Dec212009

Should you walk away from home debt?

Nothing in your hand; it is what underwater homedebtors have. They occupy a house — just like renters do — but most of them do so at a huge premium to renting. Underwater homedebtors have no equity; what they do have is the dream of equity in the future. They have a position in a financial market that most resembles an option contract that is out-of-the-money.guilt_mortgage

People who are underwater today and paying a premium are still hoping they will get a return on those premium dollars when their house value rises above their mortgage and puts them back in-the-money. Mostly this is based on fantasy or Zillow Zestimates or some other such nonsense, when in reality, their property values will likely decline further, and it will take much longer than they want for prices to come back. That is the way financial bubbles deflate.

Most people will not walk away. Most will continue to suffer in silence wait the decade or more for prices to recover. People become invested in the process. Once they have held on for two or three years too long, they feel committed to seeing it through, and many will. This was the experience of the early 90s, and since that bubble wasn’t near so massive, the market did recover in 8-10 years and life went on.

The Great Housing Bubble was much, much larger than the bubble of the 90s, and we have not deflated back to stable price levels yet. Those that hang on will likely wait much longer than those who bought in the last bubble.

Underwater and Not Walking Away: Shame, Fear and the Social Management of the Housing Crisis

Brent T. White

Abstract

“Contrary to reports that homeowners are increasingly “walking away” from their mortgages, most homeowners continue to make their payments even when they are significantly underwater. This article suggests that most homeowners do not strategically default as a result of two emotional forces: 1) the desire to avoid the shame and guilt of foreclosure; and 2) exaggerated anxiety over foreclosure’s perceived consequences. Moreover, these emotional constraints are actively cultivated by the government and other social control agents in order to induce homeowners to ignore market and legal norms under which strategic default might not only be a viable option, but also the wisest financial decision. Unlike lenders, individual homeowners have thus generally not acted to minimize their losses and have born a disproportionate share of the burden from the housing collapse.”

WalkingAway1029.pdf

From the main text:

“This article suggest that most underwater homeowners don’t default as a result of two emotional forces: 1) the desire to avoid the shame or guilt associated with foreclosure; and 2) fear over the perceived consequences of foreclosure – consequences that are in actuality much less severe than most homeowners have been led to believe. Moreover, fear, shame, and guilt are not mere “transaction costs” that homeowners calculate according to their own personal tolerance for each. Rather, these emotional constraints are actively cultivated by the government, the financial industry, and other social control agents in order to induce individual homeowners to act in ways that are against their own self interest, but which are – wrongly this article contends – argued to be socially beneficial.”

I totally agree with the observation made here. The powers-that-be are working in a coordinated effort to convince people to keep hanging on, not because it helps the borrower, but because it benefits the lender. The culmination of these efforts is a series of Bailouts and False Hopes.

“Unlike lenders who follow market norms, individual homeowners are encouraged to behave in accordance with social norms of “personal responsibility” and “promise-keeping.” Thus, individual homeowners tend to ignore market and legal norms under which
strategic default might not only be a viable option but also the wisest financial decision. As a result, individual homeowners have born a disproportionate share of the costs of the housing meltdown.”

When a borrower defaults at a bank, it is a tiny blip on some complicated financial statement of a large, faceless lender — the same lender that made a fortune putting the borrower into an unstable loan to begin with. Lenders made the problem, but they are trying, hoping, praying they can pass off the responsibility to everyone else — particularly underwater homeowners. It is the individual homeowners who bear the greatest burden and it is the borrowers who will pay the price through a decade of debt slavery with the feeble hope of appreciation to bait them on.

IMO, this is where it gets even worse. For the whole system to hold together, kool aid intoxication must be sustained. If the underwater homeowners truly accepted the idea that prices may not come back in a reasonable time — and prices will never come back as quickly as homedebtors imagine — people will default in larger numbers.

In one of the more damning portions of the paper, Dr. White writes:

… social control agents such as the government, the media, and the financial industry use both moral suasion and disinformation to cultivate these emotional constraints in homeowners.

Is he a conspiracy-theory nutter, or is he an accurate observer of what is going on? I will let you decide.

Should You Walk Away?

I found a link to a site, Pay or Go. With a few simple inputs the site will tell you whether or not it is in your best interest financially to walk away. It also has a number of informative links to major newspaper articles on the subject.

The calculator on the site has an important note that drives to the heart of the problem: people believe house prices appreciate faster than they really do.

IS IT IN MY ECONOMIC INTEREST TO WALK AWAY?

You decide. This calculator is just a tool to help. Numerous variables are involved but the biggest is probably your assessment of the future of housing pricing. No one can predict future prices, but the conventional wisdom says that it is probably not realistic to believe that housing prices will increase by more than 4%-8% per year on average.

It seems obvious to me that one of problems people were having with this tool was that they put in assumptions for appreciation that are too aggressive. It is the same kind of thinking that inflated the bubble.

Faith in market kool aid is not enough. With a massive overhead inventory of those who want or need to get out at breakeven (including the lenders and their shadow inventory), no amount of wishful thinking is going to make prices rise. Low interest rates may help cushion the blow, but peak prices are not right around the corner.

I am starting to believe that kool aid intoxication may never go away, particularly now that it is in the government’s best interest to keep it tasty and keep it flowing.