Thursday, March 06, 2008

When homeowners give up and walk away

One reason that the apparently never-ending residential mortgage crisis just keeps getting worse and worse, continually exceeding the experts' downside predictions, is that a new generation of home buyers long ago left the realm of predictable behavior far behind.

In the now distant past, home ownership was something consumers took seriously as a long-term commitment. Taking on a mortgage was a lifetime responsibility. Life savings were involved. There were requirements to be met, and everybody knew that taking on a mortgage was something you didn't walk away from lightly. This led to predictability in the market.

Sure, some buyers would run into trouble and default. But problem loans were a small, relatively steady proportion of the total, rising and falling somewhat with the economy, but essentially in a predictable pattern. Lenders could get a handle on their risk, price it into their mortgages, and have a pretty clear picture of the value of their assets. It was all based on buyers having a lot at stake.

Now, everything is up for grabs. The uncertainty is threatening our entire financial system. We're dealing with what Rumsfeld once called "known unknowns." Nobody really knows how millions of bad credit risks, marginal buyers, and overextended consumers will react to tough times, because before mortgage lending standards were shredded and thrown out with the trash, they would not have been able to buy what they bought, and lenders have no idea what to expect. There's no track record on which to base realistic projections. But some hints are starting to emerge.
U.S. mortgage foreclosures rose to an all-time high at the end of 2007 as borrowers with adjustable-rate loans walked away from properties before their payments increased, the Mortgage Bankers Association said today.

New foreclosures jumped to 0.83 percent of all home loans in the fourth quarter from 0.54 percent a year earlier. Late payments rose to a 23-year high, the organization said in a report today.

``We're seeing people give up even before they get to the reset because they couldn't afford the home in the first place,'' said Jay Brinkmann, vice president of research and economics for the Washington-based trade group.
There was a time when homeowners didn't give up and walk away from their mortgages. They had too much at stake -- big down payments, often some equity on top of that, life savings. But a new generation of homeowners already feels like virtual renters with a greedy landlord. They're facing monthly payments they can't afford, holding underwater mortgages, and their homes are worth far less than they owe. They have nothing to lose.

In other words, the same sorts of loans that drove the real estate boom have changed the nature of foreclosure, giving borrowers incentives to walk away, according to Todd Sinai, an associate professor of real estate at the Wharton School of Business at the University of Pennsylvania, quoted in the New York Times recently.
“There’s a whole lot of people who would’ve been stuck as renters without these exotic loan products,” Professor Sinai said. “Now it’s like they can do their renting from the bank, and if house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren’t any worse off than renting, and you got a chance to do extremely well. If it’s heads I win, tails the bank loses, it’s worth the gamble.”
Nobody knows how many will walk away. Not only does the future of our economy for years to come hang in the balance, but possibly the future of suburbia, as well. Will today's McMansions turn into tomorrow's tenements?


Anonymous said...

I was a first-time home buyer 3 years ago, in my mid-30s. I saved and saved before I bought and have a monthly payment that is easily do-able. (Of course, I wish I hadn't bought at the top of the bubble, but I, like most people, did not see that coming.) Anyway, what has been a real education for me -- and not in a good way! -- is how the lousy choices of other home buyers, and the lenders looking to make a profit off of them, has wound up hurting all of us in the U.S. economy. I don't consider myself clueless about money, but I just didn't "get it" in terms of the ripple effects of the subprime mess. Yikes. The money mantra I learned as a kid was "live below your means" and I have to say, I'm a little annoyed that those who tried to live above their means are messing things up for the rest of us. Lenders bear the responsibility too, but that doesn't let consumers off the hook. I wish all high schools would offer courses in financial literacy; I think it would be in everyone's best interest.

Dr Bud "caveat vendor" Diablo said...

Anon's words blaze with the fire of Truth.

I was conferring with a young couple about a business matter when the wife berated the husband for buying a brand new Pontiac off the showroom floor. She demanded to know why he purchased a gas-chugging, unreliable vehicle and saddles them with a five-year loan that would leave them owing more than the ill-constructed behemoth was worth.

The husband smiled the smug smile of a man with irrefutable answers. As to the Pontiac part, he said, his father taught him this precept: "You'll never go wrong buying Pontiac." The husband was unaware that his toy was a Consumer Reports "Car to Avoid."

As to the loan, he said that the terms were irresistable. The oan was a 10%er over five years, "so that works out to just 2% a year." The wife's jaw dropped as my pen dropped from my hand. We explained to him that the 10% was per annum. He felll silent, except to mumble that it's always easy to criticize after the fact; of course this info was available before the fact.

MadGuy, it heartens me that you have laid off the avaricious financial institutions for a moment to give equal time to stupid and greedy consumers. They want to believe that indulging their overdriven material strivings is not only possible but smart; people like that are the natural prey of the glib peddlers.

I agree that high schools should substitute a Financial Basics course for Self-Esteem 101. In the long run, nothing takes a chunk out of your ego like learning belatedly that got it Greek Style in the marketplace. The best counter-argument, I guess, is that if consumers ever became even minimally savvy, the entire economy would collapse.

Madison Guy said...

Everybody's happy when the banking system gets turned into one vast Ponzi scheme -- until they're not.