Strategic Default – Five Years Later

“Some borrowers default because they no longer possess the ability to repay their mortgage loans. However, there is a group of borrowers who may continue to possess the ability to repay but who elect to default for strategic reasons. These borrowers are commonly referred to as “strategic defaulters.” For purposes of this report, strategic defaulters have the financial means to make their monthly mortgage payments, but choose not to and walk away from their contractual commitments to pay.”  FHFA’s Oversight of the Enterprises’ Efforts to Recover Losses from Foreclosure Sales – FHFA Office of Inspector General [Audit Report October 17, 2012]

The online website, DSNews,[1] recently posted an article announcing that “According to a recent survey that polled 1,026 U.S. adults, 32 percent stated they believe homeowners should be able to strategically default without facing consequences.” The survey was conducted by JZ Analytics, pollster John Zogby’s company. According to the article, Mr. Zogby personally found the results “alarming.”  “What jumped out is how many Americans feel it is acceptable for homeowners to walk away from a mortgage and go into foreclosure. If Americans carry on with that mindset, it will continue to cause problems as the economy undergoes a slow recovery.”

What I found “alarming,” and what jumped out at me, was that Mr. Zogby, who supposedly has his finger on the pulse of America, would be surprised at all.  So, in an effort to learn more about this senior analyst at JZ Analytics, I dug into the deepest recesses of the Internet, and the best I could determine was that he apparently has been on Mars for the last five years looking for signs of intelligent life that he could give polling surveys to.  Given this professional hiatus, perhaps Mr. Zogby can be forgiven for his incredibly lunk-headed reaction to an incredibly complicated issue.

Unfortunately, we’ll never know the exact questions that were used in the polling or the demographics of the persons polled.  I’m guessing Mr. Zogby gave the poll out along with party favors at a liquor-infused retreat for lending industry big shots at some Bahamian luxury resort.

But never mind ignorant polls, polling, and pollsters.  The term “strategic default” is a pejorative term cooked up by Fannie, Freddie, and the lending and servicing industries to stigmatize the banks’ former clients as irresponsible deadbeats.  [“Don’t bother using your own money for a downpayment; we’ll just piggyback another loan on top of your first one, so you can use the bank’s money to finance 100% of your home purchase – it’s virtually free, and you can refinance over and over again, and never have to pay it off!”]  Technically, the term “strategic default,” includes an implicit assumption that the borrower can “afford” to make their loan payments, but consciously chooses not to do so.

But let’s look at the real picture:

  • The subprimers, no-doc-loan and stated-income crowd, washed out within months of their loan closing.  They were financially unqualified from the start and both lender and borrower knew it. But as long as real estate values were going through the roof, there was always a “Plan B”; either refinance[2] out of the oppressive loan[3], or sell the property at a profit.  This was in 2005; there was no such thing as a “strategic default” back then.  There was no choice, no decision, and certainly no strategy.  Within a month or two of funding, the Big Banks got their money back as the loans were packaged and sold into pass-through trusts as securities for investors to gobble up, believing the shills in the crowd ratings agencies’ assurances that they were AAA grade investments.
  •  So who are the folks defaulting today? Having spoken with hundreds of Oregonians in various stages of distressed housing situations, I believe I know.  [Mr. Zogby, are you listening?] They are the folks who, despite the loss of 40% – 50% of their home’s value; despite the loss of their entire downpayment; and despite the fact that they may owe the bank $100,000+ more than their home is worth, they’re still hanging on. In other words, they have become captive renters, unable to move forward; many used their retirement funds [at the cost of a 10% income tax surcharge]; their children’s 529 savings, and some even use their credit cards.
  • Not to be forgotten in an analysis of the term “strategic default,” is the meaning of the word “strategic.”  Obviously, it suggests a conscious decision.  In fact, it suggests more.  It implies an intelligent, considered analysis. However, in the vernacular of the lending industry and their apologists, the term includes an inference that the borrower can “afford” to make the payment, but elects not to do so.  Contrary to the short sighted analysis of some [Mr. Zogby, are you still listening?],the word “afford” is a highly relative term. For example, perhaps one can “afford” their mortgage payments, but at what long term cost?  Here are some considerations that many folks factor into their decision to discontinue making their mortgage payments:
    • The 3-Ds, Death, Divorce, and Debt.  For example, when one loses a spouse or significant other, who was wholly or partially financially responsible for making ends meet.  Divorce speaks for itself, and more loudly in times of financial stress than harmony.  Debt plays a factor, when – as many folks did – strapped borrowers lived off their credit cards or lines of credit.
    • Children. This is a broad topic.  Here are a few aspects of the issue: (a) A young couple wants to have children, but their home, its location and/or size make that impossible.  They need to move on, but are being suffocated by a home awash in negative equity. (b) School districts; a family wants to move into a district more suitable for their children. (c) Pregnancy; the family wants to move closer to friends and family to help raise the child. (d) Savings for children and their education; Homeowners are presented with a choice to pay for schooling, or for a mortgage that has thousands of dollars of negative equity that will not – for the next decade – ever become positive equity.
    • Employment.  During the economic downturn that has plagued this country since 2007, many folks lost jobs.  Some still had jobs, but found better employment opportunities elsewhere.  However, they did not have sufficient funds to bring to closing to pay off thousands of dollars of negative equity. 
    • Loan Modifications.  Although some lenders may deny it, the truth is that before most lenders will even consider a loan modification, the borrower must be in default.  I have had many clients who report that although they were not in default when they first sought the bank’s help to modify their loan, they were told they had to stop making payments.  What they weren’t told was that it would damage their credit; that the bank would pile on late fees and other charges. Moreover, many such “modifications” were denied after a year or more of trying – and at the end, applicants were informed they did not qualify. But by then, the loan was so far delinquent that it was impossible for the homeowner to get current.  [Riddle me this Batman Mr. Zogby: Does following the banks’ instruction to stop paying the mortgage count as a “strategic default”?]
    • Life.   In addition to the above, there are circumstances thrown at all of us by fate.  Illness and accidents being prime examples.  The vagaries of life can have catastrophic consequences on one’s ability to pay their mortgage.  But unlike the days when banks actually held on to their own loans, now it’s pretty hard to go to your neighborhood banker for help.  Rather, today, struggling borrowers are given 1-800 numbers answered by low-paid employees with bogus titles [e.g. “Office of the President and CEO”].  In some instances, these jobs have been outsourced, and the person at the other end of the line knows nothing beyond what’s in their script.

But wait, there’s more!  Mr. Zogby’s above quote seems to equate not paying one’s mortgage with “going into foreclosure.”  In fact, foreclosure does not necessarily follow from the act of not paying one’s mortgage.  Many, many, folks are fully prepared to try to short sell their homes rather than being foreclosed.

This option presents several advantages for both lender and borrower: (a) A short sale is a much faster disposition option than any other pre-foreclosure alternative; (b) Certainly, it is much faster than waiting around to be foreclosed, which today occurs in fits and starts, as the Big Banks continue to be entangled in fiascos of their own making, such as MERS, robo-signing, borrower litigation, and a variety of other public relation embarrassments ; (c) A short sale is generally regarded by borrowers as having less of a stigma than being foreclosed; (d) Banks prefer the short sale process because that moves the property into the marketplace, where the carrying cost of taxes, insurance, and maintenance are shifted to new buyers. (d) Short sales are preferable to the banks over deeds-in-lieu-of-foreclosure, since, again, a short sale shifts the carrying costs to new buyers.

Not to be outdone in the Nuts and Dolts Department, Mr. Zogby’s effort at insightful comment to DSNews demonstrates a complete lack of understanding about today’s financial crisis. After climbing out on a shaky limb, he proceeds to saw it off thusly: “If Americans carry on with that [strategic default] mindset, it will continue to cause problems as the economy undergoes a slow recovery.”

Wrong, again, Boy Wonder.  Today, our “slow recovery” isn’t the result of borrowers not paying their mortgages.  In fact, if there were more folks who – for whatever good faith reason – chose to stop paying the mortgage on their underwater homes, they would get queued up faster for some form of pre-foreclosure disposition, such as a short sale or deed-in-lieu.  

[BTW, I will accept almost any reason as a “good faith” reason. Remember, the bargain the banks cut with their borrowers and vice versa – which was memorialized in the promissory note and trust deed or mortgage – was that “If you don’t repay the loan, we get to take the home back and resell it to somebody else.” Also, remember that back in circa 2005 – 2007, both borrower and lender believed that skyrocketing property values eliminated any risk of payment default and foreclosure. At the time, no one, not even Alan Greenspan, saw what was to come from the “frothy” real estate market and essentially “free credit.”  In other words, the assumption by all was that even if a borrower defaulted and was unable to refinance, the lender would get a property back that was worth more than when the loan was first made.  To put a finer point on this Grand Bargain is to perhaps explain what it was not.  It was not an agreement that borrowers must pay on a loan even if it no longer made any economic sense; it was not that repayment was “required” even if doing so was to the financial detriment, and possible fiscal ruin, of the borrower and his/ her family and future.

Rather, the deal between borrower and bank has always been clearly provided in the loan documents:  “You pay off the loan and we will remove our lien from your property; You default and we get to take your property and resell it to satisfy your debt to us.”  Nowhere in the loan documents is “strategic default” – whatever that is, addressed. – PCQ]

For Mr. Zogby and others who believe their expertise in one field qualifies them to make foolish statements in unrelated fields, the reason this country has undergone a “slow recovery” is thanks to our cracker jack government leaders who gave us HFA, HAMP, HARP [1.0 and 2.0], HAFA, First Time Buyer Incentives, and on and on, ad nauseum.   The theory was to create the illusion that the Administration was actually doing something to help homeowners by throwing money at the problems, regardless of whether they worked. [This is discussed more fully here. – PCQ] But what the government didn’t do is FORCE – politically or otherwise – the Big Banks, who caused this crisis in the first place – to recast loans so they would work for homeowners.  However, bank and servicer compliance is always voluntary.  It’s all carrot, no stick.

The fact is that continental shift moves at light speed compared to loan modifications. The government has willingly permitted the Big Banks to game the system for the last five years. A crowning example of the government’s approach to helping consumers is to create the Dodd-Frank Act, a tome of 2,300 pages of gibberish that did nothing but leave the heaving lifting to the administrative process, where lender lobbyists could wine and dine their favorite political hack in order to emasculate the rulemaking.  Today, over two years since enactment, the scorecard stands as follows: 63% of its rulemaking deadlines have already passed and only 29% of the required rulemakings have been finalized.  Nice job.  Virtually every government solution, including the faux $25 Billion National Mortgage Settlement, has been voluntary for the banks. The White House talks tough, but treats the lending industry more like Johnny Appleseed than John Dillinger. In short, Big Banks are permitted to cherry pick who, what, when, why, where, and which, borrowers they will help.  The ones most in need of assistance never receive it. Default – or whatever pejorative one chooses to use, is the last resort.

When you couple the total failure of the government borrower assistance programs with the unemployment numbers, you get the real reason for our slow recovery.  Homeowners are held hostage in homes they (a) can either no longer afford, or (b) need to move from for any number of reasons.  Distress ensues.  Job creation and relocation suffer.  Confidence drops. Poll that Mr. Zogby!

Although I am not a fan of moral equivalency, no thoughtful discussion of “Strategic Default” is complete without comparing the plight of Beleaguered Borrowers with the fortunes of Big Bank execs for the last five years.  Part Two will explore that topic.

[1] “DS” as in “Default Servicing.”

[2] Refinancing generally requires a 60% loan to value (“LTV”), but with market value appreciation, it was presumed that would occur.

[3] Many had “teaser” rates that were unrealistically low, and then adjusted to much higher rates.  Some loans permitted borrowers to pay less than the stated interest rate, which meant that the deferred interest was added back to the principal and would also bear interest.  These were the infamous “negatively amortizing” loans or “Neg-Ams.”