Are Strategic Defaults Really a Problem?
Mike Calhoun: My Vision >>
I’ve been reading up on Strategic Defaults since the weekend, and I think I broke my brain.
I’m hoping our readers can help me set it straight again. Like you, I’ve seen “Strategic Defaults” back in the news in a big way, and like any other important trend in our industry, I made it a point to get caught up .. but I think I’m more confused than ever.
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The Wall Street Journal kicked off the latest round of coverage late last month, announcing that “One in Five Mortgage Defaults are Strategic.” Their source was a report from Experian and the Oliver Wyman group, and that report has been under heavy critical fire from economics nerds and housing market experts. Mike Conczal was one of the first to examine the numbers in depth, concluding that the real barrier to any “Fixes” for the housing crisis are the banks themselves:
…this is the model where the ethical thing to do involves having people eat cat food rather than having a bank meet someone perfectly halfway with a small principal reduction, which they are refusing to do.They are encouraging people to go through loan modifications, a process that has has a high failure rate and that serves to simply recapitalize fees into balance, that often leads to higher payments, a process that works as an information filter on who is willing to pay whatever it takes to stay in their homes. I don’t think we’ll ever have a good statistical definition of this: the best way to judge this is to let an actual bankruptcy judge handle it.
The most devastating article on the subject was definitely from Yves Smith, titled “Strategic Defaulters as the New Welfare Queens” .. obviously, you can tell that’s going to be a provocative article!! After breaking down four major (and persuasive) reasons she disagrees, Smith raises some important questions…
“So why all this hysteria about strategic defaulters? If I were conspiracy-minded, I’d say this is a very clever push to stoke jealousy among what is left of the middle class to keep the focus off the way the banksters wrecked the economy, got lots of cash and prizes, and have every reason to repeat that profitable exercise .. Why would the banks oppose principal mods? It will force an end to extend and pretend, and when THAT happens, a lot of financial firms will be shown to be undercapitalized and in need of rescue or resolution.
On the other hand, Chicago Business School professor Luigi Zingales makes an equally persuasive case that Strategic Defaults can actually “undermine our financial system.” Zingales is a gifted writer, and what makes his article most interesting is that he, too, concludes with a criticism of the banks!! Check it out:
Unfortunately, the major lenders oppose any reduction of mortgage principal. They’re playing a dangerous game of chicken, gambling that the real-estate market will recover and that any dollar of principal reduction now will be a dollar less in profit for them later. (Even if the market doesn’t recover, they don’t have much to lose, since if they collapse they’re likely to become wards of the state.)
Not only that .. but far from the mainstream coverage or the economics blogs, the professional press has been asking more complex questions. Debt Servicing News was wondering if strategic defaults “May Have Peaked” .. and even insider trade magazines like US Banker are running headlines like “Are Strategic Defaults Actually on the Decline?” which digs into the most interesting details of the report:
Strategic defaults have become more pronounced in well-to-do segments of homeowners with otherwise stellar payment histories: Investors have a higher incident of strategic default than homeowners, and “super-prime” delinquents — those with VantageScore credit scores of between 901 and 990 — had a 50 percent higher incident of strategic default than the overall population.
I Think I’ve Read Too Much…
So let me ask you guys .. what do you think I’m missing? What do you feel are the most important facts to consider here? Are Strategic Defaults really a problem, compared to unemployment, second mortgages, or shadow inventory?
Always Winning .. Together!!
I understand the business reason for a strategic default but the purchase of a primary residence used to be not for business reasons. When homeowners treat their home as an investment tool & purchase that home only for gain & get caught making a bad investment – taxpayers should not bear the brunt of their bad decision when they are capable of righting their own losses. Whether they got greedy & used their home as an ATM or just “had to have” that house that was overpriced, it was their decision. Higher income people are supposed to have more on the ball than the Average Joe. Common sense would alert you that when prices rise so drastically in a very short amount of time, they will also fall & someone will be left holding the bag. I personally do not negotiate strategic defaults, they have to go elsewhere. Maybe that is stupid but I do sleep well at night.
Financial Terrorists – the bankers – are quickly moving legislation establishing that the “principal forgiven debt” portion of the lender(s) mortgage will pass to the succeeding generation named debtor. This will establish perpetual debt slavery. The moving trend is seen in loan modifications which do not reduce principal, and lender(s)’ refusal of equitable property seller/buyer’s short sale negotiations – resulting in banker controlled REO.
I have no idea if Luigi Zingales is a gifted writer, but I suspect he is not so gifted when it comes to logic. This is just a dumb thing to say: “Even if the market doesn’t recover, they don’t have much to lose, since if they collapse they’re likely to become wards of the state.”
What is he talking about? In what sense do lenders become “wards of the state” exactly? If by lenders, he means “banks” — and that is a big “if,” because many lenders are NOT banks — then collapsing means that the FDIC seizes control and sells the institution to the highest bidder. That means banks have everything to lose. All the executives lose their jobs, their careers (forget about getting hired elsewhere), and their retirement benefits. The bank’s stock becomes totally worthless. To suggest that banks have nothing to lose — if that is in fact what he is suggesting — quite simply discredits everything else that he says.
Many people outside the banking industry have a very simplified view (as simple as: banks=bad) and do not understand the role that regulators play in dis-incenting principal reductions. And it would make your head hurt even more to get into it.
I do think strategic defaults are a big problem for the banking industry — regardless of whether the pace of strategic defaults is accelerating or decelerating.
Higher income homeowners may have more experience with investing- where “stop loss orders” are common and perceived as prudent decisions. If mortgages are seen as investments by the lender (and also the holder of the note via GSE’s), why shouldn’t the homeowner see their own mortgage in the same way?
The housing market is a market – why can’t we let the forces play out? We are not really aiding those with lower incomes anyway… why not allow the market forces to reestablish a true market floor, so true recovery occurs. Uncertainty about the future is a jobs killer, a capital investment killer and a disincentive to stick out a declining home value. Just ask Flint and Detroit, MI!
The Congress is incapable of making a decision that benefits the general public , the government agencies like FHA, Fannie and Freddie are the de facto mortgage holders anyways. Why not make a deal with them? The banks are passing their losses onto these agencies.
I don’t think they are. I think they get a lot of press because they’re a threat to one thing and one thing only. The profit margins of these banks.
Everyone already knows these loans are worthless. If the banks had to accurately value the loan paper on their books, they would take a HUGE HIT and some would go out of business overnight. Even major banks have this problem.
So this trend scares them because it could catch on. But is it bad for We The People? NO. And it’s good for the economy, too. People worrying about “the social contract” are thinking too much. American Families need a BREAK, badly. It’s not like the people doing a Strategic Default are getting off without consequences. They do suffer financially. It’s still way better than endless decades of debt slavery.
Folks, do not believe in this BS. This is a well-financed PR campaign from the big banks. This is a distraction from what really matters.
@MZ
“I have no idea if Luigi Zingales is a gifted writer, but I suspect he is not so gifted when it comes to logic.”
I got a chuckle out of that…mostly because I agree with you. I suspect Zingales has his nice prestigious job precisely because he’s willing to give “intellectual” weight to…pretty much whatever Wall Street wants Luigi Zingales to say. A lot of his positions just aren’t supported by the facts and I find it unthinkable that someone as smart as him is not perfectly aware of those facts. It’s just numbers, we all know them, we talk about them here on the blog all the time.
But, money talks! And always will…