Aug162010

Foolish Bankers Surprised: Borrowers Never Intended to Repay Their Loans

Some people ain’t no damn good. You’re going to meet some of them in today’s post. For those of us who didn’t participate in the housing bubble, no good deed goes unpunished. I have been the whippin’ boy for kool aid intoxicated fools who can’t deal with the inconvenient truths I display on a daily basis. I’ve had that pleasure for years and years. Second best is all we seem to get by playing by the rules. Irresponsible homedebtors get loan modifications, no-interest loans, and principal forgiveness, and we have to pay for it! And the irresponsible get to walk away from their debts with no repercussions, and many don’t think they did anything wrong. They’re victims of circumstance so they say. Everyone else did it, so it must be okay.house_pay_the_loan

I say screw them. Get the lazy squatters the hell out of our houses! What the lenders lifted up must fall. We are all waiting outside to claim their tumblin’ walls.

Debts Rise, and Go Unpaid, as Bust Erodes Home Equity

By DAVID STREITFELD
Published: August 11, 2010

PHOENIX — During the great housing boom, homeowners nationwide borrowed a trillion dollars from banks, using the soaring value of their houses as security. Now the money has been spent and struggling borrowers are unable or unwilling to pay it back.

There is a pathology at work here that lenders don’t recognize: borrowers never intended to pay that money back.

Once people accepted that house prices would always go up, they didn’t need to worry about increasing their mortgage. As long as house prices go up, if the payments become too much to handle, they could just sell the house and let someone else pay off the debt — either that, or they could just borrow more money to make the payments. In either case, the borrowers were running a Ponzi Scheme. Every serial refinancer was a mini Bernie Madoff.

The road to hell is paved with good intentions, and strictly speaking, the borrowers intended to repay. When they sold the house, borrowers accepted the idea that the lender would take a portion of their appreciation to satisfy the debt. Borrowers were okay with sharing the profits, but if prices depreciated and if the borrower might have to come out-of-pocket to pay back the loan, well… that was never part of the deal. Besides, they couldn’t pay back such a large sum even if they tried. Banks should have known this.

People who borrow money they have no intention to repay or no ability to repay are stealing. Unfortunately, the morality of this isn’t quite so black and white. We have had many discussions about the morality of strategic accelerated default and the relative culpability of lenders and borrowers. Whatever the moral and ethical implications, lenders must deal with borrowers who will not pay back loans if prices go down. This is a new fact of life for lenders they must adjust to. Perhaps it will make them pause before inflating the next housing bubble, but as long as the US taxpayer is liable for their loses, lenders really don’t care.

The delinquency rate on home equity loans is higher than all other types of consumer loans, including auto loans, boat loans, personal loans and even bank cards like Visa and MasterCard, according to the American Bankers Association.

Lenders say they are trying to recover some of that money but their success has been limited, in part because so many borrowers threaten bankruptcy and because the value of the homes, the collateral backing the loans, has often disappeared.

The result is one of the paradoxes of the recession: the more money you borrowed, the less likely you will have to pay up.

This is not a paradox. This is the obvious and predictable result of the deflation of the housing bubble. When lenders provide borrowers with money they can’t or won’t pay back, the more lenders loan, the less likely they are to get paid back. The only apparent contradiction here is that lenders didn’t realize that the people they were loaning money to would behave this way. And that merely emphasizes how incredibly stupid lenders are.

“When houses were doubling in value, mom and pop making $80,000 a year were taking out $300,000 home equity loans for new cars and boats,” said Christopher A. Combs, a real estate lawyer here, where the problem is especially pronounced. “Their chances are pretty good of walking away and not having the bank collect.”

Lenders wrote off as uncollectible $11.1 billion in home equity loans and $19.9 billion in home equity lines of credit in 2009, more than they wrote off on primary mortgages, government data shows. So far this year, the trend is the same, with combined write-offs of $7.88 billion in the first quarter.

Even when a lender forces a borrower to settle through legal action, it can rarely extract more than 10 cents on the dollar. “People got 90 cents for free,” Mr. Combs said. “It rewards immorality, to some extent.”

To some extent? LOL!

If banks give out free money, everyone will want it. This entire fiasco has made sure moral hazard is deeply embedded into the belief systems of every borrower in America. How many people buying real estate in California are doing so because they believe prices have bottomed and that lenders are going to be giving out free-money HELOCs soon? Realistically, it is more than half. Kool aid intoxication has not gone away, it has gotten worse.

Utah Loan Servicing is a debt collector that buys home equity loans from lenders. Clark Terry, the chief executive, says he does not pay more than $500 for a loan, regardless of how big it is.

“Anything over $15,000 to $20,000 is not collectible,” Mr. Terry said. “Americans seem to believe that anything they can get away with is O.K.”

It is zombie debt collectors like Mr. Terry that will make life hell for those attempting to walk away from HELOCs. Go get ’em Clark!

But the borrowers argue that they are simply rebuilding their ravaged lives. Many also say that the banks were predatory, or at least indiscriminate, in making loans, and nevertheless were bailed out by the federal government.

Let’s stop for a moment and shed a tear for the victims… You know, those HELOC abusers who pulled half a million bucks out of the wall and bought new cars and took fancy vacations while the prudent went to work and paid taxes to eventually bail them out.

 

Finally, they point to their trump card: they say will declare bankruptcy if a settlement is not on favorable terms.

They should declare bankruptcy. There is nothing wrong with that. The system was designed to provide a mechanism for those who need to wipe the slate clean and start over. Anyone who defaulted on their loans should declare bankruptcy and be done with it. Hoping the problem will go away on its own will hurt them more in the end.

“I am not going to be a slave to the bank,” said Shawn Schlegel, a real estate agent who is in default on a $94,873 home equity loan. His lender obtained a court order garnishing his wages, but that was 18 months ago. Mr. Schlegel, 38, has not heard from the lender since. “The case is sitting stagnant,” he said. “Maybe it will just go away.”

Mr. Schlegel’s tale is similar to many others who got caught up in the boom: He came to Arizona in 2003 and quickly accumulated three houses and some land. Each deal financed the next. “I was taught in real estate that you use your leverage to grow. I never dreamed the properties would go from $265,000 to $65,000.”

I guess my real estate education must have been a bit better than his. When I studied real estate economics, the professors always emphasized the prudent use of debt to maintain positive cashflow. Borrowing past the breakeven point is guaranteed to destroy your investment. At some point during the bubble, borrowers unlearned this simple truth about debt, and they sought to maximize their borrowing to acquire as many homes as possible even if the cashflow was negative. At that point, the entire market became a Ponzi Scheme waiting to implode.

Apparently neither did one of his lenders, the Desert Schools Federal Credit Union, which gave him a home equity loan secured by, the contract states, the “security interest in your dwelling or other real property.”

Look at this guys attitude. He clearly feels no responsibility whatsoever for the losses, and he really believes he is going to escape with no further damage. If he had any brains at all, he would declare bankruptcy now and start over. If he doesn’t, the lender — or the zombie debt collector who buys his loans — is going to come take whatever he has. All these people who are walking away from recourse debt will be contacted by debt collectors once they start acquiring assets again.

Desert Schools, the largest credit union in Arizona, increased its allowance for loan losses of all types by 926 percent in the last two years. It declined to comment.

The amount of bad home equity loan business during the boom is incalculable and in retrospect inexplicable, housing experts say. Most of the debt is still on the books of the lenders, which include Bank of America, Citigroup and JPMorgan Chase.

The second mortgage debt and HELOCs are the root of all our housing woes.

The main reason lenders will fail to execute more short sales is due to these seconds and HELOCs. The holders of those worthless loans have the power to hold everyone hostage and try to extort whatever they can out of both buyers and sellers. In the end, the buyer and seller are better off in a foreclosure that wipes out the seconds, HELOCs and back HOA dues.

With the huge amount of second mortgage and HELOC debt still on the books of major banks, they are still insolvent. Despite the Federal Reserve stealing from savers and giving the money to banks — which is the net effect of zero percent interest rates — it will take many more years before banks have made enough money to fully write down the losses on this part of their portfolios. It also suggests that the Federal Reserve may maintain zero percent interest rates for a very long time. Welcome to Japan.

“No one had ever seen a national real estate bubble,” said Keith Leggett, a senior economist with the American Bankers Association. “We would love to change history so more conservative underwriting practices were put in place.”

OMG! I don’t believe he said that. The reason we had never seen a national real estate bubble is precisely because we have never had such stupid underwriting practices in place. What did these idiots expect? If you give unlimited money to anyone who asks, you are going to have problems. The ignorance is truly remarkable.

The delinquency rate on home equity loans was 4.12 percent in the first quarter, down slightly from the fourth quarter of 2009, when it was the highest in 26 years of such record keeping. Borrowers who default can expect damage to their creditworthiness and in some cases tax consequences.

Nevertheless, Mr. Leggett said, “more than a sliver” of the debt will never be repaid.

You think? Not that the banks have written down the bad debt. Thanks to amend-extend-pretend, only a sliver has been written off so far.

Eric Hairston plans to be among this group. During the boom, he bought as an investment a three-apartment property in Hoboken, N.J. At the peak, when the building was worth as much as $1.5 million, he took out a $190,000 home equity loan.

Mr. Hairston, who worked in the technology department of the investment bank Lehman Brothers, invested in a Northern California pizza catering company. When real estate cratered, Mr. Hairston went into default.

The building was sold this spring for $750,000. Only a small slice went to the home equity lender, which reserved the right to come after Mr. Hairston for the rest of what it was owed.

Mr. Hairston, who now works for the pizza company, has not heard again from his lender.

Since the lender made a bad loan, Mr. Hairston argues, a 10 percent settlement would be reasonable. “It’s not the homeowner’s fault that the value of the collateral drops,” he said.

Isn’t it funny that homedebtors have no problem keeping all the profits when prices go up, but when prices go down, it isn’t their fault and the bank should absorb that loss. If the guy wanted an equity partner to take that risk, he should have sought one out. What he did was take out a loan, and lenders do not assume downside risk — well, at least they aren’t supposed to.

I sincerely hope lenders are learning the lessons of this bubble collapse. Lenders and borrowers do not view the world the same way. Borrowers expect all the downside benefits of equity participation and all the upside benefits of debt in fixed amounts. This is the new world order.

Marc McCain, a Phoenix lawyer, has been retained by about 300 new clients in the last year, many of whom were planning to walk away from properties they could afford but wanted to be rid of — strategic defaulters. On top of their unpaid mortgage obligations, they had home equity loans of $50,000 to $150,000.

Fewer than 5 percent of these clients said they would continue paying their home equity loan no matter what. Ten percent intend to negotiate a short sale on their house, where the holders of the primary mortgage and the home equity loan agree to accept less than what they are owed. In such deals primary mortgage holders get paid first.

The other 85 percent said they would default and worry about the debt only if and when they were forced to, Mr. McCain said.

“People want to have some green pastures in front of them,” said Mr. McCain, who recently negotiated a couple’s $75,000 home equity debt into a $3,500 settlement. “It’s come to the point where morality is no longer an issue.”

Earlier this year, I wrote that by the end of 2010 the idea of a moral obligation to repay mortgage debt will carry no weight. It is August, and we are already there.

Darin Bolton, a software engineer, defaulted on the loans for his house in a Chicago suburb last year because “we felt we were just tossing our money into a hole.” This spring, he moved into a rental a few blocks away.

The only positive lenders have obtained by allowing widespread squatting is that they have convinced a few people prices might come back soon. This false and misguided hope is stopping them from lapsing into the malaise demonstrated by Mr. Bolton in the comment above. As prices roll over again in the inevitable double dip, more and more borrowers are going to embrace Mr. Boltons attitude and realize that continuing to pay an oversized mortgage on an underwater property is tossing their money into a hole.

“I’m kind of banking on there being too many of us for the lenders to pursue,” he said. “There is strength in numbers.”

Borrowers who took out enormous loans during the housing bubble never intended to repay these loans from their wage income, they always intended to pass this debt to some else. Somewhere along the way this subtle paradigm shift took place. It seems very reasonable that one could merely service debt for a while and resell the property to someone else and pay off the debt then. Like any Ponzi Scheme, it works until there is no greater fool to come along and assume the debt. Then the entire system comes crashing down and a spiral of debt deflation we are witnessing today. The worst part is that this thinking is still alive and well today.

The reason this problem won’t simply go away is because incomes do not support the debt created. Even at 4.5% interest rates, as a society we cannot support the debt lenders made. Deflation will continue until prices are back in line with incomes. In markets like Las Vegas, we are already well below the price point needed, but in Orange County, our prices have not fallen enough to be supported by the local population. More pain lies ahead.