’s lending practices are.
Unfortunately we’ve become a nation of uninformed whiners who want it both ways….personal lending terms unless and until things go bad, then we want it treated as commercial lending.
December 18th, 2009 at 3:32 pm
“If the majority of folks looking to walk away today had been offered commercial, non recourse terms, they likely wouldn’t have been able to afford to buy in the first place.”
I personally know of commercial terms/loans that were even more lenient that residential loans. No money down commercial properties bought on interest only ARMs for MILLIONS of dollars. You are obviously the one who is uninformed.
December 18th, 2009 at 3:37 pm
@jface: Let me guess. You work for Morgan Stanley?
December 18th, 2009 at 3:52 pm
Occasionally this board can produce some real gems, here Jface Says:
“If the majority of folks looking to walk away today had been offered commercial, non recourse terms, they likely wouldn’t have been able to afford to buy in the first place.”
Forgetting the obvious fact that if what Jface Says “the majority of folks…had been offered commercial, non recourse terms” then the price of housing would be about 40% of what is today and houses would be far more affordable. Just as reminder, the cost of a house was far less of a worker salary 40 years ago, before all these gimmick were adding to advantage those that had…over those that didn’t. Subsidizing the selling price of a necessity will, [to the best of my knowledge] always raise the price above the true market.
Of course Jface’s argument is to look at a single fragment of a system in isolation and extrapolate it outward to encompass all. Almost all western and eastern schools of thought describe such thinkers as fools.
Which brings me to what Jface Says next:
“we’ve become a nation of uninformed whiners who want it both ways”
and there…in one isolated case…Jface’s case, he’s right.
December 18th, 2009 at 4:04 pm
@SBrennan & RUKidding: Precisely. I nearly fell off my chair reading that absurd post. Could have been written by Lord Blankfiend himself.
December 18th, 2009 at 4:07 pm
@SBrennan: I would add that you are spot on regarding the supply of credit. If it never got to this point, houses would be FAR more affordable for the Sheeple to purchase them to LIVE IN (and not FLIP as an “investment”), but no, the whiner-welfare-queens (and kings) of Wall Street love their credit-induced Ponzi Schemes until they get bitch-slapped by them.
December 18th, 2009 at 4:08 pm
Where you have a “consumption” good (housing) coinciding with an “production” investment (real estate), you have complex emotional and psychological issues that will almost always trump economics.
The fact that banks and the government are exploiting this I hope isn’t a surprise to anyone – when you steal trillions in broad daylight, what’s a little cultural manipulation, especially when that isn’t illegal?
When you look at the list of communities that are heavily underwater, I assume there could be a large percentage of Hispanic families involved. This is a culture that values commitment, family, trust and integrity – an excellent target for our Wall Street creative financial geniuses.
When you think about the idea of the “American Dream”, owning your own home, freedom, etc., I can easily see how losing the ability to buy another home for several years could be a big factor delaying walkaway decisions.
And with real estate, the future is everything – and the economic future is cloudy at best. If I am underwater but if I really expect hyperinflation, I might want to hold on to some debt and pay it off with cheap dollars, plus the price of my house might skyrocket. If you watch enough Glenn Beck, you might think if the US is going to default, and the dollar loses all value, then why worry too much about a dollar-denominated debt? Or if the world is going to end economically in two to three years, then it IS more expensive to sell and move and rent than just hunker down.
The very fact that we have so many homeowners who are willing to do the “right thing” and continue to pay should be sufficient reason to consider recapitalizing these loan values to a reasonable value. I certainly benefit since all the people aren’t dumping their houses at the same time – I would love for them to be able to stay there. At least we would be rewarding moral behavior, even if it doesn’t appear financially rational.
December 18th, 2009 at 4:10 pm
Well put, pebird. However, we unfortunately seem to reward the most immoral and unethical behavior, above all, in our culture today, so your suggested remedy probably won’t happen.
December 18th, 2009 at 4:14 pm
“I personally know of commercial terms/loans that were even more lenient that residential loans. No money down commercial properties bought on interest only ARMs for MILLIONS of dollars. You are obviously the one who is uninformed.”
I’m thrilled for you, but you know as well as I do – or, at least I hope that one who purports to be not only informed, but one who actually personally knows of lenient commercial terms – that had a homeowner who presents a single tenant, zero cash flow commercial property (which would be profile for a owner occupied residence) would not get the type of terms you outline.
Look, I’m not blindly defending the banks, but I’m certainly not blindly defending borrowers who sign up for one thing but cry for another when things go against them. This was personal lending, if you don’t like the terms don’t sign. It’s as simple as that.
The alternative is if you believe your credit will return before your equity, then by all means, walk away. That doesn’t make it right, but it’s one’s prerogative.
December 18th, 2009 at 4:23 pm
jface-
then secondly-
you’re wrong- there are many states that are non-recourse- and even those that are recourse- it would be unlikely that a judge would place a deficiency judgement against the mortgagor in the current environment-
but- think what you want- appears you have everything figured out- at least in your small mind-
List of non-recourse states
December 18th, 2009 at 4:25 pm
“Forgetting the obvious fact that if what Jface Says “the majority of folks…had been offered commercial, non recourse terms” then the price of housing would be about 40% of what is today and houses would be far more affordable.”
Right. If you felt I was defending the ridiculous “fog the mirror and you get a loan” lending practices of Banks, I was not. Without question they deserve a huge amount of the blame here, but not all of it.
“Of course Jface’s argument is to look at a single fragment of a system in isolation and extrapolate it outward to encompass all. Almost all western and eastern schools of thought describe such thinkers as fools.”
Pot, kettle, man….you argument is built exactly the same way. Some lending practices were stupid, reckless and irresponsible, “before all these gimmick were adding to advantage those that had…over those that didn’t. Subsidizing the selling price of a necessity will, [to the best of my knowledge] always raise the price above the true market”…some, not all.
Regardless, the idea that personal responsibility should be removed completely from personal lending just doesn’t hang together.
December 18th, 2009 at 4:31 pm
jface-
you’re wrong- there are many no recourse states- and even in those states that are recourse- it is not assured that a judge would place a deficiency judgment against the mortgagor-
but hey- think what you want- it appears that you have everything figured out in your small childlike mind-
List of Non-Recourse States
December 18th, 2009 at 5:43 pm
I absolutely and postively protest that my 4:23 comment was edited-
post the original post BR-
I am sure Jface here’s it all the time
December 18th, 2009 at 6:09 pm
“jface-
then secondly-
you’re wrong- there are many states that are non-recourse- and even those that are recourse- it would be unlikely that a judge would place a deficiency judgement against the mortgagor in the current environment-
but- think what you want- appears you have everything figured out- at least in your small mind-”
Dude read my first post, I clearly state: “Personal mortgages are generally (with some states and circumstances exempted) full recourse.”
I’m aware of which states are non recourse and under what terms within those states the non recourse rules apply.
Where you and I diverge is that I would never presume to know what a judge would or wouldn’t do regarding deficiency judgments, you have declared that a deficiency in the current environment would be “unlikely” and you might be right. Then again, you are just as likely – if not moreso since the documents directly contradict your opinion – to be wrong.
So you’ll understand that given that fact set, I’m neither insulted nor pleased that your personal insults to me were edited. I was looking forward to reading them. I assume they were insults since they started with “at least in your small mind…”
Speaking of which….it seems to be your lack of reading comprehension that drove you to a website to point out the fact there are non recourse states. Yes, I’m aware…I accounted for the possibility that some genius would decide to impress us all with his/her knowledge of the non recourse states by addressing it the first paragraph of my first post. Your intellectual powers are frightening indeed.
BTW, the phrase you are struggling for is “hears it all the time” not “here’s it all the time” and you’re right, I do hear it all the time. Jface is short for jerkface. I’m aware that I am jerk. To me, the dangerous ones are the ones who aren’t aware.
All that said, thanks for the internet link of non recourse states. That’s some good work right there.
December 18th, 2009 at 6:35 pm
Of course, it’s fine if Morgan Stanley defaults, right? http://bit.ly/7froS7
December 18th, 2009 at 6:56 pm
jerkface-
yeah . . .”here’s it all the time”- the problems with posting when you are constructing a few thoughts on a blog w/ no preview-
anyway- I have posted repeatedly for over a year regarding the same thought- that people can walk away in many cases with the bank taking the collateral- their only option in a non-recourse state- and true- a judge may see things differently in a recourse state- a person would have to weigh their odds and make a decision- but a better chance now then any time before- that a deficiency judgment would not be handed down by a judge- but-
anyway- just to be clear- you are a complete douche bag- but I am sure you are aware of that- and a bit of little whiny bitch as well- but . . .I’m sure you have heard that too-
so . . .anyway- bite me- thanks and farewell
the bohemian
December 18th, 2009 at 7:04 pm
oh by the way-
it was in my original post to you-
“first off-
you’re a dick . . . and then it went on with my “then secondly”
just wanted to make sure you knew where i was coming from-
not that I give shit-
the bohemian
December 19th, 2009 at 11:17 am
The herd has just begun to realize that this is the “new” thing to do… as in strategic defaults. Once they start seeing that their neighbor or friend went through it without a problem the numbers will exponentially grow…. Shame, guilt, and anxiety will go out the window just as their moral standards did when they lied about their income.
December 19th, 2009 at 11:37 am
[...] Strategic defaults – conditioning, morality, or naïveté? – THE BIG PICTURE [...]
December 20th, 2009 at 8:20 am
Debt is a symptom. Symptoms treated can eventually kill you.
The root of the financial meltdown is not debt. It is fare more fundamental than that. The best example of the fact that debt is not the problem is none other than the ubiquitous vampire octupus, Goldman Sucks’ partners (shareholders re not all equal).
Here’s Lord Blankfein handing out multibillions of dollars in bonuses to himself and his Tribe, while heaven knows how much debt he carries. Here’s my good friend, filing for bankruptcy after amassing millions in debt by not paying his withholding taxes and getting caught by the IRS and given a wrist slap and $158.00 a month payoff for however long it takes to get the government their vastly whittled down
tax bill. Here’s my tenant making $40,000 a year as a nurse and getting a divorce, and to mollify herself and her kid runs up $60,000 in credit card bills and eventually filing for bankrupcty and leaving me to spend a small fortune evicting her.
What isn’t said much on MSM about debt is that all unsecured debt and a lot of secured it now seems is either greatly reduced one way or another, or forgiven and the debtor gets to keep most of the stuff they bought with it, and my good friend after 7 years has managed to do quite well, better than most, with bankruptcy assets in his hideaways.
NakedHedge has it exactly right: the moral, ethical, and justice fibers that once were a part of our DNA have somehow become evolutionarily superfluous, like a prehensile tail.
Two things I would have done had I known how the world really works: Amass as much debt as possible,
default, enjoy.
NakedHedge +100
BR: -100
December 20th, 2009 at 5:31 pm
wow, everybody take a xanax at once now! Merry Christmas, and play with your kids (or your family’s kids) fer fux sakes! There is joy in the world still, even if we all get foreclosed upon.
December 24th, 2009 at 8:43 am
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