Tipping Point

While a fragile recovery to the credit crunch of '08 is proclaimed around the country, a very dangerous undercurrent is being ignored. That danger is the "strategic default". While most of those, mailing in their keys to creditors, are those who can no longer afford to pay their mortgages due to loss of job, ramp up of interest rates on an ARM, or perhaps now facing the need to address principle on their loans, a new class of defaulters is about to swamp this fragile recovery. A strategic defaulter is one who stops paying his mortgage because it no longer makes sense even though he can afford to pay it. This class of homeowners has taken a very rational, unemotional look at their homes and has determined that staying in them is just not worth it. Many homes are more than 25% underwater. The chances of those homes recapturing that 25% over the next decade are remote. Some bought their home at the peak in 2006; some bought well before that but sucked every cent of equity out as the house appreciated in value (for what seemed like forever). The prosperity of the last 10 years was fueled by borrowed funds from this "smoke and mirror" spending: vacations, dinners, jewelry and whatever.

The WSJ reported today that 10% of all mortgages (still existing) are more than 90 days past due on a payment; this is the benchmark figure for considering a loan on its way to default. You cannot even apply to the bank for consideration until you are 90 days late. In other words, one out of ten mortgaged homes is on the route to default. This process is creating a death spiral. As more mortgages default, the floor for housing prices falls further. As prices fall, more mortgages become underwater. As more mortgages become underwater (or further underwater), the benefit from a strategic default becomes greater. If you are 15% underwater, and you like your home and can afford to pay monthly, what do you do three months from now when you are 25% underwater? With the new frugality being hip, maybe that McMansion you bought 5 years ago doesn't look so appealing.

Is there a moral imperative to sticking with your mortgage? After all, you took out a loan and promised to pay it back. It varies from State to State as to how much personal liability one has for sending the keys to the lender. As recently shown in New York, commercial landlords have no problem sending in the keys. Stuyvesant Town/ Peter Cooper Village is an 11,000 unit, 110 building complex in midtown Manhattan. It was purchased a few years ago for 5.4 billion dollars by Tishman/Speyer and BlackRock Realty; they defaulted last month and turned the project over to its creditors. The property is worth only 1.8 billion now. Yet, neither company has declared bankruptcy or sold other holdings to keep this project afloat. In other words, they have made a strategic decision to walk away from a business deal which has gone bad. Is there a difference, morally, between a commercial enterprise walking away and a homeowner walking away?

I have been looking for a house here in Miami. It seems that there are two main categories of homes for sale in decent neighborhoods: one category is the group who still think that their house is worth 2006 prices; the second is the "short sale" where you can make an offer below the mortgage amount. Unfortunately, it takes four months to receive an answer from the bank on any offer. FOUR MONTHS! They will tell you that they are very busy and are working as quickly as possible. In reality, they are keeping bad loans on the books as "performing" and putting off the inevitable loss which will necessitate them having to raise more capital. Isn't that how Japan lost a decade or two?

The administration has been trying desperately to put a floor on housing prices but has come up empty. The can is being kicked down the street. Sooner or later, the invisible hand of the market that we hear so much about is going to smack us in the head, and the wallet.