On Mortgages and Moral Compunction

What would it take for you to walk away from your mortgage?

Kenneth Harney, in his column Nation’s Housing, reports on an interesting study recently done by the University of Chicago’s Booth School of Business and Northwestern University’s Kellogg School of Management.  This study took a look at homeowner’s attitudes toward mortgage defaults, specifically what’s come to be called “strategic” walkaways or decisions to bail on a mortgage due to purely economic reasons.  The study found that “26% of the record number of home mortgage defaults across the country” were strategic – the homeowner had the ability to pay the mortgage but chose not to because the debt was greater than the asset.  In other words, one in four of the current foreclosures is not due to hardship, but rather a lack of compunction.

My partner and mortgage rate expert, Brian Brady, has for some time now railed against the disappearance of moral compunction with regard to mortgages.  His contention, as I understand it, is that moral compunction was  priced into the model by lenders.  There has historically been a stigma attached to not paying one’s debts, especially one’s home mortgage debt.  This may or may not be true; I am no expert on the history of mortgage defaults in our nation, but it is certainly compelling.  If accurate, the obvious question then becomes: to what degree did moral compunction affect rates and if it is indeed gone, how much higher will rates go?

There is no real mystery to how mortgage rates are priced.  Mathematicians create models of mortgage “behavior” based on the 4 C’s: Capacity, Capital, Collateral and Credit.  Of these four, Credit is really what we’re talking about here.  Your income, your assets and the property’s value are theoretically objective but your credit… well, it’s not really credit that’s being measured here is it?  It’s your Character; your likelihood to honor your debts, although lenders don’t like to say that because it has a snooty, superiority quality.  Make no mistake though, character is most definitely being evaluated during the loan process.   So the question seems to be: How do these mathematicians change the models to reflect a decrease (or abandonment) of moral compunction?

That sounds like a difficult question to answer but I think we can make it a little easier.  If we read further into the study by co-authors Paola Sapienza, Luigi Zingales and Luigi Guiso we realize there is in fact a sliding scale of moral compunction practiced by American homeowners.  (That last statement should be read with tongue in cheek; sliding scale and moral compunction are oxymoronic… you cannot be a little bit pregnant.)  When asked, “81% of household heads said they believe intentional defaults on mortgages to be ‘morally wrong’.”  Yet that number dwindles down as negative equity grows; by the time we get to negative equity of $200,000 fully one in three of these same homeowners would strategically default.  Turns out the act they found “morally wrong” was actually just mis-priced.  In other words, a great many homeowners find morality to be a good thing… taken in moderation.

Besides negative equity, the authors discovered a number of other factors that might influence a homeowner’s decision to strategically default, including age (younger were less likely to have a moral issue) and political affiliation (self-described political independents were also less likely to have a moral issue).  But the other significant factor was familiarity.  Not only did having a greater number of foreclosures within the local community increase the likelihood of a strategic foreclosure, but “owners who (knew) someone who defaulted strategically (were) 82% more likely to default themselves, compared with owners who (did) not know anyone in that situation.”  As the old saying goes: “Familiarity breeds contempt.”

Earlier I wondered how mathematicians could change mortgage pricing models to reflect the empirical observation that making one’s mortgage payment has lost moral compunction.  Based on this study, there is no moral component and probably never was.  The first step then, is to remove the variable of morality altogether.  The model should instead add two more C’s: Community and Contact.

• Community would account for the percentage of foreclosures within a borrower’s local area, probably using the same distance radius now used for comps in appraisals.  Deriving a statistically significant factor for the likelihood of foreclosure based on the percentage of foreclosures within a Community should not be too difficult
• Contact would ascertain whether or not the borrower is acquainted with someone who has walked away from their mortgage.  Again, if a borrower is 82% more likely to walk away from their mortgage based on knowing someone else who has done so, that’s a pretty important variable.

Does that last one sound a little intrusive to you?  We ask similar questions of potential jurors in order to seat an impartial jury.  Is accurately pricing mortgages for the housing industry somehow above such questions?  Have you looked at a mortgage application lately?  It is easily the most intrusive document ever created for general public use.  Have a job?  We want to talk to your employer.  Got divorced?  We want to look at the entire decree.  Own your own business?  You better just send me a copy of every schedule of your tax returns for the past two years.  There is a list of over a dozen declarations you must attest to regarding law suits, bad debts, citizenship and so on.  Another question regarding your familiarity with strategic foreclosures would hardly encumber the process.

Like it or not, this issue has to be resolved.  Without a substantive discussion and response to strategic foreclosures, mortgage pricing models will have no choice but to account for foreclosures – both hardship and strategic – with across the board increases in rates.  That is the easiest hedge against increased risk.  But such indiscriminate rate hikes will only serve to diminish the housing industry and punish the vast majority who have acted responsibly.  Does that sound moral to you?

Filed under: LENDERS, LIFE THAT POPs, POLITICAL & ECONOMIC FOLLY, SELLERS , foreclosures, Moral Compunction

We Need “Stupid Stickers” for Home Loans

Do you know that there are only a couple of ladder manufacturers still in business in America?  The rest have been sued out of business or forced to headquarter in countries far superior to ours when it comes to litigous common sense.  People would literally lean their ladder against a plate glass window, fall through, and then sue the ladder company!  If you do not believe me take a look at the “stupid stickers” on a ladder in your local building supply store some time.  Covered with labels that basically say “Hey, if you are so stupid that you would (fill in the dumbest thing you can imagine here), then please read this ‘stupid sticker’ and do not do that”.

Now I am watching the lending industry go the way of the ladder industry.  We have a (very) small group of people going through a very difficult event: they are losing their homes due to their inability to pay their mortgage.  It can not possibly be their fault – that would leave them no one to sue.  So it is the lenders’ fault.  Now they have someone to blame.  The press eats this up.  Brian Brady wrote a great piece over on BloodHoundBlog regarding the San Diego couple that appeared on Good Morning America to discuss their lawsuit.  I have written previously about the two couples who appeared in the 60 Minutes segment.  Kris Berg has a current piece on a California couple initiating their law suit.  What do all of these people have in common (besides appearing in the media to tell their story)?  Every last one of them refuses to accept the responsibility of being an adult.  I am sick and tired of the lending industry being blamed for foisting “exotic” loans on an unknowing public.  What geniuses those lenders must be, what masters of double talk, what scam artists… what balderdash.

I spent years talking to clients about the loan process and advising them on how mortgages work and how they fit into a family’s financial health.  I gave countless presentations on full disclosure lending designed to save the client from themselves and you know what I learned?  People do not want to be saved.  They want the home they want and they want it now.

Can we please bring some honesty back into this discussion?   I watch people put more research into a $40,000 car purchase than they do a $400,000 mortgage.  Sometimes that abdication of responsibility comes back to bite you.  I can not decide which should be more embarrassing: going on national TV and saying “this was the largest investment of my life but I did not read the paperwork, ask questions or pay attention to the specifics of the loan” or going on national TV and saying “this was the largest investment of my life but I made a mistake and now I want someone else to pay for it”?  Maybe we should just create “stupid stickers” for loan packages that read “If you cannot afford to buy this home, do not buy this home.”

Filed under: BUYERS, INVESTORS, LENDERS, REALTORS , foreclosures, responsibility

Some Borrowers are Made Like Sausage

Over the weekend I enjoyed a lively debate regarding the couple that is suing their Real Estate agent in Carlsbad.  Brian Brady wrote a humerous post and it generated a lot of comments.  The idea that I walk away with on so many of these issues is this: what ever happened to personal responsibility.  We are all so up in arms over the housing mess and we automatically blame the lenders.  I am just as guilty.  As a matter of fact, one of the reasons I stopped blogging for a while was my disgust with the mortgage industry.  But the main reason I stopped blogging: my disgust with the average borrower that had no interest in hearing the truth!  Before concentrating on coaching real estate agents I was  a very active lender and one of the leading proponents of Transparent Lending.  (If you are unsure what that is you can search my site or Google it and you will have loads of reading material.)  Yet the more I explained to people the more loans I lost.  I guess it is a lot like the old joke about everyone liking sausage but no one wants to know what goes in them.  My clients did not want to hear how the industry really worked and how I was going to save them money in the long run.  They were interested in the quick deal with the made-up interest rates and fancy web sites.  They wanted to know how much home they could buy, not afford.  They came equipped with no knowledge of yield spread but a thorough understanding of ‘stated income’.  In short, I saw an awful lot of borrowers that brought the current problems on themselves.

 Please do not misunderstand.  There are a lot of unscrupulous lenders out there and I have written about some of the most eggregious I have seen.  I am just saying that I think, every now and then, we need to acknowledge the borrowers that lied about their income, throwing caution to the wind and stop pointing the finger solely at the lenders.

Filed under: BUYERS, INVESTORS, LENDERS, REALTORS, SELLERS , foreclosures, responsibility, stated income

60 Minutes Has No Clothes

I ran into a former coach of mine at the gym this morning.  He was a mentor of sorts to me and had a big impact on my life during my formative years.  He knows that I am involved with the real estate and mortgage industry and brought up the 60 Minutes piece that aired last night.  Now I make a dutiful habit of not watching this program, as I find that most of their stories contain what you might call a “slant” to them.  But because this man, whom I respect, had watched it and found it disheartening I thought I would check it out.  Herewith, comments on the king of News Magazines… from the peanut gallery:

The story was called “House of Cards” and it was hosted by Steve Kroft – a nice enough man.  His report was definitely more balanced than I had expected and a lot more balanced than I am used to seeing in the mainstream media.  I do wish, however, I could be there to interject some questions when they create these vignettes.  It starts off with the standard bit about lenders making terrible loans and greedy Wall Street investors buying them up and implies that this whole debacle has been “done to us”, but by now I am used to hearing such pablum.  They introduce the main area of the story’s interest as Stockton, CA, which became extremely popular for people that were priced out of the Bay Area and Silicone Valley.  Of course, this leads me to wonder how much worse it must be in those two areas if Stockton was hit so hard.  This is not addressed and I doubt the answer would have fit neatly with the show’s point.  We then hear that half of the homes in foreclosure received sub-prime loans and this is blamed on the ludicrously lax lending standards at the time.  Again, I am led to ask just how ludicrous they were since the other half of foreclosures were apparently made by the more stringently underwritten lenders rather than the bad, bad sub-prime people.  I guess that is information for another story.  Mr. Kroft went on to cover the same, tired explanations:

• ‘Stated income loans were out of control’. – Yes, stated income may be the leading cause of the problem, but not because lenders just accepted any number you wrote down.  Most lenders independently checked stated income against accepted averages within the borrowers’ industry – using such sites as salary.com – and many stated income loans were denied because the income was not reasonable.  The reason stated income loans are the leading cause of the current mess is because borrowers LIED about their personal income while keeping the numbers within reasonable limits.  You can lie to the lender all you like, but you can only lie to yourself for so long.
• Lenders “didn’t keep their dicey loans” in their own portfolios but rather sold them off to Wall Street. – This implies some type of nefarious intent when in fact this is how the vast majority of loans are made.  If the loan was not sold to Wall St, there would be no further cash to make new loans.
• Best explanation of all: these purchases were predicated on home values going up, which they did for a long time but then the bubble burst. – So in effect the people getting hurt are generally the “last in”.  This is not unique to real estate.  Any investment will eventually drop in its cyclical journey.  On Wall St. there is a saying: “the market moves to hurt the most people.”  Which is the contrarian way of saying that by definition the market must move and it must move away from the most pressure.  So also by definition the last in will be the ones that are hurt.  Many before them, however, made out just fine on their investment.  Is the implication of this line of reasoning that no one should ride the wave when an investment is increasing in value?  Do not jump in because someone has to be the last aboard?  That type of thinking would cost a lot more money in lost potential gains than is being lost to foreclosure in my opinion
• One last note: Mr. Kroft was careful to point out that there are currently 4200 homes in foreclosure in Stockton, but gave us no frame of reference with which to understand this.  To wit: how many homes are there in Stockton?  In San Diego, for instance, the number of foreclosures is .006 of the entire housing stock (that is 6/10 of 1%).  While depressing to those going through it, certainly not a staggering number on the community as a whole.

There were other aspects of the story and it was more balanced than I may be alluding to here, but my point remains the same.  When your clients see this type of report, Realtors have an absolute obligation to question it and look between the lines.  The job of the Realtor is to advise their clients on all aspects of the real estate market and sometimes that means crying out “The emperor has no clothes.”

Filed under: LENDERS, POLITICAL & ECONOMIC FOLLY, REALTORS , foreclosures, press, REALTORS

Faulty Headlines and Defaulting Home Loans

Our local newspaper has recently been ringing the bell of fear and apprehension in regard to the housing market here in San Diego County. Has the housing market come to a screeching halt? Have people stopped buying homes? Certainly the local economy is doomed by the “shattering event” of loan defaults and foreclosures. Let’s take a closer look.

On Tuesday we were treated to an article announcing a steep slide in home sales (New Home Sales Slide 3.9% in February – 03/27/07). On Thursday the front page headlines shouted out: Home Loan Defaults Skyrocket in County – 03/29/07 (emphasis mine). As you read further into Thursday’s article you find that “…homeowners throughout San Diego County are defaulting on their loans and losing their properties to foreclosure at an increasingly rapid pace…” The key word here is pace. They are not losing their homes at a record level or even new levels. In fact, we are currently experiencing defaults at about two-thirds the level of our record setting year of 1996. What has increased is the pace of defaults as measured against this same time last year. What is needed is a little perspective: at this time last year we were still experiencing well above average appreciation and home owners were able to sell their way out of any problems. It is not so much that defaults are abnormally high today, but rather that defaults last year (and the preceding 4-5 years as well) were abnormally low. As you read further into the article you discover that the default rate in San Diego County is approximately one-third of one percent (.0033); highly stressful for the homeowners going through it, but not particularly significant to San Diego County as a whole. You must read through 8 paragraphs and reach page 10 (below the fold) before you discover that “… (The) default and foreclosure numbers… pale by comparison to the number of loans issued and homes sold.”

The areas most impacted by homeowner defaults are “…houses carrying subprime loans…newly built South County communities… and among condo conversions.” It is no surprise that sub-prime borrowers are seeing a higher incidence of default rate, especially given the “creative” financing that lenders were pushing toward the end of the boom cycle we just witnessed. If you take a borrower already in debt, give them a loan for 100% of the purchase price, throw in the closing costs and base it all on “stated” income and “stated” assets, you are going to see some foreclosures. Also, specific areas are being hit harder; South Bay is an example here in San Diego. I suggest that this has more to do with the high percentage of new construction in these areas. People were purchasing new construction homes from builders of entire neighborhoods – with literally hundreds of homes to sell. Combine the potential for home price inbreeding with builder’s in-house financing and you have a recipe for inflated values and upside down borrowers.

New construction homes also help us to understand the drop in new home sales reported earlier. As we predicted in late 2006, the condo conversion glut that was dampening new home median prices would not sell out until the end of the first quarter/beginning of the second quarter of 2007. Now we are witnessing the very depletion of this condo conversion and new home gluttony and what do we see? Why, a drop in new home sales of course. You have to read much further into the article before it is reported that “…sales of existing homes rose in February (2007)”.

Am I suggesting that we do not have any problems in the local housing market? Of course not; we are likely to see defaults continue to rise. Not to mention the “neg-am” or “option arm” iceberg that is only now coming into view on the horizon. Will the housing market safely navigate that debacle or sail USS Titanic-like straight into it? Too early to say; I am only suggesting that the current situation is not nearly so dire as the headlines would have us believe. We should read these reports with an analytical eye and remember that newspapers, like any living organism, have a survival instinct. Good news does not contribute to sales and survival in the fourth estate.

To Your Success

Sean

Filed under: BUYERS, INVESTORS, LENDERS, POLITICAL & ECONOMIC FOLLY, REALTORS, SELLERS , foreclosures, option arms, San Diego, The Press