Freddie Mac Shames Strategic Defaulters, Asks Them to Reconsider
On mortgage giant Freddie Mac’s blog, “Featured Perspectives,” executive Don Bisenius takes on strategic defaulters — underwater mortgage-holders (that is, homeowners who owe more on their mortgage than their home is worth, meaning that if they sell their house they will still owe the bank money) who chose to walk away from their mortgages and cede their home to the bank.
Bisenius tells them: For shame, don’t do it!
He has good reason to worry. Strategic default might be nothing more than a rational calculation for an underwater homeowner. But it might spell disaster for already stressed financial firms in the mortgage business. Freddie Mac’s exposure alone is measured in the billions. In light of that, Bisenius, well, shames strategic defaulters into reconsidering:
While I understand how that might well be a good decision for certain borrowers, that doesn’t make it good social policy. That’s because strategic defaults affect many other families and communities. And these costs — or as they are known in economic jargon, externalities — are not factored into the individual borrower’s calculations.
Let’s start with the neighbors. When strategic defaults occur, homes go into foreclosure and sit vacant for some period of time. 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. Indeed, Economy.com, the analytic firm, recently said that more strategic defaults could tip a fragile housing market back into one of further price declines. Even more families harmed.
But that’s not all. Should strategic defaults become more common, mortgage guarantors and investors, including Freddie Mac, would need to factor this risk more prominently into their credit policies and prices. The likely impact on future homebuyers: the cost of a mortgage will go up and credit terms will be less flexible. Thus, the impact of strategic defaulters on still more families might be more expensive mortgages and loans that are more difficult to obtain. The strategic defaulter does not usually consider these costs.
In short, Bisenius holds that strategic defaulters should recognize the harm they do to their neighborhoods and should remain in their homes because it is the *right *thing to do. It is now a common refrain. Caroline Baum of Bloomberg, for instance, recently also made the “foreclosure queen” argument, sneering at strategic defaulters and calling them “mortgage deadbeats.”
The problem is that strategic default generally is the *smart *thing to do — leaving morality out of it. Strategic defaults are strategic. A homeowner’s contract spells out precisely what will happen if he stops paying their mortgage: The bank takes the home, and he walks away. There used to be a tremendous social stigma attached to default, and homeowners would go into arrears on virtually every other bill before their mortgage. But the recession has upended that logic.
Indeed, this weekend, “60 Minutes” aired a segment entitled “Walking Away” on the “epidemic” of strategic defaulters. (The show did not attach a number to the phenomenon, but 11 million homeowners are currently underwater.) One strategic defaulter interviewed by Morley Safer describes defaulting as “almost the ‘in thing’ to do now.” And one adventurous businessman who assists mortgage-holders through the process of strategic default for a fee says: “As more people are foreclosing, that stigma is wearing off. Banks don’t feel shame by foreclosing on a person’s home. It’s a business decision.”
In light of that social change, Freddie Mac might be better off offering economically advantageous options to underwater homeowners, rather than shame. But here is what Freddie Mac comes up with:
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. Over time, recovering house prices and declining mortgage balances likely will close some, if not all, of the equity gap. According to the Federal Reserve, while the housing bust wiped out $8 trillion in home equity, $1 trillion came back in 2009. The point here: time might be your best ally.
Another alternative: **if Freddie Mac owns the loan, a family might be able to refinance up to 125 percent of the current property value. **In other words, if a family’s home equity has been completely wiped out and the mortgage balance is as much as 25 percent more than the home is worth, we can help.
Freddie argues that home prices will eventually rise, leaving homeowners above water again, and provides a way to refinance for lower monthly payments. But neither of these options tackle the underlying and immediate problem of being underwater. And therefore neither will be sufficient to convince people to keep on sending off that mortgage check.
For Freddie to forestall the coming summertime wave of strategic defaulters, there are options. First among them is principal reduction, reducing the value of the underlying loan. The Obama administration’s Home Affordable Modification Program has not kept pace with the foreclosure crisis. But were it to be expanded, it would help companies like Freddie keep people in their houses, paying their mortgages. (The losses for Freddie from a strategic default would be far higher than the losses from a principal modification.) Another is “right to rent,” proposed last month by Rep. Raul Grijalva (D-Ariz.) and Rep. Marcy Kaptur (D-Ohio).
Rather than shaming strategic defaulters, Freddie might consider working with the government to provide those options and help keep people in their houses.