Sunday, August 8, 2010

Recent Updates from the Strategic Default Monitor...

There is data seemingly pointing to the fact that the rich are more likely to intentionally stop mortgage payments than lower income people. The New York Times in the article titled Biggest Defaulters on Mortgages Are The Rich by David Streitfeld, the writer examines data indicating that upper income homeowners are more likely to strategically default than lower income homeowners.

Well this is certainly no surprise. The wealthy are better investors than those who are not wealthy. The wealthy will not spend money on a money losing asset such as an underwater or upside down property that has no chance of gaining equity. They are wealthy because they generally know how to protect their wealth. The moral of this story is that everyone should take lessons from the wealthy.

********** reports on a study that states 20 million homeowners will be underwater before 2012. In an article entitled 20 Million Homeowners Could Be Underwater before 2012: Deutsche Bank by Diana Golobay the writer reviews data from Deutsche Bank indicating a substantial increase in under water properties. It is estimated that an additional 6 million homeowners will be underwater through 2011. This is on top of the estimated 14 million homeowners who are currently underwater. In our opinion the most interesting statement coming out of this study is as follows: "Walk away or strategic default from a house with negative equity makes economic sense, especially in locations that have less expensive rentals, Deutsche Bank researchers said."

It's about time we hear a major financial institution acknowledge that a strategic default makes economic sense.


The Wall Street Journal blog reported that nearly one in five homeowners strategically default. Let's look at two key points in the article.

"The research follows on an earlier report by Experian and Oliver Wyman that first aimed to quantify the share of mortgage defaults that are “strategic.” Strategic defaulters are defined as those who miss six straight mortgage payments without missing multiple payments on auto loans and other consumer debts for the six months after they first fell behind on mortgage payments."

My Opinion: This definition of what constitutes a strategic default is somewhat arbitrary. I believe it is built on the wrong assumptions. It assumes that consumers value a house more than credit cards or a car. It assumes that a homeowner would stop paying their credit cards or auto loan before missing a mortgage payment. Mortgage payments tend to be higher percentage of a home owner's monthly income. It is also as likely that a homeowner is unable to afford their mortgage payments but can afford the lower credit card and auto payments. For example, a car can be seized if the payments are not made. The car could be used for work, taking the family to the hospital, taking the kids to school, or for travel. The credit cards may have available credit so a strapped homeowner can tap cash or charge necessity. A strategic default is primarily based upon on premise: It does not make sense to make payments on or put money into a worthless asset. It is a rejection of economic slavery. Countries, governments, businesses, investors, and individuals have been strategically defaulting since the beginning of time.

I guess the real question is: For whose purpose does the definition serve?

This dovetails into another article from the Wall Street Journal blog where it was asked How Far Underwater Do Borrowers Sink Before Walking Away?. Let's look at a few key points in the article.

A study by the Federal Reserve Board of Governors found that borrowers strategically default when the mortgage balance exceeds the value of their home by 62%.

"concerns are mounting among lenders and investors that some borrowers who owe far more than their homes are worth are now choosing not to pay mortgages that they can afford...But the silver lining here is that it suggests a rather high threshold for borrowers to walk away...The Fed study finds...that borrowers are more likely to walk away from homes in states where lenders can’t sue them for a deficiency judgment."

"Borrowers with higher credit scores also find it more costly to default. The median borrower with a credit score between 620 and 680 walks away when their loan-to-value ratio hits 151%, while the median borrowers with a credit score above 720 walks away with a loan-to-value ratio of 168%."

My Opinion: The first question is...who is the target audience of these studies? The target audience appears to be lenders, investors, and the government. Why? Well let's quote once again from the article "concerns are mounting among lenders and investors that some borrowers who owe far more than their homes are worth are now choosing not to pay mortgages that they can afford".

Why are concerns mounting? The quote is self evident and self proving. Lenders, investors, and the government are all very use to borrowers acting against their financial self interest. Essentially expecting borrowers to continue making payments on properties, loans, bailouts or debts that simply drain cash and have absolutely no chance of providing a return. These payments from borrowers are the last and final source of cash for our heavily indebted lenders, investors, and government.
I may be scared if I were in their shoes.

Bottom Line: Borrowers do not want to (and probably should not) pay mortgages on properties that are underwater. It is against their financial self interest in all respects. On top of that lenders and investors routinely follow the principles of strategic default.

The next government study should be entitled
"Banks and Creditors Have Decided To Reduce Principle Balances In An Effort To Reduce Strategic Defaults"

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