30 November 2009

Walk away from your mortgage? Just do it, says one professor



By Kenneth R. Harney, Special to the Times 

In Print: Saturday, November 28, 2009

WASHINGTON — Go ahead. Break the chains. Stop paying on your mortgage if you owe more than the house is worth. And most important: Don't feel guilty about it.

That's the incendiary core message of a new academic paper, "Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis," by Brent T. White, a University of Arizona law school professor.

White argues that far more of the estimated 15 million American homeowners who are underwater on their mortgages should stiff their lenders and take a hike.

Doing so, he suggests, could save some of them hundreds of thousands of dollars that they "have no reasonable prospect of recouping" in the years ahead. Plus, the penalties are nowhere near as painful or long-lasting as they might assume.

"Homeowners should be walking away in droves," White says. "But they aren't. And it's not because the financial costs of foreclosure outweigh the benefits." Sure, credit scores get whacked when you walk away, he acknowledges. But as long as you stay current with other creditors, "one can have a good credit rating again — meaning above 660 — within two years after a foreclosure."

Better yet, you can default "strategically." Buy all the major items you'll need for the next couple of years — a new car, even a new house — just before you pull the plug on your current mortgage lender.

"Most individuals should be able to plan in advance for a few years of limited credit," with minimal disruptions to their lifestyles, White says.

What kind of law school professorial advice is this? Aren't mortgages legal contracts? In an interview, White said that in so-called anti-deficiency states such as Arizona and California, mortgage lenders have limited or no legal rights to pursue defaulting homeowners' assets beyond the house itself. In other states, lenders may decide it is not worth the legal expense to pursue walkaways, or consumers may be able to find flaws in the mortgage documents, disclosures or underwriting to challenge the original contract.

The main point, he says, is that too often people's "emotions" get in the way of clear financial thinking about mortgages, turning them, as he describes, into "individuals who choose not to act in their own self-interest." Most owners are too worried about feelings of shame and embarrassment after a foreclosure, and ignore the powerful financial reasons for doing so.

Buttressing these emotions is a system that White labels "the social control of the housing crisis" — pressures and messages continually sent to consumers by the "social control agents," namely banks, government and the media. The mantra these agents — all the way to the president — pound into owners' heads, says White, is that "voluntarily defaulting on a mortgage is immoral."

Yet there is an inherent imbalance in the borrower-lender relationship that makes this morality message unfair to consumers: Banks set the rules during the housing boom, handing out home loans with no down payments, no income checks and inflated appraisals. Now that property values have dropped 20 to 50 percent in many areas, banks have been slow to modify troubled mortgages and reluctant to reduce principal debts.

Only when homeowners cut through the emotional fog and default strategically in large numbers, White argues, will this inequitable situation be seriously addressed.

How does White's 52-page manifesto go over with mortgage lenders? Predictably, not well. Officials at Fannie Mae and Freddie Mac — investors who fund the bulk of all new mortgages in the country — disputed White's characterization of how quickly after foreclosure a walkaway borrower can obtain a new loan. It's not three years, they said; it's a minimum of five years, absent extenuating circumstances such as medical or employment problems that caused the foreclosure.

"Borrowers who walk away from their mortgage obligations face serious consequences," including severely depressed credit scores for extended periods, said Brian Faith of Fannie Mae. In addition, he said, "there's a moral dimension to this as homeowners who simply abandon their homes contribute to the destabilization of their neighborhood and community."

Lewis Ranieri, CEO of several major mortgage-related companies and one of the pioneers of the mortgage securities industry, called White's argument "incredibly irresponsible and misinformed." Not only is the professor urging consumers to break legally binding contracts, said Ranieri, but if large numbers of them did so it would send mortgage rates soaring and "tear apart the very basis" upon which mortgage lending rests — the understanding that borrowers will honor commitments and pay back the money they owe.

Ken Harney can be reached at kenharney@earthlink.net.
This article ran in the St. Petersburg Times on Saturday, 28 November. It's a pretty controversial idea and one that doesn't sit well with me. What do you think? Are you still required to be true to your word when circumstances change? Is defaulting on a mortgage due to job loss or illness more moral than "strategically" defaulting? What would you do if this described your situation? If it does describe your situation, is a planned default something you'd consider?

13 comments:

  1. One way to think about it (and I'm not sure I agree with this, but am trying to look at all sides) is to look at it like it was a business.

    If a business took out a loan or bought a property, and then wasn't able to pay back the loan, is that more or less ethical than if it was a person? Do we give a company more leeway than we give people? Companies file bankruptcy, effectively defaulting on loan payments and then get to continue operating (airlines and car makers, anyone?)

    Again, I was raised that you pay back what you owe, but I'm willing to look at the other side.

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  2. I'm more or less torn along the same lines Eric. A big part of me holds that everybody's obligated to honor his agreements, and yet another can see the other side too. These kinds of moral dilemmas, and they are moral dilemmas, are beyond interesting.

    I subscribe to a particularly rigid set of ethics, and I wonder how rigid they would be if I were in an underwater mortgage situation.

    At the same time, it's estimated that 15 million people in the US are currently upside down. What would happen if all 15 million of them suddenly walked away from their homes?

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  3. I disagree with the logic. It may be self-serving to an individual, but if many homeowners in one area follow this advice, the value of property will decrease exponentially for the neighborhood. Who would buy a house with empty, foreclosed houses on the same street? The ethical homeowners who own their house or have equity in their property will watch their investment erode.

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  4. I'm definitely on the 'take a hike' side (though I'm not in the underwater situation so it's easier for me to say). The ethical standards that so many bind themselves to are a result of traditional standards that no longer exist. Homeowners are not the only ones I know of who have walked away from their financial obligations due to this recession. I find it ironic that the very taxpayers who are clinging to their sinking ships are responsible for bailing out the very banks that torpedoed them.

    While it is apparently a sound business decision on some levels to walk away from a money pit mortgage, it's clearly not just about business. Were it so, I doubt the 'moral dilemma' aspect of it would even be an issue. This is personal. For most people, buying a house is the biggest purchase they will make in their lifetime.

    Unlike the business that goes under, where the owners protected by corporate law that allow them as individuals to walk away unscathed and turn right around and open a new business (as a new entity) with out skipping a beat(No moral dilemma here!) --the homeowner is affected personally.

    I say: Walk away and don't look back. You only live once. You don't get a do-over (even though you can recover your credit eventually and buy a house maybe someday). You agreed to play by the rules --only they changed the rules.

    Perhaps there needs to be an upheaval created by people walking away. I've suspected that the bank bailout might have served to enable the banking industry (like a junkie on Methadone) to continue it's bad habits rather than reform it.

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  5. Cathy and Pam,

    Thanks for your comments, it's precisely these kind of thoughts I wanted to stir up.

    The point to this is not that there's a right or a wrong answer, what I find so interesting is the kinds of deeper questions the first series of questions poses. So if a person has to stand by his obligations, but a corporation doesn't, how ethical is the body of corporate law behind that behavior. If a person is required to have ethics and morals, why can't a corporation be compelled to have ethics and morals too?

    That real tragedy of organized religion's conscription of ethics and morality is that those terms get twisted to serve religion's ends. The term "immoral" has come to mean licentious and that's a real crime. Discussions and debates about ethics and morality are vital to the health of society. Ethics are the glue that binds together a group of people. They are the rules that undergird our culture. If you can't talk about them, all of them, how can you know what they are?

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  6. Call me an old prude, but I have a thing about honoring a contract to which I've committed. Antiquated ethical standard or not, there's no way I could shirk the responsibility of my home. I'm not in danger of defaulting, so maybe I'd drop those standards when the payments start piling up but I can't imagine just walking away from a committment of that magnitude and being able to sleep at night. I imagine this kind of behavior would have grave repercussions for the financial industry.
    I can't help but think that this article is representative of what's wrong with a lot of people - an overwhelming compulsion to do what's best for themselves with no regard for anything or anyone else. In short, it's an easy way out for hordes of self-serving louts.

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  7. I don't think it's an antiquated ethical standard at all, and you're right. Behaviors all but endorsed in that article from the St. Pete Times are at the root of the current financial mess. Pretending that ethics and morals stop with reining in sexual impulses leaves the door open for the rest of humanity's baser instincts to run riot.

    Western capitalism as it's practiced now is a concerns itself with short term gains exclusively. Using resources wisely, planning for a future, choosing a later reward instead of an instantly gratifying fix, etc. are all concepts that never make it onto the table.

    It's easy to point to individuals who behave dishonorably, but all they're doing is mirroring practices that are fully endorsed by their employers, their government and the rest of the institutions that are supposed to be in charge.

    Ours is a society adrift from its moorings and I say it's been set adrift on purpose. By restricting talk of ethics and morals to sexuality, corporations get a free pass and churches and politicians get to manufacture some really powerful wedge issues.

    Talk about a Pyrrhic victory.

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  8. This is a very enlightened discussion; I'm going to dim it down a bit.

    Two wrongs dont't make a right.

    Simple.
    Sure there's black and white and grey, but, individuals with a 25,000$ annual income aquiring a 250,000$ home loan is not grey.

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  9. I keep going back to this paragraph in particular:

    Better yet, you can default "strategically." Buy all the major items you'll need for the next couple of years — a new car, even a new house — just before you pull the plug on your current mortgage lender.

    I mean, isn't that just outright underhanded? Isn't that a slap in the face to those of us who pay our bills and take our financial responsibilities seriously?

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  10. Not dim at all Susan. And you're right on. Someone getting a $250k mortgage with an income of $25k is an ethical breach. But it's just one breach in a series of them that extends far beyond the individual. So in an unethical system, where does it stop? What's the obligation of an individual to act morally in an unethical system?

    Ethics define the rules, but more importantly they define the obligations people have to one another. In marginalizing discussions of ethics and morals, what stops are left to curb behaviors geared to short term gains without a thought to long term stability?

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  11. That's the same paragraph that got me all plugged in too. It is underhanded and it's gaming the system and it's wrong. At some point in the years since World War II, there's been a shift. Corporations used to be held to the same rules that bound people to one another. It's a gross simplification of course, but it seems to me that as corporations and institutions have been loosed from those ethical standards, individuals have been encouraged to adopt the same lack of ethics.

    If a bank can make billions of dollars evaporate and then be rewarded in the form of a bail out, what stops are left to keep individuals from doing the same thing?

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  12. I find it repulsive to walk away on a loan or any contract unless there is just no other choice - meaning you have lost your job, can't find another one, and have defaulted in this case. No one was complaining back in the beginning of 2000 when the houses they bought doubled in "value" overnight. No one went to the bank then and asked to have their mortage rewritten to reflect the current "value" when they were so far above the water their heads were in the clouds. Now this idiot says they should just walk away because the shitty McMansion they bought is not worth what they paid for it because they were stupid enough to buy in at artificially inflated prices and take out a shady loan they can't pay? A lot of these loans were taken in the hopes of flipping the house and making a profit. Now that it is not an option in the near future, people want to walk away from their obligation. Buying a house is not a get-rich-quick scheme. It may even cost you money in the end - imagine, paying money to live somewhere, how unjust!

    The stuff I buy on my credit card depreciates generally. Just because the stuff is not worth what I paid for it anymore, I still owe the money on it. My student loan debt was incurred getting a degree that did not land me a job right now in my field. I guess I should just walk away from the debt now. Who cares that other people might need loan money for school? Who cares that once the economy picks up I might get a job using that degree? Right now, my investment is not generating a return, therefore I don't owe on it. That mentality is so juvenile and self-centered it doesn't even warrant a page of newsprint, or anymore comments from me.

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  13. I agree with you David and I still say that a newspaper article touting the virtue of abandoning a mortgage that's no longer functioning as a get rich quick scheme is symptomatic of a deeper problem. I don't think it's so much self-centered as it is short-sighted. Real self-interest looks to the long term and tempers everything with a set of ethics that makes clear that one's obligations to one's self and to one's society are actually the same thing.

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