Strategic Defaults (aka "Walking Away") are OK

By
Services for Real Estate Pros with Zillow

I've kept mostly silent on this blog about a very important issue affecting the housing market -- strategic defaults. This is the phenomenon where a homeowner, so deeply underwater on their home, decides to stop paying the mortgage and let the bank foreclose upon the home. Some estimates say that this describes as many as 1 in 5 foreclosures, which is very scary considering that housing data shows around 23% of mortgage holders are now upside down on their home, and 0.11% (1 in 1000) homes in the US were foreclosed upon last month.

Well as you can imagine, I have strong opinions on this subject, but I've mostly kept them to myself. But since last night's 60 Minutes segment brought this issue to the forefront of national debat, I decided it was time to chime in.

60 Minutes interviewed Brent White, a University of Arizona law professor who wrote an influential paper on the subject last fall. I actually posted that paper on this blog around that time, but didn't opine on it.

Professor White is one of the leading academic advocates (if you can call them that) of strategic defaults. (It's sort of like being an advocate for assisted suicide; no one really promotes it because it's a terrible thing, but there are people who clearly advocate for the right to do it.) Professor White argues that an underwater homeowner has no moral obligation to the bank. The mortgage agreement clearly spells out what happens if mortgage payments aren't made (i.e., the bank takes over the house) so therefore the owner is upholding his end of the contract by turning over the house when payments aren't made. In addition, both Professor White and 60 Minutes both point out that corporations walk away from financial obligations all the time. Think of the many times that private equity firms turn over failing companies to the bondholders even though they could continue to service that debt (e.g., my old firm TPG Capital turned over Washington Mutual to the bondholders when their equity was wiped out). And closer to the real estate industry,  think of the many real estate developers who walk away from their equity and turn property over to debtholders (e.g., Tishman Speyer and Stuyvesant Village in NY).

I strongly agree with the theme of the 60 Minutes story: mortgage holders should act in their own best interest and if that means walking away from an underwater loan, then so be it.

I think it's funny how 60 Minutes sort of threw in there at the end a homeowner who thinks it's not right to strategically default, in order to provide some balance to the story. But even that homeowner concedes that maybe he should (and in fact maybe he will) walk away from his home.

In my opinion, the most valid argument against walking away is that it's really rude to your neighbors. It brings down the value of their home when your home becomes foreclosed upon; it's kinda like not mowing your lawn. I definitely see that point, but that's not enough to make someone feel guilted into throwing money away month after month.


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Comments (119)

Anonymous
Yvonne Arnold

I'm not sure anyone in this stream including Spencer addressed the DELAY issue.

Default and Foreclosure under any name is still Default and Foreclosure. 

The issue is not the reasoning behind the strategy of the borrower, whether it be moral, business or anything else.  The issue is with the owner of the note and the time frame they choose to complete the process of Foreclosure.

Right now in the Southern California market we have borrowers living in their homes for over 2 years without having made a payment and NO NOD filed.  Due to the Government and Financial Institutions insertion of "guidelines" and Loan Mods and Short Sales, people have just figured out they can just stay "rent free" for a very long time. 

Then once the Foreclosure does complete, the eviction process can take up to 1 more year!

The days of someone feeling there is any sort of consequence for not abiding by a legal contract is long gone. 

Strategic Default is fine, if someone has assessed their financial situation and deems it the right thing for their family.  But, I bet if the Foreclosure process didn't have as many delays and loopholes as it does today and if the process started and completed within a 6-9 month period as it used to, borrowers may look a little harder at the decision to walk away from their home.  Since there wouldn't but as much of a financial strategy.

May 10, 2010 01:20 PM
#101
Lynda Eisenmann
Preferred Home Brokers - Brea, CA
Broker-Owner,CRS,GRI,SRES, Brea,CA, Orange Co

Spencer ~ Double ditto on #92 comment.

Btw, I recently read that each and every baby born in the U.S. today enters the world with  $43,000 debt...with things like this it's no wonder.

May 10, 2010 01:39 PM
Lane Bailey
Century 21 Results Realty - Suwanee, GA
Realtor & Car Guy

I am going to go "Cliff Notes" on this... there is a LOT more to say.  But, the "doing the best for their family" line is getting a little old.  Wouldn't it be better for my family if I just took groceries from the store without paying for them... or gas for the car... or anything else the family needed? 

But that is theft...

And when a home is foreclosed and drags down the values of the neighborhood, isn't that stealing value from the neighbors?  And making THEM more likely to end up in the same situation?

May 10, 2010 02:08 PM
Michael Cantwell
Clear Path Mortgage - NMLS ID #2079870 - Jupiter, FL
Helping you manage your largest asset.

Sad,  As Fannie Mae asks for more money today to bail out housing with that kind of thought process those of us that pay our debts will be left holding the bag one way or another.  Very Sad.

 

Mike

May 10, 2010 02:15 PM
Patricia Aulson
BERKSHIRE HATHAWAY HOME SERVICES Verani Realty NH Real Estate - Exeter, NH
Realtor - Portsmouth NH Homes-Hampton NH Homes

Itoo believe that unless I'm faced with the situation I don't know how I would react.

Ptricia

May 10, 2010 02:41 PM
Patricia Aulson
BERKSHIRE HATHAWAY HOME SERVICES Verani Realty NH Real Estate - Exeter, NH
Realtor - Portsmouth NH Homes-Hampton NH Homes

PS...nice feature, I think I'll reblog it.

May 10, 2010 02:42 PM
Marney Kirk
Cummings & Co. Realtors - Towson, MD
Towson, Maryland Real Estate

Spencer, if you put millions in the stock market and it tanked, you wouldn't be able to walk away. This is the same thing. So your house is worth less than you paid for it. It sucks, don't get me wrong. But those people around you whose houses have gone to short sale because they LOST THEIR JOBS or their rates went up so high that they couldn't afford it -- how is it OK for you, who should be grateful to HAVE YOUR JOB and HAVE YOUR HOUSE and BE ABLE TO MAKE PAYMENTS decide, well, it isn't worth what it was, let the bank deal with that problem?

I agree whole heartedly with #92. That is what upset me more than anything. They are living "free of charge" until July when the house is foreclosed on? What gives people this sense of entitlement?

May 10, 2010 02:44 PM
Kim Dove
Watson Realty Corp - Jacksonville, FL
Realtor - Jacksonville FL

Now I hate that I missed the piece on 60 minutes! 

May 10, 2010 04:46 PM
J. Philip Faranda
J. Philip Faranda (J. Philip R.E. LLC) Westchester County NY - Briarcliff Manor, NY
Broker-Owner

I have mixed views about your post Spencer.

First, I wonder if you drank half a bottle of scotch prior to writing it. But there aren't enough spelling or syntax errors. 

Second, I wonder if someone hacked your AR account, but then they must have also hacked your Twitter, because that's what brought me here. 

If I go to jail for murdering a crowded McDonalds I am not upholding my social contract, I am suffering the consequences of NOT upholding my social contract. The same goes for a mortgage default. The defaulters aren't upholding their end, they are suffering the consequences of breaking the contract. There is a huge difference.

You made far more sense at NY Raincamp.

Good God man, you are the COO of Zillow, not Joe Shlabotnik blogger. You do great damage by writing something like this. I would think that if you are also a proponent of polygamy you'd keep quiet about that.  

May 11, 2010 12:50 AM
Cindy Jones
Integrity Real Estate Group - Woodbridge, VA
Pentagon, Fort Belvoir & Quantico Real Estate News

It is interesting to read all of the comments and emotions this subject brings forward.  Who started the downward spiral of housing prices in your neighborhood?  Was it the investors who thought they would make money with a quick flip and when they found out they couldn't they walked away?  Is it the homeowners who saw the handwriting on the wall a few years ago and managed to "buy and bail?"  Or is in the opportunist who now is part of a "flopping" transaction cosing lenders millions of dollars and keeping the comps for your neighborhood low?

It is easy to point the finger at current homeowners grappling with what to do next and suggest that their strategic default is wrong.  Yet we have already forgotten about those who made the decision before and left today's homeowners holding the bag.  Let's be careful in judging others and instead work to solve the problems that led us to where we are today.


May 11, 2010 01:15 AM
John Thomas
E3 Green HOMES - Boulder, CO
EcoBroker, MSEE, MBA

Markets will always correct one way or another. Strategic Default is a part of it all. Do you think banks would have any hesitation to change their mind if the pendulum swings out of favor for them?--of course not. Just look at how they have raised credit card rates. It needs to be a level playing field for everyone. Playing the moral card on the consumer (guilt) while the banks simply have they (deliberate abuse) is not right. Social uprisings occur when governments fail. We evolve. Consumers have a right to change their minds too and push back. my two cents...

May 11, 2010 03:13 AM
Greg Nino
RE/MAX Compass - Houston, TX
Houston, Texas

LOL @ #109

May 11, 2010 03:32 PM
Maria Morton
Platinum Realty - Kansas City, MO
Kansas City Real Estate 816-560-3758

#109 was funny! 

It might have been more effective to distribute the stimulus money to the people instead of the banks.  As for the incrasing number of homeowners who are walking away, there may be consequences that we cannot yet see. Is it right or wrong?  Maybe.  Are the banks right when they continue to refuse to work with homeowners who want to stay in their homes?  Will the banks find a way to use this phenomena to their advantage? 

May 11, 2010 06:09 PM
Damon Gettier
Damon Gettier & Associates, REALTORS- Roanoke Va Short Sale Expert - Roanoke, VA
Broker/Owner ABRM, GRI, CDPE

I was wondering how any competent professional REALTOR would ever suggest that someone just walk away...than I noticed that you were with Zillow.  I answered my own question.

May 12, 2010 05:29 AM
Tina Gleisner
Home Tips for Women - Portsmouth, NH
Home Tips for Women

Thanks for the pointers to the supporting info

May 12, 2010 06:16 AM
Eric Michael
Remerica Integrity, Realtors®, Northville, MI - Livonia, MI
Metro Detroit Real Estate Professional 734.564.1519

I love reading the back and forth comments about heated topics. My position is, do what's best for your family first, uphold your personal commitments a close second.

May 12, 2010 08:20 AM
Randy Randolph
RSVP Real Estate - Redmond, WA
Uber Broker , Redmond, Kirkland, Renton, Short Sales

Oh, how I love a good debate! Thanks Spencer for initiating this one!

When you took out the loan you agreed to pay it back or loose your house to foreclosure. The mortgagee agreed to assume the risk that you would pay them back or they would get the house.  The contract (at least the ones I have seen) doesn't say anything about you having to make the payments no matter what. It just says that as long as you make the payments you can keep the house. When you stop (for whatever reason) you will loose the house.

It doesn't say anything about what happens if you loose your job, get a promotion, have triplets, get divorced. It just outlines 2 scenarios: Pay = Keep the house; Don't Pay = Loose the house.

The mortgage also does not say anything about "doing the right thing" or "keeping your promise."

If you bought 1000 shares of GE and the next month the company files BK you would get nothing. That is the risk you take on with a business transaction.

Likewise, if Bank of American loans you 300k for a house with only 3% down and you loose your job and can't make the payments; they get the house back. That is the risk they took with a business transaction.

Someone in my family recently decided to do a strategic default. We have had this house for sale for over 6 months and haven't gotten any solid activity. We priced it at a level that would cover all the costs of selling it and give my family member exactly $0.00 after closing.

It has taken me months to convince them to do a strategic default. They don't live in the property anymore (they moved to take care of a sick family member). We could not get it sold for 30k less than they owed on it. We talked to both of their lien holders and they would not do anything to help out since the loans were current.

So finally, April 1st, they stopped making their payments. Since then we have been able to imitate loan mods on both loans and my family member may in fact get to keep the property with a lower payment.

I don't have any problem discussing strategic defaults with my clients. They need to know all of the options that are available to them.

And if anyone says that "walking away isn't right" ask them if they are divored!

May 12, 2010 06:11 PM
Christine Donovan
Donovan Blatt Realty - Costa Mesa, CA
Broker/Attorney 714-319-9751 DRE01267479 - Costa M

Right and wrong is such a slipperly slope in this situation.  Is it wrong not to pay?  Is it right to walkaway?  Is it wrong to take care of your family?

I hesitate to say what's right or wrong as a general answer as there are so many different situations.

May 12, 2010 08:23 PM
Mike Linkenauger
Jacksonville, FL
Short Sale Specialist Network

I agree with you also, its becoming more and more practical to do a structured default.

Short Sale Specialists

May 13, 2010 05:28 AM
Tony and Suzanne Marriott, Associate Brokers
Serving the Greater Phoenix and Scottsdale Metropolitan Area - Scottsdale, AZ
Haven Express @ Keller Williams Arizona Realty

Strategic Default is an acronym for cowardice.  If one is an ostrich - then stick your head in the sand.  If you are a responsible individual - do a Short Sale - unless your legal and tax advisors tell you to do otherwise.

Jul 09, 2010 06:59 AM