Strategic Mortgage Defaults a Growing Problem

The Brave New World of the Uncle Sam economy has brought our economy and markets into realms very rarely seen or experienced. One of those realms which has received very little coverage but will have major implications for the economy and markets going forward is “strategic mortgage defaults.” What are strategic mortgage defaults and what will the growing impact of this phenomena? Let’s navigate.

High five to KD of 12th Street Capital for bringing this development to our attention. The Los Angeles Times profiles this very troubling slope on our economic landscape in writing, Homeowners Who ‘Strategically Default’ on Loans a Growing Problem,

With foreclosures, delinquencies and loan losses at record levels, strategic defaults and walkaways are among the hottest subjects in residential real estate finance. Unlike in earlier academic studies, Experian and Wyman could tap into credit files over extended periods to identify patterns associated with strategic defaults.

The number of strategic defaults is far beyond most industry estimates — 588,000 nationwide during 2008, more than double the total in 2007. They represented 18% of all serious delinquencies that extended for more than 60 days in last year’s fourth quarter.

Strategic mortgage defaults are nothing more than a very calculated financial maneuver primarily by people with high credit scores. These people are literally walking away from their homes, and the mortgages on those homes, with little to no warning or indication of stress typically identified by increased delinquencies on the mortgage payment or other credit payments.

Why are people doing this? To fully understand the reasoning behind people strategically defaulting, we need to understand why people bought these homes and took out these mortgages in the first place. Over the last decade, many people purchased homes, including their primary residence, for investment purposes as much as for shelter and protection. As with other investments, these high credit and financially savvy people are assessing the market value of their home relative to their carrying costs (mortgage payments, taxes, utilities, etc) and making the decision that they are better off financially walking away from the property and mortgage than continuing to make the payments.

Is there a moral failure in this practice, especially on behalf of those individuals who do have the financial wherewithal to make their payments? Perhaps, but we should not kid ourselves that people bring their morals or lack thereof into their financial affairs.

Have loan officers, bank examiners, and regulators factored these strategic defaults into their financial models and loan loss reserves? Rest assured, the thought of strategic mortgage defaults was not incorporated into a bank risk model prior to writing the loan.  Now loan officers, bank examiners, and regulators are likely working overtime to incorporate the actuality of this phenomena creating a vicious cycle downward for housing just as the actual lending practices and accompanying purchases of homes drove the housing market higher over the last decade.

Did Secretary Geithner incorporate this phenomena into the Bank Stress Tests? Not if we checked the default assumptions on HELOC (Home equity lines of credit) relative to the actual statistics. To do just that, please review, Bank Stress Tests: Vigorous or Sham? Let’s Review HELOC Losses written at Sense on Cents this past May 20th.

What are the implications of these strategic mortgage defaults?

  • more pressure on the housing markets where these loans were originated. Where’s that? Start with California, Arizona, and Nevada,  move to Florida, but also appreciate it will impact every market where Jumbo mortgages were written.
  • increased losses for those holding these mortgages. Who is that? Institutional investors which originated or purchased the Jumbo mortgages in search of higher yields, including: bank portfolios, insurance companies, and the Federal Home Loan Bank system.
  • less credit availability in general and specifically for the Jumbo mortgage space. Why? Banks need to increase loss reserves against their current Jumbo mortgage portfolio.
  • as strategic mortgage defaults continue to increase, and homes are foreclosed, real estate appraisals on these homes will continue to decline as the supply of homes in this segment of the market increases. As a result, potential buyers of these homes will wait and rent thinking the market will continue to soften.
About Larry Doyle 522 Articles

Larry Doyle embarked on his Wall Street career in 1983 as a mortgage-backed securities trader for The First Boston Corporation. He was involved in the growth and development of the secondary mortgage market from its near infancy.

After close to 7 years at First Boston, Larry joined Bear Stearns in early 1990 as a mortgage trader. In 1993, Larry was named a Senior Managing Director at the firm. He left Bear to join Union Bank of Switzerland in late 1996 as Head of Mortgage Trading.

In 1998, after 15 years of trading and precipitated by Swiss Bank’s takeover of UBS, Larry moved from trading to sales as a senior salesperson at Bank of America. His move into sales led him to the role as National Sales Manager for Securitized Products at JP Morgan Chase in 2000. He was integrally involved in developing the department, hiring 40 salespeople, and generating $300 million in sales revenue. He left JP Morgan in 2006.

Throughout his career, Larry eagerly engaged clients and colleagues. He has mentored dozens of junior colleagues, recruited at a number of colleges and universities, and interviewed hundreds. He has also had extensive public speaking experience. Additionally, Larry served as Chair of the Mortgage Trading Committee for the Public Securities Association (PSA) in the mid-90s.

Larry graduated Cum Laude, Phi Beta Kappa in 1983 from the College of the Holy Cross.

Visit: Sense On Cents

4 Comments on Strategic Mortgage Defaults a Growing Problem

  1. One year ago on my blog “Ironies Too” I proposed a means of avoiding this problem applicable for the UK. I quote the last paragraph of that 22nd September 2008 posting :

    Mortgages have always assumed the equity provided by the mortgagee is the first at risk. In this crisis that has to be changed. I suggest that for houses purchased since Gordon Brown, in the words of incoming BoE Governor King, to paraphrase ‘moved the Goal Posts and excluded house prices from the CPI’ any loss of value on the resale of such houses be directly proportioned between the first mortgage holder and the mortgagee. This is potentially expensive, but less so if it halts further slides in house prices. As the country is effectively bankrupt such a move will need financing and as a further step to somewhat also put the cost of the greed at the door where it lies I would further suggest the exemption of the first home from capital gains tax be withdrawn.

    Labels: UK House price crash

    posted by Martin at 9:29 AM

  2. This seems to me to be a sign of just on ongoing sociological problem with this country. It seems that we’ve almost gotten too modern. Everything is a business decision and no one has any sense of pride or keeping their word on something.

    Selective defaulting is a project that I feel should come with some negative consequences. Its going to have to be done on the banks end though. They need to start trying to pursue these people’s money more rather than just taking back the property. Pursuing it though is costly as well. Its just business decision after business decision. We might as well have computers running this whole affair. I think that if we injected a little more human into all ends of this and all other aspects of the financial spectrum, we’d all be a whole lot better off for it.

    Check out my blog on selective defaulting and personal financial irresponsibility at…..

  3. How is the mortgage crisis, and drop in home prices, likely to be fixed if folks can not locate a new job? There are an enormous number of families which have lost their houses to foreclosure and many more will until America starts generating something more then excuses. It’s time to alter the trade policies with the Chinese. For crying out loud, our greatest trade partner is known to manipulate its currency!

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