Mortgage Defaults

"Just when it was looking like things couldn't get any worse in the housing market, government officials announced Tuesday that home prices had their biggest fourth-quarter drop in 17 years. At the same time, foreclosure filings in California soared 120% in January from a year earlier to 57,158, according to Irvine-based market researcher RealtyTrac. California's foreclosure rate was second only to Nevada nationwide. ... 'People who are selling now are really feeling it,' said Doug Willis [DW], a Pasadena real estate broker. 'After taking money out of their homes for years, they're realizing they might have a significant loss on their property compared to what they owe for it.' ... On Monday, the California Assn. of Realtors reported that home sales statewide fell about 30% in January from a year earlier and that the median price of an existing home was down 22%", http://www.latimes.com/, my emphasis, 27 February 2008.

"When Raymond Zulueta went into default on his mortgage last year, he did what a lot of people do. He worried. ... Then in January he learned about a new company in San Diego called You Walk Away that does just what its name says. For $995, it helps people walk away from their homes, ceding them to the banks in foreclosure. ... Last week he moved into a three-bedroom rental home for $1,200 a month, less than half the cost of his mortgage. ... Twenty-nine percent of buyers put no money down [in 2007]. For first-time home buyers, the median was 2 percent. And many borrowed more than the price of the home to cover closing costs. ... For some people, then, foreclosure becomes something akin to eviction, a traumatic event, ... but not one that involves the loss of life savings of years spent scrimping to buy the home. ... In recent months top executives from the Bank of America, JPMorgan Chase and Wachovia have all described a new willingness by borrowers to walk away from mortgages. ... Carrie Newhouse, a real estate agent ... in Minneapolis ... , said ... 'I've had people say to me, "My house isn't worth what I owe, why should I continue to make payments on it'?' ... Todd Sinai, an associate professor at the Wharton School [said] 'Now it's like they can do their renting from the bank, and if the house values go up, they become the owner. If they go down, you have the choice to give the house back to the bank. You aren't any worse off than renting, and you've got a chance to do extremely well. If it's heads I win, tails the bank loses, it's worth the gamble'," John Leland (JL) at http://www.iht.com/, 29 February 2008.

DW's statement is important, i.e., people don't understand profit and loss. Dozens of times I've told people they cannot deduct such "losses" on their tax returns and each profited from his home. Here's an example. Suppose someone buys a house for $100,000 with $80,000 down. The house increases in value to $300,000 and the homeowner refinances, taking a $300,000 100% mortgage. The house now decreases in value to $250,000 and the taxpayer asks me to deduct the $50,000 ($300,000 - $250,000) "loss". I tell him. "you have a $200,000 tax free gain on the house as it was your residence". Most people I see don't believe they made a profit on the house. Really.

What's the big deal JL? What do leveraged buyout shops like KKR, Blackstone and Apollo do? Encumber operating entities with debt and profit if things go well and dump the losses on the bond holders and banks if they don't. Why is anyone surprised homeowners would do this too? I wonder if Stephen Cutler at JPMorgan has an opinion on this. See also my 10 December 2007 and 14 February 2008 posts. That "top executives" at large banks didn't expect this is amazing. What are they paid for anyway? Where were the banks supposed risk managers when these loans were made?