The Miasma Of Strategic Default

Written by John Clapp
on May 27, 2010 No Comments
Categories : Blog View

[i]BLOG VIEW:[/i][/u] Most Americans agree: Walking away from your home is unacceptable.[/b] At least that was the conclusion drawn by a pair of recent surveys. According to results from a Harris Interactive survey released last week on behalf of Trulia.com and RealtyTrac, 59% of respondents say they would not consider abandoning their home, regardless of how deeply underwater they become. This finding seemingly supports a [link=http://www.fanniemae.com/media/pdf/2010/Housing-Survey-Fact-Sheet-040610.pdf ]Fannie Mae survey[/link] published in April. The Fannie study – which gauged participants on everything from the desirability of renting relative to the appeal of homeownership, to their overall confidence in the housing market – found that a whopping 88% of Americans frown on the idea of strategically defaulting on a mortgage obligation. Yet, not long ago, Morgan Stanley analysts estimated that 12% of mortgage defaults in February were strategic in nature. Interestingly, the Fannie survey showed that respondents – whether current or late on their mortgage – are doubly as likely to have seriously considered defaulting on purpose, however, if they know someone else who has already defaulted. Earlier this month, [link=http://www.cbsnews.com/video/watch/?id=6470184n&tag=related;photovideo]60 Minutes[/link] mainstay Morley Safer examined the strategic default phenomenon in a segment featuring two couples in Arizona who were in the process of walking away from their homes. One couple made it clear that they never anticipated to be in their current situation. Nonetheless, their ‘it's just business’ attitude ultimately overrode any moral qualms. When Safer noted that the Phoenix-area couple was hardly alone, the husband replied, ‘It's interesting the number of my coworkers who have approached me to say, 'How are you doing this, because I need to do it.'’ It's abundantly clear that negative equity is a key factor driving strategic defaults. And judging from Fannie Mae's findings and the 60 Minutes segment, strategic defaults can also spread through social networks. But as Steven Horne, CEO of Wingspan Portfolio Advisors, observed in regard to the 60 Minutes piece, borrowers – who might otherwise reject strategic defaults as unethical behavior – often point to their frustration in dealing with servicers as justification for their actions. ‘If you ignore the borrowers or you're not treating the borrower well, then the borrower views the servicer as having broken the social contract first,’ Horne said. ‘Once they feel it's a purely economic contract, like their honor is no longer at stake, then they make economically what they see as a rational decision.’ Brent White, an associate law professor at the University of Arizona, agrees. White, who published a [link=http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1494467]white paper[/link] on strategic defaults back in February, was featured on the 60 Minutes piece. He also spoke with [b][i]Servicing Management[/i][/b] for its February 2010 cover story on strategic defaults. ‘Among the people who walk away, most say that they try to work with the bank but wind up walking away when they don't get cooperation from the bank,’ he told [b][i]SM[/i][/b] at the time. ‘They get a false promise of modification – when they get an actual modification and see it is not worth [the effort], they walk away.’ Mortgage professionals – such as Don Bisenius, EVP of Freddie Mac's single-family credit guarantee business – are trying to contain the contagion by educating borrowers on the downside of default. In a May 3 [link=http://freddiemac.com/news/featured_perspectives/20100503_bisenius.ht]op-ed[/link] posted on Freddie's website, Bisenius noted that a strategic defaulter's credit score takes a big hit, and in some states, the borrower might be subject to a deficiency judgment. And, perhaps in an appeal to those borrowers who are more likely to default if they already know someone who has, Bisenius plays the guilt card. ‘In the end, borrowers considering a strategic default should recognize the damaging impact their actions can have on others,’ he wrote. ‘While a personal financial strategy might argue for a strategic default, entire communities and future home buyers can be harmed as a result. And that is why our broader social and policy interests will be best served by discouraging strategic defaults.’ Whether Bisenius' approach is actually successful in deterring defaulters is hard to tell, but I applaud the idea. Servicers are often required by law to include lists of HUD-certified housing counselors in communications about foreclosure avoidance options. Would it be such a terrible notion to also include a brief pamphlet describing how foreclosures affect credits ratings, prolong woes in the housing market (and, in turn, the economy as a whole) and sometimes don't completely extinguish a borrower's debt to the lender? At least this kind of communicative option is within servicers' control. What's not within servicers' control, on the other hand, is the media. And, as Grace Brasington, LPS' EVP of strategic consulting services, points out, coverage of strategic defaults might have as much of a role in continuing the trend as any other factor. ‘The concern I have is there's so much press about it, that unfortunately, I sometimes feel it potentially feeds the behavior,’ she said. – John Clapp, editor, [i]Servicing Management[/i] [i] (Please address all comments regarding this opinion column to clappj@sm-online.co

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