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Saturday, November 7

Strategic default: "The most disturbing aspect of this is that it's becoming acceptable to do."

Strategic defaulting or 'voluntary foreclosure' is where homeowners who can afford the mortgage walk away from it because they figure it doesn't pay to keep up the payments on a house that's fallen considerably in value. I've heard before about the phenomenon, which has mushroomed during the recession. But the reporter who wrote the following article for USA TODAY marshals facts about the trend that, to my mind, point to a larger issue.

One of the biggest problems found in third world countries is that the people have so little trust in the government and the economic structures that they fear making long-term investments. That hampers economic development so there's a vicious cycle in effect: the more the people cling to very short-term investing, the harder it is for capitalist measures to take effect, leading to the continuation of a moribund economy, thus further entrenching bad socialist-style government policies, thus leading to more mistrust of the government.

The ease with which many millions of Americans are taking up strategic defaulting, which wrecks their credit rating, suggests a breakdown of respect, and lack of trust, for economic structures in this country, including the credit and banking systems.

Is this trend simply a byproduct of hard times, something that will pass when the economy improves? Or does it indicate that the cumulative effect of financial scandals over the past decade has altered the American social fabric?

I don't know. I do know that short-term thinking in financial areas shouldn't belong in a first world nation and that if it continues in this one, it will lead to the same vicious cycle found in countries with chronic poverty.

The USA report, which I republish below, contains a number of hyperlinks and an interactive map of U.S. foreclosures state-by-state; see the USA TODAY website to access these.
More walk away from homes, mortgages

By Stephanie Armour, USA TODAY, November 2, 2009

When Sharon Sakson was laid off recently from her job as a television writer and producer, she burned through her savings to pay the $2,400 monthly mortgage on her home. But she soon decided it didn't make sense: Her home was worth thousands less than the mortgage she carried on it.

The home had been appraised at $390,000 when she refinanced in 2006, but she estimates it's not worth the $320,000 it initially cost in 2004. So Sakson did what a growing number of homeowners are doing today: She stopped paying and decided to let the bank take her home.

"I'm walking away from my house," says Sakson, 57, who stopped making payments about six months ago on her home in Pennington, N.J. "The bank can have it."

What Sakson did is called a strategic default, or a voluntary foreclosure, and it's fast becoming a major challenge to the government's $75 billion effort to keep distressed borrowers in their homes. Walking away from a mortgage is serious business — it can knock 100 points off your credit score and make you ineligible for a new mortgage for seven years. Yet, about 588,000 borrowers walked away from homes last year, double the number in 2007, according to a recent study by credit-scoring firm Experian and management consultants Oliver Wyman.

While home prices are rising, the increases pale compared with overall drops in home prices since 2005 that threaten to push millions more homeowners into Sakson's predicament, owing more than their homes are worth and seeing little chance of rebuilding equity soon.

More will walk away, which will hamper the housing recovery, reinforce lenders' tight credit policies and drag on the economy's recovery, economists say.

"It's increasingly a more important factor driving the foreclosure crisis," says Mark Zandi, of Moody's Economy.com. "As we move forward, the job market will stabilize, and the big thing will be strategic defaults. People are going to determine it doesn't make financial sense to hold on to their homes. That's going to be a significant problem. Strategic defaults mean foreclosures could be high for a long time."

It's not just economists who are concerned about strategic defaults.

The mortgage unit of Citigroup says one in five borrowers who defaults does so willingly, even though they're able to pay the mortgage. "It's a very large number, and it's a very, very significant risk to the housing recovery," says Sanjiv Das, CEO of CitiMortgage, adding that new government programs to curb strategic defaults may be needed.

Waiting for prices to stabilize

How bad the strategic defaults issue gets may depend on how much more home prices fall and whether the government does more to help homeowners with mortgages larger than their homes' value. Both Zandi and Das suggest further actions to reduce mortgage principal for underwater borrowers.

"A better way to do it may be an incentive to stay current for a period, and after two years of being current, they get a principal reduction," says Das.

Under the government's Making Homes Affordable Program, borrowers are ineligible for refinancings if their unpaid mortgages are more than 125% of the home's market value. Loan modifications under the program do not have any loan-to-value limits.

Nationally, median prices have fallen about 25% from their peak in late 2005, although prices recently have risen compared with prior months this year. The median price in the second quarter — $170,000 — was at roughly the level it was in autumn 2003.

But price declines have been worse in some markets. A closely watched barometer of home prices, the Standard & Poor's/Case-Shiller 20-City Composite Index, shows they have fallen more than 25% in 12 markets and more than 50% in two — Phoenix and Las Vegas — from peaks hit in 2006 or 2007.

Fifteen out of the 20 metro areas saw a rise in prices from July to August, but those increases are not anywhere close to the losses that have already occurred.

The number of borrowers who walk away is expected to increase, along with the rise in homeowners who owe more than their homes are worth. An unprecedented 16 million homeowners currently are underwater, according to Moody's Economy.com. That's about a third of all homeowners with a first mortgage.

Moody's Economy.com estimates the number of underwater borrowers will peak at 17.4 million in the third quarter of 2010.

An even higher estimate comes from Deutsche Bank, which predicted in an August study 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, by the time home prices stabilize.

Not coincidentally, strategic defaults have been highest where prices have plunged most, such as California and Florida.

From 2005 to 2008, the number of strategic defaulters went up by 68 times in California, according to the Experian-Oliver Wyman study published in September. During that same time period, the median price for existing, single-family homes in California fell from $522,670 in 2005 to $346,410, according to the California Association of Realtors.

In other geographic regions, the increase in strategic defaulters ranged between 3 times and 18 times more.

The Experian-Wyman study found borrowers with higher credit scores when they applied for their loan were 50% more likely than other types of borrowers to walk away from a mortgage only because they were underwater, even though they could afford to pay. The study was based on an analysis of about 12 million borrowers.

No household would default if the equity shortfall is less than 10% of the value of the house, according to another study this year, done by the University of Chicago, Northwestern University and the European University Institute. But 17% of households would default, even if they could afford to pay their mortgage, when the equity shortfall reaches 50% of the value of their house. That means the market value of a mortgage property is that much below the amount of loan taken against it.

There also appears to be a contagion effect. Borrowers who know someone who defaulted are 82% more likely to declare their intention to do so.

Growing acceptance

"The most disturbing aspect of this is that it's becoming acceptable to do," says Joel Naroff, an economist with Naroff Economic Advisors. "What does that mean down the road for housing and the economy if people are happy to walk away and destroy their credit? They're saying, 'Why pay a high amount if they can get something, even a rental, for less?' "

Because of the time and expense involved in completing a foreclosure, borrowers who decide to walk away often wind up staying in their homes for months after they stop paying their mortgage.

In most states, lenders can go after homeowners for past-due payments, but many fail to take such action when borrowers abandon their properties, because the legal costs are so high.

Short sales, in which lenders agree to the sale of a home for less than the balance of the mortgage, is an alternative to a strategic default. Many lenders are now encouraging them, but Zandi says that alternative may seem too time-consuming for borrowers who want to quickly get out from under their homes.

Janet Speer, 51, isn't happy to be walking away from her 200-year-old home in Royersford, Pa., but she doesn't feel ashamed. Speer says she was paying about $1,400 a month for her home, which was appraised at about $155,000.

After getting laid off last year, Speer said, she tried to modify her mortgage to more affordable terms but was denied because her unemployment benefits and alimony didn't count as income. Speer stopped paying on her mortgage in September 2008.

She is still living in the home and waiting to be foreclosed upon. Speer is saving her unemployment benefits for an apartment once the bank takes over her home.

"I got letters and calls from the bank at first, but they stopped," said Speer, who now earns commission income from a job in the health care industry. "I have a three-story house. It's way too big. I just want a little two-bedroom apartment. I don't want this place anymore. I would never have chosen to do this, but it's going to work out."

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