by Bill McBride on 6/27/2009 01:42:00 PM
Saturday, June 27, 2009
Here is an interesting new paper on homeowners with negative equity walking away: Moral and Social Constraints to Strategic Default on Mortgages by Guiso, Sapienza and Zingales. (ht Bob_in_MA)
The WSJ Real Time Economics has a summary: When Is It Cheaper to Ditch a Home Than Pay?
The researchers found that homeowners start to default once their negative equity passes 10% of the home’s value. After that, they “walk away massively” after decreases of 15%. About 17% of households would default — even if they could pay the mortgage — when the equity shortfall hits 50% of the house’s value, they found.Walking away (what the researchers call a "strategic default" and the mortgage industry call a "ruthless default") is when the borrower decides to stop paying a mortgage even though they can still afford the payment. This has always been difficult to quantify. Whenever a lender calls a delinquent homeowner - if they can reach the homeowner - the homeowner always tells the lender some sob story about why they can't pay their mortgage (lost job, medical, rate reset, etc.). As the researchers note:
“Our research showed there is a multiplication effect, where the social pressure not to default is weakened when homeowners live in areas of high frequency of foreclosures or know others who defaulted strategically,” Zingales said. “The predisposition to default increases with the number of foreclosures in the same ZIP code.”
It is difficult to study the strategic default decision, because it is de facto an unobservable event. While we do observe defaults, we cannot observe whether a default is strategic. Strategic defaulters have all the incentives to disguise themselves as people who cannot afford to pay and so they will appear as non strategic defaulters in all the data.So the researchers conducted a survey to attempt to quantify the percent of strategic defaults. This has drawbacks - the questions are hypothetical and there are no actual monetary consequences - but the results seem somewhat reasonable.
Note: the researchers use Zillow for negative equity numbers, and I think those are overstated. I prefer the research of Mark Zandi at economy.com or estimates from First American CoreLogic.
I think one of the key points in the research are changing social norms - the more people a homeowner knows that he believes "walked away" the more open the homeowner will be to mailing in their keys. This is what I wrote in 2007:
One of the greatest fears for lenders (and investors in mortgage backed securities) is that it will become socially acceptable for upside down middle class Americans to walk away from their homes.This research suggests that this is happening in significant numbers.
This has led many people to suggest principle reductions (as opposed to payment modifications) is the only solution. Tom Petruno at the LA Times has more on this: Is it time for underwater homeowners to be given a get-out-of-debt-free card?
Government and private-lender attempts to stem the home foreclosure crisis so far have mostly focused on loan modifications or refinancing -- giving borrowers a temporary or permanent reduction in their monthly payments.And a final note, the researchers also touch on the recourse vs. non-recourse issue:
But some housing experts say the next wave of help will have to address the core problem for many homeowners: negative equity.
This camp believes that there is no alternative but outright forgiveness of a substantial chunk of mortgage debt for many people who are underwater in their homes and at risk of foreclosure.
While only few states have mandatory non-recourse mortgages (i.e., do not allow creditors to pursue borrowers who walk away from their mortgages for the difference between the amount of the mortgage and the resale value of the house), the cost of legal procedures is sufficiently high that most lenders are unwilling to sue a defaulted borrower unless he has significant wealth besides the home.And that fits with an email Tanta sent me in 2007 on recourse loans:
Back in my day working for a servicer, we never went after a borrower unless we thought the borrower defrauded us, willfully junked the property, or something like that. If it was just a nasty RE downturn, it rarely even made economic sense to do judicial FCs just to get a judgment the borrower was unlikely to able to pay. You could save so much time and money doing a non-judicial FC (if the state allowed it) that it was worth skipping the deficiency.