Feb212012
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.”
Remember the cocktail parties in 2004-2006 when every conversation revolved around how much their house was worth and what they were spending the money on? I do. ~~ giggles to self ~~
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.”
The investment didn’t pan out. They are wise to dump the property because prices aren’t going up in those neighborhoods any time soon.
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.
The gentleman profiled below has an amazing case of cognitive dissonance. 
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….
FHA is implementing a higher for mortgages between $625,000 to $729,000. It might a reflection of the higher risk to the FHA trust fund with these higher loans.
Your taxpayer dollars at work:
Treasury Increases Incentives for Principal Reductions
A recently released Supplemental Directive from Treasury increases incentives for second lien investors when loans receive principal reductions.
The increased incentives apply to permanent HAMP modifications with principal reductions through the government’s Principal Reduction Alternative (PRA) that have trial period plans starting March 1 or later.
The incentives are also available when second liens are completely or partially eliminated through the Second Lien Modification Program (2MP) on loans modified starting June 1.
For loans no more than six months delinquent over the previous 12 months, investors may receive $0.63 per
dollar of written down principal between 105 percent and 115 percent market-to-market loan-to-value ratios (MTMLTVs), or $0.45 per dollar of written down principal between 115 percent and 140 percent MTMLTV.
For loans that have been more than six months delinquent sometime in the previous 12 months, investors may receive $0.18 per dollar of written down principal, irrespective of MTMLTV ratio.
Regarding second liens modified through 2MP that have not been more than six months delinquent in the previous year, investors may receive $0.12 per dollar of unpaid principal balance eliminated on second liens.
While servicers may reduce principal below 105 percent MTMLTV, they will not receive incentives on the portion of principal reduction that brings the MTMLTV below 105 percent, according to Treasury.
Investors may also receive $0.12 per dollar of eliminated unpaid principal balance on second mortgage liens more than six months delinquent in the year prior to the “date of extinguishment,” Treasury stated in the directive.
“This guidance does not apply to mortgage loans that are owned or guaranteed by Fannie Mae or Freddie Mac, insured or guaranteed by the Veterans Administration or the Department of Agriculture’s Rural Housing Service or insured by the Federal Housing Administration,” the directive states.
The average OC residents net worth is less, incomes are less and so the amounts they can leverage will be less = more proof that the great re-pricing event (homes will no longer be priced as investment, but as shelter) will continue for years to come.
I’ve considered calling the CA Bar Ethics Hotline before to ask if strategically defaulting on your home is considered an unethical act, or act of moral turpitude, requiring self-reporting to the Bar.
Interesting thought. However, I see it as nothing more than a simple breach of contract. Why should the fact that it is a mortgage be treated any different than any other contract?
If I breach my rental agreement, I can choose to pay the liquidated damages penalty of an extra month or rent or I can help my landlord cover her damages by finding another tenant to take my place. Does that make me unethical if I find another place I want to live and breach my lease? The remedies for my default were known in advance to both parties (either in the contract or through common law). I don’t think anyone would consider a breach of a lease unethical if it left my landlord and I in the same place that we agreed when we entered into the lease. Why does it become unethical if it is a mortgage?
I agree, but that foreclosure is going to harm, if not kill, your security clearance with a high-grade federal government job. Why? Presumably because it’s considered “unethical,” no?
However you want to characterize what this guy is doing, it smells bad.
Banks who issue jumbo loans often hold them in their portfolio. What bank will want to loan this guy money in the future? His is the kind of business banks don’t want.
I’m not so sure losing your security clearance relates to the ethics of defaulting. I think it speaks more to the fact that someone may have a financial need that could be exploited by another person looking to take advantage of that security clearance. It might also bring into question honesty/integrity/loyalty issues. If I will breach my contract if it is in my best interest, why wouldn’t I also breach a confidentiality clause or other agreement that I have with the government if it suits me?
A mortgage is a different type of contract that a lease or rental.
I’ll bite. Please tell me what is the basis (legal or otherwise) for why a breach of contract related to a mortgage should be treated different than any other type of contractual breach.
It was only a matter of time until the capital in the system that could keep up this financial mirage ran out of steam. A lot of people have bought over-priced homes since the bubble burst, either using proceeds from previous sales or money gifted to them by relatives. Very few actually saved up fo down payments. This money has gradually been spent over the past few years. Now we’re teetering on the brink of total collapse in mid- and high-end markets since people simply don’t have down payments anymore. Sure you can do an FHA loan but prices are still too high for people to afford the monthly payments compared to renting. I know there are many of us who have waited it out, investing our cash elsewhere. But that number of fence-sitters isn’t big enough to absorb the massive scale of inventory we’re facing. The banks better be prepared for shocking write-downs in the near future. Otherwise it’s banking armageddon here we come!
Unfortunately, for debt-based asset holders, the current bubble is in the money.
I think we are going to see a lot of homes sell in the $600,000 to $800,000 range over the next several years. That is the limit if financing from the GSEs and the FHA with less than 20% down. Very few have the 20% needed for a house over $800,000, and few have the income, even with the sub 4% interest rates. The quality of the houses selling in the $600,000 to $800,000 range will continue to get better over the next two years.
If the quality of $600k-$800k homes goes up, i.e. you can buy a house for $700k that previously went for well over a million, then that will result in further reduction in move-up buyers. People sitting in homes that they now think are worth $600k will see big drops in their value and ability to sell for a profit. Many of these people have borrowed from their perceived equity. I also don’t see GSEs/FHA loans as being a widely available option for still over-priced homes in the longrun.
As prices collapsed unevenly, we saw a huge spread develop between low end prices and high end. I think this will compress greatly as high end prices fall and low end prices stabilize. The remaining air will be expelled from the system. I agree that the move up market will be dead for quite a while. I estimate at least five years because we won’t have appreciation locally for another two years, then it takes three more years for the people who bought at the bottom to have any equity to move up with. It may even take longer because appreciation is likely to be very slow coming off the bottom.
Indeed, prices in the lower-tiers will be pushed down accordingly. That means the current floor is built on sand.
And the reason for that is…..?
1. Most folks in Orange County have incomes that can support a mortgage of $700K?
2. Most folks in Orange County have 20% or more down to qualify for any loan?
3. Jobs are roaring back into Orange County?
4. Home prices are now at 1990 levels?
Because interest rates are so low, people can afford to borrow $625,000, but the cost of money increases dramatically going FHA to go up to $729,750. Borrowers need 20% down to go any higher.
I don’t think we will see a lot of sales in that price range because prices are going up. I think the sales will be on properties that used to be priced higher that are going down to where financing is available.
Return to 1990′s home values…a possibility
By Mike at North Orange County Housing News
First, I’m not saying this will happen but there is a possibility this can occur only if certain economic and financial conditions are met. For this event to occur the right conditions would have to happen in the right order and they would have to be severe. But if the home values did return to 1990′s prices, I think eventually demand would return and boost prices back to the early 2,000′s. However, according to historical data, there’s possibility of a return to 1990′s home values.
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