Walking Away from the Mortgage Contract

As noted below, lenders are concerned that there has been a change in the willingness of homeowners to walk away from their mortgage contracts. Why is this happening? The decision to walk away from a mortgage can be viewed as an unexercised option contract, and that approach can shed light on the source the change in the number of homeowners choosing to default.

I'm sure most of you know what an option contract is, but just in case, here' a quick review. There are two types of options, calls and puts. A call option gives you the right to purchase an asset at a pre-specified price, called the strike or exercise price. The purchase must be made on or before a specific expiration date. For example, a March call option for Google stock with an exercise price of $75 gives you the option to purchase Google stock for $75 at any time up to and including the March expiration date. It doesn't matter what the actual market price of the stock is, you can always purchase at $75 so long as it's on or before the expiration date (there are actually two types of options, an American call option gives you the option to purchase the stock up to and including the expiration date, a European option can only be exercised on the expiration date, not before).

Options do not have to be exercised, the holder of the option chooses whether to exercise it or not. When would this option be exercised? Suppose the price of the stock increases to $100 after you purchase the option (when the market price of the stock exceeds the strike price it is said to be "in the money"). If you choose to exercise the option and purchase at $75, you could then sell the stock at $100 on the market making a gross gain of $25. Thus, whenever the market price exceeds the exercise price, the option is in the money and can be redeemed for a gain.

The purchase price of the option is called the premium. There are ways to value options and set the premium, and I will skip that, but let's just say that the price of the option, i.e. the premium, is $10 for illustration.

Recapping, you purchase a call option for $10 that allows you to buy the stock for $75 at any time between now and March. Then, after the option is purchased but before the expiration date, the stock rises to $100 so you exercise the option making a profit of $25-$10=$15. [If, on the other hand, the price never rises above $75 before expiration date in March, the option will be left unexercised and you will lose your $10.]

A put option is just the opposite, an option to sell rather than buy at a specified price on or before a specified date. For example, you might pay $10 for the right to sell the stock at $75 at any time through March, i.e. you hold a March put option. In this case, the option will be exercised only if the stock price falls below the exercise price. Thus, if the price falls to $50, you can buy the stock for $50 on the stock market, then turn around and sell it for $75 according to the option contract realizing a profit of $25-$10=$15. However, if the price stays above the exercise price, the option will remain unexercised through the end of the contract. [If my quick explanations aren't clear, the Wikipedia explanations linked above might help.]

Now, how does this relate to walking away from a mortgage? A mortgage contract grants an implicit call option contract to the borrower. [Any non-recourse loan backed by collateral has this property. A non-recourse loan means the lender may not sue the borrower for further payment beyond the value of the collateral even if the collateral is not enough to cover the loan]. To put the mortgage in option terms, think of the borrower as turning over the collateral (the house) to the lender with the option to reclaim the collateral by repaying the loan. If the loan is not repaid, if the borrower uses the option to walk away, then the lender keeps the collateral (is stuck with the house).

When should the borrower walk away? If the value of the loan is less than the value of the collateral, the best option for the borrower is to leave the option unexercised, i.e. to walk away without using the option to repay the loan and claim the collateral (you want the house only if it's worth more than the loan). I should note, however, that this abstracts from any future reputational effects (i.e. a bad credit rating in the future represents a cost that must be considered) or ethical behavior (you pay the loan even if it costs more than the collateral is worth to honor the contract you signed). That is, this is the case where the borrower and lender agree in advance that walking away is not a sign of bad faith. If that is not true, if walking away has future costs or is constrained by ethics, this must be considered in the analysis. But both the reputational and ethical effects are easy to incorporate, it just means that the loan value must exceed the collateral value by some critical amount (by the value of losing reputation or behaving unethically) before the borrower will choose to walk away from the contract.

Interestingly, there are indications that the reputational or ethical effects are becoming less of a constraint to borrowers walking away:

Jingle mail, jingle mail, jingle mail — eek!, by Paul Krugman: Via Calculated Risk: The WSJ reports that homeowners whose mortgages are bigger than their houses are worth are starting to walk away from their houses, even if they could afford the mortgage payments. ...

Here's a bit more from CR:

One of the greatest fears for lenders (and investors in mortgage backed securities) is that it will become socially acceptable for upside down middle class Americans to walk away from their homes.

See these comments from Bank of America CEO Kenneth Lewis via the WSJ: Now, Even Borrowers With Good Credit Pose Risks

"There's been a change in social attitudes toward default," Mr. Lewis says. Bankers typically have believed that cash-strapped borrowers would fall behind on their credit cards, car payments and other debts -- but would regard mortgage defaults as calamities to be avoided at all costs. That isn't always so anymore, he says.

"We're seeing people who are current on their credit cards but are defaulting on their mortgages," Mr. Lewis says. "I'm astonished that people would walk away from their homes." The clear implication: At least a few cash-strapped borrowers now believe bailing out on a house is one of the easier ways to get their finances back under control.

... there is a new class of homeowners in name only. Because these people never put up much of their own money, they don't act like owners, committed to their property for the long haul. ...

So, there are three separate factors that could contributing to the increase in homeowners walking away from mortgage contracts, a fall in the price, a decreased concern with future reputation, and a decline in ethical behavior. Obviously the fall in price is a big factor, and it appears that an unexpected fall in the ethical or reputational effects may be contributing as well.

The last question to ask, I suppose, is why has there been a decline in the stigma from walking away? One potential reason is that the news media has played this as largely arising from predatory behavior by lenders, and therefore going into default is not seen as a personal failing as in the past, but rather as being a victim of unscrupulous behavior. Second, mortgage problems are being reported as widespread, not isolated, and the "everyone else is doing it" effect lessens the stigma. Third, that a more general decline in social behavior has caused what's individually rational from an economic perspective to be valued more, and concerns based upon the social stigma from being a "deadbeat" valued less. That is, general societal changes have caused individualism to become more important, and social interactions (e.g. what other people think of you)  less important. But I'm not so sure about the last one, or that the three together capture all of the reasons for the change in behavior. Any other ideas?

Comments

[mort_fin]

The large number of mortgages to investors is a further factor. The "reputational" hit to walking away from 5 mortgages is probably a lot less than 5x the hit to walking away from one mortgage.

[Nicholas Weaver]

Don't forget the increase in speculators with no money in the game. A large number of the forclosures in various areas are speculators of various stripes, speculators without much/any money of their own.

Someone explicitly speculating/"investing" is probably more likely to use Jingle mail than someone who's primary view is as a home.

[mort_fin]

And reputational cost might not be constant across FICO scores. The reputational cost to a 580 FICO borrower might be a lot less than the reputational cost to a 740 FICO. In fact, the causality could run the other way. People who put less value on reputational cost might disproportionately become 580 FICO borrowers. Increased lending to people in lower FICO ranges might very well mean increased lending to people who put less value on financial reputation.

[matt-h2o]

The reputational impact (qua credit rating) is important, and probably does still act as a brake - but I think there's been a fundamental shift in popular understanding of credit and risk.

Crucially, people now understand that many financial transactions are basically agreements to take the opposing sides of a bet.

Thus, people don't see banks as institutions imbued with moral authority any more: they seem them as risk-taking businesses that are just taking the other side of a bet on long-term house prices and on the ability of the borrower to repay.

When you look at a mortgage that way, walking away from negative equity doesn't seem like an unethical thing to do at all - it's the rational economic course of action. It's not as if the banks would show much flexibility if the borrower had difficulty repaying (given that securitising the debt means that the originators' hands are tied), so it's not as if the bank is operating to a superior moral standard either.

[calmo]

It took me the longest time to get a handle on the remark that he feared it could become "socially acceptable" to send in the keys.
Did he mean socially respectable? Did he mean socially tolerable? [It never crossed me mind that it might mean "unethical"..or "unlawful".]
Was he drawing a parallel to smoking dope? to swapping wives? to cheating on your income tax?
Did he just mean frightfully common?
Which is where I settled: a few neighbors abandoning the struggle may not deter your ambitions to hold onto that dream, but a few more will make you wonder about your decision to carry on despite the falling house prices and your stagnant wages.
Eventually there are enough that the path becomes socially acceptable and you can review your decision in a way that includes this social acceptability in addition to the costs and benefits of staying in the neighborhood.
So the last remaining homeowner in the neighborhood forgoes the social acceptability of leaving (a benefit) and is regarded as a donkey or worse by the rest.(a cost)
This supposes that the homeowners are not raging flippers or retired owners who have lived nowhere else and whose next move is to heaven. Normal people with the normal dream of moving every 5 years or so...in their quest to...raise a family who in turn will have your grandchildren...who you can spoil the snot out of.

[wally]

Attitudes toward ethics are generally expressed by the visible members of society. When the first instinct in politicians is to cover up and lie rather than openly discuss actions and when the general behavior of major banks and investment houses is to loot the public and pay themselves a bonus for so doing, what do you expect from anybody else?

[bakho]

Add Depersonalization

The friendly local banker does NOT hold the loan and is NOT the one being jilted. The payment goes to one of the numerous unknown corporate entity. Stiff one and there are still others willing to loan.

People can easily rent a cheaper place or move in with Granny. Without a credit card, you cannot rent a car, delay payments or pay most bills online. Many banks charge transaction fees to get cash from an ATM or use a debit card so it is more expensive to not have a credit card. Some of the above posters are correct that walking away from a mortgage could actually improve a credit score. Taking a store credit card to get that extra 10% savings can drastically bump the interest rate on the VISA/MC and lose more than the 10% savings. The financial industry has become more like loan sharks as the need for every higher profits drives their greed.

I would love to see the whole private sector student loan business collapse altogether so the government would replace the loans sharks with a student-friendly program. If you pay online, they can lock you out so your payment is not on time and then hit you with a late fee. It is a racket.

http://bostonphoenix.com/boston/news_features/top/features/documents/03351782.asp

[mort_fin]

bakho adds a good point about rent. With more borrowers out there with high interest rates (large spreads) there should be more borrowers who will find renting much cheaper than owning. You might not walk away if you only saved a little by renting, but the bigger the differential the more likely it is. Capozza and Thomson had a paper a few years ago where they argued that rents in a market were an important determinant of mortgage default.

[groucho]

"The last question to ask, I suppose, is why has there been a decline in the stigma from walking away?"

Mark, By now a majority of citizens know that the game is rigged. People see deception, fraud and corruption all around them every day.

In the US we now have "salesman ethics". Talk your book and close the deal.

From the house flipper to the fraudulent appraiser to wall street.

From the day trader to stock analyst to wall street.

From WMD to Iraq to the White House.

Lies and deception are the rule, not the exception.

People respond to these social developments in easily predictable ways.

Look out for yourself and keep the cash-flow coming.

[nihil obstet]

general societal changes have caused individualism to become more important

I think this one is a lot more important than you do. In financial matters, the emphasis is on doing well for oneself. Executives pull down billions in compensation, with large segments of an adoring press cooing over their brilliance (witness the NYC public "incentives" to Goldman Sachs at the same time that the city claimed to be unable to reach an agreement with transit workers, when the incentives exceeded the demands of the workers. A few executives at Goldman Sachs took rich rewards for that. Gee, ya think maybe there's a societal change in favor of "individualism"?)

We all hear daily that it's inevitable for good jobs to be shipped abroad to countries with no labor rights or environmental standards. It's just business, not morality. When executives raid pensions, I admit there's some "Tut tutting", as the judge in the Delco case ruled in dismissing a union lawsuit, Yeah, it seems bad when a few managers take the bulk of the pension fund in bonuses to themselves, but that's usual and reasonable in today's business environment.

Faced with loss of jobs, loss of pensions, loss of health insurance, denial of medical services costs by insurance companies, et cet. ad inf., most people have left the nostalgic world where one's word is one's bond. But I guess elites are always outraged when others adopt their sense of exemption from morality. And bystanders are baffled.

[Brock]

Isn't this the very problem that private mortgage insurance was designed to address?

Under the terms of my mortgage, I was required to pay for PMI until I had 20% of the loan paid off, at which point I presumably had negligible risk of going upside down, if the appraiser valued my house correctly.

Are PMI companies in trouble now?

[slacker kate]

A lot of people feel they were snookered into the mortgage in the first place, and they're just working the system like the big fish do. they're not wrong.

I think dealing with mortgage servicers also has an impact. they're impossible to negotiate with, and they play the same crappy games your credit card companies do, holding your payments to make them late and chargin you a fee... or worse... servicing fraud is rising... http://www.msfraud.org/

it demonstrates the backwardness of the trickle-down model - it's more of a food chain; the plankton theory, if you will...http://www.pimco.com/LeftNav/Featured+Market+Commentary/FF/2007/GCBF-+March+2007.htm

[The Baron]

I thought the shift in action was well understood? I've been reading about it for a while.

[William Smith]

Prof Thoma,
Don't forget that in many traditional mortgages, the borrower pays money up front to establish some equity. That tends to keep the borrower personally invested over the course of the 10, 15, even 30 year loan.
Now, a sub-prime borrower, even one able to afford the monthly payments after reset, has little equity because 'no-money-down' and significantly less time spent building equity since then. If everyone is taking a dive, but it is costing some thousands in foreclosure fees + the credit score hit + credit history hit, I can see more and more people saying "Let's save the hassle and the thousands in fees and just walk away."

[eightnine2718281828mu5]

---
That is, general societal changes have caused individualism to become more important, and social interactions (e.g. what other people think of you) less important.
---

"what other people think" is what led people to buy big houses they couldn't afford.

And for historical context, maybe a quick review of Thackery, Dickens and Twain would shed some light.

[Ken Houghton]

The ethics claim is bullshit, not to be subtle. It's Ken Lewis not understanding what Ken Lewis hath wrought.

As I said at CR, this is an economics question, not an ethical one. When primarily mortgage debt was sustained through bankruptcy, it was a priority. If you make mortgage debt (6-11%) pari passu with credit card debt (18-30%), no one should be stupid enough to pay for their house instead of their credit cards.

If I have $100 and a $90 mortgage and two credit card bills of $50 and $30, it used to be that I might pay the $90 and fall a little behind on the other two. Ken Lewis--CEO of the former MBNA--and his buddies changed the rules so that the first thing to look at is the interest rate. So now you pay the $50 and $30 and left the house slide.

Ken Lewis can **** ** ***** if he wants to try to frame that as an ethical issue.

[Growler]

Wally nailed it. The majority of people who purchased homes over the last few years are part of generation X & Y. These demos are very savvy and cynical. All day long their inundated with article after article detailing how this person looted such and such, this company knowingly did X......etc,etc,etc.

Don't be fooled. Their is not 'love' or ethics binding bankers (corporations (maybe apple), politicians (aside from maybe Ron Paul) ) and these demos.

This is one of the only times in life when a Gen X & Y 'r can screw over the people who have been screwing everyone else.

[Gerard MacDonell]

My uninformed intuition is that increased geographic mobility has increased anonymity and thereby relaxed the reputational constraint, which arises as much from social pressure as from a desire to preserve standing as a future creditor. What is described as a moral issue is, as often, a lagging indication of some aspect of PHYSICAL reality.

[Peteb]

I've been wondering lately about how many houses are being "accidentally" burned for the insurance, which is another way out of an unaffordable mortgage. If you can't afford the payments, but don't want a foreclosure on your credit rating, well, maybe the house will just happen to burn down and save everyone the trouble of foreclosing.

Burning down an unaffordable house actually had a cute name in Northern Minnesota at one point- people called it a "friction fire, from all those bills rubbing up together".

Does anybody know anything about whether arson rates are going up, as well as foreclosures?

[paine]

"there are indications that the reputational or ethical effects are becoming less of a constraint to borrowers walking away:"

mark i caution all folks looking at this
to not take that statement as fact till
proven beyond deeply shadowing doubts

[richard]

Twenty-five years of "I got mine, screw you" leads to the current "I didn't get mine, so screw you".

[paine]

hey drop the spec scare crow
mark is here talking about home owners own home

not real estate skinned market carny-ed rubes
fleeing the scene of their market skinning
no body give's a rats tail pipe about spec rubes
their reps or their ethics

folks losing your home
that's the social concern
and if its because household income hit
a job market based pot hole
or a health based one
or a ....

hey the default risk premia
are maybe by all of us
for this debacle
if the f heads set them too low
who's fault is that

[paine]

hey using a house lots vale as collateral
is like using stocks as collateral

the fals may be in slow motion
which is a blessing
but the falls will come

borrowing to buy
house lots on zero margin

that's the game here
took
two to play it
okay so the loan originator
passed it up the daisy chain
and it came back around

booom

great eh ???

[paine]

"Twenty-five years of "I got mine, screw you" leads to the current "I didn't get mine, so screw you".

love it baby love it

creative destruction little guy style
too bad he has to blow off
one of his own feet to do it

[Patricia Shannon]

Does anybody know if it is any worse to a person's credit to walk away from a mortgage, versus paying on it as long as you can, then losing it anyway to foreclosure?

[Patricia Shannon]

Peteb, good point.

[paine]

hey you can run but you can't hide..

even renters must have credit

let go my fico

[dd]

What about the "ethics" and "morality" of staying in a contract that inflicts emotional, mental and monetary distress on the family unit? Is the borrower's "ethical" and "moral" obligation to securitized lenders greater than to the family?

[Lord]

Many of these purchased because it became cheaper than renting and when it becomes more expensive will return to renting. Extending home ownership to new highs, extends it to many who simply see it as facing immediate necessity and not a moral issue at all. Landlords have had to face this all along, as lenders now do.

[Peter]

I was a loan officer/mortgage broker from 1994-2007. To my knowledge during that timeframe I had 2 borrowers foreclosed on. I am proud of that record.
Early on, I was taught the simple fundementals of subprime lending. First was the "3 Cs"; Character, Capacity & Colateral. Second was to never make a loan that did not have a definable FINANCIAL advantage to the borrower. These rules defined subprime. If a borrower was damaged in one of the 3 Cs, there was a loan there, damage in 2 made a unlikely deal, damage in all 3 was a show stopper, and a borrower who had nothing to gain also had nothing to lose and was not a good risk. During the last 2 years I was in the business I noticed some very disturbing trends. They were the reason I got out.
The first problem was a complete disregard for the actual value of "Colateral". In "old school" subprime, a house was not worth what some idiot was willing to pay for it, it was worth what we could get for it if we had to foreclose. We would never allow a valuation gain of more than 10% in a year without significant physical improvement to the property (not new paint and carpet), and the standing rule was 75cents value gain for every dollar of cosmetic improvement(including kitchen and bath upgrades). When we began to ignore realistic collateral valuation, we started the water filling behind the dam.
The second problem was degradation of "Character" qualifications. I came into this business before credit scoring. We made judgements on the likelyhood of mortgage repayment on patterns of behavior. Borrowers needed confirmable 2 year mortgage or rental histories, and these counted for the majority of the decision making process. If a borrower was responsible on the payments for shelter, there was a loan there. The worse the pattern of lates, the less the LTV available. Credit scores are not reliable. I have seen spreads of 100 points between scores on the same borrower with the same information. When a credit score that often included nothing more than credit cards and car payments (sometimes not even the borrower's) became the decision factor, the water started to top over the dam.
The third problem was was letting go of "Capacity". 100% Stated Income/Stated Asset loans are suicidal. Especially to a subprime borrower. If you put someone into a loan that there is no rational expectation that they can pay, they won't. Period. That started the erosion of the dam itself.
Finally, ignoring FINANCIAL BENEFIT TO THE BORROWER so that commissions could be made and loans could be packaged and resold was stupid beyond belief. Moving someone into a new home with twice the mortgage payment because it is "nicer" or giving a huge amount of cash to a known irresponsible borrower for frivilous spending, while ignoring the "3 Cs" was dropping a dynamite charge behind a flooded, eroding dam.
Subprime borrowers are not the problem. They were always stupid with their financial decisions. The qualification/processing/underwriting process was meant to protect the system and the banks from excess risk. We ignored lending fundimentals. We now have a wall of floodwater rushing down the valley. We created it, we deserve it, and we can't stop it. All we can do is survive it and clean the shit out of our basements after it is over.

[dirtyal]

Many refi mortgages contain a "personal deficiency" clause that allows a lender to go back to the borrower for the shortfall. I believe the law varies from state to state. In California, you can't require a "personal deficiency" on a mortgage for a new purchase, but you can on a refi. So, at least in some cases, there is more than a moral obligation to repay a loan.

The current threat of foreclosures has spawned a new process called a "short pay" process in which a borrower has to get the lenders permission to sell the property for less than what is owed. The lender agrees with the borrower to accept a "short pay" in lieu of complete repayment. If this takes place prior to the sale of the distressed property, the borrower is off the hook.

[LJM]

Bottomline, people shouldn't live beyond their means, but too many do. I'll have my townhouse paid off in less than 5 years. Maybe people should be taught that's a good thing, rather than to having debt beyond their eyeballs being the American way. I've always had a healthy fear of debt.

[Preston Gardner]

People have to know a bit about default and bankruptcy law to exercise this option (to put the house in exchange for the debt). The reason is that in bankruptcy, for the last few years, you cannot "put" your primary residence and force the lender to cram down the value to its current market value. The law changed in 2003, I think.

In other words if you have -10% equity and the bank has 110% of the equity on your house, and you go bankrupt, you are still on the hook for 110%. This is not true of other kinds of collateral. (See creditslips.org for lots of information about this.) To effectively apply "jingle mail", you have to figure out how to walk away from the house and default on that loan but NOT go into bankruptcy. I am not sure how to do that (and creditslips.org doesn't tell you how either).

Of course if you just dropped dead and didn't have the money the bank would have to take whatever it can get from your estate. But if there are any workout plans that come out of bankruptcy they strongly favor the mortgage lender even if you've got -10% equity and the value of their loan is absurd.

[Ethics]

The public school system does not have an organized program in place to teach ethics. When was the last time successful completion of an ethics test was required by the state before a diploma was issued? With both parents forced to work to make ends meet, all too many delegate the task of teaching their children (including ethics) to the school system.

To have an ethical nation, children must be taught ethics while they are still young. Then most will follow the ethical principles all the days of their lives.

[Bruce Wilder]

Ethics: "To have an ethical nation, children must be taught ethics while they are still young. Then most will follow the ethical principles all the days of their lives."

C'mon. You don't think Barbara taught young George W., traditional ethics?

[paine]

ljm
all paid up ...
the cat eatin the partridge

smug in this life
hair afire in the next

[Patricia Shannon]

Yeah, they don't make them like Dick Cheney any more.

[lonesome moderate]

Isn't this talk of ethical constraints mostly theoretical? I can really only think of one other time when there has been a significant number of landowners with negative equity in this country, that being the farm bust of the early eighties. I'm not sure how many farmers mailed in the keys then, but it definitely happened, and there doesn't seem to have been much of a stigma.

[Tom]

There might be some miscalculation of reputational cost going on. During the boom, subprime borrowers (including those who had destroyed their credit by walking away from a home) were able to find credit. Thus, the reputational costs of walking away were relatively small. One predictable effect of the subprime mess and the proposed solutions is that it will be harder people with low credit scores to buy a house in the future. In other words, the reputational costs are rising in an observable way.

If we are seeing a rise in non-distressed, upside-down homeowners walking away, these folks might be valuing reputation (their credit scores) based on the past rather than the foreseeable future.

says...

C'mon. You don't think Barbara taught young George W., traditional ethics?

I don't think Babs could teach young George anything; he was dyslexic. He proudly said Yale taught him nothing. The guy is and never has been into "learning" anything.

says...

Sorry, meant to say "is not"

[RobbL]

Mark,

I think they nailed your original question on CR. There may or may not have been some greater ethical gradient in the past. What has changed is that lenders are perfectly willing to lend to someone with bad credit. This did not used to be true.

Why should you worry about walking away from a bad loan today when you know that the lending biz will be competing to lend you more money tomorrow?

It is amazing to me that suposed capitalist heavyweights, like the financial sector in general seem not to understand the simplest market forces. They apparently see nothing wrong with buying mortgages from brokers who have no incentive whatsoever to avoid liending to bad risks.

[lonesome moderate]

Is that really all there is to it--just send in the keys, and it's over? The mortgage companies can't come after any of your other assets or garnish your income, ever? This makes it sound incredibly easy.

[Patricia Shannon]

Redstone Federal Credit Union foreclosed on my home in Huntsville, AL when I was out of work and had paid ahead 7 months on my home equity line of credit with them, had previously always paid off my loans ahead of time, and had paid 4 years ahead on the first mortgage.
When they sent me a letter asking me to inform the local tax officials I no longer owned my home, which was evidently causing RFCU some kind of problem, I ignored it, and I don't feel at all guilty, even though I am a very ethical person. I have to say I hope it caused them a lot of trouble.

[maynardGkeynes]

When we bought our house we signed something called a "note". I thought that this meant that we were personally liable for any shortfall in the event of a foreclosure. In other words, I thought most home mortgages are NOT non-recourse as seems to be the assumptopn in this thread. Maybe I'm wrong. Does anyone know?

[Bob Dobbs]

Ethics, smethics. The big dogs would love for the little guys to have ethics -- while the big dogs do as they please. Such an advantage it gives.

But in reality, no one will play by the rules if it puts them at a disadvantage to those who break them -- and there is no enforcement to punish the rule-breakers. And boy, there has been a positive _vacuum of enforcement.

[J Huss]

To me, this is similar to what happened between employer and employee.

After businesses had been regularly flushing employees down the commode for the weakest of reasons, employees got the message and started doing things to protect themselves.

Then employers complained that employees showed a distressing and unaccountable lack of loyalty to their employer.

[MR]

I think the leaders of Wall Street have done a splendid job of demonstrating how to walk away from losses with a full wallet and no regrets or consequences. The homeowners are only emulating those leaders. We want the public to become members of the “ownership society” — who could blame them for following the lead of the irresponsible wall street titans who are supposed to be the best examples of the ways of capitalism. Do you really think that we can hold individual working folks to a higher standard than the wealthiest one percent of society? I say they should not walk away from the houses, they should shove them up the butts of the irresponsible lenders and financiers who got us into this mess.

[Bruce Wilder]

lm: "Is that really all there is to it--just send in the keys, and it's over? The mortgage companies can't come after any of your other assets or garnish your income, ever? This makes it sound incredibly easy."

Of course, you have to be in a strict non-recourse State, like California.

Lots of people live in less enlightened locales, and many people have other loans -- so-called second mortgages and lines-of-credit -- that may have recourse.

I wonder about these stories, where people not only send in the keys, but abandon the houses. It would seem to me, that if your house were financially "under water", the smart thing to do, would be to stay in the house as long as you could, not paying mortgage or rent, but accumulating as much cash savings as you could.

A clever person could probably delay foreclosure by weeks, maybe months, with the banks overwhelmed by foreclosures, and eviction would probably take months after foreclosure went through.

[Fred]

Is that really all there is to it--just send in the keys, and it's over?

Yes, in California at least, that is all there is to it, provided this was the original mortgage and there has been no refinancing.

The reason you are surprised is that, at least in the past, this wasn't such a great deal for the borrower. Suppose you put down 20%, and you had already paid down the 80% mortgage by another 5%, so that your total equity was 25% or more before the price decline. Not much advantage for foreclosure here unless prices really collapse to an extraordinary degree. Presumably, the assumption when the law was written was that it was only for situations that probably wouldn't happen that often. What changed things was getting rid of the 20% down and slowing down amortization, so that you might have 0% equity BEFORE the price decline. All of a sudden, this jingle mail option starts to make a lot of sense for lots of people.

The subversive monkey-wrencher in me is heering for the little guys to really sock it to these crooked banks by sending jingle mail en masse. Unfortunately, the little guys are such dummies that many of them are probably refinancing as we speak, thereby losing their rights to send jingle mail.

[Philip]

"People have to know a bit about default and bankruptcy law to exercise this option (to put the house in exchange for the debt). The reason is that in bankruptcy, for the last few years, you cannot "put" your primary residence and force the lender to cram down the value to its current market value. The law changed in 2003, I think."

Wrong! Federal bankruptcy law has prohibited 'cramdown' of a mortgage on a primary residence since the late 18th century -- that is, the excess of the debt owed above the current fair market value cannot be converted to unsecured debt and subsequently blown off like it was credit card debt. In fact, it used to be prohibited on all loans secured by real estate. When the old Bankruptcy Act was replaced by the new Bankruptcy Code in 1978 the prohibition was lifted for all real estate loans except primary residence mortgages. (And the recent 2005 reform law didn't change a thing for mortgage debt.)Why would the liberal, post-Watergate Congress that enacted the '78 Code keep the 'cramdown' ban for homes? Because they were concerned about redlining of neighborhoods and lack of access to mortgage credit by women and minorities, and they wanted to keep the risk of extending mortgage credit low so that millions more could have a piece of the American Dream. And it worked (perhaps too well).

Making the put option available through bankruptcy now, as some are proposing, will let borrowers break the contract and still stay in the house. That may help some in the short run, but in the long run all future home buyers will face higher mortgage interest rates and down payment requirements because the risk equation will have been permanently altered. Choose your poison.

[Bob]

Two more reasons why it is more acceptable to walk from an option/mortgage:

1. Because so many companies have been built upon limited partnerships and legal entities that are intended to shield them from downside risk... Why can't the rest of us play that game? We watched Enron, and learned about "Other peoples money".

2. The cost of a low FICO score is not as bad as people think. People will always be hungry to loan money against the yield curve. You can recover from a bankruptcy in 3 years. You cannot recover from an underwater house in 3 years.

[Lafayette]

Article: When should the borrower walk away? If the value of the loan is less than the value of the collateral, the best option for the borrower is to leave the option unexercised, i.e. to walk away without using the option to repay the loan and claim the collateral (you want the house only if it's worth more than the loan).

Merry Christmas, sucker!

And, what if the collateral is "no down payment" at all?

That's even more of a reason to walk-away ... one assumes that the payments were "rents", which, in a way they were. The "buyer" was renting the value of the house without really exercising their option to purchase it.

French TV televised a report on a new "squatters camp" of 200 people; about 60 tents that cropped up on the outskirts of a medium sized city in central California. All the families had all been summarily evicted. A new blight on the American Dream? Maybe, maybe not.

But, it is indicative that Lead-head has NO INTENTION WHATSOEVER to rush to their aid. After all, they're the dummies who signed the bum credit facilities, didn't they? Hey! It was all black and white, wasn't it? Didn't it say there, on page three, "Look dummy, this loan is a 'low-ball' - 16 months down the line, when you are really feeling comfy in your castle, we're boosting the payments to 75% of the net salary you declared to get the credit!"

Ho, ho, ho! Merry Christmas, sucker!

[Real Person from the Real World]

just a thought here.... as with so many things in this society, buying gets you less and less though sellers have you pay more and more. With a condo, you own 4 walls, but many condos are priced as if they were free standing houses. If I had an overpriced mortgage on a condo, and felt cheated, walking away would certainly be an option, since I really only own 4 walls. Just curious, but I wonder how much of the mortgage crisis involves condos? Condos were the big boom for the last 10 years in some cities where the far sighted lenders dreamed of all the retiring babyboomers and singles who would downsize....

Credit cards have lead the way to the innovations of finance and the wholesale fleecing of customers. Now the chickens have come home to roost, everyone holds credit cards and has been squeezed dry while good paychecks and jobs dry up. and gas makes so many things so much more expensive. No wonder people aren't as careful about "obligations."

[Lafayette]

rpfrw: as with so many things in this society, buying gets you less and less though sellers have you pay more and more.

There's a grain of truth in what you say.

But, most western economies are structured upon a Consumer Society. So, unless you have a better, workable alternative ... nothing much is going to change.

Not all societies are as hell-bent on "acquisition" as America's, which has developed it to a fine art. But, a great many still hold the US as a role model. Think of all those nations who want, fervently, to "live like Americans".

What would you tell them? Paying less and less to get more and more is the way to go?

[Lafayette]

P: That may help some in the short run, but in the long run all future home buyers will face higher mortgage interest rates and down payment requirements because the risk equation will have been permanently altered. Choose your poison.

Perhaps the correct word is not "poison". It depends upon how the word is used.

There are two directly opposed objectives as regards credit markets. One is cheap credit (the money pump of a consumer society). The other is secure debt (the kind that permits people to remain in their residences without defaulting).

Why do roads have speed limits? If everybody could drive at 100mph, think of the time they would save getting home. If they got home. Accidents happen.

I see the credit market in the same terms. Cheap credit primes the money pump, which dynamizes the economy. It is, however, a salutary lesson to have learned the ill effects of "money too cheap".

As in all dynamics -- whether it is driving a car or overseeing credit markets -- a sensible balance must be achieved. We can't have it both ways.

In the future, more expensive mortgages -- accompanied by more diligence in lending practices -- will make for a dull but moderately expanding housing market that will house inevitably all Americans, comfortably and securely.

And a word about Speculative Frenzy -- it's like body fever. We are being told that something is very, very wrong with the system.

[Real Person from the Real World]

Layfette: Generalizations cover a lot of territory. There is the price of an item that goes up because it costs more to make. There is the flim-flam of marketing, that raises prices on garbage that convinces some to pay more for something, not because it is worth more or costs more to make, but because of perception (Noka Chocolate anyone?). There are also FADs. The "innovations" in mortgage lending, that has now gotten the US in trouble, and upset the global economic apple cart. While you would likely not admit this, there was a lot of lies and decpetion going on to take advantage of others, that should not have taken place, if the proper laws had been in place.

[Lafayette]

rpfrw: While you would likely not admit this, there was a lot of lies and decpetion going on to take advantage of others, that should not have taken place, if the proper laws had been in place.

We live in a commercial jungle

There is, indeed. This particular attribute of a market is called "market knowledge".

A market is "perfect" if both contracting parties have full knowledge of the terms of transaction. That is the, value of the object being transacted to both parties, both seller and buyer, is well known in all its aspects. In fact, that criteria is what characterizes most law as regards transactions. (And is the basis of the wave of lawsuits we shall be seeing resulting from the sub_prime mess.)

Of course, no markets are perfectly perfect. Companies can hide no or little value by a great deal of hype. (Lord knows, I've seen my fair share of "vaporware" in the I.T. industry.) Still, if you want feature by feature breakdowns on products, you can typically get them -- and if one cannot, it would be best to walk away.

If the information is available, but either party does not avail itself of that information, then whose to blame? Fraud occurs when the information is misleading or hidden -- and it takes a court to decide whether such has occurred.

Problem is, people are stupid. They can easily be led by the nose, and the sub-prime mess is just one more example of how a "sucker is born every minute".

Or, as the Roman's said thousands of years ago, "Caveat Emptor" ... Let the Buyer Beware.

There is NO excuse for not educating a people out of their ignorance. Otherwise we live in a commercial jungle.

Generalizations cover a lot of territory

Yes, which is why they are sometimes useful.

[Unsympathetic]

All these comments about the lack of ethics in borrowers are cute - and sadly misinformed.

Long before he became Fed chair, Alan Greenspan said that regulations aren't needed because "businesses will always act to maintain their reputation." These words have been proven to be 100% false, of course.

If any I-bank exec wants to know why people are jingle mailing (if they're bothering to mail anything) -- they should look in the mirror. The very people who want to rant about ethics and morality of the people they're loaning money to.. aren't fulfilling their end of the bargain.

If a banker's reputation with customer X means nothing to the banker, why should customer X consider their reputation with the bank for one second?

Banks want people to respond to moral suasion? Hey, guess what.. that means banks need to act morally. This isn't a one-way street, despite how much they want it to be.

[Real Person from the Real World]

Layfette: Spoken like a true cool and ruthless businessman:
***************
Problem is, people are stupid. They can easily be led by the nose, and the sub-prime mess is just one more example of how a "sucker is born every minute".

Or, as the Roman's said thousands of years ago, "Caveat Emptor" ... Let the Buyer Beware.

There is NO excuse for not educating a people out of their ignorance. Otherwise we live in a commercial jungle.
**************

Lack of integrity, greed, and predatory salesmanship has nothing to do with the mortgage mess, just ignorance of the sucker.... er customers targeted. That a poised and experienced mortgage saleman must close the deal, regardless of whether the lendee can afford the sale, or regardless of any attempts to say no, has nothing to do with it either. Better yet, sell the sucker.... er lendee a more expensive mortgage where he pays more to the bank in fees and payments.... the sooner he goes into default, the better and sooner so a more savvy buyer can snatch up the bargain, and the fees keep rolling in to up the bonuses at the bank and martgage companies.... Let the tax payers bail the mortgage companies and banks out.

Today's salesman is not passive. He is armed with the latest in surveys and psychological research to help him/her deflect all arguments and resitance.

For someone so compassionate as to favor universal healthcare and subsidized education, you seem to be curiously lacking of any sympathy here.

[Dan]

I live in Western Colorado where all of this happened before, in the early 1980s. Energy companies (oil, gas, coal, oilshale and all of the related services) were investing in new projects and hiring people. Wages were high and experienced workers were moving in from lower paying areas. They bought new houses and trucks and the economy boomed.

Then the Saudis drove the price of oil down to $10 and all the energy companies closed down their projects. They laid off all of their employees. There were'nt any comprable jobs so people couldn't pay their mortgages. People just walked away. Colorado is not a non-recourse state but most of the lenders realized there wasn't much they could do. They repossessed or took a deed-in-lieu of foreclosure and sold the houses at large losses.

Sometimes shit happens and there isn't anyhing you can do about it.

[Lafayette]

rpfrw: Lack of integrity, greed, and predatory salesmanship has nothing to do with the mortgage mess, just ignorance of the sucker.... er customers targeted.

This demonstrates an ignorance of what was happening, how and why.

The credit brokers were driven by "budgets", meaning they had to "make their numbers" or they were out the door.

So, they cut corners ... and were allowed to do so because of laxness. The industry should have been monitoring itself, and it wasn't. (It's as if GM was selling cars with serious defects that could be life threatening, but did nothing -- thinking it could get away with it until "somethin' happens". Well, something happened.)

We shall see all this come out in the trial procedings ... I am confident of it.

[Real Person from the Real World]

Layfette says:
"they cut corners ... and were allowed to do so because of laxness. The industry should have been monitoring itself, and it wasn't."

Just a little laxness, eh? When has anyone in business ever admitted problems like the mortgage subprime meltdown was anything other than greed alone? Why should business ever plan legislation to control "innovation" first before the greed gets out of hand? Greed, by definition, is about continually sticking the hand in the candy jar, as many times as possible, before getting slapped. Once the candy is in hand, it's too late to put it back. It's eatten now, and everyone will suffer because of the stomache ache it caused the greedy.

says...

can any one tell me the best way to learn about whether I should mail in the keys to my defunct mortgage lender? I have a 80/20 with them and trying to sell my house.

renting in another state - took a nice transfer and got stuck selling in this mess.

don't want to do anything un"ethical" and could keep paying but I am trying to figure out why I should pay and keep doing this gymnastics on finding ways to sell the damn house. I paid 281k in 2005 for this 4 bedroom/3 bath custom home outside Cincinnati. I owe about 269k and it's listed for 277k now. The agents alone will eat up 15k on this transaction...

my feeling is I am a very busy person, working in IT sales and need to focus on myself for a change. If I keep house and rent it out.. I am gambling things will improve next year. I have doubts about future.

I make excellent money, but things can change and always do. I'd rather stop stressing about my situation and just move forward.

With my income and perfect payments on credit cards and all loans.. my credit score is all over the board .. so I personally think the FICO system is a scam. I track it monthly and let me tell you.. I rarely can get it over 800 on all three reports. So, once my revolving debt is cleared up, I will not be using them any longer.

Who do I need to talk to? A real estate lawyer? Who should guide me through this process to either:
1) mail in keys and move on
2) short sell with bank's approval
3) turn my house into a rental and perhaps set up a LLC?

Any advice would be appreciated.
Thanks,
Traysea

[Patricia Shannon]

Good luck. I would have been better off if I had walked away, instead of putting my money into a house I wasn't even living in, and eventually having it foreclosed anyway. I don't know what's best for you. I couldn't rent mine because I couldn't afford to fix it up enough to rent, so I wasn't in the same situaltion.

[Food4thought]

Low Rates "cheap money" is not the problem-"cheap money" isn't this relative anyway. Relative to inflation. Find an alternative to the Cartel that affects the price of just about every good and service we purchase and interest rates can be sustained at lower levels. Rates have been lower than the recent dips in 2002-2004. They where lower in the 60's and 50's prior to the rise of Communism and the oil embargo in the 1970's. But then again, in the 50's and 60's borrower's had greater vested interest in their homes. The problem we are in now was caused by the voracious appetite by the investment banks for high yielding collateral backed fixed income securities. They threw risk right out the window. The pendulum is now on the other side of the risk spectrum and prime borrowers are having problems gaining access to credit. This just accentuates the problem. Less borrowers=less demand=more supply=lower prices=more foreclosures=more supply, etc, etc, etc . Not sure when the spiral is going to stop. Fun quote,
"A Banker is the person who lends you his Umbrella when the sun is shining and wants it back the minute it rains" - Mark Twain