We are all Melmottes now

Well, in one framework it just looks to me like we are somewhere near the trough of a broadly-interpreted Minsky cycle, probably the downslope before the bottom. I would have to look at GD I or other depressions, especially those rare periods of declining real estate values, to know if this was secular. My personal experience is limited, but I do know of personal defaults during the Texas real estate crash of the early 80s.

It could, of course, be an actual permanent secular change in human nature or culture.

FDR put extraordinary effort into keeping people in their homes.

Mike Shedlock posts:Consumer Credit Drops 17.5 billion, largest decrease since 1940, with some charts.

Could be a secular change, looking at the charts. But we haven’t had a long depression this bad since the 30s, so could be part of a long long cycle. When general trust & confidence is lost, you can be screwed for a generation+.

Somebody blew it.

Of course the consumer credit system can survive this. Defaulting on a loan still marks you as a poor credit risk with all the associated negative consequences. The people you see walking away are typically hundreds of thousands of dollars under water on a non-recourse secured loan; the solution is to not make loans that are likely to go hundreds of thousands of dollars underwater. This is not hard to do – get a decent appraisal and require a significant down payment.

PS: liar loans were for the bank’s benefit, not the consumer’s.

Steve Randy Waldman has a series of posts, with great commenters, on strategic defaults.

Here’s a quote:

“I wonder what new moral lessons these men, indeed our whole generation, will now teach our children and grandchildren. I’ll guess that the content of these lessons will not include much sense of moral obligation or sympathy towards banks. Perhaps that’s for the best, moral intuitions being supportive of certain beneficial survival instincts in the modern dog-eat-dog financial world where ordinary folks need be constantly on their guard. I hope it doesn’t spillover, baby-with-the-bath-water-like, and create a generational animosity for a free market economy and open society in general.”

We have a model(s), which is close to Minsky’s (last chapter of the Keynes book is all I know), and the one that got us out of the last depression. When the economy becomes aware of the radical uncertainty and loses social cohesion, the only power that can bring it back in a socially just form is government. Massive (40-50%+ of GDP), aggressive, permanent, at least apparently, gov’t intercession. New Deal, WW II, Truman.

We may not be in that bad a shape yet, and the social conditions are not yet ripe. I think we will get there.

I suppose there can be other social equilibriums: Authoritarianism, fascism, caste systems. They aren’t as attractive to me.

And it might that the technologies of social control have developed to a point that something I can’t understand will be created. But we have a problem.

Thinking government is an autonomous savior is depressingly dystopian. Governments only respond to pressure from interest groups. Unless those at the bottom and middle of the pile organize and create a hullabaloo government will ignore them. Starting from a position “only the government can save us” is dangerous as it misunderstands the dynamics of government.

@djw

Actually declines in housing values have been very rare in the US for any extended period of time, although I did witness just such a bust when I was a much younger man. That was localized but did take over a decade to correct following the ‘malaise’ years, in Bend Oregon. Bend again had very strong growth (population grew 5X in 25 years) going into the latest decline and is again being very negatively impacted as an attractive resort and retirement location with limited industry beyond home building. But I digress; moving into an overheated market my choices were to join in and hope for the best, or stay on the sidelines and rent. Im a fairly pessimistic guy regarding the use of housing as a primary investment, contrary to many in the US, and I did expect the bubble to at least stall and possibly retract some, but the actual decline has been stronger than most would have expected. I didnt drive the prices up all by myself, and I did desire a comfortable place to live. While others were churning housing to make a strong profit I was just hoping to combine needed housing with little long term financial gain. (I’ve regularly read Krugman, Thoma and DeLong for the last several years as point of reference.)

Of course at some point ‘in the long run’ we are all dead.

My 1/3 rent comment may be misleading somewhat since it assumes rental of more modest housing than what I ‘own’. Children are gone and parents are independent so we are free to downsize. In the local market the rental rates appears to be running around 60% of mortgage payments for similar units. Of course since the tax code is subsidizing the mortgage that gap shrinks considerably after the tax deduction is factored in.

Something I havent seen anyone suggest is that ratcheting down the mortgage interest deduction could reduce the incentive to overinvest in housing in the US. This is of course opposed by powerful lobbies and is popular with the middle class, however the benefits fall primarily to those in higher income and tax brackets who can afford to carry the higher debt and then sell at a profit to boot (until recently) while living in ever more plush domiciles.

Where’s the big hoo-ha in the idea of defaulting on a mortgage? Stories about people posting [mailing] their keys to the bank were rife in the big early-90s downturn in the UK.

“The problem for lenders now is that they will increasingly have to act on the assumption that their borrowers (including those who appear creditworthy on the old standards) are planning, at a minimum, to use default as an insurance option. The only good way to protect against this is to demand lots of secure collateral. That means less liberal credit (and, given higher default rates, higher interest rates) for everyone and no credit at all for lots of us.”

Mebbe. My personal prediction is that we’ll see a lot of lobbying and agitation from the mortgage lenders to alter State laws on mortgages. Some States are currently recourse but most (? how many “most”?) are not. I’d expect to see a lot of effort put into getting those States which are currently non-recourse to switch.

Whether it will work or not is another matter.

Alex, jingle mail didn’t really work all that well in the UK. All mortgages in the UK are recourse. You can walk away from the house but if you’re underwater you still owe the bank/building society.

The nett effect is that it makes default on a mortgage much more costly. Instead of just a hit to the credit rating (as happens in a non-recourse jurisdiction) the only way to get out from underneath the debt is full blown bankruptcy (or variants thereof like an IVA).

I have read and heard the following from several different sources:
“If one has not cheated he did not do everything he could to win.”

Jake @5 and Alex @13 are right. Consumer creditors have never trusted the moral fiber of their debtors: only their incentives. For example, the U.S. law of student loans has long been predicated on the idea that students would default on their loans if they could–and they usually could. So these loans are mostly undischargeable in bankruptcy. James Grant has written on how the long history of mortgage lending is a set of pleasant surprises to the lenders that consumers pay their debt more readily than the lenders could imagine. (All historical trends come to an end–and this one just did.)

I’m trying to figure out what specific claim is being made here. Is it

a) The optimal level of defaults, balancing equity and efficiency, is zero; or
b) The optimal level of defaults is greater than zero, but there is reason to believe we are already at or above the optimum; or
c) It doesn’t matter whether more defaults would make the world better by any standard; people simply have a duty to pay their creditors in full regardless of the outcome.

It also seems you believe it is impossible for changing standards for default to result in a net transfer of wealth between debtors and creditors. But why not? Why is it obviously true that the transfer to debtors in the form of increased default will be offset by less loans, leaving debtors as a group worse off? Do you also believe that it is impossible for e.g. organizing by workers to help workers as a group, since higher wages for some will just be offset by lower employment? If not, why are your intuitions so different in the two cases?

Finally, I wonder how much you’ve studied the history of sovereign defaults, and if you’ve examined the evidence (as here) that there is often no impact on later capital flows, so that the defaults simply represent a transfer for (richer) creditor nations to (poorer) debtor ones. Why couldn’t the same be true of consumer debt?

This gets me a bit fired up.

STRATEGIC default on home loans sucks. If you have the means to pay, then you should. In a real market, there are winners and losers, so we will collectively eat these decisions to walk away. Why?

I understand getting wiped out and being given opportunities to rebuild. That’s different than being upside down — those are YOUR decisions. If you entered a $750K mortgage agreement when you’re making $45K/year and didn’t understand the terms, then you deserve to be punished for your stupidity. Sorry. If you don’t understand what you’re doing, then learn.

If businesses do this as an acceptable strategy, then they deserve to perish.

Come on. This is idiotic, and I’m sick of paying for others’ poor decisions built atop a foundation of bad economic ideas. These people are NOT victims.

Out of perhaps tangential curiosity, why does recourse vs non-recourse always seem to be a setting mandated one way or the other by law? What are the practical obstacles to its being a choice available to borrowers with associated cost tradeoffs, like adjustable vs fixed rate?

Anyone tempted to follow the advice should note that laws do differ from country to country. Here in Canada you cannot walk away, see here.

Is it coincidental that a couple of minutes after opening this thread I got a spammoid pop-up offering me “my credit score”? Should I be nervous?

“What does “walking away” mean exactly? If I have negative equity in my house and a large sum in my bank account, can I “walk away” and keep the money?”

I think it depends on how well you can play the system. In many cases the lender doesn’t bother to go after a defaulting borrower because they assume there’s nothing to get. I wouldn’t assume that they don’t have a legal handle, though. This needs to be clarified with a good lawyer depending on the jurisdiction.

On “walking away”: many (perhaps most) loans made by banks and secured by collateral are “recourse” loans. That means (roughly) that if the borrower doesn’t pay, the lender can attach the collateral, but if the collateral doesn’t satisfy the amount owed, the lender can seek “recourse” against the borrower, suing her for the rest of the amount owed. So, imagine you take a loan from a bank to buy a car and the car itself is the collateral the secures the loan. But then you crash the car and decide it’s no longer worth it to you to pay the loan, since you can’t use the car- “why pay?” you think. The bank gets the damaged car, but of course now it’s not worth enough to satisfy the loan, so the bank will sue you for the rest of the money and can do all the normal things to enforce the judgment (liens, attachments, garnishment, etc.)

But, for various historical reasons, in most US states home loans(*) are “non-recourse”, so if the bank forecloses, and the sale of the house doesn’t bring enough money to pay off the loan, the bank is just out of luck- they cannot attempt to get the rest of the money to satisfy the loan from the borrower. (There are plausible reasons for this approach. Historically, and often enough now, someone whose home is being foreclosed has very little money and is usually barely staying afloat. Coming after them for the rest of the money might well force them into full-blown bankruptcy, if they are not there already, and other problems. There’s other reasoning behind it, too, but this is a big one.) So, if one has a non-recourse loan for a home, one can “walk away” and the lender is left with just the home and whatever they can get for it. (This might be even less than expected, as foreclosure sales usually don’t bring top price, for a number of reasons.) Of course, this will hurt one’s credit rating and the like, but might still be the “rational” thing to do in many cases.

(As a further point, I’ll note amusement at people in the treasury dept. and business saying that people walking away from a loan they _could_ pay are dirty “speculators”, as if those making the claims thought speculation was bad! )

(*) I’m not certain, but believe that this rule only applies to owner-occupied homes and not to commercial realestate loans and the like.

Got an email yesterday from an acquaintance that I have not seen in at least 10 years. Did the american thing, college (big debt), worked full time. Spent vacations making more money to get a little ahead. Email said “I have not been straight with you, I know I didn’t return the CDs you loaned me to start a radio show, but pride is gone. I live with 3 roommates in a one bedroom. If not for food stamps, we’d starve. We’ll be evicted on Jan 15 if we don’t pay something against the rent. I’m asking for $100.”

For my disability. this is a huge sum. I sent it a check. I am human. The american government and the oligarchs are not.

There is a blog where a husband and wife team blogged about their trip from careers in north central Texas to north central Florida. Professionals that got stranger and stranger in their emails. Writing of seeing a note taped to the mail box saying the keys are in the door, the banks got it now. Once was strange, the number they documented sounded horrifying.

Winter is coming on. Is anyone getting the supplies and space ready to keep the refugees from freezing and starving? One thing that my atheist ass knows is that the Xians are not going to do jack shit. All of those huge food dumps on every military base and all of the extra housing that the military can’t do without needs to surveyed and planned in. Won’t happen, the senior military are stealing too much to focus on the americans.

Good luck.

Banks oppose the best way to avoid walkaways. Allow principal cramdowns in Chapter 13.

Real estate law is stable to the point of quaintness because of constitutional protections of property rights. Once vested, the government cannot deprive you of a right without due process of law, or take property without compensation, so when you enter into a contract, you can depend on that contract being enforced in accordance with the law at the time. I believe most jurisdictions in the US allow only non-recourse liens on real property, and my recollection is that this became pretty universal during various panics and depressions in our history. Up to this point, real estate values were always adequate, and jingle-mail made no sense. The right to walk away has always been part of the deal, everyone in the loan business understands this perfectly well, and losses are factored into the cost of doing business. So, where is the moral issue ?

My parents’ generation (depression era USA) was horrified by bankruptcy, foreclosure, and debt in general. Failing to pay a loan was a sign of moral failure. That attitude has been eroding for decades but I suspect recent corporate behavior has eliminated shame as a factor in personal finance. People will play the sucker only for so long before adopting the tactics of their creditors.

I started investing in real estate (single family homes) in the late 1980s. All my experiences with banks/mortgage lenders have impressed with their general lack of competence. At one point I couldn’t get a $25K loan on a $300K rental property I owned free and clear. Because it was not owner-occupied it didn’t fit underwriting standards. A few years later the bank was willing to loan me 125% of the home’s value! Which I didn’t do because it made so sense for me.

A note on “no recourse” loans. These are historic fallout from people losing their homes in the Great Depression, a backlash against banks. But only original purchase money loans are non-recourse. If you refinance or take out a home equity loan this changes the situation. Even when banks can pursue deficiency judgments they often choose not to do so. In my state, Washington, banks can do a fast foreclosure via a “non-judicial” process or opt for a lengthy civil suit in Superior Court. The latter process will sometimes allow for a deficiency judgment but it could take years of litigation.

The flip side of walking away from a home is to put all your assets into a home in a state, like Florida, which has an unlimited homestead exemption. Creditors can take everything but your home, no matter how expensive. That’s why O.J. bought an expensive home in Florida. It can’t be touched by his creditors.

Isn’t real estate fun?

Ted and Ciaran, that’s a good point about this being civil disobedience. That’s both right on and slightly off. It’s slightly off, because there is an element of self interest (unless you want to classify acts of conscience as being a higher form of self interest with an emotional payoff) involved in strategic default that is not involved in acts of civil disobedience. It is right on in that civil disobedience involves the deliberate breaking of a law and a willingness to accept the penalties that come with that because you view the upholding of some principle or combatting some larger injustice as requiring it.

For more interesting discussion on this, refer to Bob McManus’s link to Steve Randy Waldman. He’s had an ongoing discussion with Megan Mcardle about the ethics of this. Waldman notes that business have for a long time adopted the rule of “We are only obliged to obey the law and live up to our contracts “(in accordance with Milton Friedmans’ view about corporations having no “social” responsibilities).

What I find interesting about this debate is the question of motive and attitude by the defaultor. It reminds me of the experiment where a day care center instituted a fine for picking up your kids late from day care. What they found was that paradoxically, this actually increased the frequency of the undesired behavior. Prior to the institution of the fine, parents actually felt a sense of moral obligation to abide by the terms of the deal and pick their children up on time. After the institution of the fine, parents’ began to look at the fine as a fee and picking up your child late as another service that one can purchase by paying the fee. It’s a basic difference between viewing things from a moral/social responsibility framework and viewing something through a market framework. Notice that the term fine itself carries ovetones of legal and moral responsibility while the term fee does not.

In the case of strategic default, one is not viewing it through the lens of “One must try as hard as possible to live up to one’s promises, even if it would be more convenient to simply renege and then accept whatever contractual consequences follow”. From the market/business ethic way of thinking, the hit to your credit record and the loss of the house are simply the “fee” that you pay from getting out of an undesirable economic situation where you are paying a good deal more for a house than it is worth.

Note: my info on the day care experiment comes from an interview and excerpt with Dan Ariely “Predictably Irrational”.

Also, I found the reference to divorce in the original post quite relevant. A few years back I was shocked to hear the term “starter marriage”. People of liberal inclinations recognize that there are all kinds of reasons why divorce may be both necessary and better than maintaining the marriage. But the conventional attitude is that both parties go into the marriage with the expectation and hope that it is permanent. Not go into with the expectation that the out clause will be exercised if convenient and all appropriate legal penalties are paid.

Personally, I would be less inclined to endorse the idea of strategic default if not for the fact that banks and other businesses have for quite a long time maintained that they have no social obligations other than to obey the law. It seems rather hypocritical for bankers and their apologists to make the argument that creditors have moral obligations above and beyond what is spelled out in the contract.

I can go on forever about this and I’m assuming that other people have, in this context and in others. I think this essentially highlights a problem with an ideology of captialism that views people as isolated individuals with no connection or responsibilities other than that mandated by law. Societies are Humpty Dumptys. Once you break them apart, it’s very hard to put them back together again.

Is this behavior historically unusual for underwater home owners? Let’s see the evidence that people in the same situation are actually behaving differently instead of just more people being in that situation doing what they have always done before we declare this to be a moral crisis.

Maybe it’s the difference between a more …eh… palpable? entity, like the local hospital, or neighborhood bank (where, I imagine, you would borrow in the 1930s) – and a highly abstract entity that holds your mortgage these days. I don’t think the guilt of not paying to some GMAC thing can be too terrible.

41: yes, I’d forgotten that. Only the first mortgage is non-recourse in almost all places. HELOCS, second mortgages and the like are recourse.

Jamey @48 Feeling some sort of moral obligation to an entity or an institution is less likely than it is towards a person anyway

Unless you are a judge interpreting the ‘written’ US constititution

I’d prefer an explicit rule that secured loans can be completely discharged by turning over the property securing the loan.

In most parts of the US that’s actually the rule for purchase-money owner-occupied homes. (It’s certainly not clear that it should be the rule for anything else, regardless of whether we think it’s the right rule for these loans.) That’s what it means to say the loan is non-recourse. If you also mean that people’s credit rating shouldn’t take a hit for turning over the house even though it won’t satisfy the amount of the loan, I think there’s a less strong argument for that but would be willing and interested to hear the argument (especially as credit scores and the like are just commercial ratings of how eager people ought to be to lend you money.)

On the moral obligation to honor contracts: you should be aware that since the 19th century it has been the explicit position in American law that the remedy for breach of contract is to make the injured party whole. There is no punitive or exemplary element to damages awarded for breach of contract. As expressed in modern economic terms, the law allows parties to do the rational economic thing: if breaching the contract and suffering the consequences is less burdensome than honoring the contract, the law exacts no punishment for doing so. Judge Richard Posner, among others, argues that failure to breach a contract in such circumstances is inefficient and thus bad for society, and therefore breaching the contract is the right thing to do. This known as “efficient breach” and there’s a good discussion of it here:
http://en.wikipedia.org/wiki/Efficient_breach

Bloix is correct that “efficient breach” has been supported as rational economic policy. My law school contracts professor Wallace Loh (now moved on to bigger things) was a proponent of this position. But 20 years in the salt mines of law has convinced me the theory lacks reality. Breaching parties do not care about making the other side whole. They try to breach and avoid the contract consequences altogether. If the injured party has comparable resources the two can battle it out in court (itself a very inefficient process). But if there is a great disparity of resources between the breaching party and the injured party, the injured party has little hope of compensation.

In the housing arena, an example of this problem is where banks take over condos in foreclosure and refuse to pay HOA dues. This can devastate small owner’s associations. But a civil suit against BOA or Wells Fargo would bankrupt most associations long before even completing the discovery process. The prevailing party can get attorney fees and costs but only if the party can afford to get a final judgment. In most cases, the “efficient” outcome is the injured party recognizing that they can’t afford to be made whole, accepting the loss, and walking away. This may be “efficient” in some calculations but only if you ignore the cost to the idea of equal justice under the law.

But in the cases we are talking about here, the disparity in resources runs overwhelmingly the other way.
Is this actually true? The whole point of the securization business was that the owners of the loan are now institutional investors, like pension funds. They have little knowledge of the actual details of the mortgages or even mortgaging as a business, and every mortgage is split over several tranches with different owners.

Under such cicumstances, it’s not that clear that the owners of the loan have a serious advantage when it comes to a court case. They might have in a few publicity cases meant to set an example, but if many people walk away, the mere cost of organizing a court case is probably higher than the potential benefit they can get from it.

I should clarify my remarks at 57. I was discussing “efficient breach” in general rather than specifically in regard to home owners walking out on mortgages. In the latter, the owner usually has so few assets that litigation isn’t worthwhile to a bank or institutional investor. Being “judgment proof” is protection against some litigation but not the most desirable (sort of like jail being an alternative to homelessness).

No matter how divided the interests in securitized mortgages, the interests of the mortgage holder are represented by banks or investment groups with armies of lawyers on staff. Securitization has created some interesting issues on who is the proper party to foreclose on a property. A couple of canny public interest lawyers have at least delayed some foreclosures by arguing that the plaintiffs had only a secured interest in the subject property but that only the actual holder of the original note could sue to foreclose. In some cases the plaintiffs could not locate the note or identify who actually held it post securitization. Most homeowners facing foreclosure, however, lack any legal representation.