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  1. Wealth
April 23, 2010

The No-Fault Default

By Spear's

Sod the banks, is the thinking, and I totally get that.

Chalk it up to the law of unintended consequences. Or self-fulfilling prophecies. Or what goes around comes around. Or what’s good for goose is good for the gander. For whatever cliché you choose, it will almost certainly apply to the second round of the US housing market bust.

First, there were all the defaults on mortgages people could no longer afford, which led to a massive wave of foreclosures.

But now there’s another phenomemon: a full one-third of new foreclosures are not because people can no longer afford their mortgage payment, but because they’re choosing to walk away from a now-overvalued mortgage. 

The reasoning goes a bit like this: a man in his late twenties explained that several years ago he bought a property for $210,000, putting only $20,000 down and mortgaging the rest. Now the property is worth only $45,000, roughly the amount the man has paid to the bank. So in his estimation the bank has been paid the value of the asset, and he has stopped paying the mortgage while explaining (in writing) his reasons to the bank, who have been either so dumbfounded or so overwhelmed that he remains in his home, despite not having made a payment since late 2007.

He’s happy to pay again if they readjust the mortgage to a defensible current market value, but they won’t. So the stalemate continues and he’s effectively a squatter in his own home.

He’d rather spend his money on taking care of his family or even spend it on leisure rather than effectively paying the bank huge profits on an overvalued asset. Besides, he figures, it’s banks’s predatory, greedy and unconscionable behavior that caused the housing market bust in the first place, so they should not be paid to effectively turn profits both in the lending practices that caused the crash and in the repayments in spite of the crash they caused.

Sod the banks, is the thinking, and I totally get that.

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What about the fear of a bad credit rating? Well, the man reasons, he can probably rebuild his credit rating faster than the housing market can recover. Good point. In the meantime, he’ll use his newly freed-up money wisely.

As you can imagine, bankers aren’t happy with this state of affairs, and there are two effective counterarguments.

First of all, as bankers point out, when people buy a property and take out a mortgage, they are effectively gambling on the future value of that asset. When everyone was making huge amounts of money flipping property, no one ever went into their local bank with a big fat cheque to thank their banker for helping them fund a good investment, saying: “Hey, here’s an extra $20,000, your share of the profits.” So if the banks didn’t share in the boom to customers, should they be punished for the bust?

Second, and this is where consequences keep rippling out, the rise in defaults further depresses the housing market, leaving more mortgages “under water” and creating a greater incentive for more people to walk away from their mortgages, which leaves even more mortgages “under water,” and so on and so forth, creating an accelerated downward spiral.

However, and this is the goose and the gander bit, big business is doing the exact same thing as homeowners. Even behemoth real estate developers Tishman Speyer and Black Rock have recently walked away from mortgages worth billions more than the property and these companies defend this action as a simple “sound business decision” in defense of their balance sheet and income statements.

So what about a family’s balance sheet and income statement? Shouldn’t they be defended in the same way big businesses defend theirs?

It seems the American consumer has been paying attention and learning from the bankers and developers who profit off them, giving them a bitter taste of their own medicine.

You’ll forgive the wry smile then.

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