This post is not legal advice. For legal advice, consult an attorney, not a blog.
There was a very interesting piece in Sunday’s Seattle Times regarding “strategic defaults” (intentional abandonment of the debt, and eventually of the property, by the debtor/owner, due to depressed value far in excess of amount owed). The article was written by Brent White, a law professor. In my mind, this article implicitly raised a larger issue: As real estate professionals (i.e., anyone who makes a living in the real estate industry) do we owe some larger duty to the market itself that requires us to universally discourage these defaults?
To put the question into context, its apparent that some larger concern drives the passion of those who disagree with the author. I mean, threatening notes? What would drive somebody to threaten this guy? Besides, the counterargument is obvious and called out in the article:
[Mr. White] also rejects the argument that homeowners are wrong to strategically default because of the potential collateral damage to the economic stability of their neighborhoods. Some critics take their concerns further: that if walkaways occur in large enough numbers, there’s potential harm for the overall economy.
Mr. White discounts this argument, claiming that statistics have shown that an increased number of defaults will have no downward impact on the economy. While that may or may not be true, I imagine that regardless of the impact on the larger economy, additional defaults will lead to additional foreclosures which will lead to further downward price pressure in the housing market. In my prior post I off-handedly referenced a “collapse” in the housing market in places such as Flint, MI, and Las Vegas. The tone of my post was, in retrospect, inconsistent with the seriousness of the topic. The worst part of any bubble is of course the ensuing contraction, and a “collapse” is the worst case scenario that will inflict a lot — a LOT — of pain. Certainly some markets are at higher risk for this sort of catastrophic contraction, but EVERY bubble — and thus every local market, other than perhaps Texas — carries with it the risk of a very painful contraction.
So do we have some obligation to take steps to avoid this pain, specifically to encourage people to honor their mortgage debt regardless of the personal impact, in the interests of preventing harm to the larger society? I say, “No.” As professionals, we have an obligation to act in our client’s best interests. So when I meet with a client, its not appropriate for me to take into consideration anything other than what is best for my client, period. Concerns about “society” have no place in that conversation, other than — perhaps — confirming that the client is aware of this larger issue and can make her own decision about it.
And what about my comments to the public, i.e., non-clients? Unfortunately, I am simply not comfortable with a “public face” that is inconsistent with my private beliefs. I’m not willing to be known for one position in public — “You’re immoral and a lousy deadbeat if you stiff your lender!” — versus another in private — “Your mortgage is a black hole and there is relatively limited downside to foregoing that obligation.” So for good or ill, I find myself wholly on board with Mr. White’s message: It may be in your interests to walk away from that debt, and don’t let others influence your decision. While we’ll never know what imact this counsel will have on market values, time will tell the final cost of the housing bubble. But that cost is, in the final analysis, not my concern.
If you’re interested in my perspective on this specific issue raised — whether or not owners/debtors have some moral obligations to their creditors above and beyond the obvious legal duties — see my post on one of my own blogs.
Great topic. Greater concern. Real estate related professionals should only suggest consumers contact tax or legal counsel when faced with the prospect of a short sale, foreclosure or filing bankruptcy.
My belief is that we are weaving an incredibly destructive behavioral response to debt and losses when an asset class such as real estate goes down in value. While it may be legal to walk away from debt and enjoy the legal avenues afforded to us, the end result is a total disregard for the destructive wake that is caused by the reckless lack of personal responsibility of living within your means and reducing debt load.
Tim — I thought I was included within the term of “RE professionals.” That was my intent. This post was in no way meant to encourage brokers to dispense legal advice. Trust me, that is the LAST thing I would encourage.
Addressing the substance of your comment, two points. First, I STRONGLY disagree that anyone considering a strategic default has engaged in “the reckless lack of personal responsibility of living within [their] means and reducing [their] debt load.” That is simply not the case. I have met LOTS of people who led prudent and conservative lives until they (a) bought a house in 2007 and (b) can no longer afford it (e.g. job loss) and/or must find another home (e.g. new job, babies, etc.). To simply label these people as “irresponsible” is neither accurate nor fair.
Second, although unclear you seem to be saying, “We should discourage strategic defaults.” My concern? That places the crushing burden of these devalued and borrowed-against assets squarely on the shoulders of millions of people. And the banks? Well per your comments it seems they get a pass. So what if they were co-enablers of the bubble? So what if they had the sophistication (ability to assess risk and consequences) and power (they made the loans, after all) to avoid the bubble? So what that banks have gotten significant government assistance, and in fact have returned to substantial profits? If the banks get off scot-free, and the people are forced to struggle literally for years if not decades as “required” by “personal responsibility” — well, that seems fundamentally unfair.
Craig, much of my commentary got lost. I must of done something wrong. Anyway…
Banks and Wall Street should never get a free pass and some of their executives should be in prison.
I know that others disagree with my sentiment as well. I’m not going to sugar coat this difficult issue.
Catastrophic health issues and job loss certainly play roles in financial distress. But having so much financial distress that you can’t handle your debt load when income is reduced is a symptom of a greater problem. It’s called lack of planning, living paycheck to paycheck and too much consumer debt.
Not everyone, but a huge segment of our population serial refinanced and now that their vacations are over, the market has gone down and they cannot afford their financed toys and housing because their income has dropped shows me they worship at the the alter of “self” and want to socialize the losses on everyone else who were responsible (ie, free can clear homeowners who didn’t use their home as an ATM, lived within their means, etc…).
I completely get the point of many who argue to the “it’s not financially feasible or smart” to stay in an underwater house. I understand that. I just think it is a cop out. What happened to the thought of ASSESSING RISK? Risk is never in the equation. Life events, job loss, health issues always seem to take the back seat.
Perhaps that’s the conversation they should have had in the first place before taking on too much consumer and housing expense.
Or how about the “strategy” of “if they come after me for the $326,000 deficiency on the HELOC I took out I’ll just file BK”. Again, socialize the losses. How many vacant houses in disrepair or lack of maintenance do people want to live by that affect their values in a negative way? Not many people want that.
I’m working with a Physician who resides in Kentucky on her refinance. She’s so PO’d because her neighbors long since walked away have left the adjacent property in utter disrepair and it’s affecting not only her property value but could potentially impact her ability to refi at all, never mind try to sell.
I see loan applications from all over the USA and in most cases the debt load people have is what is forcing them into loan modifications, short sales and other programs to assist with high CLTV’s.
All that to say I have empathy for those that are caught in this wake but have a hard time empathizing for people who are part of the problem.
How many individuals, friends, family members, or loan officers and real estate agents do people know of that had substantial incomes (huge in some cases) during the boom and now are facing foreclosure and walking away or BK? Why?
Tim, the only reason any one buys a home is for financial security. It’s a business decision whether you own one property or a thousand.
People should get legal advice, but the decision is financial in nature.
If banks, or Wall Street were concerned about the mortgages they would never have given away more money than the properties were worth.
The legal recourse the banks fought for, over decades, was simple foreclosure. Well, they got that.
On a personal note I have been referring people to your brokerage, you personally, because of your views.
I have taken the view lately that home owners should sue the lender.
It’s hard to see it here in the United states but my wife is from peru and we go there to visit. Ten years ago people were living on a dollar a day and there was no credit. There were open air markets, and a central shopping area.
Today every one has a credit card, shops at Wong’s Super market, and the malls. The price of housing has tripled in six years. Mortgages are now common.
The money will never be repaid. It’s ridiculous to think some magic economy will form there.
I have some business interests is Barcelona Spain. Property prices quadrupled there between 1998 and 2004, everybody has a mortgage, very few will be able to pay.
Shanghia, forget about it.
This is a global banking issue that won’t be resolved by everybody paying up on properties that will continue to decline in value.
I’m baaaaack. I checked in on RCG and WOW found my favorite topic. Tim, you know my opinion and how I have debated with you in the past about this. I encourage everyone to watch this video and ask themselves “who is the idiot here?”
Yes, people are responsible to make sound financial decisions and obligate themselves to agreements they make. HOWEVER, these same people have greater obligations that supercede any agreements made after their initial. This original agreement I like to call a 1st Mortgage if you may. It is to care for yourself and your family and provide for them to the best of your ability. While keeping this initial contract in mind, we then live our life and all further contracts get in 2nd and 3rd positions if you may.
We real estate professionals should state the facts and support families with factual stories of what millions of others are doing and have decided to do years ago. We should also point those suffering to the ramifications of their decisions and to offer real life support groups that are travelling the County Court Houses now of “Produce the Note” campaigns. I see them every Friday now it seems at the Courthouse.
There is strength in numbers and as a veteran, health professional for nearly 17 years, and a RE Broker I’m here to advise everyone life will go on and each and every client, friend, investor, and relative I know that decided to strategically default years ago said it was the BEST decision they have ever made. The stress in their lives were relieved and in turn health and stability returned to their homes.
Great comments. I could misunderstand some viewpoints but I think some logic is missing. For example based upon what I’m reading the following would be the case:
I’m going to sue the Casino because they should not have let me in the door to lose my shirt.
I’m going to sue the lender because they should never have given me the loan or I didn’t know what I was signing or that my payments could adjust up or down or have a neg. amort.
I’m going to sue the brokerage because they should never have given me online access to my account so I could buy stock, play the options gamble, etc.
In housing, where were the conversations with people that 10% yoy gains, and in many communities much more, was fraught with RISK.
Ray, I understand the point of view to do what is in the best interest of your family and agree with much of it, but having that conversation after many put themselves into a pickle and asking everyone to pay for their financial mistake is what is at stake. What we are creating is social engineering: if I ever get into trouble, I can strategically default.
To get back to part of Craigs post, the economic damage from mass strategic default is, in my opinion, not going to be pretty the longer this gets carried out. At some point the ramifications of this issue is going to reach out and touch everyone as it has with my family and colleagues in the business.
Tim, I’m sorry to inform you this but I think you already know it. We have seen NOTHING yet and it will “play out” for many many years.
Wall Street carried us all along as simple pawns in their game and the educated and well informed should never be left holding the bag or advise others to do the same because of moral opinions of whats right or wrong.
I continue to support all who walk and question those who stay. Kicking the can down the road, and creating financial hardship in the future does nothing for a family unit.
Tim, all these homes are coming back one way or another. Be it this year, or in 5 years. They are all coming back.
Tim — nobody is talking about suing! Rather, the issue is whether we hold one party to the contract — the borrower — to a different standard than the other party — the lender. So a better example would be along these lines:
Casino spends money on marketing campaign promoting gambling. Gambler No. 1000 walks into casino. As with Gambler Nos. 1-999, Casino fronts him money, without any meaningful due diligence regarding his ability to repay. Gambler then loses shirt. Because of losses sustained by Gambler Nos. 1-999, Casino has received substantial public support in order to remain in business. And Casino has in past defaulted on obligations that it felt were onerous and “bad business.”
The question is, Should Gambler No. 1000 default on the debt? Casino has repeatedly made bad business decisions in loaning funds, plus Casino — like any business — defaults when it is in the Casino’s interest to do so.
Your point is still a good one: Gambler No. 1000 should exhibit a degree of personal responsibility. The problem is that the standard is being applied to Gambler but not Casino. Doesn’t Casino bear responsibility for its poor business decisions? Shouldn’t we at least apply the same standard to both parties?
That said, and as you suggest, we really could be jeopardizing the financial system if we apply the same standard to debtors as we apply to creditors. So maybe this falls into the “life is unfair” category: People who don’t repay debts are lousy deadbeats; businesses who made poor decision to loan them money, and who have defaulted themselves when it is in their interests to do so, and who encouraged and abetted the borrowing, are simply poorly run businesses.
But I’m not willing to take that stance. Regardless of the consequences — or, more accurately, recognizing that we may need to take further action to mitigate the consequences — I think the same standard should be applied to borrowers and lenders.
Craig – Switch “sue” for “blame”
In my hypothetical, are you suggesting that the casino does not merit any blame at all? The casino is not at ALL responsible for the loss? Seems like the casino is getting a HUGE free pass from you, if that is the case. Remember, the casino did not even bother to confirm that the gambler could pay the debt.
Regardless, though, “blame” is sorta like an opinion: we’ve all got one, and they all stink. Who cares if the gambler blames the casino or not? The question remains: Is the gambler’s loss 100% the fault of the gambler such that only the gambler should feel any pain?
Yes, the gamblers loss is 100% of their own making. Further, the ramifications of their gambling also impacts society- but that’s another issue altogether.
I realize we are way off topic of whether real estate professionals should discourage strategic walkaway situations, but it is difficult to not tie in the substantial underlying issue: debt load and where it came from.
Like you say, if we have a few more years of unwinding, I think the burden to the economy and households will very apparent. The good news is that many are saving like never before.
And yet nobody would apportion blame ANYWHERE if the roles were reversed:
The casino signs a contract for the construction of an expanded “gaming” floor (love that rebranding!) with a contractor, betting that business would improve. After signing the contract, the casino realizes it isoverleveraged and unable to assume the risk of the expansion. So it then breaches that contract, of course accepting — while mitigating — the legal consequences.
Does anybody apportion “blame” to the casino? No. Does anybody think the casino should “suck it up” and operate at a loss (presumably requiring capital calls) in order to honor that contract? No. Does anybody accuse the casino of damaging the local construction economy? No. You advocate a grossly unfair double standard, Tim.
I am talking about suing.
What Tim is stubbornly refusing to look at is that I am a very savvy investor. I have counseled all of the people who work with me that to mitigate risk you need to own the property free, and clear. It’s never a gamble if you follow a financial plan.
The mortgage companies have never given me a loan until 10 years ago. Then it was like pulling teeth, and I had to provide not only my financial, but cash on hand, plus a projection. It cost me $1000 smack a roonies to put my loan package together, plus a 30% down payment, plus closing costs out of my pocket. In 2006 I bought a house in a week with no money down, sold it for a profit, but bought it with no money down, no closing costs, nothing.
Show me the logic in that. The millions of loans that were written on property prices far in excess of value.
You see property values never change. All properties have an economic viability. Prices can go up and down, but values remain tied to the Consumer Price Index, but not a part of the Index because some properties have an intrinsic value that is hard to quantify.
I’m going to sue first the servicers on my mortgages, both Wells Fargo, and Bank of America because my loans are all screwed up, a topic for another time. In my opinion these mega banks created a situation, by credit, of over inflating the price of housing. In my opinion it is a deliberate action that we are all paying them for.
go get em David. Join some “produce the note” group meetings or join the class actions against Wachovia/BAC/Chase etc. I hear the food is good at some of the meetings and you can pound your head against the wall with all the others. or……………..
you can simply move on by making the right decisions and understand the rules of the game have changed and you need to adjust accordingly whatever portfolio you have intact. I shifted gears about 4 years ago and it to was the greatest financial move of my life.
Either way…God Speed
It’s interesting that when Bank of America took over Country Wide I would get statements from both. I paid Country Wide one more month than I needed to because I didn’t want any trouble. My statements from Bank of America came, and were paid, but there was a statement on the billing saying this may or may not reflect all payments. Fine. Then I began to notice that my payment amount was going up from $600 to $800. Fine. Then a statement was asking me for close to $1000. Not fine.
My Wells Fargo account applied a payment to the principal balance because it was less than a full payment. Fine. Then they opened an escrow to pay my property taxes without notifying me. Fine. My payment went up $1700, we negotiated to $700. Fine. Because my payment was less than a full payment I have been a payment short for over a year. They won’t take partial payments to catch up. They have made accomodations for the escrow balance, but not to catch up the partial payment.
Is all of that clear to you? Because all I have figured out is that Wells Fargo has run up $5200 in late charges, which of course is where my payment behind went to pay.
If you look at the foreclosure articles there are several that have to do with people who think they are current on loans, but by servicer accounting they are behind. I need to pay about $25K to clear the servicing on these two loans. Will I make it? Maybe, maybe not, I don’t really care.
My contention is that the Casino fixed the roulette wheel so the house always wins.
Timely article! I read the original as well, and watched the YouTube.
As far as socialized losses, these losses wouldn’t be socialized if our government would stop socializing the banks. Frankly, they should have just gone all the way to nationalizing them (the Swedish model).
The guy in the video paid 20% down, and was $200K underwater in Vegas (bought in 2006). If it were me, and I liked living there, I would say continue making payments, even if it is $700 more than a comparable rent.
But, if he didn’t want to live there anymore, or could not for employment reasons (he was in construction), hell yeah, he should walk away. Both he and the bank accepted a business proposition, each in the hopes of making money. Turns out they were both wrong, and both lose money.
Thanks for the topic…I wonder how long this will continue to be an issue…?
Roger — a great point re: “socializing losses.”
As for the duration of this issue: My money is on another five years at a minimum. After all, even five years from now housing prices will still be below the market peak, so people will still be upside down. And in the meantime, ARMs will reset, and people will need to move (e.g. growing family, employment, etc.). So this problem is here for the long term.
Tim — I’ve continued to think about our exchange. A follow up comment:
First, let me change my hypothetical. Instead of a construction contract, assume the casino borrowed the money for the expansion, did a very poor job of managing it, realized it did not have the volume for the expansion, and then defaulted on the debt. In other words, this business engaged in a strategic default.
Do you dispute that basic premise, that businesses engage in this type of behavior? I can provide you with lots of links, but then my comment is labeled “spam” and I can’t post it. So I will simply cite the increased rise in business defaults.
Now assume you’re going to speak with two people: (1) a homeowner who had strategically defaulted; and (2) the CEO of a business that did the same. Are you going to say the same thing to both people? Scold them for “blaming” somebody else for the loss? Or for not accepting “personal responsibility”? Or for threatening the local or national economy? And if you DON’T say the same thing to both people, why not??
Strategic default should not be allowed on any level, it’s simply unfair to people that pay their way through life and strategically don’t take chances that could sink them. I came to Seattle in 2007 and knew that buying a home would be gambling and putting my future at risk. I decided to rent for the 3 years that I lived there..what an experience…anyway, I lost real money renting because of the housing bubble and knew it. Now, through my taxes I will have to pay for those that made a bad decision. This is rewarding the person that made a bad decision and punishing the ones that didn’t. People who borrowed from their homes to buy cars and vacations should have to pay it back. I pay for my cars and vacations with my own money. Imagine a society in which we all just teach our kids this lesson. Go ahead, get into debt, have your fun, spend money you don’t have, and if things don’t work out, just walk away…
Dawn – several comments in response:
1) You as a taxpayer will be on the hook for this loss ONLY if the government again bails out the lender. Its that bailout that “socializes” these losses, as noted above, not the original default.
2) Those people who borrowed money and then blew it? They very likely did so via a second mortgage or HELOC, and “walking away” does not relieve them of that debt. So those people will remain liable for the debts, unless the lender decides to settle them, regardless of their default.
3) I agree that we should teach kids to act morally: Don’t kill, don’t steal, repay your debts, etc. My problem is that we don’t bother to apply the identical same standards to businesses. As relevant here, nobody scolds a business from defaulting on a debt if that is what the business needs to do. See my prior comment immediately above yours. I think the same rules should apply to everyone.
4) You completely lost me when you said you lost money by renting beginning in 2007. In reality, you’ve saved a ton. Had you bought then — the peak of the market — you would have lost a substantial amount of equity. Good work in timing the market!
I disagree, taxpayers will end up with the bill, through bailouts of the banks. it seems that you don’t understand the point I am making, surely you know that this bubble based on a total lack of common sense drove prices of housing to unsustainable prices. In my case, looking at a 4 Bd house in a nice eastside location with good schools…well lets just say the prices where insane…and so were the rents. Well for people who weren’t drinking the koolaide like me…buying wasn’t an option so I rented at high rent…therefore loosing money. In a non-insane housing bubble situation I could afford to buy. I think what needs to be added to the discussion is that people who are defaulting had a choice to buy the house or rent, just like I did.
BTW – get ready for stage 2 of this mess…the students of today are the children of these parents defaulting. Just like the housing bubble, it’s pretty clear to me that the next wave is student debt default. So if I am a parent watching this play out, should I pay double (college bubble) for an education with real money or should the student get a loan and if things don’t work out..default? What will people choose to do?
Dawn, you seem to ignore the reality that the law is the final arbiter of appropriate and inappropriate conduct, regardless of “morality.” Generally speaking, the law is based upon and reflects prevailing morals. But it is the law that decides what conduct is appropriate and, if not appropriate, the repercussions. And when it comes to a first mortgage, the law (in WA) says you have to repay it but if you fail to do so the repercussions are limited. [NOT LEGAL ADVICE – CONSULT AN ATTORNEY BEFORE YOU DEFAULT]
In regards to student loan debt, those debts are generally non-dischargeable, even via bankruptcy. So no worries about the students of tomorrow — they will be unable to avoid that obligation, regardless of how onerous. If you care about your kid and his/her future, you should help them avoid that crushing debt load, if possible. But in any event, student loans will not be Stage 2.
Returning to mortgages, people like you and Tim should stop railing against people based on “immoral” conduct. Rather, you should direct that energy towards changing the law such that people are legally held to the debt. That is the only real way to change behavior. Presumably this will take us back to the 19th century — but if that’s what the 21st century population wants…
I think that you are underestimating the impact that future defaults of student loans will have. Just like real estate is being changed by the housing bubble, so will education as we know it. Few would have expected the fallout that we are seeing now in housing a couple of years ago. It’s just common sense, you can’t get blood from a stone. A tremendous of lending happened that will never be repaid. The Seattle Bubble has been having open discussions about these topics for years and many have predicted strategic defaults and the impact etc for a long time now.
Student loans are a pretty safe bet that some one will want a job with wages to be garnished.
Real Estate is set up so banks can have quick foreclosure. Real Estate is an asset class that has a value no matter what. The dirt has a value.
Dawn, go ahead then and add consumer debt, business debt, and sovereign debt to your list as well. The fact of the matter is that the entire country — indeed, large parts of the entire world — are overleveraged. And that’s true of people and businesses. And that means a painful contraction that is not just limited to real estate — or student loans.
I agree, we are completely overleveraged on all counts…what we are discussing here is DEFAULTING and opening the floodgates by giving society moral permission to do so…this will be premeditated before taking risk. You should also watch the documentary College Inc, a great amount of student loan debt will not be repaid and the government will absorb it…it’s already happening.