Friday, May 7, 2010

Freddie Mac says "Don't Strategically Default"

Mortgage giant Freddie Mac aka The Federal Home Loan Mortgage Corporation is a government sponsored enterprise (GSE) of the United States federal government. a recent Wall Street Journal piece the head of Freddie Macs single-family credit-guarantee business, Donald Bisenius argues that strategic defaulters destroy neighborhoods. He said "We know from experience that foreclosures and vacancies drive down the property values of everyone else in the neighborhood. Thus, strategic defaulters, in effect, deplete the personal wealth of their neighbors. Get a critical mass of strategic defaults, and broader communities and regions become affected". He also pointed out that mortgages may become more expensive in the future.

So what is Mr. Bisenius advice to homeowners with properties worth substantially less than the properties value? He feels that "[f]or borrowers who are deeply underwater and who aren’t in financial hardship, the answer is little more than to wait for home prices to improve. To quote Mr. Bisenius “For those who have not suffered any disruption in income and have a longer time horizon, simply continuing to pay the bills might be best.”


Anyway what else can he say. The real issue: There is evidence strategic defaults by strategic defaulters are on the rise. The latest quarterly findings from the Chicago Booth/Kellogg School Financial Trust Index indicated that strategic defaults have increased dramatically over the past year. The researchers, reported that:

"the number of homeowners willing to default when the value of a mortgage exceeds the value of their house, even if they can afford to pay their mortgage, dramatically increased compared to just a year ago. The percentage of foreclosures that were perceived to be strategic was 31 percent in March 2010, compared to 22 percent in March 2009...One likely reason for this growing trend is the increasing perception that lenders are not going after borrowers who walk away. In December 2009, the average homeowners surveyed said the probability that a lender will go after a borrower is 56 percent, as compared to 54 percent reported in March 2010...The results also indicate that the likelihood of strategic default increases by 23 percent when homeowners learn that their neighbor with negative equity has received a partial loan for forgiveness. Additionally, strategic default increases by 29 percent if homeowners are able to find an alternate way to finance a new home."

Essentially, Freddie Macs plea is based on fear not real solutions. There is fear that more and more homeowners will strategically default because there is no equity ("negative equity") in their home and more homeowners are beginning to recognize that there never will be any equity.

Freddie Mac knows this. However, as one of the holders and buyers of most of the issued mortgages in the country, Freddie Mac is well aware of its precarious financial position. Especially after the bailout, which by the way, has not officially ended.

It looks like the solution is to eliminate negative equity. I doubt we will hear Freddie Mac recommending it.

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