Monday, March 22, 2010

"Ruthless Default", 'Walk Away Risk", "Strategic Default Incentive" - What Are The Strategic Default Predictors and Who Really Cares?

It now begins in earnest as analysts, academics, investors, politicians, US Treasury, HUD, mortgage backed security holders, and the Federal Reserve start to analyze the strategic default phenomenon. There are various metrics, variables, models, algorithms, equations, and good ole fashion graphs being put to use to come up with a strategic default predictor.

This is our current list of strategic default predictors:

1. The difference between the value of the property and the mortgage balance. Essentially "How Underwater Is The Property?". At the surface? Below the surface? Or down in the dark deep?

2. The rate of depreciation or appreciation for a property.

3. The type of mortgage loan - fixed rate vs. adjustable rate vs. option (adjustable rate mortgage) arm vs. negative amortization.

4. The existence of a second mortgage or HELOC (Home Equity Line of Credit).

5. Borrower's current income and savings. This involves considering the increase or decrease of available cash and the increase or decrease in savings.

6. Borrower's time horizon as it relates to staying in the home. When does a borrower intent to move or relocate.

7. Other debt carried by the Borrower such as credit cards, auto loans, personal loans and/or business loans.

8. The cost to rent vs. the mortgage payment for a similar property. Basically, the amount of cash saved from renting. This relates to the tax savings/benefits, such as mortgage interest deduction and depreciation, derived from owning a home as opposed to a renting.

9. Morality/Frustration effect or in other words ..."if my friends and neighbors are doing it, why can't I." or "The biggest corporations do it, why can't I" or "The banks got bailed out, so why can't I." or "I feels wrong to do it, yet the banks got bailed out, so why can't I:.

There will be a time when there will be somewhat accurate predictors of the propensity to strategically default. For now, it's fair to say the we are in the beginning stages of this, so it will be some time to understand the full rational for a strategic default. Suffice to say that the primary rationale is cash flow and savings preservation and protection.

The following two articles shed some light on the desire to quantify and qualify those individuals who intend to strategically default.

The article Who, in the End, Will Strategically Default? written by Linda Lowell from points out the desire by large investors to determine who is likely to strategically default. She writes "The topic long been a serious concern among MBS analysts as well. Last week, for instance, analysts at J.P. Morgan Securities 'put pencil to paper' to get beneath vague generalizations that suffice for most discussions of walk away risk, to compute strategic default incentive for ever agency and non-agency securitized loan."

A Financial Times article entitled US Housing Market Hit By Walkaways raised the issue of the importance in profiling a strategic defaulter.
  • "a close look at mortgage payment trouble spots shows that the higher the negative equity, the higher the rate of non-payments."
  • “Negative equity is a big challenge. It contributes to higher delinquency and redefault rates,” Seth Wheeler, senior adviser at the US Treasury, told a conference this month.
  • “The housing problems run very deep, but so far policies have just kicked the can down the road,” says Laurie Goodman, analyst at Amherst Securities, a broker that specializes in mortgage investments. “To get an economic recovery you need to fix the housing problem. And to fix the housing problem, you need to fix the negative equity problem.”
  • "As well as banks, investors owning the mortgages that were repackaged in the last decade are also concerned that there will be further losses on many of these bonds that have already fallen in value."
This is only the beginning as strategic default continues to spread like wildfire. This most certainly raises the "money loss hairs" of asset backed security holders, government officials and investors. Expect some form of government "intervention" to put an end to the "dishonest" strategic defaults.

Until then keep learning.

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