Friday, November 13, 2009

RISKS OF VOLUNTARY FORECLOSURES

We have been reading with dismay about people walking from their mortgages even though they have the income to make their mortgage payments; these are known as “voluntary foreclosures”. The motivation is to avoid paying for a house where they owe more than the current price of the house, forcing the bank to take the loss when the house is foreclosed upon.

According to Experian, a credit rating service, over half a million borrowers walked from mortgages that they could afford in 2008, double the number from 2007. These home owners are not unemployed or out of savings, they are just choosing to not pay their mortgages anymore because they see it as an easy way to make some quick cash with no long term downside. According to Citigroup one in five foreclosures are now voluntary, people with jobs and savings and able to pay the mortgage. They are using the fact that the banks are slow in foreclosing to get a free place to live for months and sometimes years before having to move out for non payment. Surprisingly, Experian found that people with high credit scores are 50% more likely than people with average or low credit scores to walk from an underwater mortgage believing that a foreclosure will be only a minor ding to their credit score.

It may seem as though they are right. After all, there has been no public outrage at this practice and there have been no stories of anyone being arrested for financial fraud for refusing to pay the money they owe the banks while still having the same financial conditions as when they were given the loan.

The US government has electronically created almost a trillion dollars to shore up the global banking system from the problems caused by borrowers defaulting on “sub prime” loans. The loss of income to the banks from voluntary foreclosures may have even greater implications to the global economy than the defaults of high risk borrowers. Deutsche Bank predicts that the number of homeowners underwater will grow from 14 million, or 27% of all homeowners with mortgages, in 2009 to 25 million homeowners, or 48% of all those with a mortgage, before home prices stabilize. Assuming that the practice of voluntary foreclosure continues unabated and 25 million Americans voluntarily walk from their mortgages the US tax payers will be left to cover the trillions in bank losses or let the global banking infrastructure collapse in bankruptcy.

In 1985 we bought 5 acres outside of Dallas, Texas during the oil boom and when the oil boom went bust, the property became worthless. When we needed to move from the area for a job, we were stuck with a mortgage for an amount that was huge to us at the time. We continued to pay the taxes and mortgage for the property until it was paid off. After 10 years the Dallas economy recovered enough for us to sell the property for what we originally paid for it. Though we lost the use of that money and the interest on that money for 10 years, we considered it our tuition in the school of hard knocks. It taught us a lot about the real value of real estate and that knowledge has been worth far more than the money we lost on that underwater property. We currently have a Hawaii property that is underwater by over 50% and dropping. Our mortgage, maintenance and tax payments are our current tuition payments in the new economic school of hard knocks. We make those payments because we promised in writing we would when we took on the mortgage and we think keeping our promises is very important. But we also believe that walking away from our property, as the voluntary mortgage walkers are doing, would be incredibly shortsighted.


Here are the reasons we believe the voluntary foreclosure walkers are making a big mistake:
1. RENTS WILL SKYROCKET: The majority of the mortgage walkers will have to live in rentals along with the massive number of Y gens (now bigger in size then boomers) and others not able to qualify for a house loan. The increased demand for rentals will cause a sharp increase in rents. As we experienced in the 1980’s, rental costs can greatly exceed the cost owning a house. The mortgage walker may find that they are never again able to buy a house on credit making them a renter for life and exposed to the ever increasing rental rates.


2. US DOLLAR BECOMES FORMALLY DEVALUED: The massive amount of US currency being created to keep the banks afloat is causing the dollar to lose value against other currencies like the Japanese Yen and Euro. In the last 3 years, the dollar has lost 30% of its value compared with the Yen. Many large currencies have fixed exchange rates with the dollar such as the Chinese Yuan and Saudi Arabian Riyal and there is growing international pressure for these countries to formally devalue the US dollar. This devaluation could happen without notice and easily be 30% or more causing raw materials that we compete for internationally to skyrocket in price. The building materials that we were able to buy cheaply in the past may make buying a new house in the future unaffordable.


3. PERSONAL CREDIT CONSEQUENCES: So far the only consequence of walking away from a mortgage that we have heard about is losing 100 points on one’s credit score. But what if Congress decides to collect the losses being incurred by the FDIC and bad mortgages being purchased to keep the banks afloat from widespread foreclosures? They have access to everyone’s IRS statements, bank statements, and IRA/401K arming them with the information they need to uncover who is really broke. What if stronger consequences are implemented by banks and mortgage walkers lose their right to credit of any kind. They may be relegated to paying for cars, college, and clothes the way it used to be done, through layaway plans, savings and cash.


The people with good credit and income that are walking away from their mortgages may be creating another economic backlash by requiring the federal government to put even more trillions of dollars in the banking system to cover their debt. This will further erode the value of the US dollar with other international currencies making the money saved by walking away from their mortgages seem insignificant. Owning real estate and a house where living costs are relatively fixed are the primary ways to financially survive the dropping value of the dollar.

12 comments:

Anonymous said...

Small world. I lived in the Dallas area from 1987 to 1991.
The banks are receiving money from the bailout no matter what the price they end up selling the foreclosed property for. I have recently seen some ridiculous low prices that banks have sold these properties for because they get reimbursed on the back side for their "losses". It is a perfect time to buy, at court house auctions! You now see many listed with no upset price! Again, the bank doesn't care.

ami said...

GOOD!!!.......................................................................................

Anonymous said...

Thanks for this perspective and emphasis on personal responsibility. It is interesting how we have come to the point as a society where promises involving money are no longer considered to have a personal ethical dimension. That is probably due, in part, to the perception that the institutions to whom this promises are made seem to have no sense of responsibility to us. But as you point out, they are still promises and should require our best efforts if we are ever to expect something more from our institutions.

Victoria Hokulani said...

You are absolutely correct about the devaluation of the dollar impacting building materials. Currently it is much more cost effective to buy a house already built than to try to build new. Hawaii prices will come back up, our house is 50% off its high, too.
Morally and spiritually, one will pay a huge price for walking away from an obligation. Although, the folks who do this feel as if they are making a wise business decision. They are giving the house back to the bank so no big deal to them. Banks are fighting back, though, by raising interest rates on the big cash cow, the credit cards. But then consumers trump all, when they just refuse to use these things anymore. The banks are hemmorhaging money right now, since folks feel okay defaulting on anything that can be defaulted on. I feel that this nation is in a moral and spiritual downward spiral, but we will come out of it, somehow, we find ways to prevail. This is a major revolution we are in, what we look like when we come out of this vortex will most likely be a meaner, leaner society less addicted to consumerism and a lot less obsession on keeping up with the McMansions.

Anonymous said...

isn't a mortgage a collateralized debt? doesnt the bank get the proerty back if someone walks. Default on a mortgage is once option for completion of the contract, just like paying it off. The walking away owner is not getting off "Free" they take a credit hit and a loss of all the $ pay into the loan. The people that should be focus of your scorn is the government / federal reserve / freddie.fannie mae . These organizations created excessive cheap credit with lax lending standards, creating a housing bubble. I am not suprised that owners with good credit scores are walking away from these homes. They likely realize that if they are 100K upside down in a house, they are glorified overpaying renters. You can walk away, give up the house rent for 30-50% less than mort+property tax etc, take the diff and purchase gold and or foreign dividend paying stocks, you will have the lost 100K back in no time, not to mention all the money you have paid into the mortgage. The realestate market is still going to decline, and when it does start to come back watch out because the inflation will be rampant. The banksters created this situation and some people are not gonna sit back and remain suckers to the game. Focus your attention on real problem ... "wall street got drunk on greed" well no duh, and who was giving away free booze.. no more like who was PAYING people to drink? the "federal" reserve, fed govt, and their housing spinoffs.

Anonymous said...

I enjoy your blog but you are wrong on this in many ways. The housing bubble blog and global economic analysis blogspot are great places to get educated on what is really going on with housing and the economy. The situation is far different than what many people believe. Housing prices and rents are likely to fall for years, for many reasons.

Thanks for your blog, and consider these opinions from people who have called the situation correctly.

kona guy said...

Yes, you are right, prices will fall and rents will go up. There is only one Hawaii and the Asian money will once again increase prices of homes in the next 3 years. In the mean time, get in while you can cause it will not last here in Hawaii. I saw it once before in the 90s. It actually went up overnight, and all those people who I thougt were crazy for buying at those prices before it went up....became the smart ones overnight. Somethings never change and buy low and sell high is one of them. If a two income family can afford a home in Hawaii.....that is the low.....and that in my opinion is where we are now. How can it get too much lower than that.

Steven said...

I really think that the government and Federal Reserve actually believe that their Keynesian policies to try to prevent deflation will work by giving time for the banks to earn their way out of the problems. However, the govt has done little to fix the basic structural problems in the economy, of too much debt relative to peoples' incomes. And it has tried to prevent the normal business cycle from occurring, in which the recession would clear out the excesses and lead to a proper form of price discovery. Instead they have attempted to fix a debt problem with more debt, which I believe is very reckless and dangerous. Unfortunately, those in power are the same people who mismanaged things leading up to the financial crisis. So in my view, one of the few ways for those of us who understand the severity of the problems to protect themselves from the risks still out there is to invest in gold and silver related assets, because gold and silver should continue to benefit from the Fed's Keynesian efforts to avoid deflation. One company I particularly like is Fortuna Silver, which I recently saw at http://www.goldalert.com/goldmining/fortunasilver announced approval of the final permit necessary to begin construction at its San Jose silver and gold mine in Mexico. The company's stock has performed well in 2009, and I think there is a lot more room on the upside because of the increased production potential of the new mine. Overall I believe that it's worth the time investigating specific gold and silver mining companies that provide leverage to the gold and silver price because they tend to outperform the metals.

Anonymous said...

Strategic defaults are very legal. Anyone in an upside down situation with a family to support should study the idea. No one knows when the economy will turn around. The prudent, responsible thing to do is to conserve cash. Big Brother won't be as generous to the little guys as he was to the likes of Goldman Sachs.

Of course walking away is easy only in a few non-recourse states. In the rest, the bank can sue the borrower for the deficiency. You can bet that if you have income & assets, that the bank will pursue to make up their loss. The better alternative is to complete a short-sale.

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