In which I debate the housing crisis

My cousin, Wendell Stoltzfus, posted a link on Facebook to this article from the New York Times. In response to his link I wrote:

I wonder if there would be wider systemic repercussions if people started to do this more? Courson does mention that a contract default is not without its ugly consequences, but he doesn’t go into a lot of detail. This certainly sounds more appealing than giving a lot of cash to big banks, especially if it would effectively create incentive for the banks to renegotiate underwater loans. That’s something that I’ve heard is not happening much because–surprise!–there is little incentive for the banks to renegotiate.
I think our gov’t should encourage this by making a law that your credit rating and other property (cars, savings) cannot be harmed *IF* you default on an underwater loan (i.e. make a smart business decision). Would that be the equivalent of giving money to the big Wall Street corp’s in hopes of bringing them back to life?

Then things got interesting…

[Update] originally I had credited, by name and a link to his Facebook profile, the person who responded to my comment above. However, he has asked for his name to be removed from this blog, and said that “while in many ways [he’d] love to engage in further debate online, [his] available time and several other factors really do prevent [him] from doing so.” Here is his original response:

Ahem, I’m an investment banker in an area (asset backed securitization) significantly impacted by the financial crises of the last several years. In response to this article and the above response to it I must say that the “blame the bankers” mentality in the press lately is bothering me a great deal, especially since the hugely oversimplified analysis appears to be spilling over into the public at large. The fact is that the mortgage problems are a societial problem, not a problem of the banks vs the people. Most of the lax loan underwriting that contributed to the real estate bubble was done by independent finance companies, most of which are now bankrupt. Regulators, politicians, monoline insurance companies, MBS and CDO investors (incl. most people’s 401Ks), real estate and mortgage brokers, Fannie Mae, rating agencies, and, yes, homeowners (many of whom took on too much leverage and often speculated on home prices) are all complicit in the current mess, not just the “big bad [investment] banks”.

Before you further espouse the idea that somehow it is acceptable for you as an individual to walk away from your personal obligations, please consider (i) whatever moral value base you personally operate from, (ii) the fact that you probably are an indirect investor (most bond funds and mixed funds are heavily invested in MBS and CDOs), and so losses in real estate will hurt you personally, not just the banks, (iii) the reality that if people in this society no longer live up to their obligations, neither banks nor other lenders and investors will be willing to make credit available, or at the very least the cost of credit, incl. mortgage rates will rise to reflect the increased risk of providing credit, and (iv) that your failure to meet your financial obligations will and should be reflected in your credit score, which will affect your access to credit well into the future. Lastly, I find it interesting that no one seemed to complain about the benefits of the real estate bubble while they were profiting from it (whether in the form of increases in the equity in their personal homes or otherwise). In other words, people were quite happy to pocket the benefits from rising home prices several years back. Note that the upside did not go to the lenders, but to the homeowners. But now that the downside of homeownership is there, you think the lender should be stuck with the loss? And if you bought a stock that subsequently went down, you probably would want your stock broker to cover the loss for you, too, right (though you’d retain the profit if it went up? Please…

I started to write a response to his comment on Facebook, which turned into a book. I decided post it here since I think the points are relevant to the public discussion and may be useful beyond the walled garden that is Facebook.

Thanks for your response [name removed]. Your position as an investment banker gives you a slight bias on this subject, but I’ll try to overlook that in this case. I don’t think you quite understand the position that I am advocating. I will try to address each of your points.

(i) The argument that moral values somehow make the homeowner obligated to do something that would otherwise not make good business sense was addressed by the article, so I won’t spend much time other than to ask: Do you think Morgan Stanley is justified to stop paying for the office buildings in San Fran? It seems that your value system (and indeed our financial system) gives a huge advantage to those willing to “cheat” by espousing lenient moral values… The playing field must be level for everyone involved, regardless of their size, otherwise the “honest” guy gets raped by the “dishonest” one.

(ii) I don’t really hope to see much from my investments (employer-matched retirement plan) since the people making the money there are the organizations who manage the plan “for me.” I only participate because my employer matches my contribution, which yields a better return than any honest investment I could make on my own.

(iii) You’re getting at the heart of the problem, but you’ve forgotten that we are (were?) in systematic failure. Notice first that my proposed government intervention would only apply to underwater loans (I’ll add another condition: primary residence only). The credit system will not collapse because people will continue to make smart investments and the banks will give credit where credit is due (to people who deserve it). That is, unless our system is so dependent on overextended credit that it can only continue toward certain disaster in a propped-up state of denial. Then I say bring on the failure now rather than later. Why should we put it off for our kids to reap the “benefits” and bear the inevitable consequences of our bad stewardship?

(iv) I would make an exception for the credit score, cars, savings, etc. (sorry don’t know the technical term for this type of non-collateral property)–anything not written into the agreement with the bank as collateral for the loan. Note that the homeowner still undergoes significant loss in foreclosure. He loses a down payment, and every penny put into the house that would not have covered rent in an equally valued house. He’s starting at ground level, but at least he’s no longer under water.

On the contrary, I do not find it interesting that no one was complaining when times were good. Who in their right mind would do that? The Wall Street firms were making lots of cash in the good times too, it wasn’t just the homeowners. Sure some people sold at the right time and got lucky, but we’re in this together and now we’ve got to pay. If the organizations that got us into this mess are all bankrupt, where did they go and why can’t they get us back out? (rhetorical question) The fact is that those CEOs and investment bankers can go get another job and continue to rake in the dough while our system crumbles. This is a testament to the fact that the system is broken and needs intervention. If you give a break to the homeowner with an underwater loan, you’ll help him get into a position where he can buy a new home at a reasonable price (a home is a necessity in most places). If you give a lot of cash to a Wall Street bank you’ve got to make it really unattractive for them to keep it or you’ll never see it again. That is one thing that the Feds did right in the whole bailout fiasco. But back to the point, the lenders should definitely share the loss since they agreed to underwrite a loan for more than the house was worth, and they certainly made money in the transaction as well (PMI or title insurance anyone?).

I would think it is better for the bank to keep the current owner in his house, making payments (even at a reduced rate) than to have him foreclose and have the house sit empty. My proposal is really more of a stick to give the lenders incentive to renegotiate than a get-out-of-jail-free card for the homeowner (which it certainly is not).

Your comment about stocks losing value is off base–an asset such as a primary residence is a necessity for life and cannot be compared to stocks, which are essentially a gamble on whether a business will profit.

I will also note that I own a home on which I still owe money, and I intend to make good on my agreement with the bank. I own my home because I need a place for my family to live, not as an investment with which to acquire personal wealth.

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