High-end loan owners strategically defaulted in large numbers
Loan owners with big incomes believed house prices were going up forever. They bought houses they could barely afford because they believed the additional cost of ownership over renting would provide them with a return on their investment. Buying a house was part utility through providing shelter and part investment through capturing rapid appreciation. Of course, the actions of buyers willingly overpaying for houses drove prices higher in a self-fulfilling prophesy. Like all Ponzi schemes, it went on until the supply of greater fools was exhausted and lenders stopped enabling the insanity.
Now that high-end loan owners are accepting the fact that their brilliant investment was folly, many of them are choosing to dump their investments. When the investment no longer provides the return they are looking for, loan owners quite rationally decide to exit their positions. In the stock market when bulls turn bearish, they sell their shares, prices crash, and life goes on. Unfortunately when it comes to single-family homes, it’s not quite so simple. The loan owner must give up the property, an emotional hardship for many who become attached to their cash cows. For lenders the loan owner exodus means widespread strategic default on a home mortgages and millions of foreclosures.
Most of the news coverage of the crash of the housing bubble has focused on the role of subprime borrowers. They were decried as deadbeats who couldn’t make their payments. For some this was certainly the case, but for many, they were given loans they should never have been given, and their implosion was a foregone conclusion. In any case, subprime borrowers defaulted first, and their properties were pushed through the system. Wherever subprime was concentrated had a devastating market crash.
Lenders learned from the collapse of prices in subprime dominated markets, so when the more affluent borrowers faced the same problems of insolvency from excessive debt, lenders allowed them to squat in their homes rather than see catastrophic price crashes in every market. The policy of amend-extend-pretend was put in place, and lenders accumulated a huge number of delinquent mortgage squatters in shadow inventory. The buildup of shadow inventory helped sustain bubble-era pricing in many neighborhoods, but it did nothing to solve the underlying problems with valuation. Prices were simply too high. Withholding supply has caused sales volumes to plummet, and prices have been inching downward for the last five years.
Many high wage earning loan owners came to believe their neighborhoods were special. Prices didn’t fall where they lived because the properties were so desirable. In reality, prices didn’t fall because lenders withheld the inventory through both holding REO off the market and allowing delinquent mortgage squatters to stay in place. Although this policy has kept the declines to a minimum in high-end neighborhoods, it hasn’t caused prices to go up. It never could. Prices were too high and needed to fall based on affordability alone.
Since prices stopped going up for five full years, and since high-end loan owners realize prices won’t be going up in their neighborhoods for a very long time, the borrowers who overborrowed to capture appreciation have given up hope. When denial turns to fear and finally acceptance, loan owners want to get out. Many try to sell, but those who don’t or can’t simply stop paying the mortgage — they strategically default.
… A sprawling, Spanish-style estate, fringed by majestic pine trees and located near the boutiques of Santa Monica Boulevard, its former owners were served with a default notice in 2010; they were $205,000 behind in their payments on mortgages totaling $6.9 million.Welcome to foreclosure Beverly Hills-style.
First, I would like to point out that rich people do not get $6.9M loans. Rich people pay cash. Posers and Ponzis take out $6.9M loans.
Second, loans that large are not being underwritten today. Banks aren’t that stupid anymore. Since such large loans are so scarce, the air that inflated house prices has been removed. Only the low sales volumes has keep prices at such artificial levels.
Third, the HELOC abuse and excessive debt is a huge problem in these supposedly rich neighborhoods. Remember, HELOC abuse Hollywood Style? Or perhaps HELOC abuse Newport Coast Style? Or HELOC abuse Laguna Beach Style? The behavior of the loan owners in those posts was not that of rich people. It was the behavior of entitled fools who deserve to lose their houses.
Some 180 houses in Beverly Hills, the storied Los Angeles enclave rich with Hollywood stars and music moguls, have been foreclosed on by lenders, scheduled for auction, or served with a default notice, the highest level since the 2008 financial crash, according to a Reuters analysis of figures compiled by RealtyTrac, which tracks foreclosures nationwide.
As in the default-ravaged suburban subdivisions of Phoenix, Arizona, and Tampa, Florida, plunging real estate prices are the root of the problem in Beverly Hills.
But the dynamics of the residential real estate collapse are very different in elite neighborhoods such as this. The majority of delinquent homeowners here owe more than $1 million. Many are walking away not because they can’t pay, but because they judge it would be foolish to keep doing so.
They view their house as an investment, and when the returns aren’t there, they dump them.
“It’s a business decision, not an emotional one which it is for normal people,” said Deborah Bremner, owner of the Bremner Group at Coldwell Banker, which specializes in high-end properties in the Los Angeles area. “I go to cocktail parties and all people are talking about is whether it is time to walk away, although they will never be quoted in the real world.”
She said she had seen in Beverly Hills a big increase in “strategic defaults,” in which owners who can still afford to make their monthly mortgage payment choose not to because the property is now worth so much less than the giant loan used to buy it during the housing bubble.
Strategic default is an especially appealing option in California, one of only a handful of U.S. states where primary mortgages made by banks are “non-recourse” loans. That means the loan is secured solely by the property, and banks cannot go after a delinquent owner’s wages or other assets if they default.
Bremner said she helped a client buy a Beverly Hills mansion last year that the prior owner had bought for over $4 million. He decided to stop paying his $3 million mortgage – even though he could easily afford it – when the value of the property had dropped to $2.5 million.
“They were able to comfortably cover the loan,” Bremner said. “They were just no longer willing to see the value of the property drop.”
A huge “shadow inventory” is building of elite homes that are in default but have not been put on the market. Of the 180 distressed properties in Beverly Hills, only 12 are up for sale.
And the longer lenders wait to clear out this inventory, the worse their losses will be.
The backlog reflects the pent-up flood of foreclosed properties of all price ranges that are expected to hit the U.S. market this year, especially after five major banks reached a $25 billion settlement last week with the U.S. over fraudulent foreclosure practices.
It isn’t clear that these houses will all hit the MLS. Lenders will sell many as parts of bulk portfolio deals. Since these high end properties make no sense as cashflow properties, the discounts on those will be enormous.
Defaults on ‘Jumbo Loans’ Soaring
Across the United States, the largest increase in foreclosures and delinquencies, compared with 2008 levels, is with “jumbo” mortgages – loans too large to be insured by Fannie Mae and Freddie Mac, the government controlled mortgage finance providers. Foreclosures on jumbo loans are up 579 percent since 2008, greater than any other form of loan, according to a report last month by Lender Processing Services, Inc.
High end loan owners have long denied they would get their comeuppance. They were wrong.
Strategic defaults are now more likely among jumbo loan-holders than any other type of borrower, according to a report issued late last year by JPMorgan Chase & Co. Nearly 40 percent of delinquencies among non-governmental mortgages, which are mostly jumbo loans, are strategic defaults, the report said.
“Now that these homeowners with jumbo loans are finding out you can do this, more and more are doing strategic foreclosures,” said Jon Maddux the CEO of YouWalkAway.com, which advises homeowners who are “underwater,” the term for those whose loans exceed the value of their home.
Nathaniel J. Friedman, a Beverly Hills lawyer, insists he is not a strategic defaulter – that he never missed a mortgage payment in his life. But he stopped making payments on his five-bedroom, six-bathroom Beverly Hills house on Schuyler Road three years ago.
Friedman, who had mortgages totaling $3 million with the now-defunct Countrywide Home Loans, returned home one evening in January 2009 to find a letter from Countrywide freezing his $150,000 line of credit, which was linked to his second $900,000 loan. His primary loan was $2.1 million. The property is worth about $2 million today.
Friedman says he decided to stop paying out of a sense of vengeance from the moment he received that letter. He has been in negotiations for months with Bank of America, which took over Countrywide after its collapse, to modify the loan.
“I thought to hell with it,” he told Reuters. “Why should I keep feeding a dead horse if the bank has no confidence in me?”
“I was able to maneuver things my way because of the inertia of the banking sector,” Friedman said. He believes the bank will blink first, and eventually modify his loan.
For as much as I enjoy seeing the banks get reamed, I hope they boot this delinquent mortgage squatter.
Although, he isn’t the worst offender….