It should be clear to all of us by now that the single driving factor in this economic downturn was the meltdown in home values. All the talk about how the big banks screwed us over is relevant only as it relates to the massive devaluation of our largest personal asset; our homes. If home values had stayed relatively stable, or come down at a reasonable rate, the bank crisis may have been manageable. It may have been seen as a bad couple of quarters rather than the catastrophe it became.
But that didn’t happen so here we are. And where we are may very well precipitate another huge devaluation of homes which would then lead to another round of bailouts and takeovers. This is because according to most experts, there is still slack in home values that has yet to be taken in; that our homes are still overvalued despite dropping 30-35-40%.
This has created a situation that is evidently not unprecedented except in scale; people with “underwater” mortgages - where they owe more than their house is worth - simply mailing the keys to their domicile to the bank and walking away from their mortgage obligations. Many simply stop payments and dare the bank to foreclose and evict them. Others find cheaper quarters by either renting, or taking advantage of cheaper mortgages.
There were a few of these walkaways during the housing bust of the early 1990’s. But today, nearly 5 million mortgages - about 10% of all residential mortgages in the country - are underwater (defined as a mortgage where the value of the house is 75% or less than the principle). And while no one is keeping track, one outfit has estimated that a half million people took the walkaway route last year.
Financial advisors are at the point of actually urging their clients to walkaway. Sure, their credit rating will take a hit. Better that than pouring money down a black hole where you will never realize any return on your investment.
There are a couple of ethical questions associated with walkaways that need to be addressed; one is personal, the other is an apparent double standard in the application of society’s disapproval.
Case in point; a New York developer walked away from paying the loan on 11,000 apartments in Manhattan:
The rules are different, though, for the walkaway of all walkaways.
That title is reserved for what happened to one of New York’s trophy properties, the 56-building Stuyvesant Town and Peter Cooper Village complex. Spanning 80 acres on Manhattan’s east side, it’s the largest single-owned residential area in the city. Its red brick buildings, built by Metropolitan Life in the 1940s for World War II veterans, are still a haven for the city’s middle class.
Commercial real-estate firm Tishman and its partner, investment firm BlackRock, paid $5.4 billion to buy the property from MetLife in late 2006 — right at the market’s peak. They hoped to make money by converting rent-regulated apartments into luxury condos and raising rents.
Then the housing crash hit. The value now: $1.8 billion.
And you thought you overpaid for your house.
“They made assumptions that things would grow to the moon, and things certainly did not,” said Len Blum, a managing partner at investment bank Westwood Capital.
Tishman said last week that it was turning the property back over to creditors to avoid filing for bankruptcy protection. In recent weeks, Tishman failed to restructure $4.4 billion in debt, and couldn’t find another buyer, according to a statement from the company.
Will Tishman come in for less disapprobation than a homeowner who walks away from a mortgage where he is paying 40% more than the house is worth? It’s a certainty that banks are treating Tishman differently than the ordinary homeowner:
Walking away isn’t risk-free. A foreclosure stays on a consumer’s credit record for seven years and can send a credit score (based on a scale of 300 to 850) plunging by as much as 160 points, according to Fair Isaac Corp., which provides tools for analyzing credit records. A lower credit score means auto and other loans are likely to come with much higher interest rates, and credit card issuers may charge more interest or refuse to issue a card.
In addition, many states give lenders varying degrees of scope to seize bank deposits, cars or other assets of people who default on mortgages.
Even so, in neighborhoods with high concentrations of foreclosures, “it’s going to be really difficult to prevent a cascade effect” as one strategic default emboldens others to take that drastic step, says Paola Sapienza, a professor of finance at Northwestern University. A study by researchers at Northwestern and the University of Chicago found that as many as one in four defaults may be strategic.
The double standard is easy to understand, less easy to justify. The fact is, a bank is less apt to severely penalize someone who owes them billions as opposed to someone who is into them for a few hundred thousand. The “sin” may be similar, but repentance is more complicated. It’s as if a rich man and a poor man both stole a loaf of bread; the poor man was forced to knee walk up a rocky mountain and say the rosary while the rich man got away with saying one our father, one hail mary, and a glory be (old line catholics will recognize that penance immediately).
Ideally, the same sin should engender the same penance or punishment regardless of wealth or social station. But in this case, we hold people and corporations to different standards of behavior and hence, different attitudes toward walkaways.
But it is the personal ethics of abandoning a promise to repay monies loaned in good faith by a lending institution based on your past history of good credit and timely repayment that is of most relevance for us. What happens when so many walk away from their obligations not because they can’t pay but because paying what they owe is a bad personal financial decision?
We can all sympathize with the walkaway and wonder if we’d do the same in their situation. But from an ethical standpoint, this is really rotten. By walking away, these homeowners are making it more difficult for the rest of us to get a homeloan or refinance our existing home. This is an inherently selfish act in that the walkaway fails to take into account the effect on the community and society.
And then there’s the prospect if there are enough walkaways, a tipping point will be reached and all that bad paper that is still on the balance books of major banks will cause another meltdown necessitating still more bailouts and takeovers when home values go into another death spiral.
What happens if five million Americans decide to stop overpaying their mortgages and mail the keys back to the bank? There would be a sharp decline in housing values. There would be another downward leg to the financial crisis, with a big hit to the capital of banks and other institutions holding large mortgage portfolios.
I think the housing decline would be a healthy thing, as this market is still overvalued. I don’t believe we would see a deflationary spiral, a widespread collapse of debt values, and a descent into a full-fledged Great Depression II. This was the great fear when the bubble first started popping in late 2006.
But since late 2008, the Bernanke Doctrine has showed that the modern Fed has the tools to keep this from happening. Administration officials can say whatever they want, but Too-Big-To-Fail is still reality.
What of the decline in individual purchasing power, the so-called adverse wealth effect, that would come with lower housing values? It would be muted because making mortgage payments on an overvalued house diminishes purchasing power just as badly.
But the net effect of the Great Walkaway would still be a strong downdraft in the overall economy.
I don’t for a moment believe that 5 million people will strategically default on their mortgages. But who can guess where the tipping point might be? Who can be sure that 1 million or 2 million such defaults wouldn’t crash the economy again?
All because people selfishly took stock of their personal financial situation and decided it was OK to saddle the rest of us with what is, after all, their problem. I say they have no ethical right to do it and that Congress should make it easier for banks to collect from these voluntary deadbeats.
Not surprisingly, Congress will treat these people as victims and no doubt either bail them out (one estimate is it would take about $750 billion to pay off the difference between what underwater borrowers owe and what their houses are worth), or make some accommodation with credit reporting services to give these strategic deadbeats a pass. Encouraging irresponsibility has been the hallmark of the Obama administration housing policies so why should we expect anything to be different here?
For the vast majority of us who have suffered a big hit on the value of our homes but continue to remain faithful to our obligations, this whole walkaway phenomenon is a slap in the face. We are being played for suckers. And it’s depressing to think that rewards will accrue to those ethically challenged scofflaws who don’t play by the rules but come out smelling like roses anyway.