Wednesday, July 30, 2008

VOLUNTARY FORECLOSURES RAISES NEW BANKING THREAT

BBC - Faced with seemingly never-ending falls in the value of their properties, some American home-owners are taking radical action; they are choosing to walk away from homes and their mortgages.

In May 2006, at the height of the housing boom, Karen Trainer bought a $500,000 apartment in California - with money borrowed from her bank. By this year, Karen still owed $500,000 on her mortgage, but her apartment was worth $200,000 less. So she was deep in negative equity and, to make matters worse, the interest rate on her loan was about to increase. . . As a successful professional, Karen could comfortably have managed the higher mortgage payments her bank demanded. Instead, she decided to stop her mortgage payments altogether and let her bank repossess her apartment. . .

Her credit record will be badly damaged by the decision, but Ms Trainer expects this to recover soon. . .
Though banks can repossess and sell the homes of borrowers who stop paying their mortgages, under a legal quirk originating in the Great Depression of the 1930s, banks cannot easily pursue borrowers for any balance outstanding on the main mortgage on their homes.

Traditionally in America there is a social stigma attached to those who default on their debts, which should be a deterrent to walking away from your home. But according to Susan Wachter, professor of real estate and finance at Wharton School of Business, in the depth of this crisis the social attitudes to such actions are changing. "This is the kind of conversation that's going on at cocktail parties, at swimming pools," Professor Wachter says. "And suddenly this option which was truly unthinkable in the past becomes thinkable."

Professor Wachter believes that, to date, most people have had their homes repossessed because they could not manage the repayments. The trend of people now positively choosing to walk away because it makes financial sense to do so is a worrying new development. "The dangers are extraordinary," Professor Wachter says. "If all that is needed is that the house value is less than the mortgage value, there is a large number of homeowners in the United States who are in that situation".. . .

It is impossible to know for sure how many of the people who are now walking away from their homes could have gone on paying their mortgages.

But Professor Nouriel Roubini of New York University, one of the first economists to warn of the dangers of the American house price boom, believes the number of people positively choosing to walk away is growing rapidly. "This is becoming a tsunami of voluntary defaults," Professor Roubini says.

"The losses for the financial system from people walking away could be of the order of one trillion dollars when the entire capital of the US banking system is only $1.3 trillion. "You could have most of the US banking system wiped out, so this is a total disaster."

6 Comments:

At July 30, 2008 5:47 PM, Anonymous Anonymous said...

Look for Congress to create legislation to penalize those who default on mortgages, just as they did for personal bankruptcies a few years back.

 
At July 30, 2008 11:37 PM, Anonymous Anonymous said...

It is impossible to know for sure how many of the people who are now walking away from their homes could have gone on paying their mortgages.

This kinds of financial fear mongering is what helped enable the bankruptcy "reform". If financially responsible "fiscally conservative" voters feel that bankruptcy is being exploited, it makes it easier to sell "reform" to voters.

Similarly here, with house prices declining, yes, some people will simply choose to stop paying their mortgage. However, there's apparently no hard evidence that this is a common trend, besides these anecdotal stories. The vast majority of people who stop paying their mortgages and home equity loans will do so because of financial hardship: rising food and gas prices, lost jobs or scaled back hours, divorce, illness, and other factors outside of their control.

 
At July 31, 2008 12:03 AM, Anonymous Anonymous said...

11:37, you forget to add to your list the financial hardship of a balloon payment of full principal coming due on all of those interest only loans issued.

 
At July 31, 2008 12:19 AM, Anonymous Anonymous said...

But Gramm and the Republicans couldn’t have done it without the support of leading Democrats. The most egregious of Gramm’s legislative favors to the financiers took the form of legislation named in part after him — the Gramm-Leach-Bliley Act, which became law only after then-Treasury Secretary Robert Rubin prevailed upon President Clinton to sign the bill. The bill’s immediate major effect was to legitimize the long-sought merger between Citibank and insurance giant Travelers. Rubin’s critical support for the bill was rewarded with an appointment, within days of its passage, to a top job at Citibank (later Citigroup) paying more than $15 million a year.

That is the same Rubin with whom Democratic candidate Barack Obama met, along with other influential advisers, on Tuesday to figure out what to do about the sorry state of our economy. But what in the world did he expect to learn from Rubin? And why did he appoint Rubin’s protégé, Jason Furman, who ran the Rubin-funded Hamilton Project, to be the Obama campaign’s economic director? Hopefully, during their encounter Tuesday, Rubin offered himself as a contrite model of everything that the candidate of change needs to change.

After all, Goldman Sachs, where Rubin spent 25 years of his business career before entering the Clinton administration, has been one of the prime corporate villains in the financial shenanigans that led to the subprime mortgage scandal. As co-chairman of the firm, surely he had knowledge of the financial hanky-panky that would prove so disastrous down the road. Indeed, as Treasury secretary, he favored an extension of the deregulation that enabled this explosion of banking avarice. Not surprisingly, the current Treasury secretary, Henry Paulson, also previously headed Goldman.

When Rubin assumed a top position at Citibank after his stint at the Treasury, he was not above influencing his former employees in the government. In one notorious instance during the fall of 2001, when Enron was going down the tubes Rubin telephoned a Treasury undersecretary and asked him to consider intervening with credit-rating agencies to hold off downgrading Enron’s ratings. When the story was leaked, some media accounts noted the possibility of a conflict of interest because Enron owed Citibank $750 million, which it could not pay if bankrupt.

Despite his skills and his vaunted position as Citibank’s chairman, Rubin was not spared the disastrous consequences of Citibank’s own wild financial manipulations, which, if anything, exceeded those of Enron. Tens of billions in bad mortgage and credit card debt placed the bank at the forefront of the current economic crisis, and so it is weird that Obama would now turn to Rubin for advice.

It’s even weirder that the presumptive Democratic nominee would pick Rubin’s man Furman as his campaign economic director at a time when cleaning up the mess left by the bankers is the highest priority. Furman hardly distinguished himself four years ago in that role in John Kerry’s failed presidential campaign, with its muffled economic message that could not be blamed on the candidate’s stiff style alone.

The bigger problem is that folks such as Rubin and Furman, perhaps best known as an economist for his bold but woefully misguided defense of the Wal-Mart business model, clearly do not feel the pain of the voters who are losing their homes.

But then again, why should Rubin, or Gramm on the Republican side, be expected to care when he has made so many millions off the suffering of those voters? Not good at a time when we need a presidential candidate who sticks it to the bankers instead of sucking up to them.

 
At July 31, 2008 11:43 AM, Blogger Lars said...

Left unstated in this article is why it is supposedly so dangerous that people walk away from mortgages. The reason this will cause banks to collapse is because laws allow banks to create money out of thin air. Banks are only required to have 10% reserves on the loans that they make. This means for that $500,000 home the person bought, the bank that made the loan only needed to have $50,000 in actual deposits. Imagine if this worked on a personal level. Your buddy needs $50, but all you have is five. You create a credit and then earn interest on money you never had to begin with. Outrageous here, but that is (in a very simplified manner) how our banks are operating.

 
At July 31, 2008 5:10 PM, Anonymous Anonymous said...

Only half the story, Lars.
Having created the paper, the banks then 'bundle' it and sell the package on the secondary market. To make the bundles more attractive to investors on the secondary market, it has been common practice to fudge the numbers. Real estate appraisers are put under extreme pressure by the bankers to deliver appraisals that meet the numbers. [ What this means is that in small towns and rural communities honest appraisers are unemployed appraisers.] Once the bundles are sold, it's somebody else's problem. In states like Missouri bankers answer to no one. So long as they can fly beneath the radar of the feds, they are completely unregulated. And we all know how concerned the federal regulators have been up until now about enforcement of anything. As a result, these bad mortgages have become ticking time bombs throughout our entire financial system.
And on it continues...

 

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