Sympathy for the Deadbeat: 60 Minutes On Strategic Defaults

Encouragingly spry 78-year-old Morley Safer hustles around the Sunbelt interviewing ruthless defaulters. In the very unlikely event that the embed works, it's worth watching:

Courtesy of Calculated Risk.

Some thoughts:

* I don't really have any beef with what the deadbeats are doing here. The property is the collateral on the loan you agreed to, and seizing that property has been an accepted recourse at least since Shylock (who by the way got completely ripped off and should have had a decent lawyer) demanded his pound of flesh.

* That having been said, the first couple profiled here, judging by the interior of their house and by the fact that they're using prepacked lettuce in the inevitable ordinary-folks-at-home cooking scene, are not exactly scrimpers and savers. This renders the guy's claim about how he was raised to be a responsible person a little hollow.

* Here is the University of Arizona study [pdf] mentioned in the piece.

* Federal Housing Authority  Commissioner David Stevens deserves some credit, not just for skillfully shuffling papers on his suspiciously uncluttered desk, but for defending the principle of not providing taxpayer support to defaulters who can still afford to pay. He should of course extend that to defaulters who actually can't afford to pay, but those decisions are above his pay grade.

* It's almost comical to hear Safer trying to put the fear of God into the defaulters by talking about damage to their credit scores. When the smoke finally clears in the 24th century, it will be obvious that the holiness of the FICO score was one of the greatest frauds ever perpetrated on the American people.

Comments

[Attorney]

How come none of these people ever seem to get sued by the lenders for the deficiency?

[Tim Cavanaugh]

Morley mentions an Arizona law that the lender can't go after the borrower's other assets. Maybe that would apply to seeking other compensation as well, though I don't see how that would prevent a lawsuit seeking a specific dollar figure.

[Warren]

Can't watch the video at work. But my understanding is that in nearly all mortgage contracts the loan is secured by the property. What happens if the borrower walks away from the loan is spelled out. The lender gets the property, that's it.

Walking away from a house can be a perfectly rational thing to do. As you say Tim, the only consequence beyond losing the house is your FICO score (cue scary music).

The banks whining over borrowers behaving rationally is beyond pity. Want to keep those monthly payments rolling in? Write down the principal. Or suck it.

[Attorney]

What fool would lend somebody money with no recourse against him if the collateral is insufficient to pay the debt?

I guess we're finding out.

[Slumpbuster]

Arizona mortgage rates are somewhat higher than in states without antideficiency statutes, so the lenders price in the likelihood of loss resulting from insufficient collateral.

I suspect their pricing model wasn't all that accurate...

[ChicagoTom]

What fool would lend somebody money with no recourse against him if the collateral is insufficient to pay the debt?

The same fools that offer mortgages without requiring a down payment or proof of ability to repay.

Walk aways wouldn't be such an issue if lenders required 20% down.
It hedges a against devaluation, and it makes the borrower have some skin in the game rather than just worrying about a credit score.

[Warren]

Exactly. At the height of the housing bubble banks were lending with no down payment, to low-income and even no-income lenders. ARM loans that scarcely service on the debt for the first year. They didn't care if the borrower walked away because the housing market would go up and up forever and they could reap mega profits after repossessing. They were fools. So now they need to pay for their foolishness.

[Slumpbuster]

I don't know. I put 20% down on the house I currently own. It is now worth about 60% of what I owe on it. In a market like Arizona, even 20% was not much protection.

[ChicagoTom]

I don't know. I put 20% down on the house I currently own. It is now worth about 60% of what I owe on it. In a market like Arizona, even 20% was not much protection.

The protection isn't for you, it's for the bank.

Obviously it isn't a guarnatee that the bank wont lose money if values go down, but it's a hedge.

Also, if you put 20 percent down, you aren't just walking away from a house, you are walking away from that down payment too.

[PabloKoh]

The Federal Government through Freddie and Fannie. So in effect YOU DID! SUCKER!

[cynical]

I'm not the government, and I'm insulted that you think so.

[Slumpbuster]

A lender who makes a purchase money loan in Arizona has no reourse other than foreclosing on the collateral. They cannot sue for a deficiency.

If somebody takes a second after purchase, that lender can sue for deficiency, but they don't ever seem to do it.

If a person refinances their purchase money first, I believe it is an open question whether that lender can get a deficiency judgment.

[Attorney]

Interesting.

[Andrew]

If a person refinances their purchase money first, I believe it is an open question whether that lender can get a deficiency judgment.

There is an Arizona Appellate Court case holding that the relevant inquiry is whether the new loan retained the character of the original purchase money loan. If it's a refinance solely for the original property, a deficiency suit isn't available.

It's an open question to the extent it's an Appellate Court opinion rather than Arizona Supreme Court, but the nature of the Arizona judicial system is such that the Arizona Supreme Court is unlikely to disturb the ruling unless the other appellate division rules differently and creates a split.

[Slumpbuster]

Good to know. This is not my area of practice, so I was a bit fuzzy on this.

A court would have to struggle in a cash out refinance. Does taking a little bit out keep the character? Or does any cash out make the loan something different? If the lenders had any stomach for testing the waters (they don't appear to), there could be some interesting issues to resolve.

[Andrew]

It's not really mine, either, but I've done a little work in the area.

A cash-out refi would pose interesting issues, as would the (now formerly?) common practice of getting a HELOC as the second loan on the house when purchased. I would not want to be the borrower in a lawsuit over a deficiency in those situations.

I imagine the lenders don't have much stomach because most, if not all, of the court decisions err on the side of protecting the consumer. At this point, the lenders still have the vague threat of a lawsuit to provide leverage, but if they push it and lose, they will be completely out of leverage.

[Andrew]

As Slumpbuster describes, Arizona has a very strong anti-deficiency statute (A.R.S. 33-729 for mortgages and A.R.S. 33-814(g) for deeds of trust). The Arizona Supreme Court has held that a lender cannot waive its security interest in the property and sue on the note, which prevents a lawsuit seeking specific dollar figures on a purchase money loan.

There are probably two reasons why most of the second mortgage holders aren't suing borrowers right now. First, many of the second mortgages were taken at the time of the home's purchase, which arguably makes them "purchase money mortgages" and thus protected by the anti-deficiency statutes. Second, there's the problem of getting blood from a stone. The borrower just lost their house, so how much money will they really have? The second mortgage holder would have to spend all the money in legal fees to get the judgment and then all the fees to actually try and collect (much more complicated than most people think).

[Attorney]

Nice work, Andrew. (Seriously)

[Slumpbuster]

The new trick I am hearing about in Arizona is people who stay current on their first and yet call their second lien holder and say eff off.

The second lien holder won't foreclose because they don't want to take a house subject to a first that is bigger than the value of the house, and they don't want to spend the money to due the owner on the note. Thus, I am hearing stories of people buying out their second mortage for pennies on the dollar, because the lender has so little leverage.

[Steve Smith]

Also remember that the second lien can be stripped in bankruptcy if the value of the home is less than the amount owed on the first. The second has a very weak bargaining position right now.

[Groovus Maximus]

STEVE SMITH WANT HOME!!!!! REAL HOME!!!! TIRED OF CAVES FOR RAPE!!!!! WANT BACKGROUND MUSIC TO SET MOOD!!!!!! LIKES HIKERS STRIPPED AND LIEN!!!!!!

[Andrew]

A third reason I should've added: if a second loan holder wants to recover for deficiency, they cannot do so with a trustee sale. It must be done through a formal judicial foreclosure or by waiving the security interest and suing on the note. Either way means more legal fees with a dim chance of recovery.

[Pablo]

I'm not a real estate agent, but my understanding is that some states do not allow the lender to pursue any other assets other than the property itself in event of default. Some states do allow lenders to go after other assets. But if someone goes through foreclosure, declaring bankruptcy after that is probably not a big deal--your FICO score (pretty meaningless to begin with) is already fucked up.

Im with Cavanaugh on this one. If you are really underwater (eg the value wont ever go up to what you owe on the mortgage) it makes sense to default. Businesses break contracts all the time when it makes sense. If you owe 500K on a cheaply built ranch home in CA or NV or AZ (and many people do) and it will never sell for more than half that, you would be an absolute fool not to walk away.

[Colonel_Angus]

How come the home debtors that lied about their assets and income, and the bank people that accepted faulty contracts, never seem to end up in court for committing fraud?

[ChicagoTom]

How come the home debtors that lied about their assets and income, and the bank people that accepted faulty contracts, never seem to end up in court for committing fraud?

Maybe because in many cases it's the loan officer or mortgage broker who advised the person to lie and going after them could get messy? (and if they can't afford the home or dont have other assets, what exactly will they sue them for?)

Also in many cases the banks actually offered NINA (NO Income No Assets) NINJA (No Income, No Job or Assets) and LIAR (Stated Income) loans that required no proof of income or assets. Do you think these products were beacause the bank were naive and simply trusted all their borrowers to be honest?

The banks knew of the so called fraud but looked the other way anyway cuz it was profitable for them.

When I bought my home 11 years ago, I had to not just state my income, but I had to PROVE it, with checking/savings account statements, paystubs, W2s, tax returns etc. I also had to cleanup every single ding on my credit report (they weren't mine -- they were misreported).

Maybe the real question is why didn't the banks require that of these so called "Fraudsters"

Unless you really believe that all of a sudden large numbers of people learned how to game and defraud the system, the system was encouraging and rewarding the fraud.

[fresno dan]

Agree 1000%
But not only that - the easy credit is the main reason housing got overpriced to begin with.
In the remnants of our free enterprize system, no body made people take out loans, but nobody made the banks make loans. The deal is pretty much the loan collateralized with the house.

The banks made loans to people with incomes that could not support the loans on houses that were WAY overvalued. Banks didn't use to make loans for more than something was worth.

Its call profit and LOSS. We need to return to that banking were you make your profit by people paying their loans back - not by the gubermint making money out of thin air, giving it to you, and than paying you interest on that money.

[Alan Vanneman]

Jesus Christ, the guy used PRE-PACKAGED lettuce! Those people should be eating grass! And not the good stuff either!

[SIV]

I don't see where pre-packaged lettuce is so extravagant. The EBT card pays for it just like Little Debbies,T-bone steak, Lobster and Purple Drank

[Sinclair Lewis]

Sir, you have been repeatedly warned of your liberal use of my contemporaries ideas directly in your "works". A word please?

[The Gobbler]

Shouldn't you be working on another Jane Austin novel?

[Wood Jones]

Hey you have to do whats best for you, thats just the way it is.

Lou
http://www.online-anonymity.tk

[Aresen]

How much do you want to bet that these folks would vote for Arpaio for governor if offered the chance?

"Can't have them irresponsible law-breaking latinos about."

[Aresen]

tag close fail.

Hope this prevents mass italicization.

[BakedPenguin]

Give 'em a chance, and those fucking italics will sneak across the border...

[Captain Kanuck]

You can't do this in Canada. If you "walk away" the bank sells the property, and you're on the hook for the difference between what your borrowed and what it sold for.

Our housing market is still going up. We didn't do subprime, default swaps, and other garbage the American financial industry did, and our home owners can't walk away. Maybe there's the difference...or many not and it will be our turn next.

[Aresen]

Wrong.

Virtually every province has a "sieze or sue" option written into the mortgage law. (I know this from my own experience working in a bank.) The creditor can either sue the debtor for the balance or siese the property. The creditor may not pursue the deficiency unless the debtor has wilfully damaged the property.

What prevented the meltdown in Canada was the fact that banks, who carry most of the mortgages, are prohibited by the Bank Act from lending more that 75% of the value of the property without insuring the mortgage and the only mortgage insurer is Canada Mortgage & Housing Corporation, a crown monopoly. CMHC got badly burned by the housing busts in Western Canada in 1980-4 and in Ontario in 1988-92, so it has been extremely conservative in it's underwriting ever since (with very stiff premiums as the loan-to-value ratio rises).

The main reason that the Canadian market did not rise so high was that Canadians cannot deduct their mortgage interest from their taxable income the way Americans can.

[Darren]

Great post. I live in Canada and I thought the same as Captain Kanuck.

Either way, I was sickened by the 60 Minutes report. America did not become a great country through its citizens running away from their debts.

[Captain Kanuck]

I would have left it after the word "country", but yeah, people should take contracts more seriously. But then, the "banks" where a bunch of weasels and should be the ones who pay the price.

[Captain Kanuck]

So, you're saying if I walk away from my house with a large balance on the mortgage, that's the end of it for me? The bank cannot come after me for more? Kewl! 😉

[Aresen]

Not quite.

The creditor can choose to sue rather than sieze. Generally they don't because the property ownere has little in the way of other assets and the recovery would be less and take longer.

However, because the Canadian credit market is considerably smaller and dominated by the big 5 banks*, a bad credit report has a much more restrictive effect on the ability to borrow in the future. ["I-5" on a credit report is not a reference to a US highway, it means the creditor repossessed the asset. Even the auto finance companies (about the easiest lenders in Canada) will charge a hefty premium on your rate if that appears there.]

*For the benefit of US readers, "the big 5 banks" are the 5 largest banks in Canada. They control over 60% of the deposits and loans in the country. The Canadian credit market is much more concentrated than the US market.

[Captain Kanuck]

No, I'm saying what if he walks away? If you're saying they'll sue for the difference, then that's what I said in my first post.

[cynical]

Strictly speaking, you said that they bank "will", while Aresen said the bank "can", but "usually won't".

[ChicagoTom]

I don't really have any beef with what the deadbeats are doing here.

Why is it when an individual does it they are a deadbeat, when a corporation decides to do it, they are making a shrewd business decision.

Morgan Stanley walked away in the same way, yet no one seems to worry about the moral problems with doing so and no one calls them deadbeats:

Morgan Stanley, the securities firm that spent more than $8 billion on commercial property in 2007, plans to relinquish five San Francisco office buildings to its lender two years after purchasing them from Blackstone Group LP near the top of the market.
...
"This isn't a default or foreclosure situation," Barnes said. "We are going to give them the properties to get out of the loan obligation."

But you know, when a regular joe does makes a the same financial decision, apparently that needs a 60 minute special and an inspection of the morality of doing so.

[Slumpbuster]

As a lawyer, I see this is a business transaction for the homeowner. The lender knew the risk when it made the loan and accepted the loan with the condition that its only remedy was the recovery of the collateral. They knew that if the collateral value declined sharply that many people would make the business decision to breach the contract, because the remedy imposed against them would be less harsh than performance of the contract. Presumably, the lender priced the loan to account for that risk.

All parties to a contract have the power to breach it. It is one among many business considerations parties to contracts make every day in deciding whether to enter the deal, whether to perform it, and what to do if one party either won't or can't perform.

[MRK]

I find it hilarious that people who walk away from their mortgages are called "deadbeats", yet when Corporations and Governments do it they get bailouts.

[BakedPenguin]

Chicago Tom, MRK: Yes, the corporations are also deadbeats.

[Aresen]

There was a time that that was not so. corporations went bankrupt, their assets were liquidated and the creditors took their losses. The key event seems to have been the Chrysler Bailout in the early 1980s, which was supposedly a "success". The other factor was the broadening of the Chapter 11 section of the US Bankruptcy Code which allowed management, rather than creditors, to control the fate of an insolvent company.

As for governments, prior to the MBA loan fiasco in the 1980s, they used to suffer big time as well. (IIRC, one of the Southern US states defaulted on its bonds ca. 1812 and was not able to borrow for 150 years thereafter. I have never been able to find this reference again, so it is unverified.)

[R C Dean]

Most states prohibit recourse against the borrower in purchase money mortgages. So that's the state meddling in contracts for you.

Eventually, the vicious beating the banks are taking on these "strategic" (really, should be "convenient") defaluts is going to force rates up. So what the convenient defaulters are doing is externalizing their losses to bank shareholders and to subsequent borrowers.

I should point out that a mortgage loan is secured by a house, but the obligation to pay it is not conditional on the house holding its value. Convenient defaulters are breaching their contracts, breaking their word, if you will, regardless of whether their lender has some security for the loan. I don't regard that as an act that has no moral or ethical dimension.

[Lamar]

Breaching a contract is always about externalizing your losses. If this weren't so, there would be no reason to breach a contract over money.

[Tim Cavanaugh]

Eh, I don't know that you can blame these deadbeats for everybody's rates going up. It may happen that everybody's rates go up, but the banks and the rating agencies, not the deadbeats, are responsible for that.

The bank could just as easily say "R C Dean and Tim Cavanaugh have shown themselves to be good credit risks, through thick and (in Cavanaugh's case) thin, so they get our special low low rate, while Mr. and Mrs. 'Auditor at a Local University' have shown themselves to be deadbeats, so they will get nothing."

But that's not how the system works. We need to get past the idea that you can "repair your credit score" after defaulting on a mortgage -- by far the largest and most important loan most people will ever obtain in their lives. After defaulting on a mortgage, you should not be able to obtain even the smallest amount of credit ever again for as long as you live. No credit cards, no car loans, no store layaway, no nothing. All that could be done if this vaunted Equifax/FICO/rating agency system operated according to the slightest logic. Mr. Auditor even hints that he'd be willing to live that way, and he should be given that opportunity.

But the system doesn't work that way, and the deadbeats didn't cause that, and so in present reality, walking makes sense.

That having been said, I agree there is a moral and ethical dimension to this. As Mr. Auditor demonstrates with his speech about how he shouldn't feel guilty because the lender wasn't polite to him, he has the moral and ethical sensibility of a cockroach.

[ChicagoTom]

I should point out that a mortgage loan is secured by a house, but the obligation to pay it is not conditional on the house holding its value. Convenient defaulters are breaching their contracts,

I wouldn't consider trading the collateral in exchange for no longer paying a "breach of contract"

In fact, that's the terms of the contract. If I don't want to pay anymore you get the house. That's how the contracts are supposed to work.

[Gabe]

If the banks get fucked it's there fault. They already showed us a few ways than can steal our money via government force...this is one way the little guy can fight back...I wish I hadn't put so much money down on my house...should have done a zero down option arm on a bigger house...could have put all my savings into physical metal the last 7 years...would have come out way ahead and bought a bigger house with the ocean view free and clear now. The big banks are no different than the gangsters in the government...this is the Hobbesian world that the mythmakers pretended they would protect us from. We are living it, don't be surprised.

[Gerry]

This all sounds like a scam.

1) Person A buys $300k house
2) Person B offers $500k for it
3) Bank cuts person A a check for $500k
4) Person B "walks away"

Easy $200k.

[Lamar]

4) Person B walks away $20k to $100k poorer.

The easy $200k is for Person A, who complied with his contractual promises. Person B gets out of a bad contract at some cost.

[Warren]

Person B also occupied the house at low rent for a time.

[Lamar]

Probably left a blockbuster in the toilet too.

[creech]

Suppose Person A and Person B are second cousins or ex-frat brothers and split the loot 50/50?

[iowahawk]

5) Government C provides emergency $100k to cover loss of Bank D for making fucked loan to Person B
6) Government C provides $100k emergency loan to Person B to continue making payments on fucked loan from Bank D
7)Government C sends bill to Person E

[Aresen]

7) Government C sends bill to Person E

E = A

[I, Kahn O'Clast]

I am under the impression, and they seem to say so in the 60 minutes piece, that only 10 states are non-recourse. In the other 40 provisions vary, but in most I think you or the bank either go through a short-sale where you end up on the hook for the difference (though I think that varies and banks sometimes allow for sharing of the loss)or you declare bankruptcy and while the bank gets the house, it cannot come after your other assets.... but you do have to declare bankruptcy.

[theOneState]

David Stevens deserves some credit, not just for skillfully shuffling papers on his suspiciously uncluttered desk

Did you see how *hard* he thought about signing that piece of paper? He's an amazing bureaucrat. The way he handled those folders...he's simply one of the best.

[Chuck]

I don't see how these people are deadbeats. Looks to me like efficient breach.

[ChicagoTom]

I don't see how these people are deadbeats. Looks to me like efficient breach.

Chuck Chuck Chuck --

It's only an efficient breach when a corporation does it.

When you and I do it, it's a moral failing and the decline of our civilized society.

[Slumpbuster]

I agree. Any decent lawyer would advise a client in this position to breach the contract. When the economics clearly make breaching better than performing, it makes little sense to perform any more.

[Tim Cavanaugh]

My Random House defines deadbeat as "a person who deliberately avoids paying debts." Doesn't say anything about whether avoiding paying is the smart move. Since efficient breach inolves payment sufficient damages to make the creditor whole -- which will clearly not happen in this case, wherein the bank will definitely lose money on the deal -- I'm not sure it applies here. In any event, this fall under the rubric of "We've already established what kind of woman you are; now we're just haggling over the price."

[Lamar]

Merriam-Webster has the first definition as "loafer" and the debt part second. Of course, we all know that "deadbeat" carries a negative connotation, when breaching a contract might be a smart move.

[ChicagoTom]

My Random House defines deadbeat as "a person who deliberately avoids paying debts."

Oh please.

Are you really going to pretend like deadbeat doesn't have a derogatory connotation? Are you really going to pretend to be naive?

When companies do this same thing, no media reporting EVER refers to them as deadbeats.

[cynical]

CT: I don't see how these people [who deliberately walked away from a debt] are deadbeats.

TC: My Random House defines deadbeat as "a person who deliberately avoids paying debts."

CT: Are you really going to pretend like deadbeat doesn't have a derogatory connotation?

Non sequitur much?

[Slumpbuster]

I sort of wonder about Tim's comment about how the interior of this house makes the owner look like a spendthrift.

The kitchen appears to be a fairly standard builder kitchen in the Arizona market with perhaps $5,000 of upgrades thrown in. Depending on when the house was built, that may well have been the standard builder kitchen. Granite, stainless steel and maple cabinets were pretty much the norm in 2005. If they were upgrades, they were not expensive, and pretty much all houses in that neighborhood probably look about the same inside.

The furniture he was sitting on looked like a Room Store special--the entire living room set, tables included, probably didn't cost $1,500.00.

This house, depending on where it is at in Phoenix, may not be worth more than $100,000.00. Granted, when they bought it, the house probably sold for $300,000 to $400,000 depending on neighborhood.

[Tom]

Encouragingly spry...

Oh, you just turn 40, too?

[brec]

[T]he first couple profiled here, judging by the interior of their house and by the fact that they're using prepacked lettuce in the inevitable ordinary-folks-at-home cooking scene, are not exactly scrimpers and savers. This renders the guy's claim about how he was raised to be a responsible person a little hollow.

I encountered no such claim in the video, but even if it had been made, this is a non sequitur: the guy doesn't claim to be unable to make the mortgage payments, only to be unwilling.

[Big Chief]

So are we going to start seeing this with cars? I've not done the math, but my understanding is that most people with any long term car payment (5 years or more) spend most of the time "underwater". Are these deadbeats in going to (literally) walk away from their cars?

And why no comments about the short sightedness of this? It's possible these houses will be back above water in a few years. Why is the current value all that's considered?

[?????]

usefully, prevents mass italicization.